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When Will Fast Growth Return to Latin America?

Commuters wait for the train in a subway station in Sao Paulo July 13, 2006.

From 2003 to 2008, Latin America experienced an annual average growth rate of 4.7 percent. Understandably, as a result of the global financial crisis, during 2009-2010 the region’s growth rate declined to 2.4 percent. However, for the period 2011-2013 it increased to only 3.5 percent, and for 2014 the expectation is that it will drop again to 2.7 percent. Further, forecasts for 2015-2018 estimate growth at 3.3 percent. Although these are averages across countries, and there are relevant differences between them, growth rates are declining in most cases. It is thus increasingly clear that Latin America’s mediocre growth performance can no longer be attributed to the global financial crisis, but, rather, is a reflection of deeper issues intrinsic to the region. Unless these challenges are tackled, it is unlikely that Latin America will repeat the growth performance observed in the first years of this century.

In the context of macroeconomic stability, high and sustained growth is associated with strong productivity growth, and it is in this last dimension that Latin America faces its greatest challenge. Unfortunately, the region’s achievements in terms of better macroeconomic management have yet to translate into improved productivity numbers. Compared to countries in East Asia average annual productivity growth in Latin America between 1980 and 2011 was -0.54 percent versus 0.15 percent (although both regions were affected by the global financial crisis).

Why does productivity lag behind in Latin America? There is broad agreement that three elements are critical for raising productivity (although the relative importance of each varies across countries). First, a country’s human capital, the education and skills of its workers, must be high. Second, the labor market, the central arena where the interactions of firms and workers translate into how much value is produced, must function well. And third, savings rates must be high in order to support investments, particularly in infrastructure.

Human Capital

Evidence points to large gaps between Latin America and other regions of the world in indicators of human capital. The Program for International Student Assessment (PISA) exams provide measures of educational achievement (as opposed to attendance or coverage) comparable between countries. In 2012, 62 countries participated, including eight from Latin America (Argentina, Brazil, Costa Rica, Chile, Colombia, Mexico, Peru and Uruguay). These Latin American countries all fell in the lowest third of the rankings, and seven out of the eight fell below the minimum levels of basic competency in mathematics. Data on workers’ skills are even scarcer, but what there are show low investments in developing workers’ abilities and shorter tenure in individual jobs vis-à-vis developed countries, resulting in less time for on-the-job learning and reduced investments in workers’ training by firms.

The Labor Market

Measuring performance in labor markets is even more difficult, but a central feature of Latin America is its high rate of informal employment: On average, more than half of the region’s labor force is informally employed. High informal employment goes hand-in-hand with high rates of firm informality, and result principally from a complex interaction between the region’s segmented social insurance systems, its labor laws, and its tax regimes. Contributory social insurance systems bundled with cumbersome labor regulations create a tax on formality, and informal employment is subsidized by well-intended but poorly designed non-contributory social insurance programs.

Informality is an enemy of productivity: Too many individuals with few skills work as self-employed or as micro-entrepreneurs, and there is excessive worker rotation from job-to-job. In addition, too many small and inefficient firms survive because enforcement of tax, labor and social insurance laws is focused on large firms, and in some cases explicitly exclude the self-employed or family firms with non-salaried workers. The resulting dispersion of economic activity into myriads of small and often illegal firms is an environment that is hardly conducive for exploiting economies of scale and scope, facilitating firms’ access to credit, applying modern management techniques, training workers, and innovating; in short, for increasing productivity. A study on Mexico, for example, found that one peso of capital and labor invested in an informal firm yielded between 35 and 50 percent less value than the same peso invested in a formal one. More generally, research shows that misallocation of labor and capital in Latin America is substantially higher than in the United States or in emerging economies for which data is available, a result of the dysfunctional labor and credit markets associated with informality.

Savings and Investment Rates

Finally, the region’s savings rates are low compared to other developing countries. The country with the highest savings rate in Latin America saves less as a share GDP than the country with the lowest savings rate in emerging Asia. Because high and persistent current account deficits cannot be sustained for very long, low savings translate into low rates of investment, particularly in infrastructure. It is estimated that to develop an infrastructure comparable to that of its competitors, Latin America should be investing about 2 percent more of its GDP than what it currently does.

There are no surprises: Latin America’s growth rate is low because, ignoring Asian tail winds and abnormal conditions in international capital markets, there are no good reasons for it to be high. While in some countries demand management policies may yet produce short-term growth spurts, these policies are not substitutes for addressing the factors behind stagnant productivity, and could hurt more than help if they generate uncertainty about the sustainability of the country’s fiscal position and distract policymakers’ administrative and political capital.  

In the years ahead accelerating growth in Latin America will be doubly challenging. On the macro side, countries have to pay more attention to fiscal issues: While the region’s fiscal position now is more solid than in the 1990s, the opposite is true when the comparison is made to 2007, the year before the global financial crisis. In parallel, countries will face global monetary normalization. On the micro side, Latin American countries need to urgently accelerate productivity growth, which is not an easy task as policies to do so are complex: They deal with sensitive issues like taxes and the architecture of the region’s labor and social insurance systems. In addition, some of these policies, like efforts directed at increasing workers’ human capital, need time to bear fruit. But this is what is needed for fast growth to return to Latin America.

The author’s opinions do not necessarily coincide with those of the institutions he is affiliated with.

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