The Lagging Continent
Why does Latin America, economically, continue to be the sick man of the West?
The source: “Latin America in the Rearview Mirror” by Harold L. Cole, Lee E. Ohanian, Alvaro Riascos, and James A. Schmitz Jr., in The Federal Reserve Bank of Minneapolis Quarterly Review, Sept. 2006.
Economically, Latin America is the sick man of the West. While many ailing nations—Italy, Spain, and Portugal—checked out of the financial hospice after World War II, Latin America grew more feeble. Compared with the United States, the region has become dramatically poorer over the past 50 years, while the economies of Europe have taken off. Ireland, only recently a basket case, is now 80 percent as well off as America, in terms of its per capita gross domestic product (GDP). Argentina, which 200 years ago was richer than the United States, has fallen to 30 percent of the U.S. level of GDP. Since 1950, the average Western European country has boosted its typical citizen’s income from 40 percent to 70 percent of the U.S. level. Meanwhile, Latin America has fallen from 28 to 22 percent.
Latin America, argue economists Harold L. Cole, Lee E. Ohanian, Alvaro Riascos, and James A. Schmitz Jr., should do better. Its citizens share descent, language, religion, and form of government with the world’s wealthiest nations. “Latin America and the other Western countries should have the same innate ability to learn and adopt successful Western technologies, and . . . with similar cultures, they should have similar preferences for market goods,” Cole and his colleagues write.
The authors rule out many of the usual explanations for the region’s lagging performance. Compared with the rest of the world, Latin America does not suffer from massive unemployment, a lack of basic education, a capital shortfall, a staggeringly high birthrate, or an utter lack of democracy. Quite the contrary, say Cole and Ohanian, professors at UCLA, and economists Riascos, of the Banco de la Republica de Colombia, and Schmitz, of the Federal Reserve Bank of Minneapolis.
The Latin American employment rate is about 70 percent of the rate in Europe and the United States, a significant gap, but not enough to explain the region’s economic stagnation. Argentina’s and Chile’s over-25 populations in 1990 had 7.8 and 6.2 years of schooling, respectively, the authors say. Latin America has not experienced a major deficiency in the amount of capital available for investment in recent decades, and Latin American governments on average have been almost as democratic as those in Western Europe over the past 15 years, according to research cited by the authors.
To be sure, some Latin American countries are doing better than others. But compared with the United States, which had a per capita gross national income of $43,740 in 2005, Chile weighs in at $5,870, Venezuela $4,810, and Bolivia $1,010. The figure for the poorest developed Western European country, Portugal, is $16,170.
The inefficiency of Latin American economies can be traced, in part, to government policies, the authors say, including tariffs, quotas, multiple exchange-rate systems, regulatory barriers to foreign products, inefficient financial systems, and large, subsidized state-owned enterprises.
In one of several instances when barriers were lifted—foreigners were allowed to invest in Chile’s previously nationalized copper industry—copper production grew by 175 percent in 10 years. Individual mines became more efficient, and Chile’s relative productivity increased from 30 percent to 82 percent of the U.S. level. The 1991 privatization of the Brazilian iron ore industry, after nearly 20 years of negligible growth, sent productivity soaring more than 100 percent by 1998. One key to the growth of the industry, the authors say, was changes in work rules that had limited the number of tasks a worker could perform. Machine operators, for example, were prohibited from making even trivial repairs to their machines. With looser rules and private ownership, output increased by 30 percent.
In contrast, the authors say, the nationalization of the Venezuelan oil industry in 1975 led to a decline of 70 percent in productivity and 53 percent in oil output in less than 10 years.
Why would a government choose to make its economy unproductive? The answer, the authors contend, is that a small part of society would be harmed by economic changes, and this group has sufficient resources to block their adoption.
Governments have an incentive to make it virtually impossible for foreign competitors or even local entrepreneurs to start businesses that compete with incumbent, low-efficiency producers. “When competitive barriers are eliminated and Latin American producers face significant foreign competition, they are able to replicate the high productivity level of other Western countries,” the authors conclude.