The Copacabana Pact sounds vaguely enjoyable, but is in reality a major threat to the world’s financial system. President Nestor Kirchner of Argentina and President Luis Ignacio (Lula) da Silva of Brazil agreed earlier this month to coordinate their debt negotiations with the International Monetary Fund. Creditors of the world, beware!
The last few years have not been good to the free markets in Latin America. Argentina has defaulted on its debt, expropriated middle class savings and elected a socialist-populist president, although it has since economically rebounded from the trough of a 23 percent decline in gross domestic product.
The Lula government in Brazil, having behaved admirably orthodoxly in its first year in office, is now facing increasing demands for the resignation of the Finance Minister and the Governor of the National Bank, and their replacement with more pliable and expansionary substitutes.
President Hugo Chavez of Venezuela is drifting steadily away from democracy, and from economic sanity — his economic madness is only propped up by the current very high oil prices.
The democratically elected, economically sensible Bolivian president Gonzalo Sanchez de Losada, was forced out by a Castroite leader of the former cocaine growers’ union.
Mexican president Vicente Fox, the hope of liberalization on his election in 2000, has achieved almost nothing in that direction and seems likely to be succeeded by the mayor of Mexico City, Andres Manuel Lopes Obrador, a man who regards the 71-year ruling Institutional Revolutionary Party (PRI) as excessively committed to the free market.
Given the worldwide successes of the free market since the 1950s, and indeed before 1914 (in the latter of which successes Latin America of course largely shared) one must ask why Latin American countries do this. Is it something in the water?
Nearly all countries elect economically and politically reckless governments occasionally — it’s the nature of democracy; voters from time to time like to believe they can get something for nothing, or at the expense of somebody else. But in Western Europe, or in Asia, the economically reckless come to power only occasionally — the last example in a major Western European country was Francois Mitterand’s first government in 1981, the one before that Britain’s Harold Wilson in 1974 — and generally don’t last long. The Mitterand government overhauled its policies, bringing them back towards reality, in 1983, while the Wilson government’s flirtation with economic autarky ended after only 15 months, in mid 1975, well before the International Monetary Fund stepped in and enforced discipline.
Latin America, of course, is considerably less wealthy than Europe, although some countries, notably Argentina and Venezuela, enjoyed near-European affluence 50 years ago. However even among poor countries, some of which have also become locked into a cycle of poor electoral choice and progressive impoverishment, there are occasional breakouts from poverty and when they happen, they tend to last.
India, poorer than most of Latin America in 1950 and proceeding along a parallel downward track throughout 1950-90, not only turned towards economic reform in 1991, but intensified and deepened the process, achieving progressively higher rates of economic growth by doing so, so that at this stage, even though India remains a predominantly very poor country, it seems most unlikely that a relapse into socialism and decline will take place.
India is actually a very good benchmark, because the intellectual odyssey undertaken by the Indian political system was so different from that in Latin America. When the first reforms were tried, after 1991, they produced a certain measure of progress, in particular a move away from the near bankruptcy of 1991, but then stagnation again set in, and progress slowed. However, instead of declaring reform a failure, the then opposition party, by no means ideologically committed in principle to economic reform, took up the reform banner and promised to intensify the changes, winning an election by doing so and then indeed carrying the process to new heights and achieving a level of success that was undeniable and very likely irreversible.
In Latin America, this doesn’t happen. Time after time, in country after country, a reform process is begun with great fanfare, makes considerable progress against the country’s problems in the early years, and then slows to a halt, while the anti-reform political factions eat away at any progress that has been made. When difficulties reappear, they are blamed on the reforms, and an electoral mood of revulsion against “neo-liberalism” sets in, returning the country to its initial state, albeit with yet more billions of international debt, on which it probably ends by partial or total default.
This happened in Argentina after the reform process that began in 1989, in Bolivia after 1985, in Venezuela after 1989, in Mexico after the reform process under presidents Salinas and Zedilla, and in Brazil first under the military dictatorship of 1964-85 and now apparently again after 1994. Only in Chile, where democracy was firmly suppressed for 16 years under president Agosto Pinochet, does economic reform appear to have taken root and to have continued after the initial impulse.
Apart from cultural factors, which are very difficult to assess with any degree of objectivity (and where in any case if there is a Max Weberian “Protestant work ethic” it should be more easily matched by Catholic than by Hindu societies) two factors in particular differ between India and Latin America, and may explain part of the difference in performance: they are the relative GINI (inequality) coefficients and the involvement of the IMF/World Bank group.
As is well known, Latin American societies have very high GINI coefficients, a measure of inequality. Whereas the United States has a GINI coefficient of about 0.4, Western Europe has GINI coefficients ranging between 0.25 and 0.35 and emerging Asia generally has GINIs in the 0.3-0.4 range, most GINI coefficients in Latin America are above 0.5, and Brazil’s is close to 0.6, a level exceeded only by South Africa. India, on the other hand, has a GINI coefficient not much above 0.3, although its GINI has increased somewhat from about 0.28 during the years of economic reform.
It is generally held, at least by right wing economists, that a high GINI coefficient tends to lead to faster economic growth. After all, if a society is very unequal, the inequality should provide the sharpest of incentives to entrepreneurs and the young, both positively in terms of amassing great wealth and negatively in terms of avoiding destitution.
For moderate GINI coefficients, this works quite well. Britain, for example, had a very low GINI coefficient, around 0.23, in the middle 1970s, and began to function much better as an economy when GINI coefficients rose under Margaret Thatcher. Now, with a GINI around 0.35, Britain has relatively good incentives and a reasonably high degree of economic innovation.
Above 0.40-0.45, however, the incentivizing effect of a high GINI coefficient appears to go into reverse. This intuitively makes sense — there is little incentive effect in inequality if the society is so stratified, and accumulation of either financial capital or social capital in the form of education so difficult, that upward mobility appears hopeless.
This reverse incentive effect of very high GINIs is only moderately strong in oligarchies, like most of Europe (or indeed Argentina) in the 19th century, but is reinforced in countries that are fully democratic. The high level of inequality, and the apparent impossibility of self-betterment, produce a society in which the political and economic system appears irretrievably corrupt and closed to the outsider, so that the only way in which a poor or even middle class individual may hope to better his lot is by forcible redistribution of the rich’s wealth. In such a society, property rights, whether of the rich themselves, of foreign creditors, or of middle class savers, appear moot: property appears simply an instrument by which the rich oppress the poor and prevent them from improving their situation.
The other difference between India and Latin America is the heavy involvement in the latter of the IMF and the World Bank. Because of the huge size of the Indian economy, the IMF played little role in India’s recurrent financial crises before 1991, although the World Bank was active in project lending. From 1998-2000, the Indian nuclear test caused a suspension of IMF and World Bank activity, which itself increased the independence of India from their economic guidance. Then, in 2002, India announced that it would no longer be a borrower from the IMF, but would instead be a lender, helping poorer countries achieve self-sufficiency.
In Latin America, it is a very different story. Brazil and Argentina are two of the IMF’s largest borrowers, and together represent almost 50 percent of the IMF’s loan portfolio — an extraordinary situation, since together they represent only 3 percent of the world’s population. The IMF and World Bank were intimately involved in the failed “reform” programs in both Brazil and Argentina in the 1990s; more perniciously, in both countries they have continued to provide money as the private sector has retreated.
By doing so, they have reinforced bad policy in both countries, and prevented the market from applying its corrective deflationary effect on government spending, which would otherwise have taken hold of both countries by the late 1990s, rather than in 2001-03. Now, even more perniciously, they are providing to Argentina at least an incentive to default on its private sector debt; why should it pay private creditors when by not paying them it can improve its own cash flow and get any “necessary” project funding from the international institutions?
From the Indian and Latin American experiences, it is very clear that the World Bank and IMF have become part of the problem, not part of the solution. Cutting these unaccountable bureaucracies off from their sources of funding, as quickly as possible, by forcing a draconian audit of their loan portfolios, thus destroying their spurious AAA credit rating, should be an act of the first priority once the U.S. election is over and the institutions can no longer use their resources to meddle in U.S. domestic politics.
As I have written previously, Latin America is in for a grim decade or two, whatever the international community does. Having reached its effective borrowing limits in the private international markets, and blessed by governments that will not use public money to any productive purpose, the continent is doomed to considerable further impoverishment. Further subsidies from abroad, to the extent they prop up the current Latin American political system, will only perpetuate the current waste of resources and lives, and render Latin America a fertile field for Castroism, terrorism, or any other -ism that seems likely to harm the United States, which an increasing proportion of Latin Americans wrongly blame for their plight.
The solution is as usual in the private sector. Nothing should be done to perpetuate the current Latin American governing class. However, if better governments are to be elected, the poor in Latin America, at least those of them who are still young, must be given opportunities of self-improvement, particularly through education and through encouragement and protection of saving.
Private sector entities concerned about the future of Latin America thus have an enormous role to play. They can set up schools in impoverished areas, wholly outside the control of the local governments, that will both provide basic education and teach sound economics, thus producing the small businessmen and well informed voters of the future. And they can establish banks, preferably entirely outside the local banking system, that make few if any loans, “micro” or otherwise, but instead provide that most essential of all banking services: a totally secure place in which to store personal savings.
Western governments have only one role to play in this eventual renaissance. Whether by “gunboat diplomacy” or otherwise, they must ensure that the corrupt local governments are prevented from ruining the schools or destroying the banks.
In the final analysis, Latin America, and not the United States, is like the terminally corrupt and declining society of Ayn Rand’s “Atlas Shrugged.” Like Ayn Rand’s hero John Galt, Latin Americans wishing to build a better future should have only one message for their local political establishments:
“Get the hell out of my way!”
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(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)
This article originally appeared on United Press International.