From the mid-to-late 1990s, Latin America witnessed profound economic, political and distributive changes. During the 1990s, the region experienced slow growth followed by the ‘lost half-decade’ of 1998-2002. However, from 2003 to 2008 Latin America experienced an unprecedented expansion which generated an average GDP growth of 5.5 percent a year, second only to the growth registered from 1967 to 1974 (Ocampo 2008). Such steady expansion was, to some extent, a rebound from the stagnation recorded during the “lost half-decade” of 1998-2002, but featured also a sharp increase in investment rates which grew by 5 GDP points relative to 2002. However, from the third quarter of 2008, Latin America was affected by the global financial crisis which is expected to reduce GDP by 1.9 percent and produce a moderate growth of 3.4 percent in 2010 (CEPAL 2009). A second important change concerns income distribution. Contrary to the adverse distributive trends observed in the 1990s, between 2003 and 2007, income inequality declined in the vast majority of the countries of the region. Finally, since the mid 1990s, the region has also experienced a steady shift towards democratization and the election of Left-of-Centre (LOC) governments (Panizza 2005)1. As underscored by the election in mid March 2009 of Mauricio Funes in El Salvador, during the last decade the region’s political centre of gravity has shifted with surprising regularity towards regimes which attribute greater importance to social issues while avoiding the populist excesses of the 1980s. However, the recent coup in Honduras, the election of a centre-right president in Panama in July 2009, and the poor results of the Justicialista Party of President Fernandez during the July 2009 parliamentary elections in Argentina, may signal that such a trend has reached its peak.
To what extent are these changes explained by shifts in external economic conditions, and to what extent are they instead the result of the adoption of new economic and social policies in the region, especially those adopted by LOC countries? To what extent are the distributive improvements recorded since 2003 likely to be overturned by the present crisis? These are the main issues explored in this paper. Section 1 reviews the recent decline in income inequality. Section 2 discusses the factors that could explain it, i.e. improved external conditions, a positive business cycle, a fall in educational inequality, and changes in macroeconomic, labor and social policies. Section 3 tests econometrically the relative importance of these factors, while Section 4 analyzes the impact of the financial crisis and uses the econometric model estimated in Section 3 to predict the inequality changes that may be expected in 2008 and 2009.