Why Latin American Nations Fail: Development Strategies in the Twenty-First Century
240
Why Latin American Nations Fail: Development Strategies in the Twenty-First Century
240Hardcover(First Edition)
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Product Details
| ISBN-13: | 9780520290297 |
|---|---|
| Publisher: | University of California Press |
| Publication date: | 10/03/2017 |
| Edition description: | First Edition |
| Pages: | 240 |
| Product dimensions: | 6.00(w) x 9.00(h) x 0.80(d) |
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CHAPTER 1
Introduction
Matías Vernengo and Esteban Pérez Caldentey
INSTITUTIONS AND THE LIMITS OF THE CURRENT DEVELOPMENT STRATEGY
There are many explanations for why some nations grow to be rich while others are poor. And there are different views on why the great majority of economies, including the Latin American ones, remain stuck in between both poles without being able to compete with poorer economies or catch up to the rich ones. The traditional mainstream explanation for the differences in economic development and growth across nations has relied on the neoclassical production function. The production function permits the decomposition of the rate of growth of an economy into the respective rates of growth of factor inputs (i.e., labor and capital) and a residual, total factor productivity, which represents the different forms of technological change.
Since growing by accumulating successive units of capital and labor is confronted with diminishing returns, a sustainable growth path can only be achieved through innovation and technological progress. This placed the focus of the analysis of growth — and of catch-up between countries — on technology, even when considering increasing returns to scale in capital and labor. However, besides insurmountable inconsistencies characterizing the specification of a production function (such as the fact that capital cannot be measured independently of prices and distribution, as pointed out in the Cambridge capital controversies), a large part of growth rates and differences in growth rates among nations cannot be explained by either factor accumulation, innovation, research and development, or technological progress (Helpman, 2004). This key failure of mainstream growth theory opened the route to consider alternative explanatory variables and, in particular, sociopolitical factors including geography, culture, and institutions.
Jared Diamond, author of the best seller Guns, Germs, and Steel, is correct to point out that, in part, technology is geographically determined; for him, geography plays a central role. Culture has fewer defenders; most prominently among modern economists is probably McCloskey (2010). But the obstacles to that argument are even more difficult to overcome, not the least because in modern times, countries with diverse cultures have become developed, like Japan and South Korea (Acemoglu and Robinson, 2012). The Weberian Protestant work ethic would not help, in this case, to explain relative development. It is important to note that culture does matter, even if it is not determinant, since different cultures produce different types of capitalism, some more benign than others (Hall and Soskice, 2001).
The explanations of growth differences based on cultural and geographic patterns lack the generality and universality required by neoclassical theory to argue that societies placed in different contexts and historical periods respond, at the general level, to one and the same principle: utility maximization. This limitation has significantly contributed to consolidating the institutional factor as the most promising mainstream line of research to explain the central divide between the levels of development across different nations and historical periods.
According to this line of research, institutions are generally defined as "the informal norms and formal laws of societies that constrain and shape decision making" (Alston, 2008, 2). "Informal norms" are standard rules of behavior that are unwritten but understood within a group or a community; more specifically, the term refers to sanctions, taboos, customs, traditions, and codes of conduct. By contrast, formal rules "are consciously designed by humans and often codified in written form — examples are constitutions, laws and regulations as well as property rights" (North, 1990, 97).
Within this view, the focus is placed on property rights as the crucial "institution" that affects and enhances economic growth and development. This responds to an issue of theoretical consistency: the definition and specification of property rights are required for the determination of an optimal allocation of resources. Also, the "one concrete institutional element on which all authors agree as a major determinant of economic development is the existence of secure property rights" (Angeles, 2011). One of the most recent statements of the view that institutions (and private property rights) are essential for development and growth is Acemoglu and Robinson's (2012) Why Nations Fail.
In the case of Latin America, the institutional approach to growth has a long history, dating back to the failure of mainstream empirical studies based on trade and protectionism to prove and illustrate the distortive and inefficient nature of the state-led growth policies advocated by different governments in the region in the 1960s and '70s — which, by the way, resulted in the highest growth rates recorded in over four decades. The weakness of this economic argument led to a body of research and thinking termed the "new political economy," which emphasizes, in a way that is very similar to Acemoglu and Robinson's distinction between inclusive and extractive institutions, the rent-seeking character of government and government officials. Rent-seeking is portrayed as a wasteful, inefficient, and costly activity inherent to any regime based on strong intervention of the state in the economy. According to this line of thinking, government intervention transformed the main agents of production and growth, namely firms and entrepreneurs, into rent-seeking entities.
More recently, Engerman and Sokoloff (2000) have provided a variation on Acemoglu and Robinson's view of the role of institutions and property rights to analyze Latin American growth performance. For them, the point is that countries in the region with a high proportion of people in relation to available land would have, according to neoclassical theory, low wages — that is, low prices for the abundant factor (labor) and high prices for the scarce factor (land). In their view, then, societies with high population-to-land ratios developed institutions that protected the white elites and were, in general, less egalitarian. Property rights tended to be more insecure, and hence innovation and growth faltered. Institutions (property rights, essentially) were central, but so too was the geographic "good luck" of abundant land.
In this book, we argue that there are several key problems associated with "new institutionalist" arguments and, in particular, with the way they are applied to viewing and understanding Latin American development. For one thing, they provide a limited view of comparative historical analysis, failing to read and understand history on its own terms. An illustrative example is Acemoglu and Robinson's (2012) characterization of the Spanish and English colonizations as being extractive and inclusive, respectively, when in fact the historical record shows that both types of colonization were at times extractive and inclusive. Also, while examples of extractive institutions and poor growth performance would obviously come up in a study that covers such an enormous territory in terms of countries and time periods as Why Nations Fail, there are also major counterexamples that disprove their main arguments — for example, the contribution of property rights to the industrial revolution.
There is solid historical evidence showing that the usefulness of patents, copyright, and other forms of property protection for explaining growth is limited at best (Moser, 2013). Hoppit (2011) argues that in the case of England,
property was often heavily taxed, frequently expropriated and, exceptionally, eradicated through redefinition. Such vulnerabilities did not diminish after the Glorious Revolution, they increased. ... The scale of that expropriation was such, and the consequences so profound, as to undermine an important thesis that property rights became more secure after the Glorious Revolution, developed in a notable essay by Douglass North and Barry Weingast and now conventional amongst some 'new institutional economists'.
In other words, the Industrial Revolution can hardly be attributed to strong property rights in England. If one thinks of modern developing countries, it is hard to be sanguine about the notion that Western-style property rights in developing countries would be a sufficient condition for catching up.
Turning to more recent historical examples, the economic success of South Korea and some other Asian nations such as Singapore can hardly be said to be based on inclusive institutions. As is well documented, South Korea (as well as Japan), in an earlier period in history, used protectionism, exchange rate control and management, credit controls, and a mix of public and private initiatives to boost its real gross domestic product (GDP) per capita from U.S. $1,127 in 1961 to $28,875 in 2013, thereby changing from a middle-income to a high-income country (Chang, 2007).
Finally, the institutions emphasized by the new institutionalism and in Why Nations Fail, fundamentally property rights, are uniquely concentrated on the supply side of the economy, along with the generation of incentives for productive investment (to buy machines and equipment).
A different story about relative development could be advanced. Adam Smith, in The Wealth of Nations, argued that the division of labor, which was the basis of technological progress, was limited by the extent of the market — that is, by demand. According to Landes (1969),
it was in large measure the pressure of demand on the mode of production that called forth new techniques in Britain, and the abundant, responsive supply of factors that made possible their rapid exploitation and diffusion. The point will bear stressing, the more so as economists, particularly theorists, are inclined to concentrate almost exclusively on the supply side.
In other words, institutions might be relevant — though not, primarily, the ones associated with the supply side, but rather those linked to the demand side, in Keynesian fashion.
Neoclassical economists, when discussing growth, always downplay the importance of demand. Structuralist authors with Keynesian tendencies, on the other hand, emphasize the role of demand-led growth. The dominance and persistence of Say's law, the notion that demand adjusts to supply, is behind the limits of the neoclassical account of the wealth of nations. Note that a demand-based argument for the wealth and poverty of nations implies that there are other institutions that matter for development. Poor countries that arrive late to the process of capitalist development cannot expand demand without limits, since the imports of intermediary and capital goods cause balance-of-payments crises. The institutions that allow for the expansion of demand, including those that allow higher wages to expand consumption and to avoid external constraints, are and have been central to growth and development. The role of the state in creating and promoting the expansion of domestic markets, in the funding of research and development, and in reducing the barriers to balance-of-payments constraints, both by guaranteeing access to external markets and by reducing foreign access to domestic ones, was crucial in the process of capitalist development.
In this view, for example, what England had and China did not was a rising bourgeoisie (capitalists) that had to compete to provide for a growing domestic market that had acquired a new taste (and hence expanding demand) for a set of new oriental goods, like cotton goods from India or porcelain from China, as emphasized by Berg (2004) among others. In the same vein, Latin American economies lacked an expanding market that would have forced domestic capitalists to produce and innovate in order to keep up with the competition. Latin American economies entered the world economy to produce silver (mining economy, Amerindian population), sugar (plantation economy, African American population), and other commodities for external markets. These were exploitation economies, less reliant on the development of domestic markets, typical of settlement colonies in the northeast United States or of the central countries in Western Europe.
CONTEXT, OBJECTIVES, AND OUTLINE OF THIS BOOK
Latin American economic development strategies have gone through significant changes over the past three decades, following the debt crisis and the "lost decade" of the 1980s. And yet, from the '80s to the present, Latin America as a whole has registered mediocre growth trend levels. The average rate of per capita GDP growth for the period 1980–2014 is 2 percent. This performance responds not only to the medium- and long-term effects of successive crisis episodes within the region — starting with Mexico's "tequila crisis" in late 1994 and culminating with Argentina's default in early 2002 — many of which were the product of unsustainable balance-of-payments difficulties, but also to expansions that are, in comparison with other developing economies, short lived and less intense.
In the most recent period of expansion (2003–08), in spite of improved international conditions associated with higher commodity prices, greater access to liquidity, and external demand that allowed for higher growth rates (Pérez Caldentey and Vernengo, 2010), Latin America reached only a 3 percent rate of growth of GDP per capita, which is below that of all other developing regions (9.3, 7.0, 3.6, 6.6, and 3.8 percent for East Asia and the Pacific, Europe and Central Asia, the Middle East and North Africa, South Asia, and Sub-Saharan Africa, respectively). This expansion period did little to change the growth trend.
Currently the region faces more stringent external conditions. The slowdown in the external demand of developed economies and also of China, which had become a major trade partner for some of the economies in the region, coupled with the ongoing crash in commodity prices, has affected those economies whose production structure and exports are resource based. The transmission channels include not only the balance-of-payments difficulties, but also lower fiscal revenues (which, in some cases, far surpass those of other sources of public income), lower rates of growth, and even contractions in domestic investment (which is based on natural resources in many economies of the region). But the concomitant reductions in foreign financial inflows and higher risk perceptions have also affected countries that are not specialized in commodities. Far from being temporary, the current slowdown seems to embody a perception of protracted economic stagnation.
At the same time that Latin America faces a more restrictive external environment, other long-standing problems of the region — such as persistant poverty rates affecting some parts and some income strata of the region, high inequality (Latin America is the most unequal region in the world after Sub-Saharan Africa), deficient education standards, and low productivity, among others — have become more visible and appear to be, if only at the discursive-rhetoric level, a more urgent priority for policy makers. This is not to deny that significant progress has been made in many different economic and social areas. However, these efforts — and, more importantly, their accompanying successes — have remained confined in scope and overall impact. They have not been able to generate the broad-based upgrade in capabilities needed for development (Paus, 2013).
Furthermore, the political shift toward democracy and the increasing importance of the rule of law as a guiding principle in civilian life that took hold of Latin American societies since the '80s, and more strongly in the '90s, has been tainted as a result of the more recent corruption scandals that affect many governments in the region. That is true even though corruption is certainly a structural problem that precedes the recent events. Also, the rule of law and democratic principles have been undermined by the persistence of political instability and, in some cases, the sudden and illegal takeover of elected governments by judicial and mediatic processes.
(Continues…)
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