Topic: International Economics and Development

Peru May Become Latin America’s Next Success Story

The Senate passed the free trade agreement with Peru on Tuesday and it could not have come at a better time. That’s because Peru is increasingly distinguishing itself in the region as a successful market democracy. More than five years of sustained high growth (Peru grew 8 percent last year) are transforming the economy and spreading development to regions of the country that have traditionally benefited little from past progress. Unlike other countries in the region such as Argentina or Venezuela that are also experiencing rapid growth, Peru’s growth is characterized by widespread investment and wealth creation as opposed to redistribution or the mere effects of high world commodity prices.

Why is Peru succeeding? Again, unlike various other South American countries, it has sustained the far-reaching market reforms of the early to mid 1990s, has deepened some of them, and maintained sound macro-economic polices. The policies of openness and stability are paying off. Anybody who has been visiting Peru during the past 15 years as I have has noticed vast improvements in countless areas of national and everyday life, including notable progress in the past several years. The center of Lima, notoriously crime-ridden and dirty, has become safe and attractive. That kind of revitalization has occurred throughout the city and in major cities and towns of Peru. Consumer goods and services—cell phones, household appliances, and private education, for example—previously unavailable or in short supply have proliferated and serve all markets, rich and poor.

A change in values more oriented to a modern society may also slowly be taking place. The majority of Peruvians supported the FTA with the United States. The quality of service and attention to detail seems to have improved among Peruvian workers and management across a broad array of businesses. Peruvian writer Mario Vargas Llosa recently noted that he was now much more hopeful about Peru, not because of Peru’s positive economic indicators, but rather because “something profound seems to have changed in the culture of the country. One would have to be blind not to see that.”

In his excellent and new book, La Revolución Capitalista en el Perú (The Capitalist Revolution in Peru), leading Peruvian journalist Jaime de Althaus carefully details some of the changes in Peruvian society.

Traditional and non-traditional exports have boomed, with the latter experiencing higher growth. Peru has now become an exporter of software, to the tune of $20 million last year and growing at a rate of 25 percent.

The middle class is growing. The gap between the rich and the poor and between Lima and the rest of the country has also shrunk. Income gains have been proportionately greater for the poor than for the rich.

Peruvian companies—many of them new—have become successful nationally and internationally, not only exporting abroad, but setting up plants and offices abroad in areas as diverse as textiles, soft drinks, mining, milk products, clothing, banking and detergents. Some Peruvian companies have seen their businesses nationalized in Evo Morales’s Bolivia.

Vast areas of the Peruvian coast that have long been desert have turned green as a result of the “silent agroindustrial revolution” that has also taken place in some parts of the interior. Peru’s produce is now diverse, ranging from sugar cane to paprika to asparagus.

Personal credit as a share of total credit has tripled in the past ten years and now accounts for about 24 percent of total credit.

Department stores and other businesses now regularly cater to the “popular” classes. Enormous malls have been built and are now thriving in some of the poorest sections of Lima.

President Alan Garcia, whose first term in office during the second half of the 1980s was a disaster, is building on this progress and—I never thought I would say this—is so far turning out to be pretty good. In recent weeks he has written two articles in El Comercio, the country’s leading newspaper, in which he sets out a bold vision of promoting growth that has set off an intense national debate and spurred the leading news magazine, Caretas, to put “The Turn to the Right” on a recent cover.

Garcia has called for Peru to grow at Asian levels for years to come. He has accused bureaucrats, NGOs, environmentalists and special interests of blocking important policy changes that would increase growth and reduce poverty. He has made specific proposals to allow private investment in large parts of the jungle so as to export wood and to better protect the region from those who illegally log it; he has called on the private titling of large areas of land so that those with resources can exploit that land; he has called on dramatically increasing private investment in mining and other natural resources in Peru; he has called for allowing more private investment in the fishing industry; he has called for hydro-electric dams to built throughout Peru by private capital, rather than the state; he has called for the state to give up property that it does not use and give up functions that are better performed by others. And so on.

Peru is experiencing market success and may still see more of it. Thus also it has become an embarrassment for Hugo Chavez, who has neighboring Bolivia and Ecuador as client states and is pouring a lot of resources into the Peruvian countryside in a campaign to promote his anti-capitalist ideology. Peru has become a key country in Latin America’s ideological battle between the modernizers and the populists.

A lot still needs to be done in Peru before it can be declared a success story. For example, property and land still needs to be titled in the mountains, taxes are still very high, bureaucratic regulations remain onerous, labor laws are extremely rigid, the educational system is terrible. But the free trade agreement will help because it will give permanence to trade policy; and policy stability and competition have been key to Peru’s success thus far. If Alan Garcia can complete Peru’s unfinished agenda, he will have finally pushed the country into modernity and would go down not only as one of the greatest presidents of Peru, but also of Latin America at a critical time in the region’s history.

Why Do European Politicians Want Tax Harmonization?

While it is possible that European politicians have a genetic predisposition for statist policies, I’ve never thought this is why they support tax harmonization. Self interest is a far more reasonable answer. More specifically, European nations generally have high fiscal burdens. For instance, government spending consumes nearly half of economic output in EU countries, compared to one-third of GDP in the United States.

Not surprisingly, this translates into a higher tax burden, which means jobs and investment generally flee Europe. Tax harmonization is an attempt to stop labor and capital from escaping by creating, for all intents and purposes, a “fiscal fence.” But European politicians also want to undermine tax competition because they know the situation is going to get worse. According to a new report, demographic changes almost certainly are going to result in an even bigger welfare state in the future. This means increasingly harsh tax rates on the remaining productive people - which means politicians will try even harder to prevent taxpayers from escaping. The EU Observer reports on the key statistic that is causing angst for Europe’s political class:

According to demographic predictions, the EU’s population will not only shrink by almost 20 million people by 2050, but its make-up will also change dramatically. While there are currently about four working people of working age for each person of pension age in the EU’s 27 member states, there will be fewer than two people to support every elderly person by 2050, with the population gradually ageing.

The Right Way to Engage China

The United States and China reached an agreement yesterday on a dispute over alleged Chinese export subsidies. In exchange for the U.S. government dropping a case it was pursuing through the World Trade Organization, China agreed to end subsidies that the U.S. claimed were promoting exports and hindering imports of steel, wood, IT products, and other manufactured goods.

Details of the case aside, the announcement shows how trade disputes with China can be resolved without resort to threats of retaliatory tariffs. This is not the first time China has changed its trade laws in response to pressure from the United States through the WTO. In 2004, China dropped a discriminatory tax refund on domestically produced semiconductors after the U.S. government filed a complaint.

Today’s announcement is another vindication of resolving trade disputes with China through a rules-based system rather than through threats of unilateral retaliation. China’s accession to the WTO in 2001 not only committed China to lowering trade barriers on a broad range of goods and services; it also brought China into the generally effective WTO dispute settlement mechanism.

In two weeks, Treasury Secretary Paulson, U.S. Trade Representative Susan Schwab and other cabinet members will meet with their Chinese counterparts in Beijing as part of the ongoing Strategic Economic Dialogue. As today’s announcement verifies, the SED represents the right approach to encouraging China to continue its evolution toward a more free and open economy.

Constitutional Reform in Latin America?

Yesterday I went over to the Organization of American States (OAS) for a roundtable on “Constitutional Reform in the Americas.” The event featured opening remarks by the OAS Secretary General, followed by country-specific presentations by experts on Bolivia, the Dominican Republic, Ecuador, and Venezuela.

I won’t bore you with the details, but three themes emerged:

1) The ever-expanding constitutions of many Latin American countries, both to strengthen strongmen (Chavez) and to add to the copious list of positive rights (Brazil). This is not good for either constitutionalism or rule of law because on the one hand you have the country’s founding document being changed at the whim of a single man and on the other a constitution bloated with such things as the fundamental right to, e.g., four weeks’ paid annual vacation decreases in legitimacy. To paraphrase an old Argentine lawyer who advised that country’s last significant amendment process in 1993-94, “constitutional inflation leads to rule of law devaluation.” Alternatively, the Latin American counterpart to the old saw about French constitutions being filed in libraries’ periodicals section is that Latin ones are filed as encyclopedias.

2) The desire to constitutionalize (or rebalance constitutional structures relating to) the “special rights” of indigenous peoples. There is nothing wrong per se with wanting to recognize that certain native peoples preceded the arrival of European colonists/conquerors (British-American in the U.S., Spanish and Portuguese in Latin America) and that these people should not be exploited as a result of their having been vulnerable to colonization. But to enact wholesale nationalizations and special privileges on the basis of race, or caste, or tribe – let alone raise these perversities to the constitutional level as is being proposed in Bolivia – is a political and legal travesty.

3) The battle over political reform is no longer, if it ever was, between left and right or socialism and neoliberalism (the common Latin American term for pro-market policies and the Washington Consensus), but rather between democracy and authoritarianism. This may not represent that much of a change from the past – the populist governments that plagued the region in the 20th century could be alternately left or right wing – but it does confirm that the “consolidating democracy” project of the ’80s and ’90s has stalled if not taken a reverse. That is, the narrative that those of us studying Latin America in college and grad school in the late ’90s to early 2000s learned – the Third Wave of democratization, Latin America finally being on the right path but just needing time to grow economically –  underestimated some nasty undercurrents of resistance.

In short, the roundtable was equal parts fascinating and frustrating. You can watch it (in Spanish) here.

More on Bulgaria Flat Tax

Adding to Dan’s note, here is today’s story from Tax Notes International (no link):

The Bulgarian parliament passed a new flat tax on income on November 16, making Bulgaria the seventh EU member state to adopt a flat tax regime …

The new flat tax will replace Bulgaria’s progressive, three-bracket income tax, with a flat 10 percent tax on income starting in 2008. Bulgaria had already slashed the corporate tax from 15 percent to 10 percent in 2006 … 

Bulgaria is the latest in a number of Central and Eastern European countries that have replaced progressive systems with flat tax regimes. The flat tax revolution was pioneered by Estonia in 1994, and since then about 20 countries in Central and Eastern Europe have followed suit.

In this country, many pundits and presidential candidates would reverse President Bush’s modest reduction in the top income tax rate from 40% to 35%. Those rates are more than three times higher than the new flat tax rate in Bulgaria, a former communist country.  

Bulgaria Takes Big Step to Flat Tax

In the first test vote, the 10 percent flat tax was approved in Bulgaria by an overwhelming margin. If the Bulgarian experience matches what happened in other nations, the low-rate flat tax will be adopted, the economy will grow faster, and the government will collect more revenue. But just to show that there are some things that remain constant, the bureaucrats at the International Monetary Fund will continue to urge countries not to adopt this simple and fair tax system. The Sofia Echo reports:

Parliament approved on November 23, in first reading, amendments to the Income Tax for Natural Persons Act, which will introduce a 10 per cent flat tax rate starting from January 2008. The amendments were supported with 152 against 36 votes, with four abstentions, Bulgarian news agency (BTA) said. The flat tax rate will replace the current progressive tax system.

England’s Free-Market Future?

No, the title does not refer to possible policy changes if Tories win the next election (after all, that would require a smaller-government agenda). Instead, it is a somewhat tongue-in-cheek reaction to a story in England’s Daily Mail about couples who choose sterilization because they think children cause an unacceptable carbon footprint.

It is probably reasonable to assume that these people have a statist orientation. Since voting patterns and ideological orientation tend to be passed from one generation to the next, the electorate presumably will shift over time in a more market-friendly direction (or at least won’t shift as quickly in the wrong direction).

From the article:

Had Toni Vernelli gone ahead with her pregnancy ten years ago, she would know at first hand what it is like to cradle her own baby, to have a pair of innocent eyes gazing up at her with unconditional love, to feel a little hand slipping into hers — and a voice calling her Mummy. But the very thought makes her shudder with horror. Because when Toni terminated her pregnancy, she did so in the firm belief she was helping to save the planet.

…At the age of 27 this young woman at the height of her reproductive years was sterilised to “protect the planet”. Incredibly, instead of mourning the loss of a family that never was, her boyfriend (now husband) presented her with a congratulations card. …”Every person who is born uses more food, more water, more land, more fossil fuels, more trees and produces more rubbish, more pollution, more greenhouse gases, and adds to the problem of over-population.” While most parents view their children as the ultimate miracle of nature, Toni seems to see them as a sinister threat to the future.

…Toni is far from alone. When Sarah Irving, 31, was a teenager she sat down and wrote a wish-list for the future. …Sarah dreamed of helping the environment — and as she agonised over the perils of climate change, the loss of animal species and destruction of wilderness, she came to the extraordinary decision never to have a child. “I realised then that a baby would pollute the planet — and that never having a child was the most environmentally friendly thing I could do.” …[Her husband] Mark adds: “Sarah and I live as green a life a possible. We don’t have a car, cycle everywhere instead, and we never fly. We recycle, use low-energy light bulbs and eat only organic, locally produced food. In short, we do everything we can to reduce our carbon footprint. But all this would be undone if we had a child. That’s why I had a vasectomy. It would be morally wrong for me to add to climate change and the destruction of Earth.”