In Today\'s Latin America, Competitiveness Requires More Than Free Trade

The lack of rule of law and fair, effective public institutions in Latin America remains one of the greatest drags on the region’s capacity to compete in the world today. Despite the benefits of free trade and over a decade of economic reforms in Latin America, other regions are attracting more investment and gaining a greater share of world trade. The reason: Public institutions in Latin America have failed to provide a stable, predictable environment for investment, trade and growth. To remain competitive in the world economy today, Latin American governments need to tackle a new generation of institutional and political reforms.

What do we mean by competitiveness as it relates to countries? The term, as it is often applied to businesses, refers to the competition between businesses for innovation, market share, and profit. In the context of increased global and regional integration, a country’s competitiveness has come to mean its ability to compete for investment and seize advantage of technology and innovation to raise productivity and income.

This broader definition of competitiveness is linked to the legal and institutional environment in which investment and innovation take place. In the past, resource endowments and geography conferred easy advantages for countries in regional trade. Today, in a global market, a country’s competitiveness depends on the stability, transparency and the fairness of the investment environment. These conditions are important not just for attracting investment. Non-arbitrary, law-based rule as well as fair and effective public institutions are essential for attracting quality investment—investment that promises greater opportunity for technology transfer and value-added production and stability. These conditions offer the surest path to innovation, economic growth and, ultimately, improving living standards.

Sadly, according to the World Economic Forum’s Global Competitiveness Report, this is precisely where many countries in Latin America are lacking. The Global Competitiveness Report rates three areas to develop a comparative picture of how countries and region stack up against one another in terms of their competitiveness. The index tries to gauge: the quality of the macroeconomic environment; the quality of public institutions,and technological capacity. The conclusions, cited in a 2001 Inter-American Development Bank report, find that Latin America ran a poor fifth among the seven major regions of the world when it came to competitiveness, outpacing only the African and Asian countries other than the economic dynamos of East Asia. Only three of the 20 countries included in the report (Chile, Costa Rica, and Trinidad and Tobago) ranked within the top 50 most competitive countries of the world, while fully seven Latin American countries were among the 11 least-competitive nations of the world.

The ranking of the countries, both in the aggregate and individually within the hemisphere, confirms the overwhelming importance of the institutional framework to global competitiveness. The index measuring quality of public institutions looks at two conditions: rule of law and control of corruption. Overall, all but three Latin American or Caribbean countries scored below the world average in quality of public institutions. Not surprisingly the three countries that ranked above the world average were also determined to be the most competitive: Chile, Costa Rica, and Trinidad and Tobago. Conversely seven of the eight countries that were ranked the least competitive in the region, also had the weakest system of rule of law and measures in place to control corruption.

Reports from the World Bank paint the same picture. A study by Kaufman, Kray and Zoido-Lobatón found that Latin America ranked below all but the non East Asian countries and Africa in terms of quality of rule of law and control of corruption. The region also scored below the world average in public sector effectiveness, a measure which attempts to gauge the independence of the civil service and business and investor confidence in official policy commitments. Not surprisingly, those regions that ranked higher in these areas tended, on average, to outpace Latin America in terms of GDP growth during the 1990s.

Of course the other measurements of the Global Competitiveness index, the quality of the macroeconomic environment and the innovation, are also closely bound up with the fairness, effectiveness and transparency of public institutions. One need look no farther than Argentina's sad recent history of economic boom and bust to see the importance of transparency and the rule of law to long-term macroeconomic stability.

Similarly, the capacity of a country to encourage and adopt technological innovation depends largely on the institutional environment that fosters these developments. An institutional environment that fails to protect patents and provide incentives for inventing and adopting new technology will only be a drag on competitiveness and productivity.

These numbers and comparisons indicate that free trade, while necessary, is not sufficient to ensure a country’s global competitiveness. Even as the Latin American and Caribbean region was deepening and broadening its ties to the global economy in the 1990s, it continued to struggle under the weight of troubled public institutions and corruption. To take advantage of the benefits of free trade—access to markets, cheaper inputs, opportunities for international investment and increased access to technology—countries need to become more competitive. This means that they must be willing to tackle the knotty and politically sensitive problems of reforming their public institutions to provide a fairer, more stable, and clearer environment for enterprise and investment.

What these numbers do not indicate is that market-based reforms were unsuccessful. On the contrary, true market reform has—in the most effectual sense—barely been tried.

Unfortunately the refrain that the market reforms of the 1990s (the so-called “Washington Consensus”) have failed to alleviate poverty and address socioeconomic inequality has been repeated so often it is now becoming accepted wisdom. While poverty and inequality have increased in recent years, they have done so not because of the creation of market-based economies, but rather have risen in the wake of market-oriented reforms that were often badly distorted by politicized institutions, unevenly applied laws, secretive bureaucracies, and half-baked procedures. Even so, the reforms did help to rationalize prices, stabilize local currencies, and increase ties to the world economy, all of which bode well for the future.

But until underlying institutional pathologies are addressed, even the best-laid scheme of reform will fall short of unleashing a truly open, effective, and competitive market economy that can provide broad-based benefits.

This is the challenge for the future. Improving market economies and increasing the competitiveness of countries in the region demands a new focus on the institutional framework in which these economies operate. Market-based reforms and free trade have not failed; but absent an effort to improve the rule of law, control corruption and enhance the effectiveness of public institutions, countries will be unable to reap the benefits of the last decade for all their citizens. What is needed is a second generation of institutional reforms that can help countries in the region remain competitive in global trade, better take advantage of its resources and endowments, and improve access to technology.

---

*Chris Sabatini is the Senior Director of Policy at the Americas Society/Council of the Americas

ABOUT VIEWPOINT AMERICAS
A publication of the Council of the Americas, "ViewPoint Americas" helps Council member companies achieve their business goals by stimulating thoughtful debate on the most pressing issues facing Latin America. The views expressed are not necessarily those of the Council.