Hoover Digest

A Deeper Kind of Revolution

Monday, April 13, 2009

The Mexican government is locked in a vicious war against powerful drug cartels that assassinate public officials seemingly at will. Bolivian President Evo Morales’s rewriting of the constitution threatens to push the country toward civil war. Venezuelan President Hugo Chávez persecutes his political opposition, supports the FARC rebels in Colombia, and is training a civilian militia supposedly to repel an impending U.S. invasion.

The Chávez government not only has purchased fighter-bombers, helicopters, and assault rifles from Russia but has invited the Russian navy for joint maneuvers. Meanwhile, a report by the U.S. Joint Forces Command released in January calls Mexico a potential failing state, likening it to Pakistan, and border issues have opened a rift between Washington and Mexico City.

The governments of a group of troubled countries that includes Venezuela, Bolivia, Argentina, Ecuador, and Nicaragua are hostile to the United States and act arbitrarily against their own citizens. What is taking place in these countries is not, it should be noted, a departure from a gloried past of rule of law, strong property rights, and economic success—it is a continuation of a long history of mismanagement, overlaid with a thin patina of anti-imperialist rhetoric.

At the same time, real political and economic transformation is taking place in most of Latin America. In Chile, Brazil, Peru, Uruguay, Costa Rica, El Salvador, Panama, the Dominican Republic, and, yes, Mexico—which is most decidedly not a failing state—there has been a quiet but substantial movement toward the creation of societies that are characterized by increased economic opportunity, social mobility, and political democracy. This is not to say that Brazilians have achieved the same standard of living as the Dutch or that the rule of law operates in Mexico as it does in Canada. It is to say, however, that these countries have undertaken a series of economic and political reforms that make them vastly different places from what they were two decades ago.

The most obvious manifestations of this change are sound macroeconomic policies that have held down inflation, opened markets, and encouraged investment, but these policies are often undergirded by changes in much deeper institutions, such as electoral rules that give rise to governments with centrist agendas or constitutional amendments that provide for independent central banks.


Chile provides perhaps the most obvious example of a country that has been undergoing dramatic changes, and its success has served as a model for the rest of the region. Beginning in the 1970s, a series of reforms reshaped the economic playing field. Analysts often point to Chile’s sound macroeconomic policies, and rightly so. But these policies are the result of parliamentary rules that create incentives for legislators to converge on balanced budgets and of electoral rules that favor the two largest parties—one of which is center-right and the other center-left, thereby minimizing the probability of a return to populist economic policies.

Other institutional reforms changed the nature of regulation and the enforceability of property rights. Under the Chilean Constitution, the government can expropriate private property only if Congress enacts a specific law, and even then compensation must be paid in cash at market prices; all economic activities are legal, unless Congress passes specific laws regulating them; and citizens can protect themselves from arbitrary government actions that reduce their rights to life, liberty, and property by obtaining an injunction from an appellate court—in which they need not be represented by legal counsel. Chilean gross domestic product per capita has doubled over the past eighteen years, the fastest sustained expansion in the country’s history. Poverty rates have fallen precipitously. Young Chileans from humble families are attending college and buying homes. Indeed, Chile has a home ownership rate roughly equal to that of the United States, about 70 percent.

In most of Latin America, there has been a quiet but substantial movement toward creation of societies with increased economic opportunity, social mobility, and political democracy.

Mexico provides a similar example. From 1929 to 2000 a single party, the Institutional Revolutionary Party (PRI), monopolized political power. After decades of corruption, economic mismanagement, and arbitrary actions against the property rights of citizens—including the expropriation of the entire banking system—the PRI was finally forced from power in 2000, when voters elected Vicente Fox, the presidential candidate of the center-right National Action Party (PAN). Voters again elected a PAN candidate, Felipe Calderón, in 2006.

Since 2000, PAN governments have enhanced the rule of law by establishing the legal principle of innocent until proven guilty, mandated government transparency through a freedom of information act, eased access to credit by increasing competition in financial services, and encouraged home ownership with reforms to contract and banking law. To run competitively against the PAN in the 2006 election, leftist Andrés Manuel López Obrador had to jettison most of his left-wing stances—and he lost anyway.

Many of Mexico’s reforms would be exciting only to an accountant; not surprising, they have gone unnoticed in the foreign press. A 2001 reform allows banks to write mortgage contracts as bilateral trusts, in which the bank is both trustee and beneficiary, instead of as liens on property. This new form of contract means that a mortgagee can no longer default on a loan and prevent repossession for years on end by using the country’s notoriously inefficient bankruptcy courts, because the assets being collateralized are held by the trust and are not part of an individual’s bankruptcy estate. As a result, banks are more likely to make housing loans in the first place. Thanks to additional reforms that created a system of private housing accounts financed by payroll taxes, and which created a federal mortgage society that operates in a manner similar to Fannie Mae in the United States, home ownership has been placed within reach of millions of Mexican families.

Young Chileans from humble families are attending college and buying homes. Indeed, Chile has a home ownership rate roughly equal to that of the United States, about 70 percent.

Recent reforms have also encouraged competition in financial services. As a first step, the government allocated charters to nonbank financial intermediaries that could make housing and automobile loans. As a second step, it granted bank charters to retail giants, including American-owned Wal- Mart, thereby allowing families of modest means to open accounts and obtain credit to finance the purchase of consumer goods. The bottom line living standards, as measured by infant mortality rates, life expectancy, and years of education, have all improved in Mexico during the past decade.

The Mexican state is weak when compared to the United States, but it is incredibly strong when compared to lands in Central Asia or Africa that are usually called failing states. There are no foreign troops on Mexican soil. There is no martial law. Garbage is picked up, streets are swept, and children go to school. Middle-class couples take weekend getaways, driving there on highways as good as those in the United States. After falling for a decade, Mexico’s homicide rate increased in 2008 because the Calderón government courageously decided to take on the drug traffickers. If it keeps rising, it may soon be as high as that of . . . Louisiana.

Chile and Mexico are not isolated cases. Recent Brazilian governments have brought an end to the country’s long history of hyperinflation, privatized inefficient and corrupt state-owned banks, and created a social-welfare system in which families can obtain public assistance only if they keep their children in school. In Peru, recent governments have not only practiced sound economic and fiscal policies but also taken seriously the advice of reform-minded economists like Hernando de Soto, granting title to some 1.2 million poor families between 1988 and 1995. The country has grown at better than 6 percent a year during the past decade.


The quiet changes occurring in most of the region tend to be lost among the din created by bombastic leaders such as Morales of Bolivia and Chávez of Venezuela and, to a lesser extent, Argentina’s Cristina Fernández, Ecuador’s Rafael Correa, and Nicaragua’s Daniel Ortega. Those leaders do not represent a break with a mythic past of strong private property rights, government accountability, and sound economic policies. The twentieth-century history of all five countries was characterized by fiscal profligacy and property expropriations.

Mexico’s living standards, as measured by infant mortality rates, life expectancy, and years of education, have all improved during the past decade.

Fernández is a case in point. For all her ability to make headlines by pronouncing her friendship with Chávez, she is not very radical by Argentine standards. Her predecessors partially expropriated the bank deposits of Argentine citizens twice within an eleven-year period. Thus, her recent nationalization of the pension funds of millions of Argentines is a new twist on an old story.

Chávez’s expropriations of domestic and foreign companies, as well as Chavista seizures of farmland and urban real estate, are also making a bad situation worse. Venezuela should have been a major beneficiary of the oil price increases that began in 1973, but systematic mismanagement meant that during the two decades before Chávez’s election in 1998, Venezuelan per capita GDP actually shrank by a staggering 21 percent.

Seen in this light, Chávez’s rise to power is easily understood. His regime is based on a simple principle: direct oil revenues toward the creation of public employment, subsidized food, and other policies that benefit the country’s poor, who, in turn, provide him with electoral support. Indeed, the civil militias he has created have nothing to do with defending the country against a foreign invasion and everything to do with putting $50 per month in the pocket of an unemployed young voter.

Countries that have chosen leaders for whom rhetoric is a substitute for property rights will find that they have painted themselves into a very tight corner.

Every country in Latin America is now being hit by falling commodities prices and the contraction of credit. The economic and institutional modernizers have sound economic fundamentals and popular political support. That will not make them immune to calls from some quarters to return to populism—and to cover that populism with anti-imperialist rhetoric and anti-American foreign policies. If that happens, we will have a difficult time stemming drug trafficking and combating terrorism. The economic and institutional modernizers are our natural partners; we need to be able to offer them more than border fences and platitudes about free trade. They will most likely need technical and financial assistance—and it is in our national security interest that they receive it.

The countries that have chosen leaders who think that bombast is a substitute for property rights are going to find that they have painted themselves into a very tight corner. The most bombastic, Chávez, will, in fact, find himself in the tightest corner of all. He has created a set of powerful expectations among Venezuela’s poor that were difficult to satisfy even when rising oil prices seemed to have no end in sight. Now, as oil prices sag, the mismatch between what his constituents have come to expect and what he can deliver grows larger by the week. In the short run, he has two options: print money or curtail imports. The outcomes of both policies will look the same: the very group that provides him with electoral support, Venezuela’s poor, will see its standard of living fall dramatically.

If the history of Latin America’s earlier populist regimes is any guide, the end will be predictable. As his base of support erodes, Chávez will be forced to increase repression, but that requires the absolute loyalty of the armed forces, which he does not have. Chávez’s situation, along with the deteriorating political futures of other populists, most particularly Fernández, is not lost on political elites in the rest of the region. The populists are, in short, becoming far less consequential to the rest of Latin America—and to us.