The Economic Plan’s Feet of Clay
In our first analysis of the Lacayo Plan, the central issue was whether the Nicaraguan economy, both rural and urban, would find itself at a dead end after the defeat of hyperinflation. We concluded that the magnitude of the monetary contraction and commercial liberalization upon which the stabilization strategy was based would lead to the decapitalization and bankruptcy of urban and rural productive and service sectors, with the consequent denationalization of the Nicaraguan economy, a greater concentration of capital and the deterioration of the popular economy. (See envío May 1991 for our detailed analysis of the UNO government's economic plan, named after Minister of the Presidency Antonio Lacayo and officially implemented on March 4, 1991.)
We predicted a high human cost of the measures due to the drastic increase in unemployment, which, in turn, promotes social instability, crime and migration to the United States. We reported that public health and education services would also deteriorate substantially as a consequence of the drastic national budget cuts.
Eight months after the implementation of the Lacayo Plan, there is no sign that these negative tendencies will reverse, nor is there any indication that the government will change the course of its economic policy. On the contrary, open unemployment and underemployment, according to the Ministry of Labor, rose from 45% in 1990 to 58% in 1991. Average salaries, which just before the plan's implementation covered 92% of the basic market basket, now only cover 72%. In a seminar organized recently by the United Nations and the government, studies revealed that 70% of the population lives in poverty, and 40% must be classified as indigent.
Nevertheless, this accelerated economic and social deterioration has not served to modify the government's economic policy in the slightest. From its point of view, this deterioration is the cost the country must pay in order to restructure the economy and make it internationally competitive. The decapitalization and bankruptcy of important sectors of industrial and agricultural production are thus seen as the natural and inevitable result of their inefficiency and inability to compete on the international market. From this perspective, the role played by the trade liberalization that accompanies the stabilization measures consists precisely in contributing to the free market's promotion of "good" productive sectors and elimination of the "bad." The government also argues that the measures' high social cost is inevitable, while claiming that it is promoting initiatives such as the Social Emergency Investment Fund (FISE) (envío, July 1991) and Social Action Fund for Oppressed Sectors (FASO) to soften the blow.
Minister of the Presidency Antonio Lacayo and his Cabinet seem more convinced than ever that the International Monetary Fund (IMF) and World Bank recipe is right and have confidently announced to the world that 1992 will be the year of Nicaragua's economic "takeoff." Their optimism is based on the success of stopping hyperinflation and significantly reducing the country's fiscal and financial deficits as well as on the foreign financial backing upon which the government is counting.
In spite of this optimism, we still maintain that the government's economic policy has feet of clay. The degree of monetary contraction being applied to the national economy, combined with the accelerated rhythm of trade liberalization, has led to a disproportionate recession with consequent social instability, instead of encouraging reactivation and economic growth. This negative economic and social environment, in turn, is not enticing to national or foreign private investors, even if the government offers all the state enterprises formed under the Sandinista government for sale at ridiculous prices.
The government hopes that this contraction of economic activity in the national market will be compensated by growth in exports. But this hope is not rooted in either a realistic assessment of the export sector's current situation or the tendencies of the international market.
The traditional agroexport sector is mainly affected by the inability to restructure and/or replace cotton cultivation in the country's most important agricultural zone. For decades, cotton was Nicaragua's principal export product, but it has not been able to recover from the crisis brought on by its lack of profitability since the early 1980s. Coffee and beef—the other two key traditional exports—are just now beginning a slow recovery process, and international prices show no indication of improving, while the development of new agroexport activities is still only a notion in the minds of some government officials and business interests. The same is true with the boastful announcement about Taiwanese investment in maquila industries—the materialization of such assembly plants for export has not gone beyond the journalists' pen.
The "record" quantity of foreign aid has been used to finance a boom in imported consumer goods, not to develop national production. At the same time, the use of part of these resources to cancel Nicaragua's arrears with the multilateral banks is the definitive step toward the country's reinsertion into the international financial system and the premature end of the concessionary aid—donations or low-interest, long-term loans—that the country received during the past two years.
This analysis examines to what point and for how long the economic stability achieved by the government up to now is sustainable. We review the contradictions generated by the government's "repression" of prices, reduction of the fiscal deficit and contraction of credit. The impact of the maxi-devaluation of the córdoba on the economy's export sector is also examined, with special attention to the role of foreign aid. Finally, while the government insists there’s no other way out, we provide the outline of an alternative course for economic policy in Nicaragua.
Economic stabilization: Is it sustainable?
The government has continued to apply the anti-inflationary policies begun in March of this year, based on price controls for basic products, reduction of the financial and fiscal deficits and maintenance of a stable exchange rate. The results of this policy show that monthly inflation has dropped significantly compared to the first months of the year (Table 1). On this basis, the government has undertaken an intense propaganda campaign to convince the population that inflation has been relegated to history.
Nevertheless, inflation, which was controlled in such a short time, could climb again due to the contradictions created in the national economy by the government's economic policy itself. First, the control of basic food prices has depended on food imports and subsidies to state service industries that will be difficult to maintain in the medium term. Second, the fiscal and financial deficits have been reduced at the cost of a profound recession in economic activity, with disastrous social consequences. Finally, a stable exchange rate cannot be maintained indefinitely without diminishing the profitability of exports and cheapening imports, thus contributing to an even greater gap in the balance of payments.
Price controls: How much longer?The control of basic food prices has depended primarily on the government's "repression" of the market by using foreign resources to import foods and the national budget to finance subsidies of state service industries. The most "scandalous" cases of food imports are poultry and rice, while the largest single subsidy to a state service industry is to ENABUS (the state bus system), to maintain low-fare public transportation in Managua.
The state is gradually turning over food imports to large private merchants, and price increases were quietly authorized in June. Parallel to this, the government touted a new drop in the gasoline tax to counteract any inflationary expectations that might have arisen.
How long will the government be able to maintain this price "repression"? Some disturbing signs—increases in chicken and rice prices—appeared in the last weeks of October, due to a decrease in imports of these products. This government import policy has generated its own vicious circle since low-priced imports lead to the bankruptcy of national producers. At the same time, it makes the country increasingly dependent on food imports, which can only be financed with foreign exchange given the enormous balance of payments deficit. A policy to keep inflation under control in the medium term, then, does not exist; this would involve financial and technical support to national producers to make them more competitive.
As part of its strategy to reduce the fiscal deficit, the government plans to substantially decrease transfers from the national budget to finance subsidies. This will come about through the privatization of state service enterprises that are currently subsidized. ENABUS, which plays a key role in public transit in Managua, is one of the enterprises included in these plans. The immediate consequence of its privatization would be the freeing up of bus fares—with a significant impact on the emaciated pocketbooks of urban popular sectors and unpredictable political consequences.
Fiscal deficit: Can it shrink more?The government's anti-inflationary policies are also limited by its capacity to continue reducing the fiscal deficit. In our first analysis of the Lacayo Plan, we explained that the initial impact of the March "shock" had been a growth of the deficit, increasing dependence on foreign aid to finance the national budget.
The government has been able to partially reverse this tendency, financing 69% of its spending through taxes between March and September 1991, compared to only 49% during the same period last year. A look at this tendency during the latter months shows that the self-financed proportion of the budget actually reached 80% (Table 2), but this is due, in part, to a natural increase in tax collection common to this time of year. The remainder of government expenses has been covered by foreign resources.
The key to this "success" has been an impressive 30% increase in tax collection over last year. This increase has been possible due to the government's fiscal reform, which altered the country's tax structure. This reform resulted in a 25% drop in revenue from direct taxes (income and property taxes) and a 29% increase from indirect consumer taxes, particularly those of the so-called fiscal industries (products to which the government applies substantial selective consumer taxes; in Nicaragua, cigarettes, beer, rum and soft drinks). In other words, the higher-income sectors of the population now pay less taxes and the lower-income sectors pay more.
How has the government increased its income from indirect consumer taxes if the economy is in recession and the population's buying power has dropped? First, controlling inflation stabilizes tax collection and value. Last year, rampant inflation "ate" fiscal income and prompted people to postpone tax payments until the face value was almost worthless.
Second, the 400% devaluation in March substantially increased the córdoba price of imports, and thus increased the sales taxes collected from Nicaragua's considerable commercial sector. The government has also played a key role in authorizing credits for imports, which facilitates tax collection. In addition, the government took repressive measures against contraband and considerably decreased import duties, stimulating merchants to process their imports through legal channels.
Third, tax collection from the fiscal industries increased because of expanded consumption of nationally-produced products, displacing imported products that had generally been entering the country as contraband. This substitution was possible both because the devaluation raised the price of imported products and because the government reduced taxes on the national substitutes when it implemented the economic plan, somewhat improving their competitiveness. After the March maxi-devaluation, the average price increase for domestically-produced cigarettes, beer and soft drinks was only half of the price hike for similar imports.
The increased sales volume of these products more than compensated for the drop in taxes per unit sold, thus increasing the government's total tax income. In addition, the government provided the Coca-Cola factory with $2 million in low-interest loans to rehabilitate its industrial plant, while the owners of the Flor de Caña rum factory successfully pressured the government not to authorize credits for rum imports.
But the deficit reduction has also been the result of a 6.4% drop in fiscal spending in relation to the same March-September period last year. This reduction would be even greater if we subtract the new, one-time occupational conversion program, which represents 9% of this year's fiscal spending. In addition, an IMF memorandum indicates that the Nicaraguan government has reinitiated its interest payments on the public debt, which represents another 7% of fiscal spending up to September. Excluding these two categories, the result is a 22% contraction in resources available for normal central government operations compared to last year.
Daily reports in the national media about the disastrous condition of the national health and education systems should, then, come as no surprise. It also not surprising that judiciary employees have decided to go on strike, or that the police cannot deal with the increase in crime due to the lack of minimal operating resources, or that there are so many other on-going signs of social disintegration.
Increased unemployment rates resulting from the occupational conversion program must be added to this. According to government propaganda, this program would facilitate the transformation of thousands of public and military employees into small businesspeople. More than 11,500 public employees—3,000 of them from the national banking system, 2,700 from institutions providing basic public services (water, power and communications) and about 5,000 members of the armed forces—have participated in the plan.
These employees, workers and soldiers were attracted by the relatively large indemnification they were offered in exchange for leaving low-paying jobs. Government propaganda dangled promises of becoming small business owners overnight: "I can already see myself with my own beauty parlor," swooned one woman in a television advertisement. But, in reality, the majority of those who accepted the plan invested their indemnity in micro-projects within the already overcrowded small commerce sector—and promptly went under due to the depressed internal market and increasingly fierce competition.
In conclusion, the "bill" for reducing the fiscal deficit has been paid by the popular sectors. On the one hand, they are paying more taxes and on the other receiving poorer services and losing their jobs. Nevertheless, despite its disastrous social effects, the government plans to make additional cuts and privatize public services.