The Expansion of Neoliberal EconomicReforms in Latin America

GLEN BIGLAISER

Bowling Green State University

KARL DEROUEN Jr.

University of Alabama

This article seeks to explain why most Latin American countries haveexpanded market-oriented reforms since the 1980s despite their gen-erally disappointing economic results. To explain deepening liberaleconomic reform, we test panel data for 15 Latin American countriesfrom 1980 to 1995, using Beck and Katz’ panel-corrected standard er-rors regression. Controlling for several competing explanations, we findthat, except under fragmented party systems, high inflation promotesthe expansion of economic reforms. We then show how our results areconsistent with Weyland’s (1996) use of prospect theory as well as Rod-rik’s (1994) work on the distributional effects of high inflation.

Since the late 1980s nearly all Latin American countries have adopted market-oriented, neoliberal reforms.1 Economic hardship caused, in part, by the previousinitiation of import-substituting industrialization (ISI) policies, convinced thesegovernments to reduce the role and size of the state in the economy. However, aftermore than 15 years of market-oriented reforms in the region, strong economicrecovery is more the exception than the rule. Despite some disappointing economicresults, Latin American governments continue to liberalize and, in fact, expandtheir reform programs (Gervasoni, 2001). Many would have thought this impos-sible, especially when these countries operate under democratic rule, and are sub-ject to popular protests and electoral pressures (cf. Bates and Krueger, 1993;Callaghy, 1993; Biglaiser and Danis, 2002). What accounts for the deepening ofneoliberal reforms in the face of growing economic despair?

The literature on economic reform provides many plausible institutional ac-counts on the initiation of policies that stress state-centric factors. Based initially onthe insular capacity of authoritarian regimes (Huntington, 1968; Skidmore, 1977),recent studies show the benefits of an autonomous democratic state that can shielditself from interest groups opposed, at least in the short term, to economic liber-alization (Geddes, 1994; Williamson, 1994; Haggard and Kaufman, 1995; Main-waring and Shugart, 1997).

Despite the wealth of studies on the initiation of policies, the expansion of neo-liberal reforms has received less attention. Moreover, some studies discuss the dif-

1 We gratefully acknowledge the assistance of Scott Gartner, Barbara Geddes, Carlos Gervasoni, Uk Heo, SusanStokes, and the anonymous referees at ISQ.

r 2004 International Studies Association.Published by Blackwell Publishing, 350 Main Street, Malden, MA 02148, USA, and 9600 Garsington Road, Oxford OX4 2DQ, UK.

International Studies Quarterly (2004) 48, 561–578

ficulties in sustaining market-oriented policies (Nelson, 1990; Haggard and Kauf-man, 1995). Because of lost patronage opportunities as neoliberal reforms shrinkthe state, as well as the long-time horizons needed for structural reforms to gen-erate beneficiaries, politicians have strong incentives to discontinue these reforms(Callaghy, 1993:483). The few studies on deepening reforms are identified in fourcategories: state autonomy; domestic economic interests; external influences; andmacroeconomic factors.

State autonomy explanations stress the importance of political institutions. Be-cause of the political costs involved in adopting what are normally perceived asunpopular policies, executives require political institutions that insulate the gov-ernment from pluralist pressures (Haggard and Kaufman, 1995; Mainwaring andShugart, 1997).2 Other studies claim that domestic economic interests are respon-sible for the expansion of reforms. Drawing on work in the pluralist literature(Frieden, 1991; Silva, 1996), increasing liberalization rests on lobbying by previoussupporters of ISI (Przeworski, 1991; Remmer, 1998). Alternatively, some argue thatit is not domestic influences but rather external pressures that affect policy course.Specifically, external pressures shape policy either through the lending practices ofinternational organizations (Stallings, 1992; Rodrik, 1996; Remmer, 1998) or thethreat of capital flight by foreign exchange holders (Haggard and Maxfield, 1996).Lastly, positive macroeconomic indicators explain deepening market-oriented re-forms. Based on the expected success of neoliberal reforms and severe problemsassociated with protectionist policies, popular support will help expand structuralreforms (Edwards, 1995; Harberger, 1997).

Using panel data for 15 Latin American countries from 1980 to 1995, this studyshows that many variables posited to have an effect on initiation of structural re-forms are not strongly correlated with deepening such policies. Political variablesincluding polarization, state autonomy for the executive, and divided government,play little role in expanding reforms, except in the context of high inflation. Do-mestic and international pressures, such as domestic export groups and the pro-vision of international aid, have some impact on liberalization, but it is generallynegative. Inflation is by far the most important factor that affects the expansion ofmarket-oriented policies.3 High inflation tells us what presidents, regardless oftheir prior ideological commitments, will decide to do; but institutions affect whatthey can actually accomplish.4 One exception to the strong positive effect highinflation has in furthering economic liberalization is party fragmentation. In fact, ina context of high party fragmentation, inflation has a negative impact on reform.Multiparty systems provide opportunities for opposition parties to deny neededeconomic reform expansion in the hope that in future elections voters blame theruling coalition.

The generally positive effect of price changes on liberalization is consistent withtwo theoretical accounts. First, complementing Weyland’s (1996) work on neolib-eral reform using prospect theory, a theory devoted to risk tolerance based onpossible gains and losses, our findings suggest that in a domain of loss (e.g., run-away inflation) leaders are risk-acceptant and willing to deepen reforms. By con-trast, in a domain of gain (e.g., growth), leaders are risk-averse, and less likely toreverse policy course. The results also bolster Rodrik’s (1994) work on the distri-butional consequences of inflation. Rodrik argues that high inflation can deterioratethe economies of developing countries to such an extent that it breaks down re-

2 See also Remmer (1998), who tests the significance of political insulation as an explanatory variable for

maintaining reforms.3 See Bambaci et al. (2002) who claims that recent economic upheavals caused by high inflation energize

executive support for liberalization.4 See Manzetti (1999), who similarly argues that market-oriented policies depend on: (a) the willingness of

leaders to pursue economic reform; and (b) government capabilities that enable leaders to implement reforms.

Expansion of Neoliberal Economic Reforms in Latin America562

sistance for reform. Because high inflation leads to economic chaos for all, restoringthe economy’s health swamps distributional concerns.

The implications our findings hold for explaining reforms are important. First,the results provide reasons to be hopeful about liberalization in Latin America.Because our findings suggest that polarization, party fragmentation, state auton-omy for the executive, divided government, and domestic and international pres-sures generally have limited effect in the absence of high inflation, we are sanguineabout the possibility of deepening liberalization. Second, from an expected utilityperspective, it is anticipated that elected leaders would opt for vote maximizingoptions over possible negative electoral implications associated with liberal eco-nomic reforms. However, empirical evidence may not bear out vote maximizationstrategies on the part of politicians. Our results suggest that prospect theory pro-vides a nuanced explanation that should attract more innovative uses of the theory.Alternatively, Rodrik’s distributional consequences model of high inflation offers anattractive political cost–benefit measure that makes reform a politically useful strat-egy. Indeed, economic reform is a vote maximizing strategy in a context of highinflation.

In section one we discuss the main possible determinants of reform deepening,including a discussion of prospect theory and the distributional effects of high in-flation. Our research design is presented in section two. Section three presents theresults. Section four interprets and discusses the results. Section five concludes thearticle.

The Politics of Economic Reform

Since the 1980s most Latin American countries have initiated market-oriented,neoliberal reforms. In the 1940s–1970s, however, countries in the region adoptedinward-oriented economic development policies based on ISI. Motivated by po-litical goals, politicians used high tariffs and subsidies to foster large domestic in-dustries and an expansive state sector without concern for economic criteria.Market distortions associated with ISI helped to generate severe balance of tradeand payment deficits and capital scarcities.5 To compensate for capital shortages,Latin American countries borrowed heavily from international financial organiza-tions and commercial banks in the 1970s, causing extreme financial dislocation inthe 1980s.6 The bankruptcy of the ISI model combined with the debt crisis forcedmost Latin American governments to initiate reforms including privatizing state-owned enterprises, liberalizing financial and commercial markets, and reforminglabor and tax codes.

The comprehensiveness of the reforms implemented in Latin America surprisedmany given that these countries had just recently returned to democratic rule.Popular wisdom suggested that because democracies needed to win elections inorder to maintain power, politicians would pursue a short-term, redistributionistapproach to economic problems. Authoritarian regimes, insulated from most soci-etal groups, would institute economic measures necessary for economic develop-ment (Huntington, 1968; Nelson, 1990).7 Despite the expected advantages ofauthoritarian regimes, Latin American democracies initiated neoliberal policies,with presidents who carried out successful reforms being rewarded by voters(Geddes, 1995; Gervasoni, 1999; Stokes, 2001).

5 For a discussion of the negative consequences of ISI, see Baer (1972), Edwards (1995), and Hirschman (1968).6 For excellent sources on the debt crisis, see Frieden (1991) and Stallings and Kaufman (1989).7 See Jowitt (1971) who makes a similar argument for the autonomy from societal interests of Leninist regimes to

carry out unpopular policies.

G. BIGLAISER AND K. DEROUEN JR. 563

Interestingly, market-oriented reforms have not produced the economic miraclesprofessed by its supporters (Stiglitz, 2002). In fact, the success of neoliberal policiesfor addressing high inflation is tempered by low growth in per capita gross do-mestic product, high urban unemployment, and increasing wealth disparities(United Nations, 2001:748–749; Wilkie et al., 2001:388–389). Economic problemstied to the ‘‘Tequila Effect,’’ Mexico’s devaluation of the peso in the mid-1990s, andthe East Asian and Russian crises of the late 1990s, caused severe economic dis-location and declining welfare. Even Chile, considered one of the most successfuldeveloping countries, experienced nearly 10% urban unemployment, unstablegrowth rates, and enduring income inequality at the turn of the century (UnitedNations, 2001:750). Despite worsening economic prospects, Latin American policymakers deepened these reforms.

There are several competing or overlapping explanations of reform deepening.These explanations are grouped into five categories: state autonomy, pluralism,international concerns, macroeconomic factors, and inflation-related theories.

State autonomy explanations stress political survival and collective action issues.In the literature, it is assumed that most political leaders want to survive in office.8

The prime interest of leaders focuses on their attempts to maximize career goals,with reelection representing an important element for fulfilling those ambitions.9

Leaders are aware that elections occur often and they need to institute policies thatin the short term bring about better economic results if they hope to retain theirgovernmental positions.

Deepening neoliberal reforms is thought to be politically risky for survival-minded leaders. Market-oriented reforms that attempt to eliminate market distor-tions and promote greater efficiency generate high short-term costs and providerewards mainly in the long term.10 Those individuals who are likely to lose theirjobs or special rewards because of market opening usually form a relatively smalland concentrated group, and thus are better able to organize against reforms (andresolve a collective action problem) compared with more dispersed and uncertainwinners of reform (cf. Rodrik, 1994).11

For political leaders to ignore the complaints of this concentrated group, mea-sures are needed to insulate political leaders from pluralist interests. Haggard andKaufman (1995) argue that centralized executive authority is crucial for the suc-cessful initiation of market-oriented policies.12 A centralized executive is able to usespecial constitutional provisions and emergency powers to bypass pressure groupshurt by comprehensive reforms. The consolidation of reform rests on reducing theexecutive’s power and building stable bases of party support. Specifically, frag-mented and highly polarized party systems make it difficult to forge stable electoral,legislative, and bureaucratic majorities that are critical for organizing a new coa-lition of beneficiaries.

Similarly, Mainwaring and Shugart (1997) argue that a ‘‘strong’’ executive isneeded for passing an agenda that includes policy reforms. However, they alsoemphasize that executives must hold a majority of seats in the legislature especiallyduring the initiation phase. Undivided governance removes obstacles to initiatingand deepening reforms. In the end, they concur with Haggard and Kaufman that

8 See Ames (1987) and Geddes (1994) for a thoughtful consideration of political survival strategies.9 Some may contend that reelection is less important in Latin America, since most presidents are not allowed to

hold consecutive terms. However, presidents in Argentina, Brazil, Peru, and Venezuela are allowed to serve con-secutive terms. Moreover, in Uruguay and Venezuela, presidents have held office for more than one term, despitenot serving consecutive terms. These examples suggest that executives are interested in surviving in office and

advancing their careers.10See Geddes (1995:60) about the short-term costs associated with market liberalization.11For a discussion of group size in overcoming collective action problems, see Olson (1965).12Also see Nelson (1990) and Remmer (1991) who claim the importance of a centralized executive for the

implementation of market-oriented reforms.

Expansion of Neoliberal Economic Reforms in Latin America564

high party fragmentation and polarization impede the durability of market-ori-ented reforms.

In contrast to insulating policy makers, pluralists claim that economic reformrests on lobbying by supporters. Following the initiation of neoliberal policies, eco-nomic incentives are expected to bolster the export-oriented sectors of the econ-omy. Lifting tariffs and other forms of protection contribute to the decline andfragmentation of uncompetitive economic sectors that prospered during the closed-market economy of the 1930s–1970s. Export interests take their place. As the ex-port-oriented sector grows, it gains greater power to pressure politicians to achievetheir policy goals.13

Alternatively, others argue that policy choice depends on external constraints,such as debt crises and changes in external lending practices of the InternationalMonetary Fund (IMF), the World Bank, and commercial banks (Stallings, 1992).The need to attract loans and foreign aid from international organizations moti-vates countries to liberalize (Remmer, 1998:12). In fact, policy makers may expandreforms as a signal to international lenders that the country is serious about struc-tural reform in order to attract capital (Drazen, 2000). High external debt is anadded incentive to expand reform programs. The availability of funding fromexternal sources to repay and reschedule debts inspires policy makers to deepentheir policies.

Positive macroeconomic factors are another explanation for expanding market-oriented reforms. Reforms are expected to produce high short-term costs. Thecreation of a competitive economy leads to price hikes (as price controls are liftedand exchange rate reform is introduced), high unemployment, and productiondecreases as industries reliant on protection are forced out of business (Geddes,1995:60). In the long term, however, new industries emerge based on the country’scomparative advantage and factor endowments that are predicted to promote eco-nomic prosperity. The expectation is that countries benefiting from high economicgrowth, a positive current account balance, and low inflation are likely to deepenreforms. The economic crisis suffered because of earlier market distortions alsomotivates policy makers to expand liberalization measures. Complementing theimportance of inflation are two other explanations: prospect theory and politicalcost–benefit ratios of policy reform. Based largely on price changes, the prospecttheory model, as developed by Weyland (1996), addresses risk-taking propensityunder domains of loss and gain (Levy, 1992).14 Prospect theory holds that peopleare risk-averse with respect to gains and risk-acceptant with respect to losses(Kahneman and Tversky, 1979). Expected utility models assume that ‘‘[decisionmakers] attempt to maximize expected utility in their choices between risky op-tions: they weight the utilities of individual outcomes by their probabilities andchoose the option with the highest weighted sum’’ (Levy, 1992:172–173).

An expected utility explanation of reform would seem to rule out the selection ofreform during the Latin American crises of the 1980s as this policy was seen as arisky option with little chance for quick success (Weyland, 1996:190). Short-termcosts associated with tough liberal structural reform might diminish the politicalsurvival of leaders. Prospect theory, on the other hand, provides an alternativeexplanation of decision making. Prospect theory is based on loss aversion as de-cision makers tend to pay more attention to avoiding losses (Levy, 1992:175).Runaway inflation is the type of loss that leaders would particularly want to avoid.The problem can worsen so swiftly that leaders cannot adjust expectations (Wey-land, 1996:190). Prospect theory would suggest that leaders sliding into a domain

13In an important example of an interest group argument, see Frieden (1991). For a contrarian view on interestgroups providing support for structural adjustment, see Waterbury (1993:25).

14See Hayashi (2001) for an interesting use of prospect theory to explain decisions during the East Asianfinancial crisis of the 1990s.

G. BIGLAISER AND K. DEROUEN JR. 565

of increasingly dismal economic performance would be willing to try the risky typeof option exemplified in neoliberal reform.15

Prospect theory has been applied to uses of military force when presidents are inpolitical trouble (see DeRouen, 1995). McDermott (1992) uses prospect theory todescribe the events surrounding President Carter’s attempt to rescue hostages in1980. In the present context, we are considering Weyland’s (1996) basic model ofwhether Latin American leaders in domains of economic misfortune manifested asrunaway inflation are more willing to adopt risky options such as economic reform.Weyland identifies runaway inflation as the most important indicator of a leader’sdomain because, unlike other factors, inflation affects all economic actors. In fact,Latin American opinion polls usually rank it as the most important issue on thepublic’s agenda (Weyland, 1996:190).

Unlike prospect theory, Rodrik (1994, 1996) provides an expected utility expla-nation of reform on the basis of high inflation. According to Rodrik, during normaltimes, the political cost–benefit ratio for executives to initiate and deepen economicreforms is exceedingly high. Economic liberalization has potentially large benefitsfor certain groups but huge losses for others. Because the winners from tradereform are not guaranteed, but rather potential, and the losers from reform areclear, the losers are better able to organize collectively. Moreover, the benefits ofreform are often delayed for years, giving a politician in power little incentive inpromoting a politically difficult program that will yield economic benefits long afterthe politician has left office.

Because reform presents clear losers in the short term and less clear beneficiariesin the long term, survival-minded politicians are expected to recognize the highcost–benefit ratios and not initiate reform. However, Rodrik argues that the dis-tributional consequences of reform recede following severe inflationary periods.Under extremely high levels, inflation has the potential to break down resistance toeconomic liberalization that under normal circumstances might have prohibitivelyhigh political cost–benefit ratios, suggesting the vote maximizing opportunities ofeconomic reform. In Latin America, for example, the negative experiences withhyperinflation did more than erode resistance to reforms; it actually helped to builda consensus for market-oriented reforms (Bambaci et al., 2002).

Complementing work by Geddes (1995), Gervasoni (1999), and Stokes (1999,2001), Rodrik contends that the political benefits for presidents carrying out suc-cessful liberalization that address high inflation have made it difficult for maximiz-ing presidents to return to protectionist policies. Indeed, the ‘‘lost decade’’ of the1980s in Latin America changed political calculations and contributed to the deep-ening of economic reform.

Research Design

We gather data for 15 Latin American countries on an annual basis from 1980 to1995. The data are comprehensive for a part of the world in which collecting reliableinformation is a challenge. These 15 years are useful for comparison since market-oriented reform penetrated nearly all Latin America countries during this time.

Dependent Variable

Morley, Machado, and Pettinato (1999) provide the appropriate data to assess thedynamics of economic reform. They combine five market indicators to create ageneral reform index (GRI). Their market indicators include (1) a commercial index

15Weyland (1996) discusses that the behavior of citizens in Latin America can also be accounted for by prospecttheory. Citizens are also in domains of loss when inflation skyrockets so they are willing to allow their leaders to tryrisky policies to alleviate the problem.

Expansion of Neoliberal Economic Reforms in Latin America566

(a measure of trade liberalization), (2) a financial reform index (a measure of do-mestic financial reform in the banking industry), (3) a capital account liberalizationindex (a measure of international financial liberalization), (4) a privatization index(a measure of the size of the state sector in the economy), and (5) a tax reform index(a measure of tax efficiency and government regulation).

Morley, Machado, and Pettinato (1999) record the value for each index on a scalebetween zero and one, with zero corresponding to the worst observation for anycountry and any year among the period and countries considered. A score of one isidentified with the most reformed or free from government interference of thecountries and years in the entire sample. The normalization procedure measureseach country’s performance relative to the most liberalized country in the regionduring the entire period of the study. These authors then combine the values forthe five indices for each country in a given year, and divide it by five to create GRI.Our dependent variable is annual level of GRI.

Independent Variables

Centralized Executive Authority. Arguments focusing on centralized executiveauthority, suggest that executives need constitutional provisions and emergencydecree powers to bypass interests hurt by market-oriented reforms. In contrast toweak executives, centralized authority enables executives to overcome politicalstalemates and impose their will on potential bureaucratic and legislative oppositionto reform. Centralized executive authority limits the number of veto points thatgroups can lobby and increases presidential autonomy. To operationalizecentralized executive authority, we design a measure based on the summary ofconstitutionally allocated legislative powers of presidents in Mainwaring andShugart (1997:40–48). Mainwaring and Shugart contend that veto, partial veto, anddecree powers, as well as the exclusive right to initiate legislation in some areasalong with referenda power are indicative of a strong executive. The president’sauthority over cabinet formation and dismissal in addition to the assembly’sauthority to censure a minister or cabinet also make up the executive strength scale.

Divided Government. Because of the political costs associated with market reforms,economic liberalization and structural adjustment are facilitated when thepresident’s party holds a majority in the legislature. When a president and adisciplined majority of the same party control the legislature, presidents can moreeasily push their policy agenda (Mainwaring and Shugart, 1997:403). In dividedgovernments, however, where the president’s party represents a minority in thelegislature, opposition parties are less likely to serve as legislative allies. To measurethe effect of the executive party’s holding a majority of seats in the legislature, thisstudy combines data from the Political Handbook of the World (Center for Educationand Social Research, several years), Mainwaring and Scully (1995), and Mainwaringand Shugart (1997). A score of zero indicates that the executive’s party does nothold a majority of seats in parliament. A score of one indicates that the party holds alegislative majority.

Polarization and Fragmentation. Haggard and Kaufman as well as Mainwaring andShugart argue that political parties affect expanding reforms. Specifically, politicalpolarization and fragmentation of the legislature are major obstacles to reform. Byfragmentation, they mean the effective number of parties competing for votes. It isassumed that multiparty systems compel contending parties to share power undercoalition governments. These coalitions undermine the capacity of centralauthorities to sustain policy reforms. To measure party fragmentation, Haggardand Kaufman calculate the inverse sum of squares of the vote going to each party.

G. BIGLAISER AND K. DEROUEN JR. 567

This study uses the inverse sum of squares for Latin America’s parliamentaryelections between 1980 and 1995.

By polarization, Haggard and Kaufman refer to the ideological distance amongparties. Polarization (i.e., the presence of leftist parties) limits support for market-oriented reforms. Conventional wisdom holds that leftist parties usually opposereforms because of its negative impact on employment and programs backed byleftist constituents. Trade liberalization and privatization contribute to downsizingin the public and private sector, important constituencies for the left. Therefore, toprotect their share of the vote, leftist parties usually oppose market-oriented re-forms. To measure polarization this study recorded the vote won by the left in theparliamentary elections between 1980 and 1995. Electoral data are drawn from thePolitical Handbook of the World (Center for Education and Social Research, severalyears), Mainwaring and Scully (1995), and Mainwaring and Shugart (1997).

Executive Policy Preference/Capacity. The previous political variables stress insulationfrom pluralist pressures that allow executives to fulfill their policy preferences.However, there is no guarantee that relatively autonomous presidents will favoreconomic liberalization. Further, institutions typically do not change much over timeso their operationalization in time-series regression may be questioned. Ideologicalpredilections and political calculations made by executives also affect their policychoices. In order to control for executive policy preference, we use three proxies.First, we include a variable in the model that categorizes politicians along a left–rightcontinuum. To measure the effect of ideology on privatization, we reviewed theexecutive party’s ideological leanings between 1980 and 1995 as recorded byCoppedge (1997) and Political Handbook of the World (Center for Education and SocialResearch, various years). The scores of 1–5 are equivalent to Coppedge’s categoriesof right (score of 1), center-right (score of 2), center (score of 3), center-left (score of4), and left (score of 5). As a second proxy, we use Stokes’ (2001:14–15) measure ofgovernment orientation. Stokes differentiates presidents as either supporters ofefficiency-oriented policies (i.e., neoliberal) or security-oriented measures (i.e.,protection). We score neoliberal presidents as 1 and protectionists as 0.

Third, we use inflation as a measure of the pressure on executives to take action.We interact inflation (consumer price index (CPI)) with three political institutions(presidential power, divided government, and fragmentation) to measure the ef-fects of economic pressures on executive policy capacity. In other words, highinflation might represent pressure on the executive to take action and the insti-tutional measure is indicative of the capacity to actually implement the policy.

Regime Type. We control for regime type using Polity IV data (see Marshall andJaggers, 2002). Many have posited a link between democracy and economicliberalization (Haggard and Kaufman, 1992; Bates and Krueger, 1993; Callaghy,1993). GRI may simply be a reflection of the consolidation of democratic institutions.Polity IV contains two separate variables that indicate the degrees of authoritarian(AUTOC) and democratic (DEMOC) rule. The polity project measures each variableon a 21-point scale from � 10 to 10 (10 being the most ‘‘democratic’’ score). Wefollow Londregan and Poole (1996) by subtracting the AUTOC score from theDEMOC score that helps produce a continuous measure that will distinguish theLatin American cases. As a result, in cases where the DEMOC score is 9 while theAUTOC score is 1, the total democracy score will be 8. This draws a slight distinctionbetween the aforementioned scenario and one in which the DEMOC score is 9 whilethe AUTOC score is 0, resulting in a democracy score of 9.

Pluralism. Unlike the previous variables that stress the benefits of stateautonomy, pluralists contend that support from key interest groups is critical fordeepening reforms. Increased liberalization depends on a support coalition of

Expansion of Neoliberal Economic Reforms in Latin America568

business elites,16 many of whom may have previously relied on ISI policies,to switch their affiliation in favor of open market policies.17 Following theinitial liberalization of the economy, economic incentives lead to the bankruptcyof firms dependent on state subsidies and protection and the creation offirms producing for the international market. These new firms will advocatedeepening market-oriented reforms because it serves their interests. Tomeasure the influence of business interests, this study adopts Remmer’s (1998)indicator based on the share of exports to GDP. As an economy increases itsshare of exports to GDP, these exporters are more likely to favor economicliberalization, and thus will lobby to expand reforms. Data for exports of goods andservices as a percent of GDP are obtained from the World Development Indicators(1999).

External Resources from International Organizations. Both loan monies and financialassistance from international organizations and commercial banks are expected tofoster the expansion of market-oriented policies. Capital scarcity is an endemicproblem for developing countries. Capital infusion and investment are importantnot only for stimulating economic growth and recovery but are also useful tocompensate losers from market opening (Kahler, 1989:143). Market-orientedreforms serve as signals to international lenders that policy makers are seriousabout promoting a favorable investment climate. To measure the effect of loans onreform efforts, this study reviews the lending patterns and credits from the WorldBank and the International Development Association as a percent of GDP. Thelending and credit information is taken from World Development Indicators (1999).We also assess financial assistance from international organizations because theincentive to provide loans may be very different from the attraction to offer foreignaid. To measure foreign aid, the World Development Indicator’s (1999) officialdevelopment assistance (ODA) is used. The ODA consists of net disbursements ofloans and grants made on concessional terms by official agencies.

Total External Debt. High external debt provides another incentive to expandmarket-oriented reforms. Increasing external debt encourages privatization, asproceeds from the sale of SOEs supply revenue to pay creditors. These sales bringmoney into the government’s depleted coffers, while at the same time not creatingadditional deficits for the state. The sale of loss-producing enterprises from thebooks also reduces the need for future loans to support the state’s deficit spending.Reducing the debt load also improves the country’s credit rating, which helps tosecure lower interest loans for capital projects. Total external debt is taken fromWorld Development Indicators (1999).

GDP Growth Rates and Current Account Balances. Positive GDP growth rates andsurplus current account balances are two macroeconomic variables that are oftenused to explain market reform deepening. High growth rates and a currentaccount surplus suggest that an export-driven economy based on privatization, taxreform, and trade and capital liberalization promotes economic prosperity. GDPgrowth measures the annual percentage growth of total output of goods andservices for final use occurring within a given country. The current account balanceis the sum of net exports of goods and services, income, and current transfers as a

16For details on the recent growth of coalition governments in Latin America, see Corrales (1998); Stokes(2001:ch. 3).

17See Geddes (1995) and Bates and Krueger (1993) for a useful discussion of business group influence on policyreform.

G. BIGLAISER AND K. DEROUEN JR. 569

percentage of GDP. Both GDP growth rates and the current account balance dataare obtained from the World Development Indicators (1999).

Inflation. Low inflation is a common explanation for deepening reforms.Governments experiencing increasing inflation are often compelled to institutemarket-oriented reforms. Reforms that include cutting government spending,privatizing in order to reduce flows of government revenue to loss-makingenterprises,18 and tax reforms that enhance government proceeds are needed tolimit the possible causes of inflation (Oxford University Press, 1995:47). Moreover,high tariffs shrink the supply of goods and services, causing too many buyers tochase too few goods resulting in inflation. Consequently, countries that deepenmarket-oriented reforms are unlikely to experience high inflation. This study usesthe CPI, the most frequently used indicator of inflation, to operationalize themacroeconomic indicator. Estimates of inflation are obtained from the WorldDevelopment Indicators (1999).19

Taken together, these independent variables represent three basic themes: themacroeconomy, politics and institutions, and incentives and capacity. Summarystatistics for all the independent variables are presented in Table 1.20

Models

We estimate the effect of political and economic variables on deepening market-oriented reforms by creating models for panel data. Because of the nature of paneldata, issues related to autocorrelation and heteroskedasticity are a concern. UsingOLS estimates of the standard errors in a panel setting is problematic because theseestimates may be misleading as a result of panel heteroskedasticity or spatial cor-relation of the errors. To overcome these pitfalls, we use Beck and Katz’s (1995)panel-corrected standard error (PCSE) procedure to estimate our model. Thisprocedure assumes that disturbances are heteroskedastic and contemporaneouslycorrelated (StataCorp, 2001, Ref. Su-Z:395–403). Beck and Katz (1995) argue thatPCSE is preferred over generalized least squares (GLS) estimation when data havebetween 10 and 20 panels, and 10 and 40 time periods. In these cases GLS isoverly optimistic (StataCorp, 2001, Ref. Su-Z:398). The models are estimated usingStata 7.0. There are many missing cases based on the political variables. This ispartly due to years of military regimes. In order to demonstrate that our findingsare robust, we present the results from several specifications. First we modelthe macroeconomic variables alone, then we add various combinations ofinstitutional and preference variables. Finally, we report the effect of interactinginflation and party fragmentation as an indicator of executive capacity. We expectthat political preferences and ideological orientation will not be determinants ofdeepening reform. Instead we expect that economic pressures brought on by in-flation and the interaction between inflation and institutions will determine thelevel of reform.

Results

The results of the various regression models are given in Table 2. The fits of themodels are quite strong though many of the variables are insignificant. Statistically

18According to Molano (1997:33), ‘‘The driving force behind the escalating fiscal deficit and mounting inflation[in Brazil] was the huge and inefficient state sector.’’ See also Naım (1993).

19Using the log of CPI generates virtually identical results. Because Weyland (1996) notes the exceptionality ofhyperinflation in his prospect theory explanation, we only report results from using non-logged inflation.

20We do not include the executive preference indicators separately in the table because one of the indicators,inflation, is already there, and the others use either dummy variables or a scale of 1–5, which will elicit little valuableinformation.

Expansion of Neoliberal Economic Reforms in Latin America570

significant variables indicate positive or negative changes in reform policy. Model 1contains only economically oriented variables. Here the lagged dependent variable,inflation rate, exports, and aid are significant. As expected, the level of reform inany given year is largely a function of the previous year’s measure. Inflation has aconsistent positive effect in all models. Aid and exports have negative impacts.

Models 2–5 demonstrate that the institutional and political variables, independentof other factors, have little impact on the expansion of reforms. The effect of astrong executive to marshal through and expand policies in the legislature is notsignificant. Dominance by members of the president’s party in the legislature alsodoes not affect policy choice. Divided governments appear no less likely to deepenmarket reforms than unified governments. Regime type also does not matter. Fi-nally, neither ideology nor preferences of the executive can account for reform level.Aid and exports maintain negative signs and are significant in some of the models.Preferences for reform appear driven by economic pressure and an economicpressure-party fragmentation interaction––not merely ideological preference.

The interaction variables can shed some light on how economic pressures canimpact policy reform. As discussed, these interactions are a proxy for the executivehaving capacity to act in the face of economic pressure. The inflation � party frag-mentation interaction is the only one that has a significant impact on reform ex-pansion in the presence of lagged reform. Specifically, when fragmentation goes upthe interaction between it and high inflation has a negative impact on reform. Theimplication is that party fragmentation undercuts the executive’s ability to respondto economic pressure by deepening reform. Complementing results found inHaggard and Kaufman (1995) and Mainwaring and Shugart (1997), multipartysystems inhibit the creation of a united government in support of expanded eco-nomic liberalization. Rather than helping the current administration, oppositionparties under high inflation will stall economic reforms under the political calculusthat retrospective voters will blame the current government in future elections ifpoor economic circumstances continue.21

The calculation of marginal effects can be illuminating. Table 3 reports marginaleffects following PCSE regression from five different simulations. The first simu-lation reports a baseline predicted level of GRI of .6476. This scenario representsall variables from model 2 in Table 2 set to their mean. The second simulationcontains constraints to reform with low executive power, and democracy, dividedgovernment, and high levels of fragmentation, polarization, aid and exports. Thisdrops the predicted reform level to .5832. By decreasing obstacles to reform with

TABLE 1. Summary Statistics of Independent Variables in Latin America

Variable Obs. Mean Std. Dev. Min. Max.

External debt 240 2.81e þ 10 3.96e þ 10 1.13e þ 09 1.80e þ 11Growth 240 2.52 4.55 � 12.58 13.12Inflation 240 38.01 38.78 .00 199.88Current account balance 240 � 3.23 4.24 � 16.70 17.04Exports 240 22.31 9.37 6.30 48.07External loans 240 .05 .04 .00 .23Foreign assistance 237 2.37 3.45 � .06 16.37Divided government 219 .51 1.80 0 1Polarization 216 .20 .17 0 .58Centralized executive 240 11.74 1.80 8 16Fragmentation 216 3.06 1.34 1.76 8.63

21For the effects of electoral accountability on economic policy outcomes, see Lowry, Alt, and Ferree (1998).

G. BIGLAISER AND K. DEROUEN JR. 571

unified government, maximum presidential power and democracy, and minimumlevels of fragmentation, polarization, aid and exports, the predicted level goes up to.7244. Concentrating on party fragmentation in the fourth simulation we find thathigh inflation and party fragmentation brings the predicted level up to .6955. Thefifth simulation contains the important interaction between pressure (maximuminflation) and capacity (minimum party fragmentation) to reform. Here we see thatthe predicted level of reform rises to .7509. Thus there is quite a margin of dif-ference when manipulating key variables in our models. Our findings generally

TABLE 2. Prais–Winsten Regression: Panel Corrected Standard Errors with AR1: Neoliberal Reform inLatin America, 1980–1995

Variable (1) (2) (3) (4) (5)

Constant .089nn .080a .085a .095n .081nn

(.024) (.037) (.038) (.037) (.023)Macroeconomy

Lag GRI .873nn .858nn .855nn .853nn .852nn

(.035) (.038) (.039) (.038) (.039)Inflation .001nn .001nn .001nn .000nn .001nn

(.000) (.000) (.000) (.000) (.000)Growth � .000 .000 .000 .000 .000

(.000) (.001) (.001) (.001) (.001)Current BOP � .000 � .001 � .001 � .001 � .001

(.001) (.001) (.001) (.001) (.001)Debt � .000 � .000 .000 .000 � .000

(.000) (.000) (.000) (.000) (.000)IBRD .122 .130 .122 .115 .112

(.102) (.111) (.112) (.116) (.102)Aid � .002b � .002b � .002b � .002 � .002b

(.001) (.001) (.001) (.001) (.001)Exports � .001b � .001 � .001 � .001 � .001

(.000) (.000) (.000) (.000) (.000)Institutional and Political

Pres. power .001 .000 .000(.002) (.002) (.002)

Divided govt. � .001 .001 � .002(.008) (.008) (.008)

Polarization .003 .006 � .002(.018) (.019) (.020)

Fragmentation .001 .007 � .000 .005(.003) (.003) (.003) (.004)

Democracy .001 .001 .001(.001) (.001) (.001)

Ideology � .002(.003)

Orientation � .011(.008)

Incentive and CapacityInflation � fragmentation � .000a

(.000)N 240 219 219 219 219Wald w2 1017.88nn 1018.78nn 1041.80nn 1072.09nn 1036.18nn

R2 .89 .90 .90 .90 .90

Note: Dependent variable is economic reform; numbers in parentheses are robust standard errors; where appro-priate the pairwise option was used in calculating the model (see StataCorp, 2001).nsignificance at .01; nnsignificance at .001; asignificance at .05, one-tailed test. bsignificance at .10.

Expansion of Neoliberal Economic Reforms in Latin America572

show that in the context of high inflation, and under a specific institutional setting,expanding reform is likely.22

Discussion

How do we account for the pattern that emerges from the statistical estimates? First,and challenging popular expectations, why are export interests and internationaleconomic assistance negatively associated with expanding market-oriented re-forms? Our models report that these measures have a negative impact on reform.Second, why is inflation, except in the context of high party fragmentation, socritical for policy deepening? Some plausible explanations are offered here, but todetermine why the pattern exists, further investigation is needed.

The effects of export interests are understandable given the economic situationfor many countries during the 1980s and 1990s. In the late 1980s–1990s, whensevere inflation placed many of these countries in chaotic economic situations, pol-icy makers sought remedies. Part of the reason for the inflationary spiral camethrough actions of exchange rate speculators. Much as occurred in Southeast Asia,currency speculators bet that the local currencies were overvalued. These specu-lators fueled a run on the local currencies, leading consumers to purchase andhoard goods rather than get left with declining pesos.

In an effort to correct for staggering inflation and currency speculation, LatinAmerican policy makers adopted currency strategies in the early to mid-1990s.Argentina, for example, used currency convertibility, devaluing the local currencyand setting it on a one-to-one basis with the dollar. Similarly, Brazil installed acurrency band under which it committed to holding currency values within publicly

TABLE 3. Marginal Effects after Prais–Winsten Regression with AR1

SimulationPredicted Level of Economic

Reform (GRI)

(1) Macroeconomic Baseline (all variables in model 2 set to mean) .6476(2) Political, institutional, and economic constraints on reform: .5832(based on model 2; presidential power, and democracy at minimum;divided government; fragmentation, polarization, aid, and exports atmaximum)(3) Decreased constraints to reform: .6621(based on model 3; fragmentation, polarization, aid and exports atminimum; presidential power and democracy at maximum; no dividedgovernment)(4) Incentive to reform with constraints on capacity: .7244(based on model 5; inflation, fragmentation, andfragmentation � inflation set to maximum)(5) Incentive and capacity to reform: .7509(based on model 5; inflation set to maximum;fragmentation � inflation based on minimum fragmentationand maximum inflation; fragmentation minimum)

Note: Variables not manipulated are set to the mean or 0 in the case of dummy variables.

22We also specified and tested interactions between presidential power � inflation and divided govern-

ment � inflation. The latter was highly significant and in the expected direction (positive) when we dropped laggedreform from the model. This further drives home the point that reform in Latin America does not appear to bedriven by ideology or policy orientation (as evidenced by the non-significant ideology and orientation variables) butrather economic pressure. We do not report these findings in the interest of consistency. However, the results areavailable from the authors.

G. BIGLAISER AND K. DEROUEN JR. 573

stated ranges against the dollar.23 Central bankers in Argentina and Brazil pos-sessed enough dollars in their reserves to handicap speculation against the pesoand real, respectively. Although currency convertibility and currency bands effec-tively addressed inflationary pressures, it also contributed to overvalued exchangerates, making it more difficult to export (Bambaci et al., 2002). Indeed, Argentina’sexports as a percent of GDP fell from 13.06% in 1988 to 6.81% in 1993. Similarly,exports fell in Brazil from 10.5% in 1992 to 7.12% in 1995.

The negative effect of foreign assistance on expanding liberalization also makessense in the context of the 1980s debt crisis. Prior to the 1980s, many Latin Amer-ican countries borrowed extensively to prop up ISI programs rather than imple-ment painful economic austerity measures. The near collapse of lending to theregion in the 1980s made borrowing no longer a viable program for maintainingprotectionist policies. However, some countries used foreign aid as a substitute forloans––to supplant and delay initiation of economic liberalization. At the end of thedebt-ridden 1980s, U.S. Treasury Department Under-Secretary for InternationalAffairs David Mulford argued that because the U.S. provides aid, countries mayactually be ‘‘doing less’’ in terms of reform (British Broadcasting Corporation,1990). In fact, developing countries use the northern desire for expansion of re-form as leverage for more aid.

The positive and overwhelming significance of inflation, except under frag-mented party systems, is explainable based on the fairly recent and chaotic situationbrought on by inflation. Latin American countries suffered from high, and in someinstances hyper, inflation during much of the 1980s and into the 1990s. Inflationlevels over 3,000% in Argentina in 1989, nearly 3,000% in Brazil in 1990, over7,000% in Peru in 1990, and almost 12,000% in Bolivia in 1985 made controllinginflation a goal in itself (World Development Indicators, 1999).

Plagued by inflation, nearly all presidents in Latin America pledged to take stepsnecessary to stabilize their economies. The reason for the universal appeal to ad-dress inflation is that few benefit from price acceleration: wealthy as well as poorcitizens are negatively affected by price advances. Moreover, the effects of inflationare often felt even more strongly by low-income voters who represent a largerportion of the electorate (Armijo and Faucher, 2002). Inflation has deleteriouseffects, especially for those on fixed incomes or whose wages are not adjusted forcost of living changes, such as the working poor in the informal sector (De Soto,2000). Union members, whose contracts may contain cost of living adjustments, areperhaps less fearful of inflation than the poor. Differences in the effects of inflationtend to aggravate income distribution, creating added incentives for the poor tofavor inflation-calming measures. Because of the severe impact of inflation on muchof the population, survival-minded politicians gain electoral backing by maintaininglow inflation. As a result, even as criticisms build against reform, the success of lowinflation may parry attempts to institute wholesale policy changes.

Both prospect theory and political cost–benefit explanations are generally con-sistent with the results, especially with regard to inflation. In both explanations, acommon theme is that ‘‘desperation’’ brings about reform––skyrocketing inflationcan cause paradigmatic shifts away from protectionism and toward market-orientedpolicies. From the prospect theory perspective, Weyland (1996:191) hypothesizesthat inflation puts leaders in a domain of loss that makes them risk-acceptant enoughto pursue reform policies. In the absence of problems such as inflation, leaders willprefer policy continuity (see also Hayashi, 2001). Although based on cost–benefitanalysis by politicians, Rodrik similarly argues that high inflation has significanteffects on the public, which creates enough policy winners to more than balance thepolicy losers from other aspects of the reform. Regardless of their prior ideological

23Other countries including Chile, Colombia, and Mexico also adopted currency bands.

Expansion of Neoliberal Economic Reforms in Latin America574

commitments, governments operating under high inflation are motivated to changepolicy course, with political institutions affecting what they can actually accomplish.Thus, under both prospect theory and political cost–benefit analysis, inflation servesas a powerful impetus to decision makers to support reform.

However, party fragmentation represents an exception to the positive impact ofinflation on reform. Based on political calculations, it is not unusual that members ofopposing parties would prefer not to implement policies to address economic emer-gencies if they can blame the crisis on the current administration. Economic failure istypically disastrous for governments facing reelection. As the cases of ArgentinePresident Raul Alfonsın (1983–1989) and Uruguayan President Luis Alberto Lacalle(1989–1994) suggest, members from opposition parties, with hopes of regainingpower, forestalled efforts to initiate more significant economic reforms (Biglaiser,2002: ch. 7). Similarly, when Alberto Fujimori won the Peruvian presidency in 1990,his Cambio 90 party held less than 25% of the seats in the senate and chamber ofdeputies (http://www.georgetown.edu/pdba/Elecdata/Peru/percon.html). In fact, partof Fujimori’s justification for his autogolpe, a coup against himself in 1992, wasopposition to expanding economic reforms during an economic crisis (cf. Ellner,2003:143). In a context of high inflation, members of the nonruling coalition adopt-ed a vote maximizing strategy, hoping to pin the crisis on the current government.

Conclusion

We compared the policy experiences of 15 Latin American countries for the years1980–1995––the period when the shift toward market-oriented reforms occurred––to assess the effect of several political and economic variables on expanding re-forms. From an expected utility perspective, elected leaders might be expected toopt for vote maximizing options over the negative electoral implications associatedwith liberal economic reforms. Our explanation suggests that except under partyfragmentation prospect theory and cost–benefit analysis linked to high inflation areconsistent with the results.

Previous work on the politics of structural adjustment suggests a number ofsubregime type factors affect the deepening of neoliberal policies. To test the rel-ative strength of these factors, this study specified a model of market reform ex-pansion that included a number of control variables in order to evaluate theimportance of party fragmentation, polarization, strength of the presidency, divid-ed government, pluralism, external resources of international organizations, andinteractions between inflation as a proxy for economic pressure and institutions.Challenging conventional interpretations, the investigation showed that politicalinstitutions that favor state autonomy are not significant for reform unless coupledwith high inflation. Runaway inflation serves as the catalyst for policy change andinstitutions affect whether governments are able to accomplish their goals. Amongpolitical institutions, only party fragmentation negates the effect of high inflationand discourages expanded liberalization.

Despite the minimal effect these variables have on policy deepening, in general,we perceive this finding positively. The fact that specific political institutions oreconomic actors outside the context of inflation are apparently not essential forinstituting neoliberal reforms suggests that there are fewer obstacles to expandingpolicy reforms. The limitations of the institutional literature and the efficacy ofprospect theory and political cost–benefit analysis related to high inflation alsomake us sanguine about the possibility of using risk tolerance and expected utilitymodels to understand why leaders will support different policies at various times.

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