Chile

Hillel Soifer’s new book, State Building in Latin America, presents an interesting historical perspective on today’s current state capacity in Latin America, and why some countries are so much better able than others to not just control territory but also to deliver for their people. Somewhat dispiritingly, he finds that state capacity, measured in terms of education, health care, military mobilization, and other indicators has changed little over the last century. Government agencies’ abilities haven’t deviated much, despite the rise and fall of conservatives and populists, of democrats and dictators, of economic booms and busts. None seem to have fundamentally altered the ability of states to provide public goods. Those that were strong in 1900 are strong now; those weak then remain so. So what made the difference? He lays out two factors that emerged in the nineteenth century: whether political elites tried to build a strong state and then whether they succeeded. These in turn depend on other causes. The decision to try depends on whether elites clustered in one or in many cities or regions. Those with a single center were more likely to see state building as the way to “order and progress,” extending the center toward the periphery. Those with multiple hubs of economic and political activity were less likely to develop a coherent ideology, much less one that involved building up the central government. For those countries that did embark on a state building mission, other factors determined whether it worked or not. If the national government sent out its own bureaucrats to deliver services, the state grew in abilities and reach. If they left it to local elites, little happened. He then shows how these arguments apply to four cases: Colombia, Peru, Chile, and Mexico. Colombia never tried to create a stronger state; Peru tried and failed; Mexico and Chile both tried and succeeded to varying degrees. Soifer’s empirical chapters draw on government archives, newspaper announcements, immunization records, school enrollments, and many other sources, tracing the efforts and outcomes to try and build up the central government’s capacity. In his exhaustive research, he finds some interesting kernels that shed light on today’s pressing topics. For instance in Mexico in the late 1800s, school systems developed differently by state. In Michoacán and Guerrero local elites controlled the rollout, and enrollment stagnated, even back then. In Sonora and other northern states, the building out of their educational systems was turned over to bureaucrats from out-of-town; the number of kids entering school surged. These trajectories led to the deep divides that continue today and are at the center of the current struggle to reform Mexico’s education system. With “nation building” an at times uneasy part of U.S. foreign policy, Soifer’s carefully constructed argument and analysis provides insight into why it is so hard to do. It isn’t a lack of resources that many bemoan. It is oftentimes alliances with local elites. While they may quell unrest in the short term, they also can undermine the project itself, elevating challengers rather than allies in the quest to build government capacity. His work shows too that ideas matter: without leaders committed to a stronger state little will occur, whatever the intentions of outside participants and donors. For Latin America, his work leads to a clear eyed but somewhat pessimistic conclusion. The World Bank, Inter-American Development Bank, IMF, and others routinely identify the same set of factors as holding the region back: bad infrastructure, poor schools, weak rule of law, inequality, low productivity. Soifer’s conclusions suggest the usual policy recommendations—doling out concessions and forming public-private partnerships, writing new textbooks and instituting teacher evaluations, or retraining police and rewriting judicial rules—won’t change things. The challenge is a more fundamental one of capacity. And the question remaining is are there other paths than those he expertly illustrates to creating a better and stronger state.

This post was co-authored by Gilberto Garcia, research associate for Latin America Studies at the Council on Foreign Relations. How can countries boost productivity and economic competitiveness? Many economists and business leaders turn to economic clusters as an answer. English economist Alfred Marshall first wrote about clusters—the geographic grouping of firms in the same or similar industries—at the turn of the twentieth century. He saw numerous entrepreneurs drawn to particular locations due to physical endowments, and their parallel efforts leading to whole new industries—think California vineyards, Texas oil, or Maine lobster. Proliferation and proximity then brought other advantages: developing a pool of skilled workers, and attracting industry suppliers. As a cluster grew, firms would specialize on a particular step of the production process, increasing their productivity and profits. A century later Harvard Business School professor Michael Porter picked up the idea, envisioning clusters as a way for firms to become or stay competitive in the global economy. For him, the biggest advantage is that proximity enables cooperation. In addition to the workforce and supply chain benefits, firms are more likely to come together to form active business associations, to work with local governments to invest in infrastructure, and to partner with local universities to tailor coursework and research. In the United States, Silicon Valley is the most successful example—with the interaction between startups, large corporations, local governments, and world class universities creating trillions of dollars in wealth and redefining daily life through inventions including the smartphone (Apple), streaming home video (Netflix), and online social networking (Facebook). Many of Latin America’s most promising sectors came about through clustering as well. The aerospace industry in Queretaro, Mexico began with Canada’s Bombardier in 2006, initially attracted by low wages. The state and federal government then worked to attract other producers through tax incentives, cutting bureaucratic red tape, and new trade agreements. The government started a new Aeronautic University, and together with the companies, developed curriculum and shared tuition costs. More than a dozen aerospace companies now operate in the city, bringing in some $500 million in foreign direct investment over the last five years. In 2014 Mexico’s aerospace industry exported more than $6 billion, supporting 45,000 direct jobs and at least twice that number indirectly. In Chile, business and government came together to expand and transform the salmon farming industry. Like minded companies came together to form Salmonchile, a business association that established industry standards and sought out new markets, in particular the United States. The public-private Chile Foundation backed pioneer firms, funded R&D, and passed on best practices to other emerging producers. Over time, Chile’s salmon clusters acquired know-how and developed new technologies, increasing production. By 1992, Chile became the second-largest global salmon producer, and by 2014, exports topped $4 billion, second only to copper. Other Latin American efforts have failed. In the 1970s and 1980s as Brazil opened its markets, shoemakers in Rio Grande do Sul grew rapidly, making leather shoes for numerous large U.S. buyers. Supported mostly by their international clients, numerous Brazilian firms upped production and improved quality. Yet by the early 1990s, these same firms were undercut by cheaper Chinese shoes. With little inter-firm cooperation or support from the government, the potential cluster lost its edge, falling behind in output and never expanding into shoe design or branding. Can, and if so, how can nations create these dynamic ecosystems? Chile is trying with Start-Up Chile, a government program that gives $40,000 and a temporary one-year visa to foreign entrepreneurs to begin their ventures in the Southern Cone nation. Now five years old, it boasts few successes. The young companies are hindered by the short time horizon and limited local venture capital money (a few of the best can receive another $100,000 in financing). 80 percent of participants leave after completing the program, many headed to the United States. If history is a guide, successful clusters grow locally and organically. Still, there is a role for governments to play in nurturing economic constellations. To start, they can protect property rights and open markets through free trade agreements. They can invest in education—including creating higher educational institutions equal to those in other nations (today no Latin American university makes the world’s top 200 as measured by Times Higher Education). And they can boost infrastructure spending, now just half of the 5 percent of GDP the World Economic Forum recommends. State and local governments in particular can encourage and work with local business associations, invest in public works and supportive zoning, develop specialized educational curriculum and training, and fund research and development. In all these efforts policymakers need a long time horizon, as changes and benefits often appear slowly. Yet it is these local custom initiatives that can constitute “smart” industrial policy, and provide promise as Latin America’s nations insert themselves into global markets.

In 2014, GDP growth in the region slowed to less than 1 percent. Expectations for 2015 are just slightly better, with forecasters predicting growth of nearer to 2 percent. The downturn reflects external factors, including the European Union’s continuing problems, a slower China, and falling commodity prices. But it also results from domestic barriers that hold these nations back. The vast majority of Latin American countries have transitioned from low- to middle-income countries according to the World Bank. But most now remain mired in what economists call the middle-income trap. Only Chile, Uruguay, and a few Caribbean countries have joined the ranks of the world’s high-income countries. The Organisation for Economic Co-operation and Development’s (OECD) recent 2015 Latin American Economic Outlook makes the case that the main barriers to climbing the economic ladder in Latin America are education, skills, and innovation. World Bank, "World Development Indicators," 2015. On the plus side, education spending has increased throughout the region. And so too has enrollment. 84 percent of children now complete the primary grades. Still, schools underserve the crucial early years as well as advanced study—pre-K and university enrollment are low relative to other OECD countries. What students get for their extra time in the classroom is also questionable—Latin American students score far behind their OECD peers on the Programme for International Student Assessment (PISA) test. The test also reveals a strong socio-economic tilt—the wealthier the student, the better the score. Organisation for Economic Co-operation and Development, "Latin American Economic Outlook 2015: Education, Skills and Innovation for Development," 2014. Coupled with weak educational systems is a skills mismatch. More than in other emerging economies, employers can’t find workers with the necessary abilities, particularly for more productive knowledge- and technology-intensive economic sectors. Instead employers face an unskilled labor surplus, many of which flood into the informal economy. Organisation for Economic Co-operation and Development, "Latin American Economic Outlook 2015: Education, Skills and Innovation for Development," 2014. Finally, the report highlights the limited expenditure on “knowledge capital,” defined as a country’s capacity to both innovate and then disseminate those advances. Latin America spends on average 13 percent of GDP, less than half OECD rates. The region falls particularly behind in R&D expenditure (as opposed to tertiary education or information and communications technology infrastructure), a recognized driver of innovation. Organisation for Economic Co-operation and Development, "Latin American Economic Outlook 2015: Education, Skills and Innovation for Development," 2014. So what can Latin American nations do? Education reform matters—revamping curriculum, improving teaching, and creating opportunities especially for those not in the upper echelons of society.  Expanding technical and vocational training can also help develop the skills needed for new industries. And greater innovation—building up “knowledge capital”—will come from not just from more foreign direct investment in R&D-intensive sectors, but also by forging links between these multinationals and the rest of the domestic economy. The path out of the middle-income trap is fraught—only a dozen or so newly emerging countries can boast GDP per capita rates comparable to those of developed economies today. But only with better policies can more Latin American countries aspire to join them.

One of the potentially biggest economic initiatives for Obama’s second term is the Trans-Pacific Partnership (TPP). Started some seven years ago by four Pacific nations—Brunei Darussalam, Chile, New Zealand, and Singapore—to spur trade by eliminating tariffs, the agreement has now expanded to encompass twelve nations, including the United States, Australia, Canada, Japan, Malaysia, Mexico, Peru, and Vietnam. The block’s combined GDP reaches some $28 trillion, with member countries conducting roughly a third of all global trade. The TPP aspires to move beyond the current free trade agreements between many of these nations. When working groups meet this weekend in Washington D.C. tariffs will be the main focus. But also on the docket are intellectual property rights, services, foreign investment, rules of origin, competition, labor, and environmental standards, and these and future discussions will touch on unprecedented topics such as regulatory coherence, e-commerce, small- and medium-sized businesses, and state owned enterprises. Not only does the TPP cover an ambitious agenda, but its time-frame is impressive, as representatives hope to finish the discussions by the end of the year. Challenges abound though, given myriad issues and agendas. Even if a draft is agreed upon, it will then have to get through various congresses to be ratified. But if successful, it could be a global game changer. The agreement would tie together a combination of mature and developing economies, of Asian and Western Hemisphere nations, likely transforming trade flows, supply chains, foreign investment, and global trade regulations. There is the potential for igniting a new global dynamism after years of trade stagnation. For Latin America, the TPP could mean developing and expanding economic ties and importantly supply chains from Chile up through Canada. Binding themselves to one another, these Western Hemisphere nations can strengthen their global position and influence.