Commentary

Economic Freedom and Confusion in Latin America

Economic freedom in Latin America noticeably increased in the 1990s. The region’s economies are now more open to trade and investment and, in most countries, high inflation and the prevalence of state-owned monopolies are things of the past. According to the new Economic Freedom of the World: 2004 Annual Report, Latin American countries increased their economic freedom ratings from 5.0 in 1985 to 5.4 in 1990 to 6.5 on a 10-point scale by the end of that decade.

That should be good news, according the report, which is published by the Fraser Institute in Canada, the Cato Institute in the U.S., and think tanks around the world. The study finds a strong relationship between economic freedom and prosperity. Countries that are more economically free are more prosperous and tend to grow faster than those that are not.

For example, countries in the top quintile of the freedom index have average per capita incomes of $26,106 and per capita growth of 2.4 percent versus $2,828 incomes and -0.5 percent growth in the bottom quintile. And economic freedom is strongly related to improvements in the whole range of human development indicators, including lifespan, infant mortality, literacy, and so on.

But in Latin America the policies of the 1990s culminated in low growth and economic turmoil in much of the region. The widespread perception that the free market has been tried and failed has led to the rise of neo-populist rhetoric and incoherent policies. Whereas the so-called Washington Consensus on the need for orthodox macroeconomic measures prevailed in the early 1990s, no policy consensus exists in the region today.

Disillusionment with the market has reached extremes in Argentina and Venezuela, the two countries that have fallen the most on the economic freedom index. Between 2000 and 2002, when Argentina’s economy collapsed, the country’s economic freedom ranking went from 28 to 86 out of 123 countries-the most dramatic short-term decrease in economic freedom in the region. Neo-populist President Hugo Chavez has also pushed his country to the bottom of the list in a process that has taken Venezuela from being ranked 14 in 1980 to 118 in 2002.

Elsewhere, economic reform has failed to produce political stability. Bolivia’s market-liberal president, Gonzalo Sanchez de Losada, was forced to flee his country last fall in the face of popular riots. And Peruvian President Alejandro Toledo is experiencing single digit popularity ratings, calling into question his ability to serve a full term despite relatively orthodox macro policies.

Has liberalization failed Latin America? The region’s experience does not contradict the findings of the economic freedom index. The financial turmoil of the past 10 years, which did so much to sour pro-market sentiments, was the result of policies fully inconsistent with market reforms. Fiscal irresponsibility and debt mismanagement caused the spectacular Mexican and Argentine crises-policy practices that have characterized Latin American governance since the time of independence.

Indeed, one of the lessons of the 1990s is the need for a coherent set of market reforms. Chile, long the country that has maintained the freest economy in Latin America, underscores that lesson. Ranking 22 on the index, Chile has achieved high growth rates that have enabled it to cut the poverty rate by half and maintain a robust and stable democracy. By contrast, most of Latin America has traveled only partially down the path of economic freedom, prompting Mexico’s finance secretary, Francisco Gil Diaz, to warn observers not to blame the region’s failures on reforms that have not taken place.

Latin America’s list of unfinished reforms is too long to itemize here. But beyond implementing and sticking to well known macro policies, Latin America should prioritize four areas it has largely ignored: bureaucratic regulation, taxation, property rights and the rule of law. Progress in those areas would directly affect ordinary citizens.

Regulation continues to be an enormous burden on Latin Americans, an area in which the region scores especially poorly on the economic freedom index. To give just one example, a study by the National Bureau of Economic Analysis found that to open a business in Canada it takes two days, two bureaucratic procedures and costs $280 in fees. By contrast, in Bolivia it takes 80 days, 20 procedures and costs $2,696. Lifting the bureaucratic weight of the state would do much to reduce the region’s large informal economy.

So would reducing Latin American value added and payroll taxes, which in many countries are two to three times the levels that exist in the United States. Argentine economist Ricardo Lopez Murphy summed it up when he complained that Argentines pay Swedish level taxes in exchange for public services of African quality.

Nor does the Latin American state protect or recognize the property rights of the poor even though that institution is the basis for a modern economy. Ninety percent of rural people’s property in Peru, for example, has no proper legal title. The result of this sort of legal discrimination is a severe limitation on the ability of ordinary people to create wealth. Here too, the region ranks poorly on the economic freedom index.

Embracing economic freedom would go a long way toward establishing the environment in which the rule of law-perhaps the most important ingredient for advanced economic development-could flourish. As long as Latin American politicians continue the long tradition of supporting arbitrary state intrusions into all facets of life, capitalism will continue to be a misunderstood and unknown concept to ordinary Latin Americans.

Ian Vásquez is director of the Project on Global Economic Liberty at the Cato Institute.