Institutions matter

This extends a comment I made here.


A commenter asked econblogger Scott Sumner:

I am curious. What is your take on those who argue (typically Chomsky followers) that Jamaica, El Salvador, Nicaragua and even Haiti have established drastic neoliberal reforms – some even banning unions, strikes, and allowing children to work – yet their economy remains stagnant?

My response was that economic outcomes depends a great deal on basic institutional structures. According to Hernando de Soto’s The Mystery of Capital, it can take up to 19 years to complete the legal processes for land purchase in Haiti. That sort of regulatory quagmire, coupled with massively unstable and confiscatory politics, will keep any country poor. There is a reason Haitians who leave Haiti do much better economically than those who stay.

The same general point applies to other Latin American countries. They operate according to a “social mercantilism” of insiders and outsiders. Hernando de Soto’s grad students famously found it took 289 days and $1,281 (31 times the monthly minimum wage) to legally register a single-employee garment business in Lima, Peru. The same process in Miami would take maybe a day. It is not hard to see why Miami (a significantly Hispanic city, after all) would have a lot more economic transactions than Lima.

Why do Latin Americans come to the US? Because the US British-legacy institutional framework works so much better than the Iberian-legacy they grew up under, so they can make a lot more income by moving north. That sort of difference is simply not covered by one commenter’s definition of ‘neoliberalism’ as:

free capital flows, less regulation, privatization, and limits/elimination of import restrictions

particularly if the only regulation you are looking at is border regulation (capital flows and trade flows).

One also has to take size into consideration is looking at the effects of protectionism, for example. The US is such a large economy, that the level of protectionism or otherwise does not make much of a difference. But Australia has done far better in comparative performance since we liberalised trade (among other things) precisely because we are a relatively small economy.

Prior to adopting a highly protectionist structure in the early part of the C20th, we had a higher per capita income than the US (135% of US per capita GDP in 1890, prior to the 1890s Depression and long Federation drought: we still managed, upon recovery, to be 105% of US per capita GDP in 1910). Once we went protectionist, we lost ground comparatively: particularly in both World Wars and during the 1920s boom (down to 77% in 1931: we had a comparatively better 1930s Depression, from 1933 onwards getting back to rough parity). We recovered from a low of 59% of US per capita GDP in 1945 to 81% in 1949 but continued to tread water (to 75% in 1983) until we started liberalising.

Since we liberalised, we have managed to improve our proportion of per capita GDP compared to the US (up to 81% in 2008: all these figures taken from the late Angus Maddison’s time series). Though, the more telling indicator of improvement is that the Australian economy has become much better at dealing with economic shocks.

Regarding New Zealand outlier performance (high in economic freedom, not so high in per capita GDP), it suffers from isolation, smallness, an unfortunate economic legacy and unhelpful comparative advantage (farming products).

My examples of appalling levels of transactions costs prompted the following comment from Doc Merlin:

Someone was telling me that for a large project it was up to 6 years in California. I guess that explains why businesses are moving to Houston where it takes days. … included permits, fighting off the inevitable lawsuits, and getting permission for the building(s) in the 6 years for a large project in California. Just purchasing the land can happen in less than day.

To which I respond: let's hear it for the power of competitive jurisdictions!

After all, it largely explains why Europe took off and why Japan (where, under the Tokugawa shogunate, the daimyo could, in terms of economics and commerce, run their provinces pretty well how they liked) was the first non-Western country to follow.