This document summarizes the transformation of Latin America from mercantilism to capitalism. It discusses how inward development strategies like import substitution industrialization led to distortions in Latin American economies, including lack of rule of law, poor property rights protection, and barriers to entrepreneurship. This resulted in consequences like high inflation, debt, poverty, and informality. The document argues for outward development strategies and bottom-up approaches that emphasize limited government, strong institutions, and protection of economic freedom to foster sustainable growth.

1. The Latin American
Transformation: Mercantilism to
Capitalism
Pedro Romero Aleman
George Mason University
08/27/2007

2. Latin America Landscape

3. The Puzzle
 “Why did Latin America stagnate
in the twentieth century while the
US and Canada surged ahead?”
Franko: 2003 p. 30

4. Conventional Answers
 Marxist theories
 Exploitation by developed countries (Colonial
Vestiges)
 Center – Periphery or International Division of
Labor
 Vicious Circle of Poverty (Ragnar Nurkse)
 Countries are poor because they’re poor
 Low income, low savings, therefore low capital
which leads to low incomes.

5. Critiques
 Poverty as a natural state of human beings
 Rich nations were also in the past poor
 People in those countries at that time faced the
same problems
 Low incomes, savings and capital accumulation
 Malnutrition, unhealthy environments, population
pressures
 But they were able to get out of the vicious circle
 Hong Kong y Chile, Cuba y Venezuela

6. An Alternative View
 "It may be true that in certain conditions, where
an undeveloped government apparatus is scarcely
yet adequate to perform [such as a minimal state],
it would be wise to confine to it, since an
additional burden would exceed its weak powers
and the effect of attempting more would be that it
did not even provide the indispensable conditions
for the functioning of a free society."
Friedrich Hayek, 1979. Vol 3 Pg 41. Brackets added.

7. An Alternative View
 Constitutions as rent seeking instruments
 Legal labyrinth
 Interest group conflicts
 Consequences: EFW, GDP pc
 Absence of enforcement
 Property Rights unprotected
 Higher transaction costs/Entry barriers
 Corruption
 Lower Economic Growth

8. Repressed Societies
Source: Gwartney, James and Robert Lawson (2004).
Economic Freedom of the World: 2004 Annual Report.
Vancouver: The Fraser Institute. Data retrieved from www.freetheworld.com
Economic Freedom Index
0
1
2
3
4
5
6
7
8
9
10
1975 1980 1985 1990 1995 2000 2002
Bolivia Colombia Ecuador Peru Venezuela Chile

9. Growth impossible without
Institutions
GDP vs RULE LAW
5
6
7
8
9
10
11
-1.2 -0.7 -0.2 0.3 0.8 1.3 1.8 2.3
Index of Rule of Law
Ln(GDP pc) PPP
Chile
Colombia
Ecuador
Hong Kong
Peru
Venezuela
US
Source: Data retrieved from the International Institute for Corporate Governance
at http://iicg.som.yale.edu/data/datasets.shtml

10. Fiscal Opacity

11. Institutional Matrix and Resources
Political System
“legal relations that govern society”
Property rights
Private-Public-Communal-Absence of Ownership
Economic System
“a process of material transformation”
Decisions
Consumption-Production-Distribution
Natural Resources
“They are out there”
Constraints/Advantages
Renewable and Non-renewable Resources

12. Latin America Transformation
 Productive structure: Consumption goods,
intermediate (production) goods, time or process
consuming time.
 Public Policies can either hinder or foster/preserve
the production process
 Institutional matrix: Rule of Law or Rule of men
 The manner in which a society structures its
political/legal institutions helps shape the
character of life in that society.

13. Mercantilism
 “The property rights over land and water within the limits of the
national territory belong to the State, which has the right to transfer it
to the individuals…The State will have anytime the right to impose
over private property any requirement stemming from the public
interest…The State has the direct control over all the natural resources
on the continent and maritime border plus everything under the
ground…” Mexican Constitution, 1917. Art. 27.
 The goal was to make an equitable (re)distribution of the
wealth.
 318 amendments by the end of 1980
 Inflation of law
 Centralization of political power, none or few checks and
balances

14. Inward Development Strategies
 Import Substitution Industrialization ISI:
government as the main developmental
actor.
 Exchange rate and trade tools used to promote
industrialization
 Raul Prebisch and ECLAC
 Keynesianism, disliking/non-satisfaction
w/capitalism, given LATAM backwardness

15. Inward Development Strategies
 Local and international elites favor short-term
profits instead of long-term dynamic growth
 Latifundia (redistribuion of land)
 Paul Baran thought revolution as the only way-out
 F. Henrique Cardoso thought that autonomous
development was possible.
 Structuralists: ToT, government as counterbalance
to Multinational Companies
 A. Hirschman: development as bottleneck, lack of
complementary factors

16. But…
 “Somewhat ironically, in the first
stages of import substitution
industrialization, national imports
usually rose.” Franko: 59

17. Outward Development Strategies
 Subsidies to production for exportation
 Cheap credit to domestic banks
 Supported by international organizations
 Interest groups, barriers to entry
 High devaluations of national currencies

18. Consequences
 Lack of rule of law
 Poor protection property rights
 Distortions of Productive Structure of the
economy
 Urban in detriment of rural development
 Low quality industrial goods in detriment of
agricultural goods
 Large Government Spending but limited
governance capabilities

19. Consequences
 Huge fiscal deficits and external debts
 Inflation, volatile currencies
 Higher interest rates than elsewhere
 A complex tax scheme that hinders
entrepreneurship
 Informality
 Poverty

20. Consequences

21. Argentina’s Happy 1990s
 So what went wrong?
 The federal government's fiscal position deteriorated steadily during
the boom years
 this partly reflected a recognition of unfunded pension liabilities.
 The fiscal problem reflected a lack of discipline at the provincial level
 Once off-balance sheet borrowing is taken into account as well, the
consolidated budget deficit was around 2½ percent of GDP even as the
boom peaked in 1997 and 1998.
 In 1994 the average federal employee was paid 25 percent more than
the average private sector employee; by 1998 the differential had risen
to 45 percent.
 By the mid-to-late 1990s, public sector employment accounted for
12.5 percent of the labor force in Argentina, compared to barely 7
percent in Brazil and Chile
 Argentina's total foreign currency debt was around five times the size
of its foreign currency receipts from exports of goods and services.

22. A Message of Hope
 “Economic achievement and progress depend largely
on human aptitudes and attitudes, on social and
political institutions and arrangements which derive
from these, on historical experience, and to a lesser
extent on external contacts, market opportunities and
on natural resources.” Bauer:1976, p. 41
 Bottom-up approaches to development
 Entrepreneurship
 No politicians
 Limited and Constitutional Government