Things to Read on the Morning of December 10, 2013
Mark Thoma: The EITC and the Minimum Wage Are Not Substitutes But Complements

The United States in the Latin American Mirror: Wednesday Focus (December 11, 2013)

Let me turn the microphone over to young Berkeley academic Patrick Iber--who I think of as a younger Tony Judt, only for Latin America rather than Europe--to tell us what us Nortamericanos should learn from the experience of our neighbors to the south.

I do think that there are important historical lessons--two of them. The first is that if you did not believe that high inequality hobbled growth, look at Latin America (in the past). The second is that if you did not believe that healthy growth is possible in an environment that is also focused on reducing inequality, look at Latin America (in the present):

Patrick Iber: What Can the United States Learn about Equitable Growth from Latin America?

When the improbably-named Fernando Fajnzylber published the unappealingly-titled Unavoidable Industrial Restructuring in Latin America in 1990, it hardly had the makings of a classic. But Fajnzylber had identified a problem so fundamental to the region’s economies that it became exactly that. At the beginning of the book, he made a two-by-two grid, labeling the rows by high and low equity and the columns by high and low growth. Looking at the period from 1965 to 1984, Fajnzylber found Latin American countries that had managed high growth, countries that had high equity, and some that had neither. But one box was conspicuously empty: the one showing simultaneous high equity and high growth.[1] Fajnzylber’s work helped make filling his “empty box”—getting to growth with equity—a policy goal of most economists and governments in the region ever since.

To be sure, the period from 1965 to 1984 that Fajnzylber analyzed was not just any time in the history of Latin America. A wave of military dictatorships had taken power in the major economies of South America. They blamed high inflation and economic turmoil on the left and sometimes on powerful unions. To combat those problems they turned to the recipes of the Chicago school: “shock therapy” that involved ending price and wage controls, privatizing state-owned businesses, and reducing tariffs to very low levels. Terror ensured that people could not effectively organize to protest their lost wages. After initial economic contraction, some countries experienced strong growth. The fact that this growth was coupled with major reductions in real purchasing power for workers and hence with widening inequality was not the sign of a process gone wrong: it was the intended policy outcome. Debt crises in the 1980s led to a lost decade for growth and further “neoliberal” reforms, as state monopolies were sold off—mostly to be replaced by private near-monopolies that created enormous fortunes for those connected to the state (for example, Mexico’s Carlos Slim, who eventually became the world’s richest man).

Of course, inequality—Latin America’s original economic sin, more so than poverty itself—was hardly new to the region. Class divisions run deep throughout Latin American economies.[2] It would be a mistake to attribute this to immutable and ahistorical national characteristics, but it is a very old phenomenon. The region’s colonial economy was driven primarily by the wealth extracted by mining precious metals and by plantation agriculture. The basic situation for European colonists—after the reduction in the indigenous population due to disease and, later, campaigns of removal—was that land was cheap but labor was scarce, and the best way to resolve that problem was through a variety of forms of coerced labor, in particular the enslavement of Africans and the indigenous people who remained. The resulting gaps between those with political and economic power and those without were enormous.

The reforms that liberal and positivist elites enacted in the early nineteenth century, after independence was achieved in the most of the region, did little to ease inequality. Liberals believed in free trade and individual landholding: they tried to distribute lands held in common to individual proprietors and reduce the power of the Catholic Church, which had operated as the region’s largest landowner, bank, educator, and welfare institution. Though they succeeded in the latter goal over the course of the century, the states they headed lacked the capacity to replace the church’s functions, and in some ways, they actually exacerbated inequality. Recent work by Moramay López Alonso, for example, on the second half of the nineteenth century in Mexico, shows that even in a period of economic growth and modernization, living standards (as indicated by heights) declined for the majority of the population.[3] In other words, growth without equity is nothing new to Latin America.

In the twentieth century, Latin America has been practically synonymous with the problem of underdevelopment. There are rival theories about its cause. To reduce things to their most basic, two frameworks have been dominant. The first was the “dependency” school, which placed responsibility for Latin America’s underdevelopment on its disadvantageous dependence on the advanced economies of Europe and the United States. The basic problem, it was thought, was of Latin America’s insertion into an imperialistic world-system. Some dependency theorists sought solutions in moderate reforms, such as introducing protections for domestic industries. These were sometimes successful, and sometimes led to the creation of uncompetitive businesses that couldn’t survive in the absence of state support. More radical interpretations of dependency also emerged, counseling armed socialist uprising and economic autarky. After its revolution of 1959, Cuba tried a version of this. Inequality fell from the levels of Brazil to levels of Sweden in a few short years, and some forms of extreme poverty were eradicated. But, facing an economic embargo from the United States, it had to rely on the Soviet Union, and its measure of “dependence” increased. To say nothing of the absence of fundamental political freedoms, economic management has careened from one unstable plan to another, and what was once one of Latin America’s richest countries has consistently lost ground.

Over time, the grounds for belief in strong forms of dependency theory looked increasingly flimsy, and historians began to offer explanations based on a growth-economics tradition.[4] The decline in the terms of trade between raw materials and finished goods that had inspired the original dependency analysis proved cyclical, not secular. Close analysis showed that Latin American economies were not helpless participants in the international economy, but able to influence important commodity prices. And socialist revolution proved either unattainable or economically disastrous. Historians and analysts increasingly explained Latin America’s economic conditions as problems of “institutions” that needed reform, not only its position in the world economy.

From the point of view of generally left-wing dependency theory, this “institutional” analysis sometimes has the appearance of victim blaming and political conservatism. But it needn’t be understood in those terms. Kenneth Sokoloff and Stanley Engerman, for example, have argued that Latin America’s institutions are precisely the result of colonial inequalities and the largely successful struggle of outnumbered elites to maintain their privileges. Their data shows, for example, a clear inverse relationship between extant inequality and the years that voting rights are extended to cover most of the population.[5] Frightened elites do not invest in, and indeed actively suppress, dangerous forms of human capital formation among the common people. The persistence of inequality is, according to this model, the expected result of elites acting to maintain their privileges over decades and even centuries. That explanation takes a view of things from a very great height, and leaves the details to be worked out elsewhere. But it sounds a powerful warning to the United States as levels of inequality there approach those traditionally associated with the other Americas. If Latin America has a lesson for the United States today, it is that maintaining a relatively egalitarian society is not only important for growth, it is also important for keeping politics balanced within boundaries that can support a healthy and responsive democracy.

In spite of the many obstacles, there have been signs of hope in Latin America for equitable growth in the last decade. The region’s economy has grown at about 4% annually over the last ten years, and, in several high profile cases, also managed to reduce measured inequality. So is Fajnzylber’s box still empty? His original table was calculated in a rather crude way. High growth was considered anything over a 2.4% annual increase in GDP, the developed world average over the previous two decades at the time of his writing. His measurement of inequality was based on the ratio of the income share of the poorest 40% of the population to the richest 10%—a calculation that did not account for relative increases or decreases in inequality. At the time, the developed world average was 0.8 – that is, the lower 40% had combined income equal to 80% of the richest 10%. Fajnzylber’s standard for Latin American inequality was, arbitrarily, half of that measure: a ratio of 0.4. His results in 1990 were as follows:

From Skitch

Using data from the World Bank, I recreated Fajnzylber’s table, using the most current statistics available and the same criteria that he established. Given the reputation that the Latin American economies have had over the last few years, the results are perhaps surprising:

From Skitch

Every country with available data in the region has grown by more than a 2.4% annual rate over the last decade with the exception of El Salvador. But there are no countries that meet Fajnzylber’s standard for relative equality left in Latin America. Indeed, to re-run his numbers is to confront a world changed by inequality, for there are few countries in the world left that meet the standard he established twenty-five years ago. His developed world average had been a ratio of 0.8; now the world’s best performers on that metric are the Scandinavian countries and a few places in Eastern Europe, hovering around 0.6. Canada and France today barely meet his lowered-expectations standard for Latin America in 1990, at 0.4. The United States has a ratio of 0.23, and the Latin American countries are terrible performers: Uruguay and Nicaragua are the only countries over 0.2; Mexico’s ratio is 0.184, Argentina’s is 0.156, Venezuela’s is 0.152, Chile’s is 0.140 and many are below 0.1, including Brazil at 0.093, Guatemala at 0.089, and Bolivia at 0.046.

Plainly, by using an absolute standard of inequality rather than one that measures the rate of change, this data does not register the progress that some Latin American countries have made in reducing inequality over the last decade. To address this, I’ve produced a modified table, using the same growth standard but looking at change in the countries’ Gini indexes over time. Most Latin American countries had a local maximum in their Gini index between 1998 and 2002, and almost all have reached a local minimum in the last year or two. If we take a significant decline in inequality to be a peak to trough reduction in Gini index of 4 points over those ten years, this is the table that results:[6]

From Skitch 2

The story embedded in the data is clear: working from an extremely poor starting point, the experience of most of Latin America has been one of strong and equitable growth over the last decade. The principal reasons that this has been possible are clear enough. Rapid growth in Asia has kept commodity prices high, and Latin America, though now also the producer of many types of sophisticated manufactured goods, remains a major exporter of raw and semi-finished goods. At the same time, most of the region has been ruled by left and center-left governments that have made improving the lives of the poor among their highest priorities. This has taken many forms. Venezuela’s has been the most polarizing: both nationally and internationally, judgments on the effectiveness of the social missions and the economic management of Venezuela’s government allow for little middle ground. In the last decade or so, the poverty rate has been cut in half, from more than 60% of the population to around 30%. But excessive oil dependence, shortages of basic goods, increasing violence, and the recent imposition of price controls suggest that, at best, Venezuela’s economy could have been managed much better than it has been, and, at worst, may be following a classic pattern of populist spending that may be lead to future adjustment that will come at a high cost, both politically and economically.[7]

Most of the region, however, has used more conventional macroeconomic management, and, somewhat in the manner that President Obama did with the health care industry, compromised with powerful economic interests in the pursuit of broader goals. Brazil’s ascent, under its charming president Lula da Silva and his successor Dilma Roussef, has been so spectacular that the old joke that “Brazil is the country of the future, and always will be,” no longer seems to hold. But other countries have had even more impressive statistical progress. Ecuador has knocked more than ten points off its Gini index, while Panama has grown at more than 8% annually over the last decade.

How then should progress be maintained and extended? There are already some signs of trouble. In Brazil, for example, once-rapid growth has slowed to a trickle; Mexico, frequently championed as one of the world’s great emerging economies, is on the verge of outright recession. And though much of the region has been governed by the left in the last decade, significant redistribution remains rare. There are signature anti-poverty programs, like Oportunidades in Mexico and Bolsa Família in Brazil, that give conditional cash grants in exchange for behaviors like children’s school attendance. But these progressive policies are mixed in with a huge amount of regressive government spending. The budget for Oportunidades in Mexico, for example, is dwarfed by the cost of regressive energy subsidies.[8] Tax collection as a percentage of GDP has increased modestly, but remains meager. As a result, major Latin American economies do almost nothing to reduce their levels of measured inequality through taxes and transfers. European countries knock 19 points off their Gini indexes through taxation and redistribution; Latin America only 2 points. Pre- and post-tax Gini indexes are virtually identical for the region’s major economies.[9]

From Skitch 3

The hopeful reading of that situation is that there are huge benefits to be gained from relatively straightforward welfare-enhancing programs and the elimination of regressive subsidies, and there is ample room for both growth and the reduction in poverty to follow. The pessimistic reading of the situation is that the last ten years have been among the most propitious in Latin American history for equitable growth, and much more probably should have been delivered. It remains to be seen whether the political systems of societies that remain grossly unequal will be able to make further progress in the decades to come.

[1] Fernando Fajnzylber, Unavoidable Industrial Restructuring in Latin America (Durham, N.C.: Duke University Press, 1990), 2. Fajnzylber’s standard for high growth was an average annual growth rate over 2.4%, the industrial world’s average. His measure of equity was the take ratio of the lowest 40% to the highest 10% of 0.4, half that of the developed world average in the late 1970s/early 1980s. [2] As Branko Milanovic has put it, inequality in Asia is based on location—some countries are much richer than others—while inequality in Latin America is based on class. Branko Milanovic, The Haves and the Have-nots: A Brief and Idiosyncratic History of Global Inequality (New York: Basic Books, 2011), 185. [3] Moramay López-Alonso, Measuring Up: A History of Living Standards in Mexico, 1850-1950 (Stanford: Stanford University Press, 2012). [4] For a introduction to this debate, see especially Stephen Haber, ed., How Latin America Fell Behind: Essays on the Economic Histories of Brazil and Mexico, 1800-1914 (Stanford: Stanford University Press, 1997). [5] Kenneth Sokoloff and Stanley Engerman, “Institutions, Factor Endowments, and Paths of Development in the New World,” Journal of Economic Perspectives 14, no. 3 (Summer 2000): 226. [6] In a few cases, there is insufficient data to make a clear determination. Guatemala’s most recent year is 2006; Venezuela peaked in 2005 and troughed in 2006 and lacks subsequent data. The CIA Gini index, which is considered less reliable than the World Bank’s, now has Venezuela’s Gini as the lowest of measurable Latin American countries, so it would probably belong in the high growth, significant decline box as well. [7] See Rudiger Dornbusch and Sebastian Edwards, eds., The Macroeconomics of Populism in Latin America (Chicago: University of Chicago Press, 1991). [8] John Scott Andretta, “¿Quién se beneficia de los subsidies energéticos en México?” in Carlos Elizondo Mayer-Serra and Ana Laura Magaloni Kerpel (eds.), Uso y abuso de los recursos públicos, Mexico, CIDE, 2012. [9] The data is from 2008. The chart comes from the OECD report, “Latin American Economic Outlook 2012,”