Political Institutions and Economic Growth in Latin America: Essays in Policy, History, and Political Economy

Published by EH.NET (April 2001)

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Stephen Haber, editor, Political Institutions and Economic Growth in Latin America: Essays in Policy, History, and Political Economy. Stanford, CA: Hoover Institution Press, 2000. x + 294 pp. $18.95 (paper), ISBN 0-8179-9662-1.

Reviewed for EH.NET by Anne Hanley, Department of History, Northern Illinois University.

Political Institutions and Economic Growth in Latin America is a book of essays that explore the important question of how, when and why institutions — the rules and regulations that permit and bound economic behavior — matter in the process of economic growth and development. There is widespread agreement among social scientists that institutions matter, but because this relationship is so difficult to test social scientists are unsure which institutions affect growth and to what degree. The principal problem, it seems, is that most research has studied cases that have long histories of well-developed markets. The question becomes one of feedback. Did the market evolve in anticipation of or in reaction to institutional innovation?

Stephen Haber, the editor of this volume as well as a contributor, argues that to truly test this hypothesis the social scientist needs cases where uncertainty and upheaval, rather than successful institutional and market evolution, reigned. We need cases where institutions departed from the progressive path to actually reduce property rights; where political regimes shifted abruptly; where social and economic revolutions made it impossible for markets to anticipate institutional change. What we need, in short, is to study Latin America. Latin America’s instability is so great, so legendary, that it makes it not just a possible laboratory but the perfect laboratory to test the central tenet of institutional theory.

The five essays in this volume, the product of a collaborative research symposium held at the Hoover Institution in 1998, examine a range of notions we hold to be true: access to capital is good for business development, railroads reduce costs and generate gains for the economy, education is critical to improving income levels and hence standards of living, clearly-specified contracts lower transactions costs, politicians can muck up the best of economies. The innovation is that the authors devise tests to measure how these truths behave in the face of political institutions that enhance, distort or diminish their power to transform economy and society.

The theoretical point of departure that binds these works together “is the notion that economic institutions cannot be studied in isolation from the institutions that regulate politics. Economic institutions, and their enforcement and refinement … are the result of both interest group demands and the specific features of decision making in the polity, which themselves are governed by institutions” (p. 10). Thus, the study of the origins and consequences of economic institutions also requires that we study the institutions that structure political decision making. The result is a powerful set of insights into Latin America’s persistent failure to break out of its poverty and rectify its inequality.

Stephen Haber takes the idea that access to capital is good for business development and applies it to Brazilian textiles to demonstrate how well-developed capital markets matter in economicgrowth. A sudden shift in political regimes brought on by a coup in 1889 ushered in a government friendly to business. This government, reversing decades of ambivalence toward domestic development, introduced sweeping changes to the regulatory environment that made it easy to form limited-liability joint-stock companies. The resulting improvements to capital mobility, Haber argues, promoted rapid industrial growth after 1890. In a rich and multi-layered analysis of the textile industry from 1866 to 1934, Haber finds that the joint-stock firms formed after the 1890 reform were larger, had higher rates of investment and growth, and higher total factor productivity than the private firms formed both before and after 1890. Institutional reform, then, created a positive environment for economic growth.

Alan Taylor addresses the stark fact that the gains of the early twentieth century, like those identified by Haber, didn’t last. Capital flows to Latin America dried up after the 1930s and incomes have fallen farther behind both the OECD and the Asian NICs ever since. For Taylor, who uses capital accumulation as a proxy for growth, an important part of the story lies in capital controls introduced by economic nationalists in the 1930s. Comparing Latin America to Asia, Taylor finds the greatest long-run distortions in the price of capital (hence its supply) in countries that actively intervened with capital controls to manage their economy vis-a-vis a disintegrating world order. Taylor correlates the propensity to intervene with the type of political regime and finds that the interveners had greater tendencies toward populism and even democracy than the regimes that didn’t intervene. In reading this essay one can’t help think that autocratic regimes allowing little competitive political participation might have produced a better record of economic growth for Latin America. Indeed, observes Taylor, Robert Barro’s “alarming claim that too much democracy may be bad for economic growth” is echoed in his findings for Latin America (p.152).

The idea that regimes responding to interest group pressures sacrificed growth for political gain is reinforced in William Summerhill’s outstanding essay on the distribution of railroad subsidies in nineteenth-century Brazil. He shows, as expected, that railroads reduced costs and generated gains for the economy. These gains could have been greater, however, because most of the rail lines generated an incredibly low or even negative social rate of return. Was the Brazilian government that bad at allocating its subsidies? From an economic standpoint the answer is yes, says Summerhill, but economic efficiency did not determine the placement of railroads. Political considerations did. This representative, majority rule, centralized government allocated benefits to regional projects via vote in parliament. This meant that provinces with more seats, and therefore more voting power, were more likely to capture the subsidies. The resulting railroad network corresponded to political benefits rather than economic efficiency, and the gap between the two “proved particularly acute in the context of low levels of overall productivity and income” that prevailed in nineteenth century Brazil (p. 64).

Productivity and income can both be increased by investment in human capital through education, but this is an area in which Latin America has clearly lagged behind other New World nations. In an engaging study comparing public education policies among New World countries Elisa Mariscal and Kenneth Sokoloff ask why only a few of the prosperous societies arising out of European colonization supported the establishment of primary schools. For them, the answer lies primarily in the extent of political participation. Analyzing data from across the Americas they find a strong positive correlation between the extent of the franchise and the spread of primary schools. In the US and Canada, adoption of universal (white) male suffrage in the nineteenth century was followed almost immediately by movements for tax-supportedschools. The many taxed themselves to provide schools for their children. In nations of restricted suffrage, however, universal education would require the few holding the right to vote to tax themselves to pay for the education of the rest. Since most nations of Latin America had either wealth or literacy voting requirements in the nineteenth century, political inequality was pronounced. Country by country data show this political inequality was responsible for regional differences in schooling. Given what we know about the strong relationship between education and income attainment, this is a powerful way of explaining Latin America’s poor record on equality and development.

Alan Dye’s research on Cuban sugar cane contracts rounds out this inquiry into political institutions nicely because it spans a period of no government meddling followed by active meddling and suggests how political considerations distort the efficient allocation of resources. In the pre-meddling period, cane supplies were delivered by independent growers to central mills based on contracts negotiated between grower and miller. Left alone, these parties over time worked out contract provisions that successfully reduced the costs of transacting cane. Overcapacity and international crisis in the 1920s and 1930s disrupted this relationship, however, when the government intervened to fix quotas for growers and millers. The reason for this intervention was political: the least efficient mills turned out to be Cuban owned while the more efficient mills were foreign owned. The quota system protected Cuban growers and millers in an environment that almost certainly would have wiped them out, but the action compromised long-run growth. Dye finds that sugar-to-cane yields, which had been making steady gains up to the 1920s, stalled as a result of economic nationalism.

The essays in this book, as well as the comments and critiques provided in a concluding chapter by Douglass North and Barry Weingast, all raise questions, qualifiers, and caveats that provide additional avenues of research into the relationship between political institutions and economic growth. The strongest case for research, implied but largely unstated here except in Summerhill’s concluding remarks, is that Latin America’s poor growth record has far more to do with local institutional arrangements than with the external culprits championed by dependency theory. The fine articles brought together by Stephen Haber in this volume demonstrate the power of wedding economic history to institutional history and the promise of doing so in the Latin American laboratory.

Anne Hanley is author of “Business Finance and the S?o Paulo Bolsa, 1886-1917” in John Coatsworth and Alan Taylor, editors, Latin America and the World Economy since 1800 (Harvard University Press, 1998) and is currently writing a book on the role of financial institutions in Brazilian economic modernization.

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