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Can Latin America Reform Itself?

What steps can Latin America take to make the public sector work for the region’s neediest?

November 10, 2005

What steps can Latin America take to make the public sector work for the region's neediest?

Development cannot be decreed or legislated. Yet, all underdeveloped countries are governed — whether by socialists, conservatives or utilitarian liberals — as if it could be.

Napoleon is said to have remarked that it was vanity that made the French Revolution, everything else being a pretext. The concept could be extended to the role of government in contemporary — or historic — Latin America.

The institutions of civilization have resulted from a long evolutionary process, not deliberate design. If the function of government is approached from this standpoint, does it mean those in charge should simply stand aside and watch? No.

Since any incoming administration inherits a heavy legacy of coercive laws and norms that constitute the accumulated vanities of previous administrations and legislatures, it cannot sit idle.

That legacy in Latin America actually translates into hundreds of thousands of rules that govern not just the economy, but also the lives of people in each country. The other part of the equation is the bureaucracy that enforces the laws and a dependency on government support on the part of those who live in extreme poverty.

Those rules are the lifeline of the corporatist, state-mercantilist, privilege-driven, wealth-transferring, political law-based state.

But that is not all that any new administration inherits from its predecessors. It also inherits an underdeveloped society that functions under those rules, however it chooses to respond to them — including disobedience and the use of parallel, spontaneous rules.

If government cannot legislate progress, but presides — by legacy — over a sea of coercive norms and a society that lives or survives under those norms, what can it do? It can do many things, bearing in mind that reform ultimately involves undoing more than doing.

The acts of reform fall into one of four categories. The first two, cleansing the law and sanctifying the choices of the poor, are two sides of the same coin. The third, empowering the justice system, is a natural consequence of the previous two.

The last, providing a gentle and secure transition for those who currently depend on the government for their subsistence or for services such as health and education, is the only humane response to the given situation.

The first mission requires subjecting the whole body of laws and norms to a painstaking scrutiny that judges each one by the same standard. The standard is set by five questions: Does it relate to individuals in general or to corporations?

Does it make success or failure dependent on state interference? Does it favor particular groups of people, and does it therefore discriminate against the rest? Does it transfer wealth from one group of citizens to another?

And lastly, does its coercive power, either to make something happen or to forbid, derive from political law — that is, from the authority of the politicians or bureaucrats who passed the norms — or, rather, from a higher principle of which those politicians were careful guardians?

The second mission (which is really the other side of the same coin) amounts to an act of learning. The government engages in an equally diligent scrutiny of the way people have responded to those norms and laws in the conduct of their everyday business.

This process will set the individual free. In every area — from monetary to fiscal, tax, trade, financial, investment, labor or any other policy — the result will be liberating the Latin American citizen from authoritarianism.

Citizens will not be exploited by a monetary policy that debases money through the artificial expansion of credit or devaluation, or by unduly high interest and exchange rates that raise costs and make products more expensive abroad. Nor will citizens be forced to trust one, and only one, particular banknote issuer.

Citizens will not face competition from any entity owned, subsidized or protected by government in any sort of productive or commercial activity. Citizens will not be taxed simultaneously as producers, savers, investors and consumers — or punished for creating more wealth than others.

Sales taxes are currently the only significant sources of fiscal revenue. It would make sense to concentrate taxation at that end of things during the transition to the free society, abolishing income, corporate and capital gains taxation.

A low sales tax grounds taxation in a measure of personal choice, a healthier way of going about the process of expropriation that is signified by taxation.

Citizens will not be forced to pay more than is necessary for the goods and services they buy because of direct or indirect tariffs, nor will anything be taken away from them to encourage their neighbors' exports — or to pay a penalty for wanting to export something themselves.

They will not be robbed in order to reward irresponsible bankers for the losses incurred by a financial institution through credit given to government cronies, nor will they be constrained by any law as seekers of credit or as investors who want to move money into or out of the country.

They will not face restrictions as providers of financial services, such as having to place reserves in the central bank or suffering the consequences of open market operations aimed at influencing rates, being constrained from setting interest rates according to choice or having to comply with forced, ever-changing levels of fractional reserves.

They will not suffer expropriation in order to subsidize the investments of others, nor will they face barriers to entry, subtle or unsubtle, in any legal activity whatsoever, or impediments to obtaining and freely disposing of profits.

Those who already participate in agriculture, industry, commerce and any service activity, including the utilities, education and all other sensitive areas, will not be able to stop them — by any direct or indirect legal mandate originating in the political system — from entering or exiting the field if they wish in order to compete with existing producers in the pursuit of consumer interest or to bow out.

Likewise, professional associations will not usurp the role of the courts by preventing people, with the use of political norms and laws, from engaging in any profession.

Money will not be stolen from people in order to support organized labor against their wishes, and the people will be able to determine wages and other employment benefits through direct private contract with employers should they wish to.

In that way, sustained institutional frameworks guaranteeing freedom can engender a cultural evolution toward those values that today seem to distance Latin Americans from free-market capitalism.

The repeal of thousands of laws and norms, as well as the transformation of the very nature of the law, will lower what economists call transaction costs. It would also offer a sense of security beyond anything Latin American citizens have witnessed.

I am skeptical of figures that anticipate the infinite choices of free individuals, but there is no question that liberty will beget prosperity. There are those who say, for instance, that a flat income tax of 10% (something I am not advocating) would increase tax revenue by 4% of GDP. Taking into account that much of the underground economy would turn legal, it could even rise perhaps by 7%.

There are those who maintain that, with the end of the system that forces millions of people to do business illegally, Peru could see the size of its economy grow by more than 50%.

These figures sound perfectly reasonable, as would any others that prognosticate a huge increase in the amount of wealth created after the liberation of Latin America.

The effect of taking corporatism, state mercantilism, privilege, wealth transfer and political law out of the legal system would be the immediate end of second-class citizenship, the condition shared by millions of Latin Americans.

Incorporating a business involves two procedures, two working days and negligible costs in Canada. But it involves 40 procedures, 82 working days and more than two and a half times the per capita rate of GDP in Bolivia. Clearly, if the cost of doing business legally was reduced, friendly transaction costs and increased security would expand wealth beyond the imagination even of enthusiastic economists who like to anticipate figures.

The liberation of the British from the restrictive corn laws in the mid-19th century turned that country into an economic power house. There is no telling what wonders the liberation of Latin Americans from a million corn laws would do.

Adapted from “Liberty for Latin America: How to Undo Five Hundred Years for State Oppression” by Alvaro Vargas Llosa, published in 2005 by Farrar, Strauss and Giroux.