Latin America's Never-Ending Story

Here we go again. Latin America is in deep trouble and the usual suspects (the IMF, the US Treasury) have come to the rescue. The world has seen all of this many times before.

Thirty years of macroeconomic upheaval in Latin America can be boiled down to a simple lesson: governments throughout the region are too large compared with their ability to raise revenue through normal types of taxation. Until this vital issue is solved, crises will be the norm, because the fundamental economic choice these countries face will continue to be one between raising revenue through inflation or letting debt grow.

The typical cycle -- Argentina offers a perfect example -- is one where inflation is allowed to rise for a period. With this, tax receipts grow while debt remains stable. But over time, people learn to live with high inflation and insulate the economy from its effects, thus reducing the revenues gained by the "inflation tax." At this point, government revenues fall, the benefits from high inflation vanish, and political support for stabilization consolidates.

Stabilization is typically followed by a short honeymoon. Eventually, however, with inflation lowered and high levels of public spending unchanged, debt starts to grow again. A new crisis beckons. The exchange rate is devalued. Some debts are repudiated and high inflation rates (and the inflation tax) return, both of which help balance the budget.