Problems with Domestic Market Orientation in Latin America

In last year’s Center for Latin American Economics Annual Report, Executive Director Carlos Zarazaga addressed Latin America’s wave of dissatisfaction over market reforms that had failed to deliver the promised growth. Several Latin American countries have elected officials who say they are committed to undoing the “Washington Consensus” reforms that were intended to make economic institutions more efficient. Even where politicians have been less polemical, the rise of political parties and candidates suspicious of markets has been common.

Some of the reasons for dissatisfaction are easy to identify. They involve slower than expected economic expansion and widening gaps between the haves and have-nots. In both cases, a relevant question is whether the so-called liberal reforms are the problem or if the problem rests in the insufficiency of the reform itself.

The discipline of economics has not fully come to grips with either the economic or political dynamics that have triggered moves away from market-based policies across Latin America. Some current presidents whose elections signified moves away from a market orientation still follow fiscal and monetary policies reminiscent of their more market-oriented predecessors. Others, of whom Venezuelan President Hugo Chavez is the most vocal, have either officially pronounced market-oriented policies strongly objectionable or adopted policies consistent with such objections.

Much has been made of Latin America’s many trade openings. Mexico’s entry into NAFTA and its free trade agreements with other countries in the region are important cases in point. So are the openings through the Central American Free Trade Agreement and various efforts in South America, particularly those of Chile. Chart 1 shows the average tariff reduction in the seven most populous Latin American countries—Brazil, Mexico, Colombia, Argentina, Peru, Venezuela and Chile. Some of the trade openings have clearly been large.

The region’s domestic market orientation has also received attention. During the 1990s, Peru privatized a significant portion of government assets (13 percent of GDP). So did Brazil (11 percent), Argentina (8 percent), Mexico (6 percent) and others in Latin America. The liberalization of financial markets and the privatization of banks also distinguished the period. Governments rationalized their monetary and fiscal policies, lowering inflation rates dramatically and moving closer to balanced budgets. With some exceptions, this continued into the new millennium.

Nevertheless, many areas of Latin American domestic policy have received little attention and less reform. Chart 2 uses components of the Heritage Foundation’s Index of Economic Freedom to characterize domestic market openness in the seven most populous Latin American countries and in seven Asian countries—China, Hong Kong, Korea, Singapore, Taiwan, Thailand and India. The overall index has 10 components, of which trade and capital market openness are obviously international. The eight remaining components can be considered measures of domestic market orientation: fiscal burden, government intervention, monetary policy, banking, wage and price flexibility, property rights, regulation and informal market dominance. The lower the values of these indicators, the greater the domestic market orientation a country enjoys.

Among the Latin American countries, Chile has the lowest (best) score (1.8875). Most of the fast-growing Asian countries on Chart 2 have lower (more market-oriented) scores than most of the Latin American countries. In fact, four of the seven Asian countries have lower (better) scores than even the second-best Latin American country, Peru.

More striking is how little, in terms of economic rationalization and liberalization, these domestic market-orientation indicators have changed since the mid-1990s. Chart 3 characterizes these changes over the period 1994–2004 for the seven Latin American countries. Index values range from a low of 1.8874 (Chile, 2004) to a high of 4.1 (Venezuela, 2003). Even so, despite some increased market orientation, movements in the indexes show country-by-country liberalizations (declines) of more than 0.5 point only in the cases of Chile and Peru. Not even Mexico makes the cut.

These openings, or the lack of them, are important not only in a domestic context but also in an international environment. For example, Tornell, Westermann and Martinez (2004) suggest that bottlenecks in the nontradables sectors impede Mexican expansion in tradable goods production. Their focus is credit shortages for nontradable firms, but it is hard not to suspect that impediments to domestic market flexibility in general may exact their own taxes on growth as well. (Other examples of market inflexibility are discussed below.)

Nevertheless, in last year’s essay, Zarazaga notes that “empirically speaking, much remains to be discovered about which liberalizations are crucial.” A comparison of Chart 2 with Chart 4 provides ample evidence of this.

Using the data in Chart 2, it is possible to create an index of overall averages of domestic market orientation for the4 Asian and Latin American countries. Asia’s average is 2.44; Latin America’s is 3.04.

The comparison between these last statistics and GDP growth is striking. Chart 4 depicts real GDP growth since 1990 for the 14 countries. The order of growth rates from highest to lowest is China, Singapore, Korea, Chile, India, Taiwan, Thailand, Hong Kong, Peru, Argentina, Mexico, Colombia, Brazil and Venezuela. So of the eight fastest-growing countries, seven are Asian and one (Chile) is Latin American. In contrast, the six slowest growing countries are Peru, Argentina, Mexico, Colombia, Brazil and Venezuela—100 percent Latin American.

But while there is obviously a general relation between domestic market orientation and growth, with the less market-oriented Latin American economies growing more slowly than more market-oriented Asian economies, the devil is in the details. A glance at Chart 2 shows that China and India are substantially less domestically market-oriented than Chile. Nevertheless, China grew much faster than Chile, and Chile and India finish the growth period in Chart 4 in a dead heat. Since Chile has markedly greater domestic market orientation than either China or India, factors other than the Heritage Foundation indicators must be of crucial importance for growth. It may be that low, dollar-denominated labor costs in China and India overshadow domestic market-oriented factors. Even so, the exact combination of reasons China and India grow faster than any of the seven Latin American countries but Chile remains unknown.

Despite these complicating details, Latin American policymakers’ reluctance to pursue further market-oriented policies at the domestic level is striking. Perhaps partly as a result of this reluctance, the Latin American countries’ average rate of real GDP growth over 1990–2003 is 47 percent, compared with 113 percent (unweighted) for the Asian countries.

The Heritage Foundation indexes are not the only ones in which Latin American performance is substantially worse than Asia’s. For example, while job-protection laws remain controversial, research suggests that the high level of such protection in Latin America continues to reduce employment and promote income inequality (Heckman and Pagés 2000, Heckman and Pagés 2003, and Montenegro and Pagés 2003). The adverse impact of such regulations falls most heavily on workers who are young, female and/or unskilled.

Chart 5 presents the Rigidity of Employment Index developed by the World Bank’s International Finance Corp. (IFC). The higher the score, the more government interference in employment markets. The chart compares scores for the seven Latin American and seven Asian countries. The three countries with the most rigid employment markets are all Latin American—Venezuela, Brazil and Mexico. The three least rigid labor markets are Hong Kong, Singapore and Chile. On a scale where higher values mean more inflexibility, the average for the Latin American countries is 54, versus 29 for the Asian nations.

To offer a broader perspective, the IFC provides five measures of labor market flexibility and compares them by developing-country geographic area: East Asia and Pacific, Europe and Central Asia, Latin America, Middle East and North Africa, South Asia, and sub-Saharan Africa.[1] In three measures, only sub-Saharan Africa shows more government interference than Latin America.

Similarly, of the IFC’s four measures of how difficult governments make starting a business, two of Latin America’s measures are the worst of any of the areas (including sub- Saharan Africa). In one other of the four measures, Latin America is exceeded in difficulty only by sub-Saharan Africa.

Latin America’s reluctance to shed policies that make starting a business or adjusting a firm’s workforce difficult not only impedes efficiency—and the growth that attends it—but creates opportunities for the growth of monopolies and oligopolies. More difficulty entering an industry, for example, confers special favors and protections upon the happy few who can pull it off. Moreover, a substantial literature offers evidence that the presence of monopolies, collusive aggregations of businesses and other market-impeding phenomena retards technological progress. Such obstructions, by definition, prevent the advancement of total factor productivity in a world where small differences in such productivity can result in very large differences in per capita income.

Making Latin American policymakers’ reluctance to follow more market-oriented domestic policies astonishing is the example of Chile, the region’s clearest exception to such reluctance and easily its fastest-growing economy. Chile is the only Latin American country whose growth compares with the Asian tigers’. We do not always fully understand every detail that leads to long-run growth. Chile, however, offers evidence to suggest that the marketreluctant policymakers elsewhere in the region are sacrificing growth in the interest of politics.

Notes The data series also includes Organization for Economic Cooperation and Development high-income countries, but I have left them out of this comparison References Heckman, James J., and Carmen Pagés (2000), “The Cost of Job Security Regulation: Evidence from Latin American Labor Markets,” NBER Working Paper Series, no. 7773 (Cambridge, Mass.: National Bureau of Economic Research, June). ———(2003), “Law and Employment: Lessons from Latin America and the Caribbean,” NBER Working Paper Series, no. 10129 (December). Montenegro, Claudio, and Carmen Pagés (2003), “Who Benefits from Labor Market Regulations? Chile 1960–1998,” NBER Working Paper Series, no. 9850 (July). Tornell, Aaron, Frank Westermann and Lorenza Martinez (2004), “NAFTA and Mexico’s Less-Than-Stellar Performance,” NBER Working Paper Series, no. 10289 (February).

  |