April 8, 2010
Panama City, Panama
Do you remember that really awkward phase we all went through as adolescents?
Growth spurts, voice changes, menstruation, and yes, pimples– in the end, while we all came out of it more mature and grown up, there was a difficult and sometimes painful transition period in which we had to learn how to deal with new realities.
Developing countries go through the same sort of transition, and it can be just as awkward and painful.
Typically, they try to transition from fledgling banana republics with corrupt governments and byzantine regulatory systems to stable democracies with a growing middle class and reformed tax code.
Most countries have a very difficult time with this.
For example, I expect China to undergo significant pain as their economy continues to inflate. One day the Chinese will find that their rising currency and wages are no longer cheap, and they’ll have to seek competitive advantage in something other than manufacturing knick-knacks.
In other words, a country of a billion people cannot go from making socks to being the world’s investment bankers overnight, or without any fuss.
These sorts of transitions are very difficult because they affect the entire social landscape– employees are laid off and have to retrain to new skills, businesses go bust and reinvent themselves, etc. Of course, politicians always get in the way by passing laws which only prolong the pain.
Overall, the transition cycle is not easy, and few countries pull it off well. In my assessment, Panama is one of the countries succeeding.
20-years ago, with its puppet dictator, open drug trade, and banana exports, Panama was nothing but a bad punch line. Over the last decade, though, the country has been able to successfully develop a service-oriented economy with robust tourism, banking, and transportation sectors.
Today, while the country is definitely no Shangri-La, Panama is thriving and on a very clear upward trend.
Remember, this is ultimately the most critical point to consider when planting a flag overseas– is the country or jurisdiction on an upward trend? Will it be a better place 10-years from now?
When you survey the political landscape in developed countries, the headlines generally tend to get worse and worse. Certainly, not all news is bad, but the subversion of civil liberties, erosion of financial privacy, and rapid growth of big government seem to be at least weekly occurrences.
Meanwhile, in developing Latin economies like Panama, Chile, and Peru, things are consistently improving– they are going through the awkward growth phase as smoothly as possible.
As an example, the Martinelli administration in Panama recently passed comprehensive tax code reform. While increasing the sales (consumption) tax by 2%, it cuts corporate and some personal tax rates, reduces some property tax rates by half, and completely eliminates over 30 types of tax.
This new, simplified tax code is a major step in the right direction, and it will be excellent for business.
The government here clearly understands that successful businesses hire employees and generate wealth in the economy. This model has done wonders for Singapore and Hong Kong, and Panama is following suit.
Yes, there are still elements of poverty, corruption, drug trafficking, etc. in Panama. The trend, however, is undeniably one of consistent improvement and greater economic freedom. Ultimately, this is exactly what helps countries successfully transition through those difficult growth phases.
As I’ve said before, until these economies become large or popular enough, local capital markets tend to be off-limits for armchair investors. I don’t see TD Ameritrade offering access to the Peruvian stock market anytime soon.
It is possible, however, for intrepid active investors to open local brokerage accounts and capitalize on the rising tide… though the most passive investment opportunities generally tend to be foreign bank accounts (which provide liquidity and exposure to the currency) or property (which is non-reportable and an excellent inflation hedge).
More on these topics in future letters.