South America's Balancing Act: Socialism vs. Fiscal Conservatism

(InfoAmericas, 18/05/2005)


The failed promise of neo-liberal policies to put a dent in South American social and economic inequality has tilted the region’s political landscape to the left. With few exceptions, nearly every change in government in South America since 2001 has moved the region further from the center, resulting in significant alterations in politics, society, and perceived regional stability.


This trend makes investors and business decision makers nervous. Countering the demands for more populist policies is the sobering reality for most political leaders that South America’s reliance on foreign markets and capital requires fiscal conservatism.


Populist leaders such as Luis Inácio Lula da Silva, Hugo Chávez and Evo Morales are creating an unprecedented geopolitical reality. They represent the poorest, most marginalized masses. Yet these left-leaning leaders must realize that fiscal responsibility in the short to medium term is the key to ensuring the investment necessary to generate funds for social programs in the long term. To share wealth, it must first be created and retained within the region.


Brazil is the best example. If Lula manages re-election, which at this juncture seems likely, he will preside over strong export growth and a stable domestic economy thanks to a first term largely defined by conservative fiscal policies and a laissez-faire currency model. In the second term he will have the funds necessary to inject his fledgling social programs with significantly more capital. Patience will have proved to be a virtue.


Venezuela is the exception to the rule. Thanks to record crude oil prices, Chávez continues to run fiscal surpluses in spite of his government’s decidedly anti-business policies that have punished the nation’s non-oil sectors and sent capital off-shore. Chávez maintains a high level of spending, which ensures loyalty in his own ranks as well as with his largest voting block — the poor. A sustained drop in oil prices, however, would remove the façade of support he enjoys from the masses who benefit from his generous support programs.


Bolivia is the test case. The country’s current president is barely able to preside over a largely unpredictable and extremely divided Congress. The push and pull between socialist demands and fiscal realities is tearing the country apart. Socialist leader Evo Morales is gaining momentum. His ascension to the presidency would redefine regional geopolitics largely because his loud anti-capitalist rhetoric sows little confidence among international investors. More prudent neighbors are loath to even ponder the consequences.


This struggle is most conspicuous in Bolivia but is manifest in all of the countries in South America. The lower classes across the continent widely reject economic liberalization. Yet they live in an economy that remains dependent on foreign direct investment and access to global consumer markets. It is a classic emerging market paradox.


Blockades, Natural Gas, y MAS


Bolivia’s president Carlos Mesa landed in the president’s palace in October 2003. Social turmoil, caused by the government’s mishandling of oil and gas deals with multinational companies, forced out Mesa’s predecessor Gonzalo Sánchez de Lozada after days of violent protest. The situation has not improved. Ranks of the middle and upper classes threaten secession, and hundreds of lower-class farmers, led by Evo Morales, clog Bolivian highways with rocks, debris, and people.


Faced with a decision between continued road blockades or armed force to break them up, Mesa tendered his resignation to the Bolivian Congress in early March 2005. It was rejected. Many agree that the resignation was a power play to strengthen Mesa’s political position. The gamble worked but may have done little more than extend the standoff between Mesa, Morales, and the richest levels of the upper class until the country’s next elections are held in 2007.


Mesa must now try to push through a prickly hydrocarbon bill that makes everyone happy. On March 16, the lower house in Congress agreed to legislation that levies a 32% extraction tax on oil and natural gas reserves in addition to the 18% royalty tax already in place. Morales said he was “somewhat satisfied” with the new compromise. The upper house began debating the bill in early April.


A 50% royalty would not be out of line with levies on energy companies elsewhere in the world. In Bolivia, however, foreign investors argue that they need a lower royalty to overcome the higher extraction costs of Bolivian gas and the higher country risk that Bolivia represents, which adds to their financing costs.


Bolivia is a country of 8.8 million, with an annual GDP of some US$7.8 billion. Access to natural gas reserves of 800 billion cubic meters, valued at US$70 billion, is the goldmine at the center of the hydrocarbon law debate and the future of Bolivia.


President Mesa argues that Bolivia must tax prudently to attract the foreign investment needed to extract and sell Bolivia’s lucrative gas resources. Morales, citing decades of mistreatment of Bolivia’s marginalized poor, insists that Bolivia must impose a large tax and use the proceeds to improve the lot of the country’s poor through welfare programs.


Morales knows that he can organize road blocks throughout the country to leverage his position whenever necessary. His recent two-week blockade cost the economy some US$14 million a day, leaving Mesa little choice but to appease him. Morales’ block of voting poor has established itself as a power in Bolivian politics.


The “Movement Toward Socialism”, Evo Morales’ party, holds a significant number of congressional seats, which partly explains the standoff over the hydrocarbon legislation. Now partnered with the firebrand leftist Felipe Quispe and union leader Jaime Solares, Morales promises to bring record numbers of poor voters to the polls in Bolivia’s next election due in late 2007. If Morales wins the presidency, a growing possibility, he will hold the executive branch and possibly a majority in Congress as the leader of the country’s largely indigenous poor. It would be a first for Bolivia.


The idea of Bolivia being led by a coca leaf farmer who embraces socialism and fringe movements rightfully has many worried about regional security. With Morales running Bolivian politics, the country would swing far to the left and much closer his silent partner, Hugo Chávez.


The Bolivarian Revolution and Oil


Hugo Chávez is a somewhat shrewd politician, blessed with US$25 billion in surplus foreign exchange, and a desire to engage pariah states, to modernize his military, and to spread his “revolution” throughout South America. He threatens to cut off the flow of Venezuelan oil to the United States; he has publicized bilateral agreements with Iran; and he has concluded negotiations with Russia to purchase a cache of 100,000 AK-103 and AK-104 assault rifles. He now has the world’s attention.


Chávez’s politics reflect a desire to stroke his own ego while maintaining the façade of a Bolivarian Revolution, whereby Venezuela becomes the modern incarnation of South American nationalist hero Simon Bolivar’s ideal nation-state. His intentions seem poetic, but the realities within Venezuela underline an economy dependent on the price of oil, a sharply divided society, and real concern over the future of regional security.


Chávez’s profligate spending on the strength of record oil prices is such that he has neglected the investment requirements of PDVSA, his cash cow. Any sudden downturn in oil prices cannot be offset by a commensurate increase in production, which leaves the government’s revenue base vulnerable. Outside of oil and gas and select correlated industries, such as construction, foreign investment has all but halted. Domestic savings continue to find their way out of the country in spite of currency controls. The entire business community operates with a short term mindset, ready to pack up and leave if and when the economy collapses.


Chávez’s complacent attitude toward Colombia’s insurgent armies foreshadows a future of tense relations between the US and Venezuela. Rumors of Chávez negotiating with North Korea for the purchase of conventional weapons surfaced on April 6, 2005. The Korean-made Nodong-1 missile, with a range of some 800 miles, and the Nodong-B, with a range of 1,700 miles or more, certainly interest Chávez. He perceives a need to deter what he believes to be a possible invasion from the United States or even Colombia. North Korea joins China, Russia, South Africa, Spain, and Brazil on Chávez’s long list of arms suppliers.


Chávez’s outspoken intentions to spread his political ideology beyond Venezuelan borders are more than words. His budding relationship with Bolivia’s Evo Morales will certainly flower if Morales wins the Bolivian presidency in 2007. Peru is also a target. Venezuela’s voting poor will keep Chávez in office — by way of referendum and fraudulent voting — as long as the price of oil keeps the state coffers full. In short, the voting poor and the political environments in Venezuela and Bolivia leave both countries poised to push the region’s political spectrum to the left.


Together, Chávez and Morales represent the most extreme of South America’s political leaders. Brazil helps to balance the scale. Lula’s leadership role may be South America’s most important bulwark against the creeping influence of a more radical Left.


The Sleeping Giant Awakes


Brazilian president Luis Inácio Lula da Silva first gained popularity as a spokesman and organizer for the marginalized industrial workers in Sao Paulo. He gained notoriety in Brazilian political circles after three unsuccessful presidential campaigns. His tenacity in pursuing the presidency and his passion for the rights of the poor finally unified a broad spectrum of Brazilians in 2002, elevating him to the top office.


Over the years Lula has made a steady march toward the center, but Brasilia’s fiscal austerity in 2003 & 2004 surprised observers. His desire to fight for Brazil’s poor, however, has not wavered. Lula has worked hard to initiate and adequately fund his Zero Hunger program, fulfilling a major plank in his election platform. In 2004 Lula set aside more than US$2 billion to fund various programs within the Zero Hunger initiative, an unprecedented amount.


Successes with pension and tax reform have buoyed his popularity with many Brazilian voters. Fiscal austerity has kept international investors happy. The administration’s decision not to renew its US$15.5 billion loan agreement with the IMF was more than just pre-campaign bravado. Record exports, a strengthening currency, and a stronger than expected primary fiscal surplus all contribute to Brazil’s ability to lower its reliance on last resort lenders like the IMF.


The current growth trajectory of Brazil’s economy will bring in more money for Lula’s social programs in the future. His fiscal austerity seems to have produced a win-win situation that enables him to attract more international investors while retaining enough social spending programs to keep the country’s voting poor content. The resulting combination of rising FDI and 70%-plus support in the polls is a rare mix in today’s political climate.


The shift to the left – threat or promise?


Lula versus Chávez in many ways characterizes the competition for the hearts and souls of South America’s increasingly left-leaning masses. Chávez’s international stardom is built upon the brashness of his anti-American stance and the largesse of his petro-diplomacy. But support for Chávez runs only as deep and thick as the oil it is built on. If and when international oil prices weaken, so will his support. Lula, on the other hand, has built a solid base of consensus-style politics, rooted in his role as a trade unionist more than 25 years ago. His ability to unite a divided Brazilian political spectrum behind his reforms demonstrates a skill set that he is increasingly taking to the global stage. His credibility as a prudent and honest defender of social democratic values has support not only from South America’s left but also from distant third world nations and even from the US.


More enlightened business leaders have been calling for years for a middle path in Latin American politics that combines a pro-business environment with healthy spending on human development programs like education and health. The poster boy for this Latin version of a “third way” is clearly Luis Inácio Lula da Silva.


That said, the political climate in South America remains volatile, especially in Bolivia, where the ability of Lulu-like skills to soften a class-based political divide may have limited application. Political momentum in Bolivia is trending towards an Evo Morales Presidency. Given his record, such a “victory” for democracy would not likely help the country’s economy given its reliance on foreign capital, which has already voted with its feet in recent months.


The ability of Latin American governments to emulate the relative success of Brazil in establishing the third way of politics comes down to the strength of their institutions. Nations like Colombia, Argentina, Chile, Uruguay and Brazil have built sufficiently strong legal, financial, and social institutions to court international business and narrow the wealth gap. Nations where institutions have failed to form, or have been weakened after years of abuse, face a more divided political rivalry between populist and elitist power blocks. They include Bolivia, Ecuador, Venezuela, Paraguay and to a lesser degree, Peru.


For business investors, the map of South America looks increasingly divided between the developing and the undeveloped. It is through this lens that investors should interpret the spread of the political left. In some markets, the move to the left is a welcome sign of political maturity. In other countries, it is a radical swing of the pendulum. Failing to understand the difference can be costly.