Latin America Macroeconomic Outlook in the Global Context: Are the Golden Years for Latin America Over?



  • Growth rates are cooling off in almost every major country in the region with the notable exception of Mexico.
  • The generalized cooling-off in emerging markets clearly suggests common external factors might be playing a key role in driving this phenomenon.
  • Interestingly, Latin American countries with supply bottlenecks—those where output is above the PPF—are the ones experiencing the greatest growth decelerations when comparing growth rates of the period 2012-2013 to those of the Golden Years.

Latin America is cooling off and it is doing so sharply. In contrast with the 6.6 percent average growth rates prevailing between September 2003 and September 2008—the pre-Lehman-crisis “Golden Years” for the region—LAC-7 GDP growth rates in 2012-2013 are decelerating significantly and reverting back to their historical average of 3.7 percent displayed over the last 20 years. Moreover, growth rates are cooling off in almost every major country in the region with the notable exception of Mexico. 

This cooling-off has occurred in spite of the fact that external conditions for the region are slightly more favorable today than they were during the Golden Years. If one takes a close look at the key external drivers of Latin America’s growth rates identified in Izquierdo, Romero and Talvi (2008), a model that does a very good job of tracking out-of-sample growth rates in the region, the picture that emerges is the following: i) the global growth rate (the G-7 plus China) is currently 0.8 percentage points below the observed rates during the Golden Years; ii) commodity prices are 40 percent above the average prices observed during the Golden Years and very close to the maximum values of that period; iii) emerging markets’ bond yields are close to 5 percent, a rate which is not only significantly below the average of 7.4 percent that prevailed during the Golden Years but also is significantly below the minimum rate observed during that period; and iv) capital inflows to the region— currently running at approximately $270 billon—are three times the average observed during the Golden Years and higher than the maximum level achieved during that period. 

In fact, if we use the external factors model just mentioned to simulate future performance under current external conditions and those prevailing during the Golden Years, growth rates and output levels are consistently higher under current conditions. This means that the current combination of external conditions—lower global growth with higher commodity prices and lower capital and borrowing costs—is overall more favorable than the one prevailing during the Golden Years. 

How can we explain the paradox of the regional cooling-off in economic activity in a context where external conditions are, on average, even better than those prevailing during the Golden Years? During the Golden Years, external conditions improved significantly relative to the preceding period (1998- 2003): Global growth increased from 3.0 percent to 3.8 percent, commodity prices jumped an average of 75 percent, and the yield of the emerging market bonds fell from an average rate of 13.5 percent to 7.4 percent. 

Such a huge external impulse during the Golden Years contrasts with current external conditions: They are still very favorable, but have ceased to improve. This is a crucial difference. Since improvements in some key external drivers have level effects and not growth effects, the impact on growth of an improvement in external conditions will dissipate over time. Therefore, the cooling-off we are seeing today is the natural and predictable outcome of external conditions that remain very favorable for the region, even more favorable than those of the Golden Years, but that have ceased to improve. Given the complex dynamics that link external factors with regional growth rates, the effect of past improvements in external conditions is fading away. 

The previous analysis implies that we should be careful when reading Latin America’s current growth performance: It is not the case that the region is doing relatively well in a more hostile external environment; rather, the region’s growth rates are slowing down significantly in spite of the fact that the external environment remains favorable overall. In other words, unless we anticipate that external conditions will improve significantly relative to current levels, the observed slowdown in growth rates is not an oddity that will go away anytime soon. Rather, it is more likely to be the “new normal” even if external conditions remain favorable. 

This report also explores whether idiosyncratic factors in Latin America are playing a role in either mitigating or contributing to the cooling-off set in motion by the dynamics of external factors. After many years of high growth well above the region’s historical average, it may be the case that production possibilities are being exhausted in a region where, in many cases, improvements in physical and technological infrastructure and human capital may have not kept up with the strong output growth performance of the past few years. If this were the case, the rate of growth of economic activity should decline due to restrictions in some of the inputs of the production process that make it impossible for output to continue growing at previous rates. For this reason, among the multiple relevant idiosyncratic factors, we focus on identifying countries in the region where supply bottlenecks may have developed. 

In order to identify countries with supply bottlenecks, we estimate the production possibility frontier based on the current endowments of natural capital, human capital, physical and technological infrastructure, and total factor productivity for each country in the region and assess which countries are above and below the production possibility frontier. 

Not surprisingly, the countries with supply bottlenecks—those above the production possibility frontier according to our identification strategy—are the ones experiencing the greatest growth reversals. If we compare the 2012-2013 growth rates with the growth rate of the Golden Years, the slowdown in countries with supply bottlenecks is 2 percentage points higher on average than in countries without supply bottlenecks. 

To conclude, current growth rates in Latin America are cooling off in spite of a still very favorable external environment as the impact of the past improvements in external conditions on growth dissipate through time and supply bottlenecks kick in. Even if external conditions for the region remain favorable, unless they start improving once again they are unlikely to be a renewed source of stimulus for higher growth rates as they were during the Golden Years, when external conditions markedly improved.

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