Threats to economic growth in Latin America

Economic growth
Macroeconomics - Economic growth - Monetary Policy

Growth in many Latin American economies has been poor in recent years. This column pulls together some of the research evidence on the disruptions that help to explain this decline, and outlines key areas for policy-makers to focus.

Latin American economies have had an average annual GDP growth of 3% over the past 15 years, far slower than growth in other developing regions (6.9% in South Asia 6.9% and 5.1% in sub-Saharan Africa). During this period of time, almost 80% of Latin America’s GDP growth came from population growth rather than productivity (78% and 22%, respectively).

Between 2000 and 2015, productivity across the region grew at only 0.6%, one of the weakest performances of any region in the world (63% labor input contribution for Africa, and only 14% for Asia). It is clear that without higher productivity rates in the coming future, growth is set to come under threat from three disruptive forces hitting at the same time, thus tackling the poverty and inequalities improvements; however, income inequality in the region remains high (see Lustig, 2016).

In that way, failing fertilities could be considered the first disruption, the United Nations estimates show that the fertility rate in Latin America has fallen over the past 15 years: from nearly 2.7 births per woman on average to 2.1 births that undermined growth and labor supply. For the coming decades (the 2020s and 2030s), employment rate growth is expected to fall by more than a half – to only 1.1% a year – one of the lowest rates in the developing world. With unchanged productivity growth, this implies that GDP growth in Latin America will be 40% weaker over the next 15 years.

The second disruption is the end of the ‘commodity super-cycle’ in 2011, which had fueled GDP growth, particularly in the Andes region (4.5% annual growth rate). It is evident that Latin America will continue to benefit from its abundant resources, but the current context requires a shift toward producing and using those resources more efficiently to other sectors. The current sluggish growth rates and the constraints of institutions will hinder such structural change.

The third disruption relates to the risk of rising protectionism, which could harm the region’s trade flows, with a negative knock-on effect on GDP growth. There is particular concern about trade with the United States, which is the biggest export market for Latin America and the destination for 45% of Latin American exports, and the source of 32% of its imports. Central America and Mexico, in particular, are highly dependent on trade with the United States.

To counter the threat to growth, we see five major priorities for the coming years.

Competitiveness and productivity

First, the region needs to expand high-value-added activities across key value chains by removing obstacles to competitiveness. Today, Latin America’s most productive sectors (relative to the same sectors in the United States) account for less than one-fifth of total employment in the region. On average, Latin American workers produce 25% of what US workers produce. In the same way, the sectors with lower productivity are oil, mining, and public services.

Digitization and automation

Latin America’s economies need to engage fully in the current wave of digitization and automation. According to the World Bank Development Indicators, the region invests only around 0.8% of GDP in R&D activities, compared with an average of around 2.4% in OECD countries and 1.8% in China.

We believe that almost a half of the full-time hours worked in Latin America could be automated, productivity would rise, but measures would need to be in place to help workers gain skills as they transition to new types of jobs.

The World Economic Forum Annual Meeting 2018 prioritized three transformation necessities: attracting new talent and improving skills to unlock a dormant digital market, integrating and collaborating across the built environment value chain, and adopting advanced technology on a large scale. In the same way, societies have to go digital expanding the broadband, but overall connecting rural areas, and improving the technological knowledge of older generations; probably the most important challenge implementing educational policies for new jobs (skilling for tasks).

On the other hand, the internet is increasing LAC companies’ trade in goods. For example, eBay’s data shows that in Chile, 100% of online sellers export, on average selling to 28 different markets – as opposed to the mere 18% of Chilean offline companies, which typically export to just two markets.

Since urbanization plays an important role in explaining the demand for digital products and novel advanced urban services, the LAC region could leverage its high levels to improve digitization adoption and as a consequence could improve the delivery of smart and connected assets to enhance the regional economy. LAC countries have some of the highest levels of urbanization globally but one of the lowest levels of digitization, as well as very low levels of technology adoption rates, compared to other markets; BBVA DIGix illustrates how the region is already lagging behind global trends.

Education and skills

To address challenges created by pressure on the labor market, the region’s countries need to raise technical skills through improved education and better match those skills to the ones needed by the business. According to McKinsey, between 40 and 50% of Latin American employers cited a lack of skills as the main reason for entry-level vacancies. For example, the Latin America education quality maintained equal during 1999 to 2012 (78 to 79), below the figures of Asian countries (86 – 93) and of the developed countries (92 – 94). Equally, Hanushek and Woessman (2012) explained that the main development drawback in the region is the low level of cognitive skills, been lower than Asian and MENA countries.

In 2001 expected school attainment in Latin America was 13 years, compared to 8.6 in South and West Asia, 7.1 in Sub-Saharan Africa, and 9.5 across all developing countries (UNESCO, 2015). Yet these human capital investments have not translated into clear patterns of growth and development. Not only does the low level of educational achievement account for the lack of growth of Latin America relative to the other world regions, but it also provides much of the explanation for variations in economic performance within the group of Latin American countries.

The entry of more women into the labor force would help mitigate pressure on labor pools and boost GDP growth in the short-run. We believe that rising the progressivity toward gender parity -raising women’s labor-force participation is a huge part of that—this could increase GDP by 2025 by a 14% above what can be achieved at current rates of progress.

Macroeconomics and institutions

An inclusive and sustainable growth strategy requires strengthening macroeconomic fundamentals as well as investing in the capital and infrastructure that enable productivity growth and competitiveness. With the exception of Argentina and Venezuela, Latin America has strong macroeconomic fundamentals, but fiscal vulnerability is rising, especially public debt.

As a result of the commodity price boom that started in 2003-2004 and lasted for about a decade, the process was followed by a significant re-primarisation of the structure of exports, particularly oil and gas. This re-primarisation was enhanced by growing trade with China, which became a major trading partner of Latin America after 2007-2009. For Gallagher (2016) it’s reflected in a Ricardian era of rising natural resource scarcity and high commodity prices, these expectations were based on the view that the mix of strong Chinese demand, the gradual exhaustion of new oil and mineral resources, and the effects of climate change. 

After the end of high commodity prices, the appearance of terms if trade volatility affected the exchange rate which in turn affects investment. Commodity price shocks also affect the cost of foreign borrowing and the capacity to service debt. If there was an initial surplus during the boom (2003-2004), it was followed by initial deficit during the crisis (2013-2015), the initial effect was procyclical and the countercyclical effects came with a lag.

Regarding macroeconomic volatility, Cárcamo-Diaz (2014) found a strong heterogeneity in the region related to economic performance, volatility decreased compared to the 1990s (except for Argentina, Paraguay, and Venezuela), however, it is still highly associated to low growth and external shocks, the region shows higher macroeconomics volatility than developed countries.

Possibly the best defense of the development opportunities provided to Latin America by its natural resources is that of Pérez (2010). She argues that there are ample technological opportunities associated with biotechnology, nanotechnology and environmentally friendly products—opportunities to exploit the whole value chain of natural resource-intensive sectors, and strong complementarities with Asia. In contrast, Latin America is too far behind in other technology sectors and is no longer a low-wage region, and so can compete neither in the high-technology sectors associated with information and communication technologies nor in low-skilled manufactures.

On the other hand, we don’t have to forget about institutions, the region suffers from poorly enforced regulations that encourage informality and therefore constrain productivity growth. Informality arises as many firms have strong incentives to avoid becoming formal because of high taxes, poor auditing capabilities, and low levels of sanctions.

Consequently, weak institutional frameworks in developing countries often do not allow price stabilization funds to be managed in a transparent and accountable manner. Institutional constraints are aggravated by uncertainty surrounding revenue flows, difficulty in predicting the magnitude and duration of commodity price shocks, and consequently in effectively employing counter-cyclical stabilization policies.

Climate change

Finally, projections show increasing mean temperatures of up to 2°C compared with pre-industrial levels by the mid of this century across Latin America. Associated physical impacts include altered precipitation regimes, a strong increase in heat extremes, higher risks of drought and increasing aridity. These extreme climatic events are becoming more frequent and intense due to global warming. The Inter-American Development Bank estimates that damages in the region caused by climate impacts such as increased drought, floods, and sea level rise associated with a rise of two degrees Celsius will likely approach $100 billion a year by 2050.

Climate change will also reduce agricultural yields, livestock, and fisheries; species range shifts threaten terrestrial biodiversity, and there is a substantial risk of Amazon rainforest degradation with continuing warming. Although the ECLAC’s report identifies Latin America as one region with a potential for increased biofuel production.

Sadly many of the countries of the region have not strengthened food production systems, which are very vulnerable to the variability of climate and to the consequences of drought, flooding, and other natural disasters. Under this trend, it is evident that in the coming decades there will be massive inflows to urban cities, more even it will affect the poorest populations.

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