Why Nations Succeed

There's no guaranteed formula for fostering business growth in developing countries.

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Being there for your partner every day more important than gifts or flowers, a study finds.
Being there for your partner every day more important than gifts or flowers, a study finds.

Mr. Hahn is director of economics at the Smith School, University of Oxford and chief economist at the Legatum Institute. Mr. Passell is a senior fellow at the Milken Institute and the economics editor of the Legatum Institute's Democracy Lab. They are co-founders of Regulation2point0.org, a web portal on regulatory policy.

What does it really take to succeed in economic development? Try unfettered trade and a market environment that stabilizes prices, keeps regulation to a minimum, and encourages free enterprise. That, anyway, is the conventional view that emerged after a half century of botched efforts at top-down planning in Africa and Latin America.

Conventional, yes; consensus no. Ricardo Haussman and Dani Rodrik, both influential economists at Harvard, don't dispute the importance of getting institutions right. But they challenged the aforementioned "Washington Consensus" as insufficiently nuanced. In particular, they identified what they saw as a critical barrier to development—the inability of pioneer entrepreneurs to capture much of the profit from the creation of new industries. Fixing the problem, they suggested, justified more government intervention than the conventional wisdom would have.

Now, one of them, Haussman, is back, this time joined by Columbia law professor Charles Sabel and a bevy of researchers working with the Inter-American Development Bank, to test the theory. Their book, Export Pioneers in Latin America (available free in PDF format), a collection of readable case studies ranging from the fresh-cut flower industry in Colombia to animal vaccines in Uruguay to generic TV programming in Argentina, identify a very different barrier to pioneers: The difficulty of creating from scratch the complex business ecology needed to support modern industry. And here, government intervention could play a role—albeit a less clearly defined one.

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OK, say you've got this good idea. Cheap air transportation makes it possible to ship highly perishable products like cut flowers across vast distances. But U.S. (and European) labor costs are high, and neither the weather nor the soils bode well for productivity. Why not grow the flowers in Colombia, where labor is cheaper and there's a nearly perfect environment for every variety?

Export Pioneers explores the case of FlorAmerica in the 1970s, which exported flowers to the United States using an efficient, scalable model. Imitators did come fast and furious. But the authors argue that the firm was not hampered by its inability to prevent others from imitating its approach.

To the contrary: FlorAmerica apparently benefited from the rise of competitors, which allowed the industry to grow big enough fast enough to fight effectively for its interests. That included defending Colombian flower growers from an anti-dumping suit launched by U.S. rivals, leaning on airlines to provide more efficient freight service, and investing in plant research and disease control. The case is not unique, the Inter-American Development Bank researchers conclude; the success of pioneer industries in Latin America often turns on the creation of networks to fill out the supply chain.

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Arguably the most interesting conclusions, though, are related to the role of government. While the case studies don't support intervention as a means of increasing financial incentives for first movers, they are full of examples in which government provides "public" goods and corrects market failure. In Mexico, regulators stepped in to protect the reputation of its young avocado export industry by enforcing pesticide standards. In Uruguay, the government toughened the intellectual property laws to protect software exporters. In Brazil, the government underwrote the R&D needed to modify soybeans for cultivation in new climates, while in Chile the government provided myriad technical services to protect vineyards from disease and to bring wine quality up to international standards.

But governments also trod where free-market strict constructionists were reluctant to see them go. Uruguay provided generous tax breaks to the aforementioned software companies. And Brazil pampered its fragile commercial aircraft industry in umpteen different ways to make it a fit rival for state-assisted manufacturers in Europe and the United States. In both cases, intervention "worked" in the sense that the industries on the receiving end of the help have prospered. What we don't know, though, is whether the social benefits exceeded the costs in terms of market distortions. Nor is it possible to assess how much has been lost on industries that were protected and subsidized—and never made it.

Export Pioneers makes it very clear that the view from the trenches isn't black and white: There's more to development than creating an attractive environment for business and making sure everybody plays by the rules. But the line between warranted and unwarranted market intervention remains frustratingly fuzzy. And we think there are still solid pragmatic reasons for erring on the side of laissez-faire. Most developing countries—at least those outside east Asia—have benefited most of the time from less economic regulation, not more. And in countries in Latin America, with their dismaying histories of crony capitalism, self-perpetuating bureaucracies, and populist opportunism, experiments in bigger government are too problematic to risk.

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