Debt Crises and Austerity Policies in Latin America: Lessons for Europe

The Citizen: Issue 4
September 2011

Authors: Patricia Miranda & Nuria Molina


Widespread financial and sovereign debt crises seem to be a new phenomenon in contemporary Europe, but they are common in other parts of the world. In Latin America, debt crises and the austerity policies that international creditors and financial institutions required to bail out these economies sank the region twice in the last three decades.

On both occasions, unsustainable debt levels and flawed attempts to resolve the debt crises through debt restructuring were the trigger. However, the coup de gráce for the region took the form of a set of economic reforms, known as structural adjustment, pushed by the International Monetary Fund (IMF) in their so-called ‘bailout’ packages. Harsh austerity measures, including fiscal discipline, budget cuts, and privatisations of state-owned enterprises and utilities, were some of the highlights of these packages. The consequences were staggering: the average economic growth in the region was consistently weak during the 1990s at an annual rate of 2 per cent, then fell to 0.3 per cent per year from 1998 to 2002, followed by a weak recovery in 2003. Worse than this, poverty rates shot up during the ‘lost decade,’ from 40 per cent to almost 50 per cent, while the absolute number of poor rose by twenty million people in the lost half-decade of 1998-2002.

Countries in peripheral Europe suffering similar sovereign debt crises these days should turn their eyes to the recent history of Latin America and learn what they could face in years to come. Although the IMF has, in the wake of the global crisis, slightly eased its stance on the fiscal and monetary policies it advises and the way structural reforms should be conducted, this time around the European Union and the European Central Bank have taken the lead in imposing harsh fiscal discipline and structural reforms on their bad members or the PIGS, a pejorative acronym that stands for Portugal, Ireland, Greece, and Spain.

At the end of the day, regardless of who pushes for certain economic reforms, bad policies lead to bad economic and social outcomes and, as we have seen in Latin America, citizens will suffer for the mistakes of the decision makers and the recklessness of the economic elites for decades to come.

The 1980s Debt Crisis in Latin America

Latin America had several debt crises throughout its history, to a large extent linked to the economic policies of developed countries. The most recent one, still fresh in the continent’s political memory, took place in the decade of the 1980s.

(i) The Lost Decade of Latin America

The oil crisis at the end of the 1970s had an impact on both food prices and the terms of trade in the region. This resulted in large deficits in Latin America that were financed with external debt. External finance was readily available from the surpluses generated by the very same oil crisis, which were recycled to developing countries with the help of increasingly liberalised capital markets in developed countries. Foreign commercial banks, which had an excess of liquidity, found an opportunity to allocate these resources in Latin America. On the other side of the coin, governments in Latin America – at the time, most of them were dictatorial – recklessly contracted debt, hoping to take advantage of the spread between local and foreign interest rates.

This led to unsustainable external debt piling up in Latin America, without any risk assessment made by the borrowers or the international creditors, who were complicit in these (often irresponsible) debt contracting processes. Between 1970 and 1980, Latin America’s external debt increased from US$27 billion to US$231 billion. The situation became unsustainable when escalating inflation rates pushed developed countries to implement restrictive monetary policies. This led to a dramatic increase in floating interest rates and, given the heavy debt burden of most countries in the region, made increases in debt servicing impossible to sustain.

When international liquidity dried up and governments could not service their debts, they resorted to the IMF, which provided huge bailout loans to enable countries in the region continue servicing their external debt. This came hand in hand with harsh structural adjustment policies, which are explained in more detail in the section below. This period is infamously knows as the ‘lost decade for Latin America.’ The economic and social consequences of the lost decade of the 1980s were appalling: Gross Domestic Product (GDP) per capita, investment ratios, and real salaries experienced a dramatic decline; so did the quality of life. The gap between rich and poor increased by 50 per cent between 1976 and 1983 alone.

(ii) Debt Restructuring: The Brady Plan

To avoid widespread debt default in the region, which was ever more likely at the end of the 1980s, the US proposed what has been known as the Brady Plan. The plan aimed to restructure debts with commercial banks, based on a conversion of loans at market rates and the extension of the repayment period. This came alongside the measures taken to stabilise the balance of payment problems under the IMF and official creditors’ structural adjustment programmes.

However, the Brady Plan had several flaws from the outset, which later resulted in the inability of some governments to meet debt repayments. For instance, Latin American countries had to recognise unpaid interest as part of the stock of debt to be renegotiated. This led to these countries having to meet the obligations of compound interest on debt (that is, they had to pay interest on the interest), which is forbidden in several national legal frameworks.

As a consequence, the debt crisis in the region remained unresolved, and several countries were unable to repay their debts. In 1982, both Argentina and Mexico defaulted on their debt in the midst of a severe economic and political crisis. They were followed swiftly by Brazil, which in 1987 declared a ninety-day moratorium on debt interest payments.

The absence of transparent and independent debt work-out mechanisms to provide orderly solutions to the debt crisis created unnecessary long-lasting effects that are still being felt today – Argentina, for example, is still in default and continues negotiating with external creditors. The existence of orderly and transparent debt work-out mechanisms would undoubtedly provide a more appropriate platform to resolve sovereign debt crises in more optimal ways.1

It is not only the economic and financial effects that are long felt after a debt crisis. The social debt generated with the Latin American peoples as a result of increased inequality, unemployment, and migration will also take decades to reverse.

The IMF’s Blueprint: A Recipe for Depressed Growth and Increased Poverty

Following Mexico’s default on its sovereign debt in 1982, which marked what many analysts view as the beginning of the modern debt crisis, international creditors lost confidence in the ability of many Latin American countries to repay their debts. Most commercial banks halted lending to Latin America and refused to refinance existing loans, most of which were short-term and due immediately. To avoid financial panic, cash-strapped governments and companies were forced to renegotiate the repayment periods for existing loans as well as taking out new loans in order to be able to service outstanding debt. New loans came with strict conditions, including the requirement to engage with strict IMF programmes.

During the decades of the 1990s and the 2000s, virtually every country in the region had some type of lending arrangement with the IMF – among them, Argentina, Belize, Bolivia, Brazil, Chile, Costa Rica, the Dominican Republic, Ecuador, El Salvador, Guatemala, Honduras, Mexico, Nicaragua, Panama, Paraguay, Peru, and Uruguay. The wave of IMF loans in the region came hand in hand with all-encompassing economic reform programmes aimed at opening up economies to foreign competition and allowing greater private sector participation in development. Amongst others, these reforms included:

    • trade, capital account, and domestic financial liberalisation, such us eliminating restrictions on foreign direct investment, phasing out foreign exchange regulations, dismantling regulations on interest rates and credit allocation, and privatising state banks;
    • privatisation of state-owned companies and public utilities;
    • tax reforms, such as reduced income tax rates and the introduction of a value added tax; and
    • the overhaul of social security systems to allow the participation of private agents and increased labour market flexibility.

These so-called structural reforms were coupled with stabilisation packages, which aimed to bring down large budget deficits and public debt and reduce high inflation rates. These policies were partly required by binding conditions attached to IMF loan programmes. However, they were also wholeheartedly embraced by decision makers in the region, who had a common perception that the state-led industrialisation strategy followed in previous decades (from the mid-1940s to the 1970s) had generated inefficient productive and state structures. However, more nuanced views suggest that ‘the advantages of the previous development experience, in terms of productive development upon which new forms of structural transformation could be built were ignored, [and] the risks involved in the new strategy were swept aside.’2

(i) Reforms Failed to Deliver Sound Economic Growth

The new economic policies that were rolled out across the region delivered on some fronts: improved fiscal and monetary management led to important reductions in inflation rates and budget deficits. However, the expectations that this would lead to increased investment, productivity, and economic growth failed to materialise.

Inflation rates fell across the region and stabilised at single-digit rates after 1997. This was particularly salient in countries such as Argentina, Bolivia, Brazil, Nicaragua, and Peru that had faced harsh episodes of hyperinflation at the beginning of the 1990s. Improved government finances resulted in higher public sector spending and social protection spending, which went up from 10 to 13 per cent during the decade of the 1990s.

However, the benefits of a stronger macroeconomic performance were reduced by a general tendency to adopt pro-cyclical fiscal and monetary policies, which were at the root of unstable economic growth and recurrent financial crises in the region. As a result, half of the Latin American countries experienced financial crises during the 1990s, absorbing considerable fiscal resources and disrupting the functioning of their financial systems.

Disappointingly, economic growth in the region was consistently low between 1990 and 2001 at an average of 2.9 per cent – this was above the very low levels of the lost decade of the 1980s but below pre-1980 levels (5.5 per cent).3 This weak performance was followed by a new drop in economic growth in the lost half-decade of 1998-2002 when GDP grew at the meagre rate of 1.3 per cent per annum.

(ii) Half the Continent Below the Poverty Line

Sluggish growth translated into weakness in the labour markets. Unemployment rates increased throughout the early 1990s and shot up during Mexico’s Tequila crisis and the Asian crisis at the end of the decade.4 Moreover, the few jobs created were not good jobs: seven out of ten jobs created were in low-productivity, informal sectors.

Poverty rates shot up during the debt crisis of the 1980s, from 40 per cent to almost 50 per cent of the population. Although rebounding growth in the 1990s pushed down the poverty rates again, they remained above pre-1980s levels, and the absolute number of poor people stagnated at roughly 200 million. During the lost half-decade alone, 20 million additional people fell below the poverty line.

(iii) Rise Up Against the IMF

As poverty and income distribution worsened, social unrest spread throughout the continent. In Argentina, IMF-prescribed cuts in social spending culminated in strong protests and strikes in the year 2000. The Financial Times reported that ‘a wave of discontent is sweeping across Argentina, eroding the government’s political capital and prompting it to adopt desperate measures to create jobs and kick-start the economy. But the measures may have backfired and put the brakes on the economy.’

In Bolivia, an IMF loan conditional on privatisation of water utilities led to a 200 per cent increase in water prices, provoking widespread protests. In recent declarations, Javier Comboni, Finance Minister at that time, said: ‘The fund wasn’t helpful at all. They had a big role [in] what ended up happening. They were very stringent and adamant [in] asking the government to place a new tax and lower the fiscal deficit.’5

In Colombia, the IMF loan approved in 2009 included policies such as downsizing the public sector, mainly through privatisation and reduced public sector spending. In August 2000, thousands of workers went on a strike to protest against IMF-imposed austerity measures.

In Ecuador, the IMF loan approved in the year 2000 required wage restraint, the removal of subsidies, reforms in the labour market and the oil sector, and privatisation. Thousands of protesters took to the streets that year, and workers went on general strike against continuing economic reforms demanded by the IMF. In 2005, after years of large profits from oil sales being accumulated in an oil stabilisation fund, the Ecuadorian Congress and then Finance Minister Rafael Correa made moves to set aside a portion of the fund for social sector spending. The IMF and World Bank objected and ultimately cancelled an already approved loan to Ecuador, based on their concern that these changes amounted to a ‘policy reversal.’

These are just a few of the cases where IMF conditions were not only ill-conceived from an economic viewpoint but also by-passed the decisions of Latin American elected governments and the sentiment of their peoples. As a result of mounting unrest, in the mid-2000s the region drifted away from the IMF, with the structural adjustment era giving way to a new wave of governments that cut the strings to the Washington-based organisation and its economic advice.

The renewed economic buoyancy in the region in the 2000s allowed some governments to pile up reserves, which allowed them to make early repayments to the IMF. This was the case with Brazil in 2005, Argentina in 2006, and Ecuador and Venezuela in 2007. As a result of this strategy, IMF loans to Latin America had dropped to less than US$1 billion in 2008 from the historically high US$48 billion in 2003.

Conclusions: Lessons Not Learnt

More than three decades after what has become known as the lost decade of Latin America, the debt crises in the region (and elsewhere in the developing world) remains unresolved. Most external borrowing was the result of reckless debt contracting, fostered by domestic dictatorships and external lenders who turned a blind eye to due-diligence and responsible lending principles, which should guide all lenders and borrowers before granting or contracting new debt.

The absence of transparent and independent debt work-out mechanisms to provide orderly solutions to the debt crisis created unnecessary long-lasting effects that are still being felt today. Citizens are the ones who suffer most as a result of increased inequality, unemployment and migration. In Latin America, the social debt, inequality, and poverty suffered by millions of citizens will take decades to reverse. The existence of orderly and transparent debt work-out mechanisms would undoubtedly provide a more appropriate platform to resolve sovereign debt crises in more optimal ways.6

The austerity policies and structural reforms advised by the IMF and embraced by the Latin American governments were successful in bringing down inflation, boosting exports, and attracting foreign investment. However, they failed to realise expectations on economic growth, which was low and volatile and exacerbated poverty and inequality across the region.

Clearly, the expected benefits of the reforms were overstated and the risks minimised. The fundamental shortcomings of these policies included a very limited view of macroeconomic stability, which was understood only in terms of low inflation rates and budget deficits, and dismissed crucial factors such as stable growth rates and employment. Moreover, social outcomes of the economic policies were regarded as a by-product that could be taken care of by providing assistance to those who were unable to adjust to the harsher economic context. Unfortunately, social policies were not regarded as an integral part of the strategy for social and economic development and recovery from the crises. However, social capital is part and parcel of the potential of a country to recover from the effects of devastating economic and financial crises. For this purpose, policies that result in increased progressive taxation and social spending are crucial for rebuilding the social capital that is lost as a result of a crisis.

In the wake of the global financial crisis which started in 2007, the IMF came back from growing irrelevance with renewed lending capacity and a new round of crisis loans.7 This time around, the IMF seems to have amended, if only a little, its long-held view that austerity policies, fiscal discipline, and further liberalisation of the economies are the right way to go. Although most of the fundamental tenets in their thinking remained unchanged, the IMF relaxed (to a very limited extent) its stance by allowing sustained social spending and, occasionally, counter-cyclical fiscal policies.8

European countries hard-hit by the sovereign debt crisis that followed the global financial crisis – Ireland, Greece, Portugal, and a number of Eastern European countries, for example – have now become the main borrowers from the IMF. However, eurozone countries having to resort to external assistance are swallowing exactly the same medicine that led Latin America to social and economic bankruptcy in the 1990s. This is partially due to the fact that the EU and the ECB – which, together with the IMF, are part of the so-called troika that is providing external lending to the peripheral eurozone countries – have turned out to be as harsh in their policy conditions as the IMF had been in the worst years of structural adjustment. Regardless of which institution is actually imposing the conditions, the fundamental problem lies in the fact that the economic policies imposed are as ill-conceived as they were in Latin America – and they are most likely to deliver the same economic and social disaster.

Hopefully, this time around it will not take the decades-long suffering that Latin American citizens had to cope with for citizens and governments in Europe to rise up against ill-conceived social and economic policies. A political debate in peripheral Europe should take place now, so that citizens are aware of what current policies will and will not deliver, and what alternatives might be available that would be economically and financially sensible and, above all, would deliver for the well-being of citizens.

Patricia Miranda works for Latindadd – The Latin American Network on Debt, Development, and Rights. Nuria Molina works for Eurodad – European Network on Debt and Development


1 See proposals for fair and transparent debt work-out mechanisms proposed in Eurodad, A Fair and Transparent Debt Work-out Procedure: 10 Core Civil Society Principles, (December 2009), available online at

2 José Antonio Ocampo, ‘Lights and Shadows in Latin American Structural Reforms,’ in Gustavo Indart (ed.), Economic Reforms, Growth and Inequality in Latin America: Essays in Honour of Albert Berry, (Aldershot: Ashgate 2004).

3 Ocampo, op. cit.

4 The Tequila crisis was the Mexican economic crisis caused by the sudden devaluation of the Mexican peso in December 1994; the Asian crisis was the 1997-1998 financial crisis that saw Asian currencies slump, stock markets plummet, and debt soar, threatening the global economy.

5 Transcript from ‘Morning Edition’ on National Public Radio in the US, 28 April 2009. Professor Javier Comboni (Wheaton College; former Finance Minister, Bolivia) is speaking in a segment compiled by Juan Forero. Available online at

6 See note 1.

7 See Nuria Molina, Bail-out or Blow-out? IMF Policy Advice and Conditions for Low-income Countries at a Time of Crisis, (Eurodad, June 2009), available online at

8 E. Van Waeyenberge, H. Bargawi, & T. McKinley, Standing in the Way of Development? A Critical Survey of IMF’s Crisis Response in Low-income Countries, a Eurodad & Third World Network report (Eurodad, April 2010), available online at

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