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Approved For Release 2009/10/06: CIA-RDP85T00875R001600010083-9 -- /33 1---#I - - I Secret DIRECTORATE OF INTELLIGENCE Intelligence Memorandum Uruguay's Continuing Economic Impasse- Secret ER IM 68-133 October 1968 Copy No. 69 Approved For Release 2009/10/06: CIA-RDP85T00875R001600010083-9 Approved For Release 2009/10/06: CIA-RDP85T00875R001600010083-9 WARNING This document contains information affecting the national defense of the United States, within the meaning of Title 18, sections 793 and 794, of the US Code, as amended. Its transmission or revelation of its contents to or re- ceipt by an unauthorized person is prohibited by law. GROUP 1 Eaduded from outomatic downgrading and dednccif cation Approved For Release 2009/10/06: CIA-RDP85T00875R001600010083-9 Approved For Release 2009/10/06: CIA-RDP85T00875R001600010083-9 SECRET CENTRAL INTELLIGENCE AGENCY Directorate of Intelligence October 1968 INTELLIGENCE MEMORANDUM Uruguay's Continuing Economic Impasse Summary During the past 12 years, Uruguay has slipped from first to third place in Latin America in per capita output and has been the only reasonably well-developed country in the world to suffer a pronounced decline in per capita output. Gross national pro'luct and private consumption are botch about 15 percent lower on a per capita basis than in 1955, and investment has dropped to the point that it no longer covers replacement needs in'some areas. One out of every five persons in the labor force is without work. Inflation has grown worse each year, reaching an annual rate of 169 percent during the first half of 1968. Partly as a conse- quence of the prolonged economic decay, Uruguay increasingly has experienced civil disorders. The root of Uruguay's inflationary problem has been the attempt by the highly organized urban labor force and the businesj community to protect their economic positions in the face of a decline in the per capita supply of goods. Wages and prices have chased each other with increasing speed, the race being fueled mainly by an unrestrict- ed expansion of credit to the private sector. Especially in recent years, the government has added to the inflation by enlarging public payrolls and financing the resulting budget deficits with bank credits. Inflation and the necessity to periodically devalue the currency have provoked a Note: This memorandum was produced s oZeZy by CIA. It was prepared by the Office of Economic Research and was coordinated with the Office of National Estimates and the Office of Current Intelligence. SECRET Approved For Release 2009/10/06: CIA-RDP85T00875R001600010083-9 Approved For Release 2009/10/06: CIA-RDP85T00875R001600010083-9 SECRET flight of capital, some of which appears to be lost permanently. The loss of capital, the reduc- tion in imports, the diversion of public funds to current expenditures, and growing uncertainty re- garding future prices and costs are mainly respon- sible for the decline in investment. Uruguay's inflation differs greatly from that in Brazil, Chile, and most other Latin American countries, where the government finances much of investment and its budget deficit is the principal source of monetary expansion. The administration of President Pacheco Areco, who assumed office on the death of President Gestido in 1967, has begun to grapple with economic prob- lems much more forthrightly than any administration in the last decade. Recent economic policy has been guided by the financial stabilization plan that the Gestido government introduced simultaneous- ly with a 50-percent devaluation of the peso in November 1967. The plan called for a reduction in the rate of inflation and a $30 million rise in foreign exchange reserves. These goals were to be reached by drastically reducing the budget deficit, stringently controlling private credit, maintaining a more realistic exchange rate, and directly regulat- ing increases in most wages and o ices. Through mid-1963, foreign exchange reserves rose modestly, owing to a rollover of debts to foreign banks and a severe reduction in. imports. on the-other hand, the inflationary effects of devaluation, unfavorable crop condit.ons, and strike pressure from labor led to higher than planned wage settlements in the public sector and an accele- ration of price increases during the first six months of 1968. Threatened financial chaos, near-paralysis of basic economic and social services, and increased agitation by the Communist-led students and labor unions and by terrorist groups caused. President Pacheco Areco to impose a limited state of siege in early June. Later in the month the administration took unprecedentedly strong actions in an effort to curtail labor and student agitation. The admin- istration also decreed a price and wage. freeze, which stabilized prices in July and August. SECRET Approved For Release 2009/10/06: CIA-RDP85T00875R001600010083-9 Approved For Release 2009/10/06: CIA-RDP85T00875R001600010083-9 SECRET In the coming months the government will be walking a tightrope. It will have to maintain tight controls to begin laying the foundations for economic recovery but in so doing will also be risking a serious disruption of output. Disruption could result from too much anti-inflationary medi- cine or from widespread public disorders in reac- tion to stabilization policies. The alternative to tight controls could be even worse, however. If public discontent forces the government to relax its controls, runaway inflation and a consequent breakdown of normal market activities might develop. Under the best circumstances, constraints on imports, a degree of austerity in government expendi- ture, and the expected decline in livestock output probably will hold total output in the next year at the depressed level of 1967-68. For progress over the longer term, the Uruguayan government must introduce basic reforms conducive to an expansion of exports and investment. Para- moun?. in such reforms would be a shift in economic policy from support of urban consumption to an emphasis on agricultural investment (both public ,and private) and a continuing firm effort to subdue inflation. Such a program would be vigorously opposed by the well-organized labor movement and business interests. Even the population at large would be difficult to convince that, after 12 years of eroding living standards, an extended period of government-fostered austerity was in their interest. Thus thoroughgoing reform and rejuvenation of the economy probably can be accomplished only by a government that is willing and able to thwart the popular will. - 3 - SECRET Approved For Release 2009/10/06: CIA-RDP85T00875R001600010083-9 Approved For Release 2009/10/06: CIA-RDP85T00875R001600010083-9 SECRET Introduction 1. Almost daily since the spring of 1968, Uruguay has experienced unusually severe civil dis?? orders. The agitation has included frequent general strikes and street rioting and the kidnaping of a personal adviser to President Pacheco Areco, who assumed office in December 1967 upon the death of President Gestido. While this disarray partly re- flects the growing organizational competence of Uruguay's leftists, it indicates more fundamentally the social and political consequences of longstand- ing economic decay. The disorder raises anew the questions, among others, of what is wrong with the Uruguayan economy and where it is heading. A Case of Arrested Economic Development 2. Uruguay is the only relatively developed, modern country that has failed to advance econom- ically over the past dozen years. Following a half-century of progressive leadership, the Uruguay- ans by the mid-1950's had erected an efficient economic system based on exploitation of rich live- stock resources. Recent estimates indicate that Uruguayan gross national product (GPLP) per capita in 1955 was the highest in Latin America and com- pared favorably with that in many European countries, being one-fourth higher, for example, than that in Italy.* Moreover, Uruguay had a reasonably equitable distribution of income. 3. Since 1955, however, the Uruguayan econoir.y hug been in a torpor matched in Latin America only by that of Haiti. The total output of the economy, as measured by GNP in c-)nstant prices, has not grown significantly since 1955. Per capita GNP in * The estimates consist of purchasing power parity calculations by staff members of the UN Economic Commission for Latin America, as published in Stanley N. Braithwaite, "Real Income Levels in Latin America," Review of Income and Wealth, June 1968, pp. 113-182. For the present purpose, the geometric means of results obtained with US and Latin American quantity weights are used. These estimates are for gross domestic product, which in Uruguay normally varies only slightly from GNP. SECRET Approved For Release 2009/10/06: CIA-RDP85T00875R001600010083-9 Approved For Release 2009/10/06: CIA-RDP85T00875R001600010083-9 SECRET 1967 thus was about 15 percent less than that of 1955. Activity in all sectors except crops picked up during 1964-66. But in 1967, unfavorable weather caused a decline of one-sixth in agricul- tural output; production in manufacturing., construc- tion, and basic services fell about 4 percent in the aggregate; and GNP fell by an estimated 5 per- cent. No sector has made substantial progress during the past 12 years (see Table 1) . Uruguay. Indexes of Production, by Sector of Origin Selocted Years, 1955-67 1955 1960 1963 1966 1967 2/ Gross national product 100 100 99 107 102 Agriculture 100 87 102 104 86 Crops 100 45 82 82 N.A. Stock farming 100 108 111 115 N.A. Manufacturing 100 105 101 110 N.A. Construction 100 101 69 82 N.A. Basic services b/ 100 106 103 116 N.A. Wholesale and retail trade 100 92 89 101 N.A. Other services c/ 100 106 107 112 N.A. a. Provisional. b. Electric power, transportation, and communications. c. Public administration, personal services, banking, and real estate. 4. Investment has been hit especially hard over the last dozen years as Uruguayan governments suc- ceeded in boosting public consumption (that is, cur- rent government expenditures excluding subsidies and SECRET Approved For Release 2009/10/06: CIA-RDP85T00875R001600010083-9 Approved For Release 2009/10/06: CIA-RDP85T00875R001600010083-9 SECRET transfer payments) while generally maintaining the level of private consumption (see Figure 1). Al- though GNP in 1967 is estimated to have been slightly larger than in 1955, gross fixed investment in 1967 is estimated to have been only about 55 percent of the 1955 level. The share of fixed investment in GNP was only about 12 percent in 1965 and 10 per- cent in 1966 and 1967. Uruguay's overall stock of fixed capital probably has increased a little in the last three years,* but there may have been net disinvestment in machinery and equipment. The volume of construction declined consistently from 1955 through 1963, when it was less than one-fourth of total investment. During 1964-67, construction activity partly recovered because of a diversion of funds from industry to tourist facilities and other commercial construction by investors hedging against inflation. At the same time, investment in machin- ery and equipment dropped from about 10 percent of GNP to 5 percent. 5. The impact of economic troubles on the private consumption expenditure of Uruguay's 3 mil- lion people has been less severe than that on investment. The Uruguayans have managed to maintain total private consumption at about three-fourths of GNP each year since 1955. This accomplishment nevertheless implies a 15-percent reduction in per capita consumption during 1956-67.** Rural inhabi- tants (who presently account for less than one-fifth of the population) and the young entrants into the labor force generally have borne the brunt of the squeeze on private consumption. Farm incomes have been held down by low world market prices for Uruguay's agricultural exports, by discriminatory tax policy, and by lags in the adjustment of exchange rates to reflect increases in farm costs. Unemploy- ment, which has increased steadily since the mid- * are no recent data on depreciation of capi- tal, but figures for the Zate 1950's and early 1960'a range around 7 percent of GNP. ** The data on eonsu, ption should be understood only as rough estimates. Although collectors of Uruguayan statistics impute values for contraband trade with Brazil and Argentina, their national accounts estimates may somewhat understate these flows, particularly of the consumer goods illegally imported into Uruguay. SECRET Approved For Release 2009/10/06: CIA-RDP85T00875R001600010083-9 Approved For Release 2009/10/06: CIA-RDP85T00875R001600010083-9 SECRET 19501s, is estimated to have exceeded 20 percent of the labor force in 1967. The young make up a large share of the unemployed, in part because the labor force is highly organized and union leader- ship has been concerned primarily with insuring job security and wage increases for its membership, not with bringing new wage earners into its ranks. Although urban families with regular wage earners have been better able to protect their standard of living, they also have suffered a decline in consump- tion levels. 6. Despite the decline in output per capita and consumption per capita since 1955, Uruguayans continue to fare better than most Latin Americans. The per capita G14P (on a purchasing power parity basis) of about $750 in 1967 was roughly two-thirds higher than the average for Latin America and ranked Uruguay behind only Argentina and Venezuela in the region; private consumption per capita in Uruguay of some $575 was second only to that of Argentina. Partly because the major economic activity is ranch- ing, average per capita food consumption amounts to 3,000 calories daily, approximating that in the United States. Moreover, in contrast to almost every other Latin American country, the food intake in Uruguay includes a large component of animal pro- tein. Such indicators of general welfare as rates of literacy and mortality and the incidence of disease also continue to rank Uruguayans among the most favored people in the region. In some of these respects, Uruguay matches the high standards in the United States. Impact of Reduced Export Prices 7. The economic stagnation that began in the mid-1950's was precipitated by a factor beyond Uru- guay's control: a substantial drop in world prices for its main exports. Export prices for wool, meat, and hides, which in 1954 were 35 percent above those of 1948, fell by almost 40 percent from 1954 to 1959 (see Figure 2). These export prices largely re- covered in the early 1960's, rising to within 5 per- cent of the 1948-54 average by 1964, but then fell again in 1965-67, when they averaged 20 percent less than in 1948-54. SECRET Approved For Release 2009/10/06: CIA-RDP85T00875R001600010083-9 Approved For Release 2009/10/06: CIA-RDP85T00875R001600010083-9 URUGUAY: Trends in Gross National Product, rigors i Consumption, and Investment, 1955-67 DISTRIBUTION OF GROSS NATIONAL PRODUCT BY SELECTED END USES* INDEX: 1955=100 19% 13% 17% 10% 10% 11% 11% 13% 76% 74% 77% 77% -------------------100% GROSS FIXED INVESTMENT 'In addition to the end uses shown, gross national product includes Investment In inventories and net foreign Investment, both of which may have a positive or a negative value. 1955 1956 1957 1958 1959 1960 1961 1962 1963. 1964 1965 1966 1967 Approved For Release 2009/10/06: CIA-RDP85T00875R001600010083-9 Approved For Release 2009/10/06: CIA-RDP85T00875R001600010083-9 Figure 2 URUGUAY: Trends in Gross National Product, Foreign Trade,' FOREIGN TRADE (Billion 1961 Pesos) (Million US $) 194 1955 1956 1957 1958 1959 1960 1961 1962 1963 1964 1965 1966 1967 and Export Prices, 1954-67 Approved For Release 2009/10/06: CIA-RDP85T00875R001600010083-9 Approved For Release 2009/10/06: CIA-RDP85T00875R001600010083-9 SECRET 8. Because of reduced prices, the output of stock farming and associated export industries and services -- which accounted for about one-sixth of GNP in the mid-1950's -- fell steadily through 1959. By that time, GNP had been depressed to the level of 1954. Although some output was diverted from domestic consumption to export markets, the volume of major exports tended to fall. This decline in volume and the drop in export prices slashed the value of exports by 60 percent from 1954 to 1959. Although export prices improved subsequently, Uru- guay has limped along since 1960 with annual export earnings 25 to 50 percent smaller than those of 1954. 9. The depressive impact of falling world prices on the production and export of livestock products was aggravated by government policies initiated earlier with the aim of achieving self- sufficiency in agriculture. Under the protective umbrella of high export prices, the government had fostered the diversion of pasturage to field crops through the use of price supports in the early 19501s.* Termination' of these price supports in 1957 and the acquisition in 1959 of a loan from the International Bank for Reconstruction and Develop- ment to modernize the livestock industry contributed to an upsurge in output of livestock products (par- ticularly meat) , but output has leveled off since 1964. Price supports for crops were reinstituted in 1962, and the stimulus to investment in the live- stock industry arising from improved export prices has been blunted by taxes on export earnings. 10. Although the level of imports fell dras- tically from 1954 to 1958, Uruguay was able through large-scale borrowing to restore them to more nearly normal levels in the early 19601s, thereby maintain- ing consumption and investment close to the levels of the mid-1950's. Continued low export levels and growing repayment obligations on foreign * Uruguay's occasional attempts to foster self- sufficiency in crops had been generated mainly by strained diplomatic relations with Argentina, the traditional source of wheat imports. The effort in the early 1950's reflected prolonged differences with the Peron regime. SECRET Approved For Release 2009/10/06: CIA-RDP85T00875R001600010083-9 Approved For Release 2009/10/06: CIA-RDP85T00875R001600010083-9 SECRET loans, however, have forced cutbacks in imports since 1962. Most affected by the cutbacks have been imports of capital goods and consumer durables, which provide the bulk of Uruguay's supply of such goods. Imports of industrial materials and compon- ents also have declined or leveled off, thereby preventing expansion of output in the industries dependent on such imports. Obstacles to Economic Readjustment 11. Like Uruguay, various other Latin American countries have suffered a prolonged reduction of export earnings because of weakened prices for their principal exports. And like Uruguay, they have had difficulty adjusting to the situation and have experienced rapid inflation. But none have combined stagnation of output with growing inflation for so long a period. The obstacles to economic readjust- ment and renovation in Uruguay since 1955 arose mostly from attitudes and institutions developed over many decades, which created rigidities in the structure of production and employment and in the financial system. Structural Distortions 12. Since the beginning of this century, the Uruguayans have fostered the development of the most urban, egalitarian society in Latin America. Partic- ularly since the 1930's, Uruguayan governments have promoted industrialization and urbanization by emphasizing the development of consumer goods pro- duction as a substitute for imports, using high tariffs and tax and credit incentives to this end. Almost all of the enterprises developed by this means have been unable to compete internationally but have at the same time generated new demands for imports of capital goods and raw materials. This is a normal problem of import substitution. But in Uruguay, the resources base is too narrow and the domestic market too small to give producers much opportunity to re- duce their reliance on imports. Roughly one-third of Uruguay's manufacturing establishments depend wholly or predominantly on imports for their major raw material input, while the others process mainly domestic agricultural products. SECRET Approved For Release 2009/10/06: CIA-RDP85T00875R001600010083-9 Approved For Release 2009/10/06: CIA-RDP85T00875R001600010083-9 SECRET 13. The country's commitment to liberal ideas is manifested most clearly in its extensive social security system, which resembles. the systems in, advanced Western European countries rather than that of the United States. Uruguay's system, which.covers nearly everyone and offers generous benefits;,; pro- vides about 10 percent of the incomes of households, compared with 3 percent in the United States , and, ;10 to 16 percent in Western European countries.., -. Govern- ment payments for education and. a small consumer subsidy program (which was largely terminated in mid- 1967) usually have provided another 3 to 5 . percent of the incomes of Uruguayan households.. While the system has been able to cover these payments from employer and employee contributions during most of its 60-year history, it has needed support from the government and the banking system in the 1960's. 14. Until recently, at least, the social security system clearly has acted as a major disi,.^,=!ntive to work. The fact that Uruguayan men are ab le , tor example, to retire at full pay at age 50 after 30 years of work does much to explain why the propor- tion of men 45 to 64 years old who are in the labor force is one of the lowest in the world. In recent years the purchasing, power of retirement benefits has been eroded by Inflation, but the lack of employ- ment opportunities probably has ensured the continued prevalence of early retirement. 15. The strong influence of organized labor, which is not seriously countervailed by that of a "big business" element, has been a further constraint on changes in economic policy. Most of the manufac- turing work force and a considerable share of workers in basic services are members of unions. Most unions, in turn, are members of the National Workers' Conven- tion (Convencion Nacional de Trabajadores -- CNT), which on bread-and-butter issues is one of the most militant labor movements in the hemisphere. The CNT leadership, which is dominated by Communists, general- ly has not been able to politicize the rank and file. But labor nevertheless maintains an unusually strong influence on national economic policy, partly because of the diffused nature of Uruguayan politics. In con- trast, the political influence of agricultural interests is very weak, considering the importance of agricul- ture in the economy. - 11 - SECRET Approved For Release 2009/10/06: CIA-RDP85T00875R001600010083-9 Approved For Release 2009/10/06: CIA-RDP85T00875R001600010083-9 SECRET 16. Although some of the weaknesses inherent in the promotion of "hothouse" industries and the extensive social welfare system were apparent in the 1940 's and early 1950's, their seriousness was masked by the generally strong world prices for Uruguay's exports that prevailed during those years. Even when the weaknesses were fully exposed by the drop in export prices, successive Uruguayan governments did little to alter the established policies or popular attitudes underlying them. Rather, they consistently turned to two exped- ients -- increased government spending and foreign borrowing -- that countries commonly use in efforts to live beyond their means, and exercised singularly weak control over the expansion of credit to the private sector. Financial Distortions 17. Inflation at a steadily accelerating rate is the clearest reflection of Uruguay's failure to ad- just to a lower real income. In recent years, in- flation has itself become an important cause of distortions in the economy. The annual percentage increase in the cost of living averaged 18 percent during 1956-62 -- not an unusually high figure by Latin American standards. The increase has since grown each year, however, reaching 83 percent in 1967 if average annual cost-of-living levels are compared (see Table 4) . The recent acceleration in inflation is shown even more clearly by the price rise of 136 percent from 1 January to 31 December 1967 and the further spurt in prices during the first half of 1968 at an annual rate of 169 percent -- by far the most rapid rates in Latin America in the last decade. SECRET Approved For Release 2009/10/06: CIA-RDP85T00875R001600010083-9 Approved For Release 2009/10/06: CIA-RDP85T00875R001600010083-9 SECRET Uruguay: Annual Cost-of-Living Increases a/ 1956-67 1956-62 average 18 1963 21 1964 43 1965 56 1966 74 1967 83 a. Increases are between annual averages of monthly price levels. 18. Surprisingly, the inflation has not yet grown into the runaway variety, under which normal market activities break down. During 1963-66 the increase in prices was roughly proportional to the increase in the money supply (although the supply of quasi-money. such as savings deposits, grew much more slowly). This relationship indicates that the velocity of money did not increase significantly. But for the 12 months ending in September 1967 (the latest period for which data are available). there are indications of an increased velocity of circula- tion -- a trend that could lead to a severe disrup- tion of economic activity if it continued. 19. Uruguay, unlike most other Latin American countries, has fueled its inflation mainly with an increase in credit to private business. The absence of a central institution possessing the usual powers of a central bank and the apparent unwillingness of the government to app. y what monetary controls it had probably are mainly responsible for this exces- sive credit creation. Uruguay had no central bank as such before 1964 and since that time has vested certain central banking functions in a department of the government-owned Bank of the Republic. These - 13 - SECRET Approved For Release 2009/10/06: CIA-RDP85T00875R001600010083-9 Approved For Release 2009/10/06: CIA-RDP85T00875R001600010083-9 SECRET functions -- which include credit regulation through the fixing of banks' reserve requirements and maximum interest rates as well as the issue of currency have been subordinated to the credit expansion activities of the Bank's commercial banking department. The laxity of Uruguayan monetary and credit control is exemplified by the failure of five private banks (including the country's second largest one) in April 1965, which led to heavy withdrawals of foreign exchange from the Bank of the Republic and its default the next month on its foreign exchange obligations. Although the new constitution of 1966 provided for the establishment of a central bank, the bank still was in the process of being organized in early 1968, and central banking functions were divided between it and the Bank of the Republic's department of issue. 20. During 1955-61, virtually all of the net expansion of credit by the banking system was for the private sector. Since 1961, government budget deficits also have been an important source of in- flation, inasmuch as government borrowing from the banks has accounted for about one-sixth of the net credit created. But the private sector obviously has remained the dominant factor in credit expansion. In most other Latin American countries, in contrast, the government budget deficits have been the prime sources of credit expansion. Private credit has been more severely rationed in these countries than in Uruguay, and its expansion has been more a conse- quence than a cause of price increases. Moreover, inflation in these countries was partly a result of glowing governr.ont expenditures on investment, while in Uruguay such expenditures have been declining. 21. The most important causal factor appears to be the upward push of wages as organized labor tried to protect its standard of living. Wages and prices have chased each other with increasing speed, and private credit ha:; been expanded mainly to finance a stagnant level of production at rising cost and price levels. Private investment has been declining and consequently could not have been an important cause of inflation. Until. 1963, exchange rates were kept stable for two or threc years at a time while domes- tic inflation was continuing, but each periodic re- adizstment of the exchange rate further boosted SECRET Approved For Release 2009/10/06: CIA-RDP85T00875R001600010083-9 Approved For Release 2009/10/06: CIA-RDP85T00875R001600010083-9 SECRET inflationary pressures. Since 1963, however, de- valuations have been frequent, and it has become increasingly difficult to distinguish among the various causes and effects of inflation. Expediency an Public Finance 22. Uruguayan fiscal policies have fed infla- tion and diverted funds from productive to nonpro- ductive uses . The government has made heavy use of the public payroll in an attempt to sustain urban standards of living in spite of a declining per capita output. The share of the country's wage bill paid by the central government and the public agencies and enterprises has risen from 30 percent in the mid-1950's to about 40 percent in recent years. Presently, about 20 percent of employment is in the public sector.* About 90 percent of public employees are civilians; the military estab- lishment is small, numbering less than 15,000 per- sons. Some government employees draw pay for only an hour or two of work each day -- an obvious case of disguised unemployment compensation. 23. Within the central. government, the padding of payrolls appears to have been most severe since 1961. Spending for wages rose from 45 percent of current expenditures in 1.961 to an average of more than 60 percent in 1964-65 (see Table 3) . A con- stitutional provision prohibiting wage increases in the public sector during the 1966 election year enabled the central government to restrain such pay- ments in that year and to hold the rate of growth of its total current expenditures below that of GNP. But to regain parity with private wage scales (which were not restrained in 1966) , the government advanced wages in the public sector by an average A Time veri e on t?l. rtmt;