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Vol. 2, No. 7 JULY 2007 EconomicLetter Insights from the F e d e r al R e s e r v e B a n k o f Dalla s Is Latin America Saying Adios to Market-Friendly Reforms? by William C. Gruben and Richard Alm The presidential By the mid-1980s, governments’ reckless spending and economic meddling candidates who had brought hyperinflation, stagnation and economic crisis to many Latin American have won in the countries. The hard times opened the door to what became known as the Washington past nine years seem Consensus of the 1990s, shorthand for a set of market-oriented policies that included to signal a leftward fiscal discipline, deregulation, privatization and freer trade.1 shift in at least More than a decade and a half later, analysts increasingly wonder whether five countries. Latin America may abandon its free market policies and return to its socialist past.2 The presidential candidates who have won in the past nine years seem to signal a leftward shift in at least five countries. Hugo Chavez, who advocates “a new socialism” for the 21st century, won Venezuela’s presidency in 1998 and has since been reelected. Chavez has made good on his populist rhetoric by spending lavishly on new social programs, taking control of foreign-led oil ventures, letting squatters take wealthy farmers’ land, nationalizing telephone and electric companies, and threatening to seize banks and other privately held enterprises. Chile has had a Socialist Party president since 2000, first Ricardo Lagos and since last year, Michelle Bachelet. In Brazil, Workers Party candidate Luiz Inácio Lula da Silva took office in 2003. Cuba’s Fidel Castro was among the heads of state attending the 2003 presidential inauguration of Néstor Kirchner, leader of Argentina’s Peronist Party. In 2005, socialist Evo Morales, a former coca-leaf grower and union leader, became Bolivia’s president. Assessing the leftward tilt in Latin America’s economic policies requires going beyond election results. The Fraser Institute’s Economic Freedom of the World report provides a broad, long-term gauge of nations’ commitment to market-oriented policies.3 In the mid-1980s, Latin America started gaining economic freedom faster than the rest of the world (Chart 1). In the next decade, the Washington Consensus provided added momentum, allowing the region to achieve the world average at the turn of the century. Latin America, however, has since fallen off the global pace. Despite the recent lag, it may be too soon to write an obituary for Latin America’s market reforms. A country-by-country survey leads to a less sweeping conclusion: A few leaders have steered their countries to the left, but the bulk of Latin America hasn’t lost faith in markets. Economic Freedom Trends We can delve deeper into Latin America’s economic policies by analyzing individual countries’ performance on the Fraser index since 2000. In general, Fraser equates economic freedom with greater reliance on market forces and less government intervention. Countries do better to the extent they open trade, welcome foreign investment, keep taxes and regulatory burdens low on business and labor, control government spending, hold down the hidden tax of inflation and enforce property rights. To simplify the process, we looked at the dozen nations with the largest populations and economies (Table 1). Cuba has been omitted because of a lack of data. Individual countries’ most recent Fraser scores go in every direction— up, down and mostly sideways (Chart 2). Venezuela, Argentina and the Dominican Republic moved sharply away from a market orientation in 2000–04. Venezuela’s rebound at the end of the period isn’t likely to be sustained, given Chavez’s subsequent actions, such as limiting foreign companies to minority stakes in oil and gas exploration projects. Where did these three countries veer off Fraser’s free market path? Venezuela lost points because it tightened limits on holding foreign currency, imposed price controls, meddled in exchange rate markets, added bureaucratic hassles and regulation, and burdened foreign investment. Argentina experienced rising inflation and imposed price controls—signs of monetary policy lapses that exposed Table 1 Latin America’s Largest Countries Chart 1 Falling Behind on Economic Freedom? (Fraser index, weighted by population) Index, 10 = most freedom Brazil Mexico Colombia Argentina Peru Venezuela Chile Ecuador Guatemala Bolivia Dominican Republic Honduras 7 6 Rest of world Latin America 5 4 3 ’80 ’82 ’84 ’86 ’88 ’90 ’92 ’94 ’96 ’98 ’00 ’02 SOURCE: Fraser Institute, Economic Freedom of the World: 2006 Annual Report. EconomicLetter Feder al Re serve B ank of Dallas ’04 Population (millions) GDP per capita 186.4 103.1 45.6 38.7 28.0 26.6 16.3 13.2 12.6 9.2 $4,271 $7,454 $2,682 $4,728 $2,838 $5,275 $7,073 $2,758 $2,517 $1,017 8.9 7.2 $3,317 $1,151 NOTES: Data are for 2005. Cuba is excluded because of a lack of data. GDP is in U.S. dollars. SOURCE: World Bank, World Development Indicators. Chart 2 Gauging Changes in Economic Freedom—Fraser Index Index, 2000 = 100 110 100 90 Mexico 80 70 2000 Chile Guatemala Peru Ecuador Bolivia Honduras Argentina Colombia Dominican Republic Brazil Venezuela 2001 2002 2003 2004 SOURCE: Fraser Institute, Economic Freedom of the World: 2006 Annual Report. the private sector to increased risk. The country also had problems with burdensome regulations, growing benefits to labor, and maintaining the law and order necessary for economic stability. The Dominican Republic added red tape, lost inflationary discipline and effectively drove real interest rates below zero. While these countries curtailed economic freedom, Mexico moved in the opposite direction. Improvements came largely from policies promoting market interest rates, less restrictive minimum wages and lower tax burdens. Elsewhere, Fraser’s assessments of economic freedom changed little over 2000–04. Chile and Peru were already among Latin America’s most marketoriented countries—so they remained exemplars of free market policies despite a lack of upward movement in their indexes (Table 2). Colombia’s slight regression and Ecuador’s meager progress may be reason for greater concern because both entered the new century relatively low in the economic freedom rankings.4 The Index of Economic Freedom, calculated by the Heritage Foundation and The Wall Street Journal, offers another country-by-country assessment.5 We’ve adjusted the measure to provide a sharper focus on domestic policies.6 Components for openness to trade and foreign capital have been deleted, leaving data on fiscal burden, government intervention in the economy, monetary policy, banking-market openness, wage and price controls, protection of property rights, regulation and prevalence of informal markets. Like the Fraser index, the Heritage/ WSJ data show that Argentina, Venezuela and the Dominican Republic experienced marked erosion in market orientation (Chart 3). The 2000–05 data may also provide an early hint of an ebbing in Bolivia’s index. Morales nationalized the oil and gas industry in May 2005, so the country’s small decline may be a harbinger of a trend that will emerge in subsequent reports. While Fraser indicates that Venezuela lost the most ground, Heritage/WSJ finds Argentina a bigger backslider. Argentina, however, Feder al Reserve Bank of Dallas achieves a higher overall ranking every year, signaling that it surpasses Venezuela in market orientation. According to the Heritage/WSJ data, Argentina’s domestic economic freedom faltered because authorities failed to control inflation, crimped the banking system and allowed property rights to deteriorate. The biggest contributor to Venezuela’s declining score was the growing size of government, a reflection of Chavez’s penchant for spending the country’s oil riches. The country also did worse on measures of financial freedom and corruption. The Dominican Republic’s deterioration was widespread, with lower readings for fiscal policy, size of government, monetary policy, finance and corruption. Beyond the backsliders, Heritage/ WSJ finds most Latin American nations didn’t forsake market-friendly policies. However, meaningful progress toward markets is hard to find outside Ecuador, which showed eye-popping progress. Ecuador’s results should be interpreted with caution, how- Table 2 How Nations Rank on Economic Policies Chile Peru Guatemala Mexico Bolivia Honduras Argentina Brazil Ecuador Colombia Dominican Republic Venezuela Fraser Index 2004 Heritage/WSJ Domestic Index 2005 7.44 6.82 6.64 6.62 6.53 6.47 6.19 5.88 5.75 5.46 8.10 6.66 6.17 6.46 5.89 6.14 5.69 6.28 6.00 6.16 5.43 4.44 5.69 5.06 SOURCES: Fraser Institute, Economic Freedom of the World: 2006 Annual Report; The Heritage Foundation/Wall Street Journal 2007 Index of Economic Freedom. EconomicLetter ever. The small Andes nation had the region’s lowest Heritage/WSJ domestic-policy score in 2000, the year it scrapped its currency in favor of the U.S. dollar, a move designed to corral runaway inflation. Dollarization brought improvements in monetary policy and the financial system, the biggest contribution to Ecuador’s better showing in 2005. The past five years’ progress, however, merely restored Ecuador to its 1998 level. Perhaps more telling, the country’s Heritage/WSJ ranking in 2005 puts it ahead of only Argentina, Bolivia, the Dominican Republic and Venezuela—not the best of neighbors when it comes to economic freedom. Chart 3 Gauging Changes in Economic Freedom— Heritage/WSJ Index Index, 2000 = 100 130 120 110 100 90 80 70 60 2000 Argentina Colombia Venezuela Ecuador Brazil Mexico Bolivia Guatemala Chile Dominican Republic Peru 2001 2002 Honduras 2003 2004 2005 SOURCE: The Heritage Foundation/Wall Street Journal 2007 Index of Economic Freedom. Table 3 Doing Business Measures Show Markets Still in Favor Market orientation indicators Argentina Bolivia Brazil Chile Colombia Dominican Republic Ecuador Guatemala Honduras Mexico Peru Venezuela Total Increasing No change Decreasing 6 5 5 2 7 13 12 12 16 12 0 2 2 1 0 5 7 7 6 6 5 5 11 12 11 10 12 13 12 3 0 1 3 1 1 2 66 146 16 NOTE: Data are for 2003 – 06. SOURCE: World Bank, World Development Indicators. EconomicLetter Feder al Re serve B ank of Dallas Business Burdens Regimes moving to the left typically favor workers over employers and hinder companies with excessive rules and red tape. Market-friendly reforms, on the other hand, relieve the burdens on businesses. Fraser and Heritage/WSJ pick up changes in these policies, but the World Bank’s Doing Business series provides additional detail on the everyday burdens companies and entrepreneurs face. The series collects 42 indicators for 2003 through 2006, covering a time when Chavez, Kirchner, da Silva, Morales and others were in office. The data measure hurdles private enterprises encounter in a range of areas—among them, starting a business, employing workers, registering property, getting credit, enforcing contracts and closing a business. The World Bank doesn’t present data for every country and every year, but we did find meaningful comparisons on 19 aspects for the 12 Latin American countries we studied. Looking at those aspects, we found that 212 of the indicators point to the same or greater market orientation (Table 3). All countries but Chile—the most market friendly— improved their scores in at least five categories. Only 16 measures indicate a retreat from markets. The Dominican Republic and Honduras had three each; Bolivia, Brazil and Venezuela had two. From a freer market perspective, the most encouraging Doing Business trends center on new businesses, which increase competition and create jobs. Latin America’s best environments for entrepreneurs can be found in Chile, Guatemala and Mexico, where starting a business takes a month or less (Chart 4). The biggest improvement, however, came in Argentina, which hasn’t otherwise received high marks for market-friendliness.7 The country reduced the number of days required to start a business from 68 in 2003 to 32 in 2006. Mexico shaved off 31 days, Ecuador 27 and Peru 26. Brazil and Venezuela remain unfriendly to entrepreneurs, but none of our 12 Latin American nations added to business start-ups’ time burden. The environment for entrepreneurs has improved in other ways. Eleven countries reduced financial barriers to starting a business, measured as the cost of opening up as a percentage of per capita income. Seven whittled down start-ups’ capital requirements. Three cut the number of procedures for opening a business. All told, nearly half the 66 increases in market orientation came in World Bank measures related to getting a new enterprise off the ground. Closing a business can be just as important as starting one. An efficient bankruptcy and foreclosure system allows creditors, tax authorities, employees and others to recover a greater portion of their claims. They fare better when proceedings take less time and money and enterprises keep operating in the interim. The World Bank calculates the cents per dollar likely to be recovered from a business that’s shutting down (Chart 5). Between 2003 and 2006, all countries except Chile had higher recovery rates, a signal their bankruptcy and foreclosure systems had become more market friendly. Chart 4 Days Required to Start a Business Days 160 140 2003 120 2006 100 80 60 40 20 0 Brazil Venezuela Peru Ecuador Dominican Argentina Honduras Colombia Bolivia Republic Mexico Guatemala Chile SOURCE: World Bank, Doing Business database. Chart 5 Closing Business Recovery Rate Cents on the dollar claimants recover 70 60 2003 2006 50 40 30 20 10 0 Mexico Colombia Bolivia Peru Guatemala Argentina Chile Honduras SOURCE: World Bank, Doing Business database. Feder al Reserve Bank of Dallas EconomicLetter Ecuador Dominican Venezuela Republic Brazil Latin America can’t escape the fact that left-leaning policies have historically been a drag on growth. Market reforms offer the region a chance to better itself, particularly in an era of globalization. Gains were largely modest outside of Argentina and Brazil, the latter a dismal performer in 2003. Some progress came in registering property, with 10 nations lowering the cost relative to property value. Brazil, the Dominican Republic, Honduras and Peru cut the number of days it takes to enforce a contract. Colombia did, too, but only managed to come down to an astronomic 1,346 days, making it second to Guatemala. Scant progress was made in freeing labor markets. Indeed, 10 of the 16 instances of decreasing market orientation involved restrictions on hiring and firing. Bolivia, the Dominican Republic and Honduras reduced market orientation in two of the five Doing Business labor measures. Argentina, Brazil, Guatemala and Mexico became less market friendly in one each. Venezuela showed improvement in two workplace measures, although its labor market scores remained decidedly antimarket. Among the 12 countries with the bulk of Latin America’s population, the Fraser, Heritage/WSJ and World Bank measures—taken together—find no wholesale erosion of market-based policies outside of Argentina, the Dominican Republic and Venezuela. In particular, Mexico continues to do well. A regional leader in market orientation at the start of the decade, it subsequently gained economic freedom on the Fraser index and improved its performance on six Doing Business indicators. Among the 12 largest nations, Mexico led in fewest days to start a business and highest recovery rate in liquidations. The leftward lurch perceived by many observers has been exaggerated. Even so, the data don’t show a groundswell of support for new market-oriented policies. Progress is spotty, with few countries pursuing ambitious reforms and most of them running in place. The momentum of the Washington Consensus has flagged in the new century. Growth and Reform The success of previous reforms may be one reason Latin American nations aren’t moving as briskly as they once did toward market-friendly policies. When they began to loosen the state’s grip on their economies two decades ago, most countries had long reform agendas that included opening markets, controlling inflation, deregulating industries and privatizing government enterprises. A lot of that heavy lifting has already been done. From 1990 to 2004, Latin America’s Fraser index, weighted by population, rose 30 percent. What’s left for Chile, Mexico and the other more market-oriented nations is consolidation and fine-tuning—decidedly smaller steps. Most countries have maintained the marketoriented policies put in place. In the handful of countries where economic freedom has faltered, we can’t deny the pull of populism. Bolivia, the Dominican Republic and Venezuela are relatively poor and underdeveloped, making them susceptible to the message of a Chavez or Morales. Argentina is a bit different. It ranks as one of Latin America’s richest countries but has a history of populist politics dating to Juan Perón in the late 1940s. Some analysts contend that countries adopting market-oriented policies EconomicLetter Feder al Re serve B ank of Dallas in the 1990s grew more slowly than reformers had promised. When the reforms didn’t deliver as expected, they say, it strengthened forces opposed to economic liberalization. In this political dynamic, some nations would retreat from the market ideology. Other nations may still move toward freer markets but at a slower pace than countries with more vigorous economies. The data, however, don’t support a link between sluggish economies and turning away from economic freedom. From 1997 to 2000, growth rates varied among the 12 Latin American nations: Mexico, Guatemala and the Dominican Republic gained the most, while output declined in Ecuador, Colombia, Argentina and Venezuela. Subsequent changes in economic freedom, measured by either the Fraser or Heritage/WSJ domestic index, appear random (Chart 6). Guatemala made significant progress by Fraser’s reckoning but regressed slightly by Heritage/WSJ’s. By both indexes, the growing Dominican Republic became less market friendly and slumping Ecuador gained economic freedom. Colombia’s results are mixed. Only in Argentina and Venezuela did poor economic performance precede sharp declines in economic freedom. Fraser scores show Argentina pursued market measures with some vigor in the 1990s. When the economy again slipped into a hyperinflationary quagmire, the country could have been disillusioned with the policies’ payoff. Venezuela, on the other hand, registered little overall progress toward markets in the 1990s, so it’s hard to make the case that bad results from reform led to Chavez’s election and skepticism about markets.8 The Fraser, Heritage/WSJ and World Bank data are consistent through time and across countries, making them useful for international comparisons. The bare numbers, of course, don’t fully capture the complexities of economic policy. In addition to internal political forces, nations face external pressures from markets and lenders that have at times led to sudden policy shifts. Some policies have unanticipated consequences. During the 1990s, tough stances on pegged exchange rates adopted to hold down inflation sometimes triggered an outward rush of financial capital. Evidence suggests that investors thought the stances couldn’t last because they were too tough. Tactics differ. To fight inflation, some countries have adopted specific targets, which some evidence suggests helps reduce inflation and its volatility.9 Is Latin America saying adios to market-friendly reforms? It doesn’t look like it—left-leaning election results notwithstanding. The retreats have been limited to a few countries and a small segment of the overall population. Elsewhere, the region largely retains market reforms, while some countries continue to move forward, albeit cautiously. Economic performance shouldn’t be a stumbling block. The World Bank projects healthy growth in the region—4.8 percent in 2007 and 4.3 percent in 2008. Few countries will have reason to question the effectiveness of marketoriented policies, making it less likely the contagion of a Chavez or Morales will spread. Still largely poor by U.S. and European standards, Latin America can’t escape the fact that left-leaning policies have historically been a drag on growth.10 Although they sometimes roil enterprises, industries and even economies, market reforms offer the region a chance to better itself, particularly in an era of globalization, when isolation leads to stagnation. The slow pace of Latin America’s market reforms in recent years is cause for concern, leaving the region’s market advocates looking for ways to restore the momentum of the 1990s. Chart 6 Does Slower Growth Sap Economic Freedom? Fraser Index Change in index, 2000 – 04 .6 Mexico Honduras .4 Ecuador .2 Brazil Guatemala 0 Chile Colombia –.2 Peru Bolivia –.4 –.6 –.8 Argentina –1 Venezuela Dominican Republic –1.2 –1.4 –10 5 0 –5 20 15 10 GDP growth, 1997–2000 (percent) 25 30 35 30 35 SOURCE: Fraser Institute, Economic Freedom of the World: 2006 Annual Report. Heritage/WSJ Domestic Index Change in index, 2000 – 05 100 80 Ecuador 60 40 Honduras Chile Brazil 20 Mexico Colombia 0 Peru –20 Venezuela –40 Bolivia Guatemala Dominican Republic –60 Argentina –80 –100 –10 –5 0 5 20 15 10 GDP growth, 1997–2000 (percent) SOURCE: The Heritage Foundation/Wall Street Journal 2007 Index of Economic Freedom. NOTE: Population determines bubble size. Gruben is a vice president and senior economist and Alm is senior economics writer in the Research Department of the Federal Reserve Bank of Dallas. Feder al Reserve Bank of Dallas EconomicLetter 25 EconomicLetter Notes production. See “NAFTA and Mexico’s Less-Than- The authors thank Genevieve R. Solomon and Stellar Performance,” by Aaron Tornell, Frank Julia K. Carter for their research assistance. 1 The term Washington Consensus, coined by Westermann and Lorenza Martinez, National Bureau of Economic Research Working Paper no. John Williamson of the Institute for International 10289, February 2004. Economics, refers to the advocacy of market- 7 oriented policies at such Washington-based not discussed in this article, reduced the time to El Salvador, a smaller Latin American country institutions as the World Bank, International start a business from 115 to 26 days. Monetary Fund and Treasury Department. 8 However, Joseph Stanislaw and Daniel Yergin, for 1995 and 5.5 again for 2000. The country’s authors of The Commanding Heights, contend score was 4.4 for 2004. Higher scores indicate the policies were developed “in Latin America, greater economic freedom on a 1–10 scale. by Latin Americans, in response to what was Comparable Heritage/WSJ data aren’t available happening both within and outside the region.” for 1990, but our domestic index for Venezuela Venezuela’s Fraser scores were 5.5 for 1990, 4.2 Pro-socialist web sites present the election is 4.8 for 1995 and 5.57 for 2000. It is 5.06 for results as prima facie evidence of a welcome 2005. Higher scores indicate greater economic 2 shift to the left. Some conservative web sites find freedom on a 1– 10 scale. these same elections prima facie evidence of an 9 Our analysis of Latin American economic unwelcome shift to the left. See http://weblogs. policies covers the relatively brief period since elearning.ubc.ca/leftturns/2006/10/about_ 2000, a time when doubts arose about the this_blog.php; http://hurryupharry.bloghouse. region’s economic reforms. We find no link net/archives/2007/01/15/kirchner_boycotts_ between growth and policies. Longer-term ahmadinejad.php; and http://www.zmag.org/ analyses, however, show that declines in Sustainers/Content/2003-05/19adamovsky.cfm. 3 Economic Freedom of the World: 2006 Annual competitiveness, a policy-related concept, tend to slow growth in Latin America and increases in Report, James Gwartney and Robert Lawson, competitiveness tend to increase growth rates. Fraser Institute, www.freetheworld.com. To Better policies seem to foster growth. See “Latin avoid distortions from changes in the index’s America in the Rearview Mirror,” by Harold L. components over time, we used the institute’s Cole, Lee E. Ohanian, Alvaro Riascos and James chain link index, which maintains the same A. Schmitz Jr., National Bureau of Economic components from year to year. Fraser dates the Research Working Paper no. 11008, December index based on year of publication. We have 2004. used the year that applies to most of the index’s 10 underlying data; thus, Fraser’s 2006 scores are growth in recent years, fueled by government for the year 2004. spending and financed by rising oil revenues. 4 Most of the smaller Latin American countries Chavez’s Venezuela had strong economic Despite price controls, inflation remains high— showed only small changes in their Fraser 17 percent in 2006, the highest in Latin America. scores. Among the exceptions were Belize Despite exchange controls, the currency has lost and Panama, two nations relatively strong on value. Shortages of basic goods have angered economic freedom that posted significant gains consumers and created headaches for producers. between 2000 and 2004. Oil production has faltered, although Venezuela 5 The Heritage Foundation/Wall Street Journal is published monthly by the Federal Reserve Bank of Dallas. The views expressed are those of the authors and should not be attributed to the Federal Reserve Bank of Dallas or the Federal Reserve System. Articles may be reprinted on the condition that the source is credited and a copy is provided to the Research Department of the Federal Reserve Bank of Dallas. Economic Letter is available free of charge by writing the Public Affairs Department, Federal Reserve Bank of Dallas, P.O. Box 655906, Dallas, TX 75265-5906; by fax at 214-922-5268; or by telephone at 214-922-5254. This publication is available on the Dallas Fed web site, www.dallasfed.org. remains the world’s fifth-largest producer. Little 2007 Index of Economic Freedom, www.heritage. investment is being made in the industry, and key org. Heritage/WSJ dates the index based on year managers and workers have left the country. Richard W. Fisher President and Chief Executive Officer Helen E. Holcomb First Vice President and Chief Operating Officer Harvey Rosenblum Executive Vice President and Director of Research W. Michael Cox Senior Vice President and Chief Economist Robert D. Hankins Senior Vice President, Banking Supervision Executive Editor W. Michael Cox Editor Richard Alm Associate Editor Monica Reeves Graphic Designer Ellah Piña of publication. We have used the year that applies to most of the index’s underlying data; thus, the 2007 scores are for the year 2005. 6 Analysts who emphasize the role of globalization sometimes fail to appreciate the importance of domestic policies in a global context. Bottlenecks in the nontradables sectors, for example, constrict Mexico’s expansion in tradable goods Federal Reserve Bank of Dallas 2200 N. Pearl St. Dallas, TX 75201