In the late 1990s, Latin America was believed to have adopted a “Washington Consensus” of democratic politics and moderately free market economics. At the end of 2005, it is becoming only too clear that the two parts of the Washington Consensus are in conflict in the region, with the democratic politics leading to increasingly anti-market economics, which will inevitably be followed by decline. It’s worth asking why.

Latin America has had a good 2005. High commodity prices, very low real interest rates throughout the world and declining risk premiums have enabled Brazil to pay off its debt from the International Monetary Fund and the bankrupt Argentina to make a typical exhibition of Latin macho by doing likewise. It should not be assumed however that 2005’s progress is anything more than a flash in the pan; once real interest rates finally inch themselves above zero, the problems of Latin America will resurface, particularly in Argentina where inflation is already above 12 percent and climbing.

Latin America has a lot of elections in the current 12 month period, with Mexico, Brazil, Colombia and Peru going to the polls in 2006, and Chile, Venezuela and Bolivia having done so recently (a Presidential election in Venezuela and a second round of Chile’s Presidential election are also due in 2006.) The U.S. foreign policy establishment, already disturbed by the failure of November’s Free Trade Area of the Americas talks in Buenos Aires, is increasingly concerned by victories such as that of Evo Morales in Bolivia, elected last week on an explicitly anti-American platform. In this context, success for the leftist candidate Andres Manuel Lopez Obrador in Mexico’s July 2006 Presidential election would be particularly disquieting to the George W. Bush administration.

It is however the economic policies of Latin America that are more dangerous in the long run to their own people, and more surprising to outside observers. This is not 1935; hard core Socialism was pretty well discredited worldwide by the collapse of the Soviet Union in 1991 and something approaching free market capitalism has appeared to provide a route to prosperity for more and more countries in the last quarter century, including the world’s two largest poor countries, China and India. Yet in Latin America, as the Morales victory in Bolivia and the continuing genuine popularity of Hugo Chavez in Venezuela and Nestor Kirchner in Argentina has showed, policies of opening to international trade, guaranteeing foreign and domestic property rights and removing government intervention from the productive sectors of the economy have persistently proved electoral losers, and are likely to continue doing so.

Latin America is not a particularly Socialist region, in the old fashioned sense of having a high percentage of its economic output controlled directly by the government. Tax rates are generally moderate and enforcement lax, while government spending as a percentage of Gross Domestic Product is far below the OECD average of just over 40 percent. Thus in principle Latin America should not suffer the pathologies witnessed in parts of Eastern Europe, where government continues to absorb more than half the economy.

Corruption in Latin America is high by Western standards, but not exceptionally so. Of the major Latin American countries, Chile, Uruguay, Brazil, Colombia, Mexico and Peru all had scores on Transparency International’s 2005 Corruption Perception Index higher than Poland, which is now an EU member enjoying relatively rapid growth and the beginnings of stable prosperity. China and India had lower scores still, although both scored better than Argentina and Venezuela, the Latin American corruption laggards. Certainly within Latin America the relatively favorable economic performance and good governance of Chile and Brazil and the unexpectedly poor economic performance and governance of Argentina and Venezuela may be explained by this factor, but the overall Latin American malaise cannot be due to it alone.

On economic freedom, the story is somewhat different. Only Chile, at No. 11 out of 155 countries ranks in the “Free” category in the Heritage Foundation’s 2005 Index of Economic Freedom. Uruguay, Bolivia, Peru and Mexico rank 43, 49, 56 and 63, towards the bottom of the “Mostly Free” category. Colombia, Brazil, Argentina and Ecuador, at 88, 90, and tied at 114 are “Mostly Unfree”. Venezuela at 146 is “Repressed.” Given Venezuela’s score, can there be any doubt that Bolivia’s score is due to drop like a rock under Morales, a close ally of Venezuela’s Hugo Chavez? Except for Chile, Latin American countries rank on this (admittedly imperfect) indicator well below the level that their income per capita and education levels would suggest. Again however, the rankings of China at 112 and India at 118 suggest that a low score here is not entirely incompatible with economic growth.

When looked at against the rest of the world the one feature of Latin American countries that most stands out is their economic inequality, which can be measured by the Gini coefficient. According to the World Bank database, Latin American Gini coefficients are extremely high, exceeded only by some countries in Africa. Brazil’s Gini coefficient is 61, Chile’s 58, Colombia’s 57, Mexico’s and Venezuela’s 50 and Argentina’s (not estimated by the World Bank) about 55. This compares to Gini coefficients around 40 in the United States, in the 25-35 range for Western Europe and Japan, and varying in the 30-45 range for the emerging Asian economies. Here China and India, which score below most Latin American countries on corruption and economic freedom, differ significantly from the Latin American model; China’s Gini coefficient is 44 and India’s is 38.

This at last provides a clue to the question. Latin America’s problem is not in itself corruption, or even lack of economic freedom – those are only symptoms — but economic inequality itself. Looking at Latin America’s history, it is clear that in a very unequal society economic progress is possible only under an authoritarian regime, such as in the Mexico of Porfirio Diaz (1876-1910), the Argentina of the pre-democracy oligarchs (1860-1912) or the Chile of Agosto Pinochet (1973-89). Chile’s continuing economic progress and relatively favorable scores on corruption and economic freedom are a legacy of the Pinochet era, more recent than the oligarch era in Argentina or the Diaz era in Mexico; Pinochetism has so far remained strong after failing narrowly in two agonizingly close elections in 1988 and 2000. The country can be expected over the long term to fall back to its Latin American neighbors, rapidly if it persists in electing leftist candidates such as Michelle Bachelet, the current expected victor in January’s second electoral round.

The mechanism by which extreme inequality produces economically illiterate outcomes in a democracy can only be theorized about, although deep research by the “political choice” school might be fruitful, but the pattern in Latin America is clear for all to see. One can postulate that in such a society, true progress up the social scale appears impossible for the great majority of the electorate, and the economic and political system appears irredeemably rigged to leave them trapped in poverty. Consequently, promises of an economically better long term future are regarded with deep suspicion, and candidates who promise short term benefits, such as higher welfare payments or jobs with the government, or who promise simply to attack the wealth of the rich, prove irresistible. The majority of the electorate remains trapped in cynical slum-dweller leftism, the politics of Harlem or the rioting French banlieus.

For the rich, political programs that open up their oligarchy to competition are deeply threatening, because they see every day the terrible fate that can befall those who lose their position in the elite. With the penalties for failure so high, any amount of corruption and rent seeking is desirable in order to prevent that failure from occurring. Military coups, too, are entirely acceptable, since the stability of a democratic constitution is far less important to the elite than the threat to their welfare from a Chavez or Morales whom the masses support. The tendency of the electorate to support leftist economic illiterates itself thus creates political instability as well as economic failure, because the threat to the elite from such illiterates is so obvious and extreme. With political life reduced to such a state of cynicism, private property, unsafe from depredations by the left, is then equally unsafe from illegal seizure by the politically connected right.

So what’s the solution? The changes in U.S. and world foreign policy in the 1980s increased the cost to Latin American elites of arranging military coups and abandoning democracy, so to that extent improved the stability of the political systems, even though they eliminated the possibility of an economically benign Pinochet or Diaz (needless to say, most non-democratic Latin American leaders have been nowhere near their quality.) However, they have done nothing to address the reverse problem of democratic electorates legitimately electing economic lunatics. The United States and the world have coped very badly with the problem of Hugo Chavez – a regime that destroys the economy, yet has reasonable or good democratic legitimacy is very difficult for well-wishing outsiders to deal with.

Seizing an opportunity such as occurred in Venezuela in 2002, when Chavez was briefly toppled before he had fully consolidated his power, is essential if such governments are to be removed. However even if the United States can move fast enough (as it didn’t in that case) the problem remains of re-installing a true democracy, minus the destructive regime, at the earliest possible date – the Pinochet solution being no longer available. There is always the danger that the evil leader will remain around, albeit possibly in exile, and will destabilize his successors if anything but rapid and uninterrupted economic progress eventuates. Juan Domingo Peron of Argentina, for example, not only wrecked the economy from 1943-55, but continued to meddle in Argentine politics for the next two decades, and has remained even since his death an icon, luring the electorate towards policies of statist isolationism. The electorate remembers the wealth of Peron’s early years, not realizing that it was largely his policies that destroyed it.

In most circumstances, fortunately, an economically illiterate regime will cause economic collapse, which will lead to its replacement by the electorate (provided the elections remain legitimate, which in Venezuela they have not done.) This however doesn’t address the case of Venezuela today (oil) or Chile in 1973 (copper), when the great bulk of an economy’s wealth is concentrated in a single commodity whose production is controlled by the government. If commodity prices are high, this allows bad governments to cover up their economic incompetence and bribe the electorate, blocking the economic signals that should return the country to sanity.

At the opposite end of the spectrum, the relatively reformist and sensible (by Venezuelan standards) 1989-93 government of Carlos Andres Perez, which followed the Washington Consensus and attempted reform and privatization, was thwarted by the low oil prices of that period and the consequent poor performance of the economy. Perez was impeached in 1993, a poor reward for his sensible 1989-93 government although an entirely appropriate retribution for the corrupt Socialist spendathon of his previous 1974-79 effort, which had nationalized the oil industry.

There are few good solutions. One must pity the people of Latin America for the political/economic trap into which they have fallen. The only action that may help is to preserve the utmost rigidity in the allocation of aid and foreign investment, with governments and international lending institutions refusing money to regimes that pursue policies that destroy property rights, and the private sector refusing to invest or lend there, or to restructure debts that fall into arrears. This will provide the maximum possible incentive for electorates to avoid bad solutions, as distinct from the current system that allows Argentina to return to the capital markets less than 4 years after default, thus rewarding bad behavior.

It is also the best way to avoid losing money in the Latin American slum, a perennial fate for foreign investors since it gained independence in the 1820s.

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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.