The Latin American Transformation: Mercantilism to

Capitalism

Pedro Romero AlemanGeorge Mason University

08/27/2007

Latin America Landscape

The Puzzle

“Why did Latin America stagnate in the twentieth century while the US and Canada surged ahead?” Franko: 2003 p. 30

Conventional Answers

Marxist theories Exploitation by developed countries (Colonial

Vestiges) Center – Periphery or International Division of

Labor Vicious Circle of Poverty (Ragnar Nurkse)

Countries are poor because they’re poor Low income, low savings, therefore low capital

which leads to low incomes.

Critiques Poverty as a natural state of human beings Rich nations were also in the past poor People in those countries at that time faced the

same problems Low incomes, savings and capital accumulation Malnutrition, unhealthy environments, population

pressures But they were able to get out of the vicious circle Hong Kong y Chile, Cuba y Venezuela

An Alternative View

"It may be true that in certain conditions, where an undeveloped government apparatus is scarcely yet adequate to perform [such as a minimal state], it would be wise to confine to it, since an additional burden would exceed its weak powers and the effect of attempting more would be that it did not even provide the indispensable conditions for the functioning of a free society."

Friedrich Hayek, 1979. Vol 3 Pg 41. Brackets added.

An Alternative View

Constitutions as rent seeking instruments Legal labyrinth Interest group conflicts

Consequences: EFW, GDP pc Absence of enforcement Property Rights unprotected Higher transaction costs/Entry barriers Corruption Lower Economic Growth

Repressed Societies

Source: Gwartney, James and Robert Lawson (2004). Economic Freedom of the World: 2004 Annual Report.Vancouver: The Fraser Institute. Data retrieved from www.freetheworld.com

Economic Freedom Index

0123456789

10

1975 1980 1985 1990 1995 2000 2002

Bolivia Colombia Ecuador Peru Venezuela Chile

Growth impossible without Institutions

GDP vs RULE LAW

5

6

7

8

9

10

11

-1.2 -0.7 -0.2 0.3 0.8 1.3 1.8 2.3

Index of Rule of Law

Ln(GDP pc) PPP

Chile

Colombia

Ecuador

Hong Kong

Peru

Venezuela

US

Source: Data retrieved from the International Institute for Corporate Governance at http://iicg.som.yale.edu/data/datasets.shtml

Fiscal Opacity

Institutional Matrix and Resources Political System

“legal relations that govern society”Property rights

Private-Public-Communal-Absence of Ownership

Economic System“a process of material transformation”

DecisionsConsumption-Production-Distribution

Natural Resources“They are out there”

Constraints/AdvantagesRenewable and Non-renewable Resources

Latin America Transformation Productive structure: Consumption goods,

intermediate (production) goods, time or process consuming time.

Public Policies can either hinder or foster/preserve the production process Institutional matrix: Rule of Law or Rule of men

The manner in which a society structures its political/legal institutions helps shape the character of life in that society.

Mercantilism “The property rights over land and water within the limits of the

national territory belong to the State, which has the right to transfer it to the individuals…The State will have anytime the right to impose over private property any requirement stemming from the public interest…The State has the direct control over all the natural resources on the continent and maritime border plus everything under the ground…” Mexican Constitution, 1917. Art. 27.

The goal was to make an equitable (re)distribution of the wealth.

318 amendments by the end of 1980 Inflation of law Centralization of political power, none or few checks and

balances

Inward Development Strategies

Import Substitution Industrialization ISI: government as the main developmental actor. Exchange rate and trade tools used to promote

industrialization Raul Prebisch and ECLAC Keynesianism, disliking/non-satisfaction

w/capitalism, given LATAM backwardness

Inward Development Strategies Local and international elites favor short-term

profits instead of long-term dynamic growth Latifundia (redistribuion of land) Paul Baran thought revolution as the only way-out F. Henrique Cardoso thought that autonomous

development was possible. Structuralists: ToT, government as counterbalance

to Multinational Companies A. Hirschman: development as bottleneck, lack of

complementary factors

But…

“Somewhat ironically, in the first stages of import substitution industrialization, national imports usually rose.” Franko: 59

Outward Development Strategies

Subsidies to production for exportation Cheap credit to domestic banks Supported by international organizations Interest groups, barriers to entry High devaluations of national currencies

Consequences Lack of rule of law Poor protection property rights Distortions of Productive Structure of the

economy Urban in detriment of rural development Low quality industrial goods in detriment of

agricultural goods Large Government Spending but limited

governance capabilities

Consequences

Huge fiscal deficits and external debts Inflation, volatile currencies Higher interest rates than elsewhere A complex tax scheme that hinders

entrepreneurship Informality Poverty

Consequences

Argentina’s Happy 1990s So what went wrong? The federal government's fiscal position deteriorated steadily during

the boom years this partly reflected a recognition of unfunded pension liabilities.

The fiscal problem reflected a lack of discipline at the provincial level Once off-balance sheet borrowing is taken into account as well, the

consolidated budget deficit was around 2½ percent of GDP even as the boom peaked in 1997 and 1998.

In 1994 the average federal employee was paid 25 percent more than the average private sector employee; by 1998 the differential had risen to 45 percent.

By the mid-to-late 1990s, public sector employment accounted for 12.5 percent of the labor force in Argentina, compared to barely 7 percent in Brazil and Chile

Argentina's total foreign currency debt was around five times the size of its foreign currency receipts from exports of goods and services.

A Message of Hope “Economic achievement and progress depend largely

on human aptitudes and attitudes, on social and political institutions and arrangements which derive from these, on historical experience, and to a lesser extent on external contacts, market opportunities and on natural resources.” Bauer:1976, p. 41

Bottom-up approaches to development Entrepreneurship

No politicians Limited and Constitutional Government