Shock Therapy on the Altiplano

In our last post we explained how the Bolivian Revolution of 1952 was an example of what the German sociologist Robert Michels called the Iron Law of Oligarchy. Michels noted in his book Political Parties

society cannot exist without a …dominant… or… political class, and that the ruling class, while its elements are subject to frequent partial renewal, nevertheless constitutes the only factor of sufficiently durable efficacy in the history of human development. [T]he government, or, … the state, cannot be anything other than the organization of a minority. It is the aim of this minority to impose upon the rest of society a “legal order” which is the outcome of the exigencies of dominion and of the exploitation of the mass … Even when the discontent of the masses culminates in a successful attempt to deprive the bourgeoisie of power, this is … effected only in appearance; always and necessarily there springs from the masses a new organized minority which raises itself to the rank of a governing class…” (pp. 353-354).

The “new organized minority” in Bolivia in 1952 was the MNR. In 1985 they were back in power in the form of President Víctor Paz Estenssoro, one of the founders of the party who had been president between 1952 and 1956 right after the revolution. In 1985 the Bolivian economy was in a mess. Not only were basic economic institutions extractive but there was hyperinflation. Paz Estenssoro aimed to deal with poor economic performance and inflation with a drastic “shock therapy” stabilization policy. As we emphasize in Why Nations Fail there is a great deal of variation across countries in the form of extractive institutions. Many of these are referred to by economists as “bad policies”. The Paz Estenssoro government, with the aid of then Harvard economist Jeffrey Sachs, aimed to address these bad policies. In this they anticipated the Washington Consensus.

In the Bolivian case the attack on bad policies was enshrined in Supreme Decree 21060. This decree implemented a massive devaluation of the currency, deregulation of price controls and massive downsizing of the public sector including a closing of the government owned tin mines and the abolition of government trade restrictions and cuts in trade taxes.  When the Bolivian Labor Federation (COB) called for a general strike against Decree 21060, the government declared a state of siege and exiled 175 labor leaders to a remote jungle prison camp.

Unfortunately, as with the Washington Consensus, the attempted policy reforms in Bolivia were conducted without any regard to the political problems which had created the policy distortions in the first place. Following the dominant tradition in economics, Jeffrey Sachs arrived with the implicit theory that Bolivians were ignorant of what good economic policies were. It was just a matter of getting it right — of course with good advice from clever economists. But as is often the case, policy distortions weren’t just there because people were stupid.

In fact, the distortions that the Bolivian government addressed were the tip of the extractive iceberg — the most crucial part of that iceberg which went unaddressed being the deep-rooted discrimination against indigenous people, probably 60% of the Bolivian population. The 1952 revolution had done little to empower Bolivia’s indigenous people. MNR also had little interest in this after 1985.

There should be no surprise here. Echoing the Iron Law of Oligarchy, Paz Estenssoro and the MNR, the exact “organized minority” who had taken over Bolivian society after the revolution, had no interest in changing the extractive system. They just wish to stabilize it at the edges so that it would and do it themselves at the helm. This they could do because even if they gave up one bad extractive policy, they could simply exchange it for another one and carry on with the extractive system.

In our paper with Simon Johnson and Pablo Querubín “When Does Policy Reform Work?”, we analyzed exactly this process. We explained why policy reform, against the background of unchanged political institutions, may create a seesaw effect, whereby the reform of one distortionary, extractive policy leads to the rise of another. We then illustrated these ideas with central bank independence, adopted enthusiastically by many countries with the encouragement of international organizations since the 1990s. Central bank independence, except in places such as Zimbabwe where it doesn’t mean anything at all, does take away some of the tools that politicians under extractive institutions can use for clientelism or for personal enrichment. But if their incentives and constraints facing them and the political elites are unchanged, they will often find other tools to achieve the same objectives — and these other tools may sometimes be even more distortionary. So with more constraint on monetary policy after central bank independence, many countries with weak institutions start running bigger budget deficits.

The situation in Bolivia was similar. Extraction continued, and so did underdevelopment.

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