The
literature on economic growth, development, and prosperity mostly
agrees that the key to prosperity is open markets and sound
institutions, particularly a strong rule of law. Sound institutions and a strong rule of
law permit individuals to accumulate wealth, through savings,
investment, or purchases, and permit people to work and enjoy the
fruits of their labor. The protection of private property is the
pillar to foster and sustain economic growth, because for
individuals to work, save, and invest, or for companies to begin
and expand their operations, they need to have a guarantee that
their property will not be taken from them.
Latin America went through a period in the
early 1990s in which countries began to open their markets more
aggressively than ever before. The opening of the markets, it was
said, would modernize the Latin economies, eliminate bureaucratic
distortions, attract foreign investment, and ultimately enable
ordinary Latins to have more jobs and a better standard of living.
A persistent recession since 1997 that spread out throughout the
region, along with political instability, financial crisis, and
increasing poverty, shattered the hopes for prosperity and left
many wondering if the U.S. free-market theory would really work in
Latin countries, or if it were a plan to benefit the rich at the
expense of the poor. I am here today in an attempt to provide an
answer to that question and to look at what can be done so that
Latin countries can grow and prosper as they hope to do.
I
would like to use the Heritage Foundation/Wall Street Journal
annual Index of Economic Freedom to frame the Latin American economies
and to help understand what liberalization in the region was about.
Economic freedom is defined in the Index as "the absence of
government coercion or constraint on the production, distribution,
or consumption of goods and services, beyond the extent necessary
for citizens to protect and maintain liberty itself." The Index
measures economic freedom in 10 different factors:
- Trade
Policy
This factor looks at the obstacles to trade in the form of
tariffs or non-tariff barriers, including quotas, licensing, and
corruption in customs.
- Fiscal Burden of
Government
This factor looks at the top income and corporate tax
rate, as well as government expenditures as a percentage of
GDP.
- Government
Intervention
This factor measures government consumption as a
percentage of GDP, government ownership of business and industries,
the share of government revenues from state-owned enterprises, and
government ownership of property.
- Monetary
Policy
This factor includes the weighted average inflation rate
for the past 10 years.
- Banking and
Finance
This factor looks at the amount of regulation affecting
banking and finance activity.
- Capital Flows
and Foreign Investment
This factor looks at the degree to which foreign
investment faces the same regulations as domestic investment, and
at restrictions on capital flows.
- Wages and
Prices
This factor assesses the freedom to set prices privately,
whether there is a minimum wage, and government subsidies.
- Regulations
This factor looks at the regulations affecting businesses,
such as steps required to open a business or to get a license,
labor and environmental regulations, and corruption in the
bureaucracy.
- Property
Rights
This factor assesses the strength and independence of the
judiciary to enforce the law and whether expropriation exists in a
country.
- Black
Market
This factor assesses the size of the informal sector.
For
each factor, a country receives a score from 1 to 5--where 1 is
freest and 5 most repressed. These scores are averaged to obtain a
country's overall score. Finally, the countries are placed in a
world ranking of economic freedom.
One of the major findings of the Index is
a strong, positive correlation between economic freedom and income
per capita (See Chart 1). In fact, every country in the world with
more than $16,000 annual per capita income is economically free or
mostly free in all of the Index factors, not just a few. A recent
research study by Richard Roll and John Talbott from the University
of California at Los Angeles, on the relationship between political
and economic freedom indicators and income per capita, indicates
that these variables of study explained about 80 percent of the
variation in per capita income across countries. Of all the variables involved in the
study, the property rights, regulation, and black market factors of
the Index were found to have the highest significance in explaining
that variation. In other words, this study indicates that
individuals and businesses invest, save, and work where it is less
costly to do so and where the fruits of their efforts are best
protected.
Reform in Latin America
The early 1990s were years of promise for
Latin America. The world saw democracy strengthening, markets
opening, freedom flourishing, and investment flowing to the region.
The developed world applauded reform efforts in Argentina, Peru,
Chile, Bolivia, Colombia, and saw reform replicating, although at a
slower pace, in Uruguay, Mexico, and Brazil. People who had left
their countries for economic or political reasons returned to bet,
along with their compatriots, on the promise of prosperity in their
countries.
Using the Index as a framework to take a
picture of the reform process in the countries I just mentioned, we
find that economic freedom took the form of privatization, tamed
inflation, deregulation of the banking sector and of foreign
investment, and price liberalization. But with the exception of
Chile, no Latin country strengthened its judicial system to protect
property rights, nor did any of them ease regulations on starting
and operating, primarily, a small and medium-sized business. In
addition, the informal sector activity increased. All of these are
areas that, as the research we just mentioned indicates, are key to
long-term economic growth and prosperity.
So,
the answer to our original question--why liberalism did not deliver
prosperity in Latin America--is that liberalism did not deliver
prosperity because it never existed. To call this partial opening
of markets a "free market" is to not understand what a free market
is in the first place. And to expect a partial opening of
markets--which precisely for being "partial" concentrates wealth,
destroys small businesses, and benefits parts of society at the
expense of, mostly, the poor--to deliver the kind of prosperity
that developed countries enjoy is like hoping to win the lottery
without buying a ticket.
Let
me quickly mention that Uruguay is a peculiar reform case. Reform
in Uruguay has been slow, although progressive, and reform efforts
have been preserved. It has a sound judiciary. So, from this
perspective, Uruguay has a tremendous opportunity to advance reform
and bring prosperity, since it seems to have the institution--the
judiciary--that will make that reform sustainable. All it needs is
the political will to open the markets fully.
Looking back, again, to the Latin
experiment with reform in the framework of the Index, let me offer
a few insights about our region:
- Except in Chile, there is no principled
commitment to the reform process in Latin America. The Latin
countries reform in response to a crisis, or to the prospect of
good relations with the United States that eventually can give them
some kind of access to the U.S. market. Also, reform sometimes is
imposed by international organizations like the World Bank or the
International Monetary Fund (IMF) in exchange for loans. When
reform is imposed, it is hard to sustain.
- Without easing the burden of taxation,
corruption and bureaucracy on small and medium business, the Latin
countries will not be able to foster a dynamic economic
environment. As a result, problems of unemployment, recessions, and
political instability will become persistent.
- And the most important conclusion is that
economic reform without a strong rule of law cannot be
sustained.
With
the right policies, Latin countries can expect to have economic ups
and slowdowns, but they will not plunge into a deep crisis every 10
years, wiping out years of reform efforts. It is ultimately their
choice whether they want to develop or to live eternally in poverty
and instability.
Ana I. Eiras
is Senior Policy Analyst in the Center for International Trade and
Economics at The Heritage Foundation. She spoke at the Artigas
Institute of Foreign Service in Montevideo, Uruguay, on March 12,
2003.