The following is abridged from a speech delivered at “Evenings at FEE” in April 2007.
Many years ago I attended a seminar here at the Foundation for Economic Education, and in the 13 years that I have been writing for The Wall Street Journal, I have always considered FEE a guiding light for economic freedom. It is very exciting to see the renewed energy and spirit here. It&’s great to be back at FEE!
I chose the title for my presentation tonight for a reason. Ever since the limited economic experiments of the 1990s we have seen a tendency in Latin America to give the name liberalism (in its classical sense) to antiliberal policies, such as taking public monopolies and changing them into private ones through government intervention. That is what made Mexican media tycoon Carlos Slim the richest man in Latin America and the second-richest man in the world.
When this application of the word “liberalism” was criticized it was changed to “neo-liberalism.” That is when my friends and I decided that there is no such thing as neo-liberalism but instead there should exist a word “neo-socialism,” sort of a new rerun of the old values of socialism.
Look at Venezuela. You see a democracy with an elected president, Hugo Chávez, but with the absence of any individual or economic freedoms. What you see is in fact a very sharp slide toward socialism. It is highly improbable that the Venezuelans can become free people any time soon. The situation there looks very grim—much closer, I think, to what we are seeing in Russia right now.
There is a group of Latin American countries that are following Chávez, and that tend to have more closed economies and underdeveloped institutions. Among them are definitely Bolivia and Ecuador, and to a lesser extent Nicaragua, which we have to remain vigilant about.
However, it is also very important to recognize that not everyone is following Venezuela. There is a whole other part of Latin America that we should be cautiously hopeful about, which includes Colombia, Chile, Peru, Brazil, Mexico, and several Central American countries (although there is a very serious problem with the rule of law in Guatemala right now).
In those countries political institutions are more or less holding up: the elected presidents in fact leave office at the end of their term and a new president gets elected; congress and courts (i.e. the competing branches of power) actually exist. Of course none of the courts functions adequately, but at least we see a semblance of institutional order which makes me somewhat hopeful.
Chile, for example, has done a good job of setting up a rule of law, opening the economy, and becoming very competitive. But to the surprise of many, the ideas in Chile have failed to “infect” other Latin-American countries. Chile is simply too small to affect the development of the whole region.
The Case of Brazil
There is a definite need for one of the larger economies on the continent to start a more positive trend. One such possible country is Brazil. But on this count, Brazil has been a very big disappointment. Today most people think of Brazil as one of the biggest developing economies in the world, along with Russia, India, and China. Those four countries are often referred to as BRIC.
But Brazil has actually underperformed its BRIC peers. My economist friends in Brazil have been telling me for years, “Don&’t worry, there is not going to be a big collapse, but do not expect anything on the upside either. Brazil simply is going to be mediocre forever.”
How can this be? I spent two weeks there last summer and saw the incredible potential:
- The natural resources are boundless.
- Immigrants, with their work ethic, give the country a huge advantage in human capital.
- Brazilian entrepreneurs are competitive, outward looking, and educated. You meet them all around the world! And if you go to the informal markets in São Paulo, Rio, or Bella Horizonte, you see the same entrepreneurial hunger in the general population.
Why is it that Brazil, as an old joke has it, remains and always will remain the country of the future? Why then do we have Brazilian mediocrity instead of the Brazilian miracle?
The Brazilian government under the leadership of President Luiz Inácio Lula da Silva, known as Lula, takes pride when announcing a 3.5 percent annual GDP growth with interest rates at a “low”—below 15 percent. That is how low the expectations are for a large country with great economic potential.
What is the politically correct explanation for this inadequacy? It is, of course, “inequality”: there are too many rich people who refuse to “share” their assets with the less fortunate. Foreign-aid experts, who will do very well as long as Brazil stays poor, offer their own reasons and solutions. First, Brazilians are uneducated. The government&’s failure to spend enough money on education is one of the justifications for constantly raising taxes and redistributing wealth. The second reason is inequality in health care. The answer is to undermine pharmaceutical patents and to aggressively promote the production and sales of cheap generic medicines so that every Brazilian can have free health care.
These are some of the solutions that according to foreign-aid experts will change the Brazilian picture. To them foreign aid should simply provide enough money for the poverty to go away. They fail to see that the experiment in Brazil, which has really been a 25-year experiment with socialism, shows that this is a losing battle. But the Brazilian people are beginning to see the real problem: low growth. As prominent free-market economist Peter Bauer once said, “Lack of money is not the cause of poverty, it is poverty.”
Another obstacle on the way to prosperity is the lack of understanding of the proper role of government. Have you have ever seen the Brazilian constitution? A pocket-book version of it is 400 pages long! Obviously the government has a host of obligations to meet. The government is charged with doing everything, including guaranteeing that the people will have enough leisure time. Of course this particular obligation is easy to meet: the unemployment rate is so high that Brazilians are guaranteed lots of leisure time.
A Vicious Cycle of Poverty
With Brazil and its neighbors, I think we are facing three major problems:
- The failure of the constitution to limit the power of government.
- The failure to ensure equal rights under the law. The idea of equality is in everybody&’s mind, but they understand it as equality of incomes, rather than rights.
- The protectionist policies and high tariffs that were established in the middle of the 19th century and have been pushing the whole region back considerably.
In the 20th century this policy continued. There was a very short period of time before World War II when the tariffs were lifted only to be reintroduced during the war. Around 1950, an Argentinean economist, Raúl Prebisch from the UN&’s economic commission on Latin America and the Caribbean (CEPAL), suggested that Latin America should introduce extremely high tariffs, which would allow infant industries to grow and mature. Then lift the tariffs. More good advice from the UN! Now, 70 years later, we are still waiting. The infants have never grown up.
Central America experienced the highest import tariffs and import protection in the world. These policies caused the extreme poverty in Central America, which continues to proliferate to this day. The region not only lost investment, but also the information and the connection with the rest of the world. As a result, Central American countries were not part of the process of innovation and discovery that fueled the growth of the countries with more open economies.
Latin America continues to be a closed economy with very strong domestic interests in each respective country. Government-protected domestic monopolies have the money to lobby the policy makers for further protection from all competition. This creates a vicious cycle propagating a closed economy and thus poverty. Unfortunately Brazil is no exception.
In his book, The Power of Productivity, William Lewis (the founder of the McKinsey Global Institute) observes that Brazil has an impressively high level of productivity in its formal sector and yet is condemned to suffer the consequences of a huge informal sector mired in misery.
He completely dismisses the idea that the lack of education of the Brazilian workforce is the reason for the country&’s inability to close this productivity gap. It is rather an excuse for poor economic performance. There are many examples—from banking to food processing—where companies have been able to match productivity levels at the economic frontier with the existing Brazilian workforce. In other words, the job training provided by the private sector, not government schooling, is the primary avenue through which workers attain the skills necessary to perform at the economic frontier.
So the true problem is not education, but the high cost of conducting legitimate business in the formal sector. Big government demands big taxation. Companies in the formal sector have high productivity, but they are also the ones paying all the taxes.
The common incentive thus is to work in the informal sector, where you don&’t have to meet regulations or pay taxes, and that&’s how you survive. And he says the two characteristics of Brazil&’s economy are the large size of the informal sector and the large size of government. They are connected.
Half of all Brazil&’s workers are in fact outside the formal economy and their low productivity fuels poverty. In a developing country the problem should take care of itself as more productive formal businesses with lower prices and better services overtake the informal enterprises. But it is not happening in Brazil. In fact, the informal sector is growing bigger and bigger.
Now what&’s the problem with the informal sector? The problem is that in the informal sector you cannot take advantage of the efficiency or technology of large-scale production. Otherwise you run the risk of getting on the government&’s radar screen and being nailed for tax evasion.
The culprit here is the voracious appetite of big Brazilian government, which constantly needs resources. Despite higher productivity, legitimate enterprises do not have any pricing advantage against informal, less-productive businesses because they&’re saddled with the payroll tax, value-added tax, sales tax, income tax, and corporate tax, which is scandalously high in Brazil. As a result Brazilian companies pay 85 percent of all taxes collected, compared with 41 percent for U.S. corporations. This not only hampers legal businesses, it also deters small informal businesses from growing and moving into the legal sector.
Today the Brazilian government spends 39 percent of the country&’s GDP compared to 37 percent in the United States. For a developing country, that is outrageous. No country could ever hope to pull itself from the grips of poverty with such a high and destructive level of taxation.
Cut the Size of Government
There is only one prescription for this disease: cut the size of government! One would hope that Brazilians would all go to the polls and vote to oppose all of those regulations, interventions, and taxes. But instead the masses keep voting for more and more government. They do not have much confidence in politicians&’ ability to establish equality under the law and thus the opportunity to move up the social ladder. Under those circumstances people simply vote for whoever promises them the biggest piece of the redistributive welfare pie. They have no incentive whatsoever to support the idea of limited government.
One avenue for change is free trade. Besides obvious economic benefits, trade encourages information exchange as well as discovery and innovation. That triggers change in the climate of ideas, the way people think and relate to each other. Suddenly a monopolistking of everything becomes just another competitor in a global market.
Part of the problem is bad incentives created by foreign aid and faulty advice, both coming from Washington, D.C. We put pressure on those countries to implement more labor regulations, to pour more money into government health care and public education. Such an additional financial burden is counter-productive to the growth of the economy and makes their potential to overcome poverty even more doubtful.
We Americans should do better. We should stand for open trade. We should repeal the protectionist regulations, which hold Latin Americans in poverty and hurt consumers at home. We should stop pushing social safety networks and labor regulations, and encourage the emergence and growth of the freemarket institutions that generate economic prosperity and safeguard the rule of law in the United States.
It is very difficult to break the vicious cycle of poverty, but it is not impossible. Every year we see more and more believers in the free market across Latin America. Those talented and dedicated people from many walks of life really want to change their countries. And with our help, I am hopeful they will.
Mary Anastasia O&’Grady is a leading editorial writer for The Wall Street Journal and a member of the Journal&’s Editorial Board. As the editor of the “Americas” column, she regularly exposes the never-ending corruption and failed policies of the socialist regimes in Latin America.
In addition to her post at The Wall Street Journal, Mary O&’Grady is a co-editor of the Index of Economic Freedom, published by the Heritage Foundation. In 1997 she won the Inter American Press Association&’s Daily Gleaner Award for editorial commentary; in 2005 she was awarded the Bastiat Prize for Journalism.
Ms. O&’Grady is equally disliked by the left-leaning American media and by Latin America&’s socialist governments. The Cuban government named her a “counterrevolutionary” for her uncompromising criticism of Fidel Castro, Hugo Chávez, and the like.