Why Doesn't Capitalism Flow to Poor Countries?

This title may be a play on Robert E. Lucas's famous piece Why Doesn't Capital Flow From Rich Countries to Poor Countries but the question it raises is perhaps even more fundamental.  If market orientated policies are good for growth why are they so unpopular and why are they particularly unpopular in poor countries?

The celebrated Austrian economist Ludwig von Mises claimed in the 1940s that the reason poor countries were poor was not because of capitalism but because of the absence of capitalism*. But the accepted wisdom of the time was quite different.  Now that Mises's argument has become broadly accepted (even if it is not yet conventional wisdom). The question now is why does capitalism not take root in developing countries? And why is there a deep distrust of capitalism in these countries?  This is the question Harvard Business School economist Rafael Di Tella and Robert MacCulloch tackle in this paper. The argument is outlined in this online lecture which has William Easterly as a discussant.

The answer according to Di Tella and MacCulloch is corruption. Corruption reduces the moral legitimacy of markets.  First they consider the evidence for the claim that capitalism doesn't flow to poor countries. They note that even right wing parties in developing countries rarely adopt free market rhetoric and that they tend to view economic liberalism warily. The evidence suggests that voters in developing countries view markets with suspicion. When market orientated policies have been imposed it has often been either through external pressure (i.e. Mexico and Argentina) or through a dictatorship (i.e. Chile or China). Coding political parties in a large number of parties along a left-wing - right-wing spectrum, they find that.

'Rich countries (i.e., in the top third of the income distribution in our original sample) are again associated with more right wing governments across all definitions, even after controlling for other variables that could be associated with different color of government. It is worth noting that more unequal countries tend to have more right wing parties.'

The authors go on to argue that perceptions of corruption are critical and that corruption harms perceptions of capitalism even when it is bureaucrats who are becoming corrupted.

'When business people are perceived to be failing to deliver on their social contract, either because they are polluting the environment or because they are corrupting bureaucrats, offended citizens vote for more controls in the forms of more regulations.'

Perceptions of corruption led to anti-market policies because as the evidence from ultimatum games suggests, individuals are willing to give up money in order to punish what they perceive to be 'unfair' behaviour. This creates the following negative externality:

'The existence of corrupt entrepreneurs hurts good entrepreneurs by reducing the general appeal of capitalism.'

This accords with the idea that capitalism and capitalists have to be perceived to be legitimate if market orientated policies and values are to become embedded in a society and a culture.

Ludwig von Mises, Human Action (1963 [1949]) p 836

Comments

[Jeff]

Very interesting, Keep up the writing.

[Markus Eberhardt]

Maybe the narrow focus on corruption is too restrictive here: why not consider the general institutional environment, including all the sort of stuff the World Bank tries to measure with its Doing Business surveys, but also the entrepreneurial spirit and networks prevalent in the countries. Oxford Development Economist Marcel Fafchamps recently commented on growth in Africa by calling on local entrepreneurs (and policymarkers) to start and learn doing business the way developed nations do. The idea is that in African countries there is an approach to business that recognises all the weaknesses of the prevailing institutional environment, but rather than to challenge them, businesses adopt strategies to work around them. As long as these strategies will be continue, African entrepreneurs and their developed country peers will operate in different spheres/networks, with the latter hesitant to engage in trade/exchange/business deals. Once Western firms are confident they understand the institutional environment in an African country and can predict how this will react to their actions, they will agree to increase their involvement in business on the continent. A note of caution, though: this cannot be the only story in town. There is a wealth of accounts in the popular business literature how Western firms blew tons of money in China, due to their problems with a complex cultural & institutional environment in transition. Yet they kept coming back. African countries have thus far not been that lucky.