Day 1: The economist sitting next to you on the plane

So, my first flight was about the marketing of collection clothing for children. What could top that? A second flight discussing Chilean and Latin American economic policies with an economist working for the IMF!

The gentleman sitting next to me noticed the book I was reading (Finance for Development) and asked to look at it. He flipped through it, went to the references section and found his name. This is how I was introduced to Leonardo Hernandez. Leonardo got his PhD at Columbia University in New York in Economics. He worked in academia in Chile, the World Bank, and the Central Bank of Chile. He now works for the IMF.

I had just read about how some economist believe that growth in Latin America is limited by the size of and available of instruments within capital markets. The capital markets in Latin America are much smaller than those of the east asian countries. The theory is that these small capital markets simply do not allow for enough small and medium sized enterprises (SME's). While this may be true in some parts of Latin America, there are strong universal (central) banks that provide the same liqudity as capital markets do. Leonardo thinks there's a much more likely cause.

In economics, institutions are defined "as formal and informal rules that shape the behavior of individuals and organizations by reducing uncertainty (Stallings)." Leonardo felt that institutions were the major limiting factor in growth and stability of Latin American economies. He cited two examples.

(I'm not an expert on law, and I'm paraphrasizing the conversation, so send me corrections if I'm wrong.;-))

First, he talked about the differences between the systems of law. The English system (common law) is interpreted on a case-by-case basis by the judicial system. The French system (civil law) is interpreted based upon previously legislated statutes. Since judges are free to interpret law in common law, regulation does not have be as codified as in civil law. In the United States from a law perspective, it doesn't take all that much to get a business going and to keep it going. However, in Chile, there are more laws in place and therefore more bureaucracy to get through to start up an SME. The speed at which an economy can grow is limited by the system of law.

The second institution he talked about was cultural institution. If you have a society that condones corruption and cronyism then these politics can significantly hamper the development of SME's. No country or culture is without corruption, but countries that do seek out and bring to court bribery and cronyism cannot stabilize their economies. Chile works hard to try and keep it's corruption at bay, but recently Chile's ailing transportation system had fell victim to these vices. The cultural values, it seems, can provide a breath of life to or can brutally suffocate small business development.

So, in essence these institutions have more influcence over the performance of the economies of Latin American than the capital markets.

References:

Stallings and Studart, Finance for Development: Latin America in Comparative Perspective

http://www.imf.org/external/index.htm

http://www.bcentral.cl/eng/

http://en.wikipedia.org/wiki/Civil_law_(legal_system)

http://en.wikipedia.org/wiki/Common_law