Thursday, January 06, 2005

Barriers to Competition

A new paper notes that Latin American countries are the only western countries that are not catching up to the US. The emphasis is on western here. Latin America is placed in a peer group along with Europe, Australia, and New Zealand. We are supposed to believe that Latin American culture is, for the purposes of economic development, not distinguishable from the rest of the "western"cultures. That way, it can be said that "...since the Europeans who populated these regions established Western religion, language, and culture, then it should have been feasible for [the Latin American countries] to replicate the successful economies of the West.

The growth performance of Latin America is shown to be pitiful.

...all the other poor Western countries have had significant catch-up over the last 50 years. The average European country in this group increased from 40 percent of U.S. income in 1950 to 67 percent in 2000. In contrast, Latin America lost ground, falling from 28 percentof the U.S. level in 1950 to 22 percent in 2000.
The paper is also successful in showing that Latin America's growth failure is not the result of insufficient capital accumulation (even including human capital), but rather the result of unexplained total factor productivity. That is, Latin America has lagged behind the rest of its "peers" because it has used its capital inefficiently.

Why has this happened? Lack of competition, say the authors. Latin American countries have set up protectionist barriers that have sheltered domestic producers, and high barriers to entry that have sheltered incumbent firms. The most striking evidence is anecdotal. The Venezuelan oil industry was nationalized in the mid-1970s, and this was the result:

By 1985 productivity had fallen over 70 percent from its 1970 peak, and was at its 1955 level. Output fell 53 percent between its peak in 1970 and 1985, and was also at its 1955 level. It is striking that the large output loss was accompanied by an increase in employment, which suggests that the local managers were not nearly as efficient at running the operation as the foreign managers. Moreover, this output loss is not the result of OPEC policies; many OPEC members increased their output considerably in the 1970s and 1980s.
In Chile, the Pinochet government protected the national copper company, Codelco, because 10% of its revenues went to the military. After democracy was restored, foreign competition entered the picture and productivity sky-rocketed. After import bans in the computer industry were removed in Brazil, productivity lost one third of its gap with the US, a dramatic achievement given that productivity in the US computer industry was growing at 30%.

I tend to believe the results of this paper, but frankly it's not the empirical exercise that convinces me. The reason I'm convinced is that these guys are preaching to the converted. I believed to begin with. Frankly, their argument that you can lump in the Latin American culture with the Protestant cultures of northern Europe and the US is flimsy. It is probably no coincidence that the "peers" that did manage to catch up to the income of the US were Canada, Australia, and New Zealand. Did they notice that the sample had just been split into the countries that speak Spanish and Portuguese and the countries that speak English?

Regardless, "culture" is a very vague term, and economists who claim to understand it rank up there with the sociologists who try to explain monetary policy. This is a good paper that could have been a great paper if it had not crossed over into this dodgy territory. Why did they have to mention culture to begin with? The anecdotal evidence on productivity is fantastic.


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