Factors contributing to the situation:
The pendulum shift towards market reform was largely a result of two factors; pragmatism and political emulation. One exception may be Chile, where ideology played a big part.
With regards to pragmatism market reform was partly a result of lack of other alternatives. ISI could no longer solve the problemsof the nations, and communism as well as Keynesianism was out of favor. What then, explains the failures of ISI as a development model?
ISI was largely a response to the Great Depression, which highlighted the vulnerability of dependence on single-commodity exports. Industrialized nations around the world had also started to produce more technologically sophisticated goods contributing todeclining terms of trade. ISI strategies were influenced by dependency theory, market failure and Albert Hirschman´s concept of bottlenecks and backward and forward linkages. The state gained a significant role in counterbalancing the dependency on center countries, acting as an engine of growth and keeping employment high in so called state owned enterprises.
However, ISI had some clearlimitations. First, the expensive projects run by the states gave poor returns and the time horizon for these investments was often not compatible with the terms of their debt obligations. Second, there was actually a rise in imports as they were still dependent on capital goods in order to industrialize. To keep imports relatively cheap, exchange rates were often kept artificially high, which in turnaffected the competitiveness of the export sector. Third, this had important implications with regards to financing the model. As export revenues are a source of foreign currency, LA nations often had to resort to external borrowing instead. Bond finance was scarce and so was foreign direct investment, as protectionist measures were necessary to let domestic industry develop free from internationalcompetition. Fourth, SOEs did not have any incentive to become efficient as they were protected from competition. Moreover, they were subject to populist policy-makers who used them to sustain their patronage networks. As result they were often overstaffed. In addition, populist politicians often ran unrealistic programs that would keep employment high, promote generous welfare programs and keepprices low through subsidies. In short, revenues could not cover government expenditures, leading to deficits that had to be financed through debt or printing money. The ISI model thus was dependent upon continued external borrowing in order to keep it running. Once the US and Europe went into recession, interest rates peaked, and LA was cut off from further borrowing possibilities, they had noother alternative for financing than printing more money. As they were simultaneously in recession, this would end with stagflation and the inability to service external debt obligations.
The effects of crisis is also essential as to understanding why policy-makers were eventually willing and able to implement market reforms. ISI showed signs of exhaustion well before these reforms wereactually implemented. But as policy-makers are concerned about political survival, and dependent upon the support of members of political coalitions as well as the voter base unfortunately it seems that crisis was essential in respect to giving policy-makers both the willingness and opportunity to implement bold and otherwise sometimes highly unpopular reforms. Privatization for example, wouldimmediately affect employment as cut-downs would be made in highly overstaffed SOEs, it would affect the bargaining power of the unions, who were traditionally the backbone of coalitions like for example that of the Peronist movement in Argentina. But politicians too would see privatization as a threat, as they used the SOEs to sustain their patronage networks. After running on a platform of state-led...