October
4, 2005
Leaders and Crises
By Alvaro
Vargas Llosa
The recent
World Economic Outlook report by the International Monetary Fund
(IMF) has an interesting surprise. It includes a chapter on institutional
reform that places responsibility for economic success or failure
squarely on the side of institutions.
Institutions
are defined as “the set of formal rules-and informal conventions-that
provide the framework for human interactions and shape the incentives
of members of society”. Not bad. Someone at the IMF has been reading
Nobel Laureate Douglass North.
Good institutions,
the report continues, are those that create “rent-free environments
in which small groups are not able to take advantage of—for example—a
monopoly position in a particular industry or activity, or privileged
access to natural resources”. Countries that prosper are those
in which the government neither bends the rules to favor certain
groups nor limits the entry of those without power into the marketplace.
If institutions in Africa could be improved to the level of developing
Asia, Africa’s GDP would double, we are told.
Article
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So far, so
good. The IMF looked at sixty-five countries that have undergone
institutional reform in the last three decades, asking itself
what determines institutional change. This is where the study
runs into some trouble. To answer this question they conducted
econometric exercises mixing the data from the various countries
and coming up with certain patterns. The problem is that econometric
exercises don’t really work with factors that have to do with
ideas, choices, and historical contexts rather than numbers.
The IMF concludes
that trade openness, freedom of the press, neighbors with good
institutions, higher levels of education, and higher initial per
capita income tend to determine institutional reform.
But a look
at countries where institutional change has taken place indicates
that most of these factors followed rather than preceded reform.
Opening countries
to free trade is an institutional change in and of itself. Chile
privatized companies and liberalized internal markets even before
it opened the country to substantial international trade (only
recently did they bring their tariffs down to an average of just
over 2 percent). Estonia got rid of its tariffs in the initial
stage of reform, starting a sequence of changes that subsequently
encompassed other institutional areas.
Freedom of
the press is extremely important, but it is not a precondition
for institutional reform. There is no freedom of the press in
China and that country’s dictatorial bureaucracy has been implementing
reform since 1978.
Good neighbors
are also not necessarily a great incentive. If that were the case,
Mexico would have copied U.S. institutions a long time ago. Ireland
was stuck next to Britain for centuries before it decided to catch
up institutionally.
Higher levels
of education are no precondition either. Spain had one of the
lowest education levels in Western Europe when Franco started
to open the economy and that had not changed by the time Felipe
González got rid of many old institutions in the 1980s. The two
most successful reformers in Africa-Botswana and Ghana-do not
have higher education levels higher than dismal Latin American
reformers like Honduras and Paraguay.
Finally,
a higher initial per capita income can actually work against reform.
Argentina was prosperous for half a century (including the early
20th century) and then produced Juan Domingo Peron, who destroyed
that prosperity. Bolivia was the first Latin American democracy
to engage in reform in the mid-1980s and it had the lowest per
capita income in South America (the reforms were ultimately insufficient
but so were those of other countries).
Here are
two factors the IMF might consider as determinants of institutional
reform in the future: leadership and crises. Most successful reformers
had enlightened leadership in times of political, economic or
social upheaval. The combination of the two factors created the
conditions for reform. That is true historically as well as in
contemporary times.
In the nineteenth
century, the emergence of the Meiji leadership in Japan during
a time of conflict with the U.S. after a long period of isolation
created the conditions for modernization. In nineteenth century
Britain, the relentless leadership of Richard Cobden and John
Bright combined with the Irish potato famine forced the repeal
of the Corn Laws.
In contemporary
times, the leadership that brewed in opposition circles under
Communism in Central Europe was able to take charge with the collapse
of totalitarianism. I am thinking of Charter 77 in Czechoslovakia
and the Budapest intellectuals in Hungary—as well as the Solidarity
movement, a less intellectual but equally important leadership
(initially, at least) in Poland. In New Zealand, the economic
crisis of the 1980s combined with the emergence of a visionary
leadership in the Labor Party (an unlikely catalyst of change)
that included people like Roger Douglas gave rise to a free-market
transformation. Even in China, the crisis brought about by the
disaster of the Cultural Revolution and the emergence of Deng
Xiao Ping, a very intuitive despot, generated reform.
In Latin
America, the crisis of hyperinflation in the 1980s produced a
struggle between statists who wanted to nationalize everything
and protectionists who wanted to maintain private property. The
result was preemptive reform led by the latter. It did not generate
the desired results, but that is s different story.
Leadership
and crises cannot be measured econometrically. But if we want
to make reform more credible in the eyes of the skeptical, let’s
be clear about its causes.
Alvaro
Vargas Llosa is a Senior Fellow and director of The
Center on Global Prosperity at the Independent
Institute. He is the author of Liberty
for Latin America.
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