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When Governments Can’t Be Trusted

Amidst an economic and political crisis, the Venezuelan Government took control of a General Motors auto plant and seized their assets(1). Despite the obvious objection to a foreign government essentially stealing property from Americans, this fiasco illustrates a deeper problem.

A common criticism of “Globalization”—a multifaceted term that encompasses free trade, unrestricted capital flows, and foreign investment—is that it enables rich countries to control the natural resources of poorer ones, thus extracting wealth and impoverishing the native citizens. While this is true to a certain extent (see De Beers diamond mining in Africa) much of the reason the citizens of developing countries do not see their living standards increase to their fullest potentials is because of the actions taken by the domestic governments. In the aforementioned criticism of globalization, money flows from the rich countries to developing countries—seeking the highest rate of return. Somewhat paradoxically, the opposite is true, money flows “uphill” from developing countries to rich countries (2). So when domestic capitalist make profit from their industries, instead of investing that money in the domestic economy, they choose to invest it in rich countries like the United States.

The explanation of this phenomenon can be understood through the concept of asymmetrical information.

George A. Akerlof won the Nobel Prize in Economic Sciences for his paper “The Market for ‘Lemons’: Quality Uncertainty and Market Mechanism” (3). In this paper he uses the stylized market of used cars to explain a fundamental concept of economic incentives. If the buyer does not have sound information regarding the pertinent information of his purchase, he will be reluctant to make said purchase.

This is the same reason why capital tends to flow “uphill”. As an investor you want to be certain the pertinent information regarding your investment stays the same. This includes the laws of the land and the actions of governmental institutions. In developing countries where power tends to be concentrated in the executive and judicial supremacy is non-existent—who knows what will happen next. An investor feels much more comfortable putting his excess money in the US, because he knows what the governing laws are, and that they cannot be broken on a whim.

If money were to stay in developing countries the people (who tend to be poor) would benefit greatly. They would have more accesses to capital and living standards would increase. Instead the actions of these governments are reckless and uncertain, so capital leaves the country. This problem is illustrated by the recent events in Venezuela. It is both wrong and reckless for the Venezuelan government to seize property of GM simply because they are in an economic crisis. To be sure, investors will avoid Venezuela in the future, and it is their own citizen who will suffer.

Sources:
1) http://www.reuters.com/article/us-gm-venezuela-idUSKBN17M08I?utm_source=applenews
2) http://www.nber.org/papers/w9971.pdf
3) http://www.dmv.org/automotive-law/lemon-law.php

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