State Capacity in Latin America
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State Capacity in Latin America

The debate on the role of the state in the economic development of Latin America swings from the defense of state activism to the minimalist view emphasizing the advantages of market liberalization and privatization. Too often, this ideologically driven controversy between market mechanisms and state intervention assumes that the government is capable of delivering whatever society wants from it. Rather than asking whether the state should be in or out of the development strategy, this paper deals with the more basic question of what drives state capacity, defined as the ability of the state to provide public goods and support the economy with a sound legal framework. Despite the intense controversy on its role, the Latin American state has been extremely weak in terms of the most basic capacity measures. This is what is salient about the region, compared with other more successful development experiences.

The term state capacity has been used in the social sciences with multiple interpretations and meanings. In the more recent economics literature, a distinction has been made between "legal" and "fiscal" state capacity. Legal capacity encompasses what is now known as "contracting institutions" (that is, institutions supporting private contracts) and "property rights institutions" (that is, institutions constraining government expropriation), to use Acemoglu and Johnson's terminology.1 In this paper, building on the recent work by Besley and Persson, the emphasis is placed on the "fiscal" dimension, which is the state's capacity to raise revenues from the population (including [End Page 1] the ability to tax incomes).2 Fiscal state capacity is essential for the state to be able to deliver public goods or to engage in redistribution between different groups in society.

The paper's main claim is that fiscal state capacity is stunted in Latin America as a result of the high concentration of economic and political power. Although this argument is not new, the paper tries to innovate by formalizing the specific channels linking inequality and state capacity, while providing some empirical evidence that supports the model's predictions. To put the argument in its simplest form, investing in state capacity involves costs (sacrificing present consumption) and benefits (future provision of public goods or redistribution). The key insight is that when the group making the decision has much more income and political power than the rest of the population, there are fewer incentives to invest in state capacity. The fear of losing power in the future, and therefore the possibility that state capacity ends up in the hands of the opposition, is another deterrent. All these forces lead to under-investment in state capacity.

The paper also explores other potential determinants of state capacity. For years, the bellicist approach to state development has emphasized the role of interstate threat and war, arguing that societies that engage in external conflict are more likely to build their state apparatus. With a few exceptions, major external confrontations have been rare in Latin America (in part as a result of the Monroe Doctrine, which has kept other global powers outside the region). In contrast, internal conflict and civil war—which have been more common in the region than external wars—destroy, by definition, state capacity. This explanation is particularly relevant in explaining weak state capacity in Latin America, as Centeno argues.3

The paper is structured in the following way. The next section introduces the appropriate definitions and measures of state capacity and provides the key stylized facts on the underdevelopment of state capacity in Latin America. The second section discusses the literature on the specific mechanisms through which political and economic inequality reproduce weak state capacity. The third section develops a model where the two forms of inequality (political and economic) and the two types of conflict (external and internal) determine the equilibrium investment in state capacity. The fourth section presents the econometric evidence supporting the predictions of the model. The main result is that political inequality is a major obstacle to the development [End Page 2] of state capacity. The incidence of external wars, while greatly important when long-run data are used (1900-75), loses relevance when the analysis focuses on the last...