Latin America’s challenge

After a euphoric decade, reforms to consolidate recent gains and confront challenges ahead are needed. Are Latin America’s economic fortunes changing? Over the last decade, policymakers and the general public became used to good news from this lively continent. Latin America was abuzz with optimism, buoyed by strong growth and rising incomes.

Such was the euphoria that some commentators wondered if the continent was not at last “decoupling” from the world economy, able to thrive regardless of the US in particular. Indeed, most economies in the region weathered the storm of the global financial crisis rather well. Although the collapse in external demand and commodity prices caused Latin America’s GDP to contract by 1.5% in 2009, it rebounded by 5.7% in 2010 and 4.4% in 2011.

The region’s success was in part homegrown, thanks to a mix of fiscal prudence, well-capitalised banks and credible inflation policies. Strong growth in other emerging markets–especially China– also helped, as did record low financing costs via global markets. There was a reduction in absolute poverty from a headcount of 33% in 2002 to around 22% in 2010, according to figures from the UN Economic Commission for Latin America and the Caribbean. Inequality has been falling steadily in most countries at a time when income inequality in OECD economies has been on the rise, though there is still some way to go before inequality narrows to around OECD average levels.

Can this speed of economic progress be maintained in the years ahead? It will not be easy, for as the Latin American Economic Outlook 2014 points out, there are headwinds to contend with. China’s own rebalancing is putting less upward pressure on commodity prices, which will affect Latin American export earnings, while external demand from OECD countries remains sluggish. Capital flows and exchange rates throughout the region have started to look more volatile, as international investors prepare for quantitative easing (QE) tapering in the United States.

In 2013 the less dynamic global environment affected Latin American growth, which averaged around 2.6% over the year, with only a modest pick-up to 2.9% expected in 2014.

A return to moderately normal growth and policy conditions in the US could help, since around 35% of Latin America’s total exports still go to the United States. But the tightening in monetary policy that will eventually come with it can create bumps along the way. Governments in Latin America must work hard to manage weaker fiscal and external positions, and avoid the risk of a sudden halt in capital inflows.

But the main risks to Latin America’s outlook lie in structural weaknesses, which the current difficult economic situation could expose. Most countries in South America have concentrated their exports more on natural resources with few linkages to the rest of the economy. Central American and Caribbean countries are struggling to increase the competitiveness of their firms and retain more value added within value chains. All in all, Latin America should aim to raise its growth potential from the current 3-4% to 5-6%, in order to improve resilience, and reduce poverty and inequality at a faster rate. In other words, policy should aim for more robust productivity rates, with the aim of making economic growth more inclusive.

Reform priorities vary from country to country, but with similarities. Most countries need to upgrade their infrastructure and logistics in order to boost competitiveness across more international markets and global value chains. As shown in the Latin American Economic Outlook 2014, the region’s logistic costs are almost nine times larger than tariffs, and far greater than in the OECD area. Modifying rules and regulations to enable more effective use of current infrastructure is also needed. For example, single-window facilities for foreign trade can reduce time and logistics costs. Inducing more competition among transport firms might also reduce costs: between 2000 and 2006, the collusion of some 40 airlines increased the costs of Chilean exports. Eventually, the airlines were forced to pay more than 1,800 companies around US$113 million in compensation.

Latin American countries need to use the fruits of recent growth to incite a move towards more knowledge-based sectors, by investing in research and development, fostering start-ups and cultivating the 21st century skills which are needed to tap into global opportunities. At the same time, governments must cater to an emerging middle class with more and better public goods and services.

Click to enlarge

Can the public sector keep up? Clearly, more fiscal revenues will be needed: in 2010, Latin American economies only raised an average of around 19% of GDP in tax revenues, compared with almost 34% in the OECD area, according to Revenue Statistics in Latin America (2010). Training civil servants, building capacity and fighting corruption all require tough reforms, and are vital in a region where trust in government and public administration is low.

There are many challenges ahead for Latin American countries, but luckily the region’s leaders have their feet on the ground. The policy debate in many countries has become quite pragmatic, while discussions on issues that have led to heated debates in the past, such as trade and foreign direct investment, are now carried out in a cooler manner and on a more technical level. Several countries, such as Mexico, are implementing difficult reforms to tackle their structural problems in areas such as telecommunications, labour, energy and fiscal policy.

Mexico, like Chile, is of course an OECD member country. Colombia is on the way to joining, while others, such as Costa Rica, are also drawing closer to the organisation. These are concrete signs not only of a determination among the region’s leaders to reach out, learn and improve their policies, but of an unshakable optimism that, for Latin America, the best is yet to come.

References

OECD/EClAC/CAf (2013), Latin American Economic Outlook 2014: Logistics and Competitiveness for Development. OECD Publishing.

OECD (2013), Start-up Latin America: Promoting Innovation in the Region, OECD Publishing.

OECD/EClAC/Inter-American Center of tax Administrations (2012), Revenue Statistics in Latin America. OECD Publishing.

Economic survey for Mexico (2013)

Economic survey for Chile (2013)

Economic survey for Brazil (2013)

Economic survey for Colombia (2013)

©OECD Observer No 297, Q4 2013




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