Latin America’s Irrational Exuberance

Latin America is coming to the end of an extraordinary cycle of growth that has transformed much of the continent, especially its commodity-exporting countries. But, as the boom recedes, a deep, debilitating weakness is becoming increasingly apparent: the region’s inadequate education systems. This shortcoming undermines the continent’s longer-term economic prospects, social stability, and fight against poverty.

Such dire warnings have been obscured in recent years by headline-grabbing GDP figures. From 2004 to 2011 (excluding the crisis year of 2009), the region almost doubled its long-run average growth rate. This sustained period of expansion was all the more noteworthy because it followed a half-century of relative decline, with Latin America’s per capita income relative to the United States falling from around 50% in the 1950’s to 23% in 2004.

Faster economic growth, rising incomes, and wealth redistribution over the past decade – fueled by sound macroeconomic policies, foreign investment, and rocketing commodity prices – have helped to reduce poverty rates by 13 percentage points, and extreme poverty by five percentage points. This has expanded the middle class (as measured by household income), which in turn has helped the region consolidate democracy.

The good times were also buoyed by easier access to low-cost capital, much of which has come in the wake of the global financial crisis. As investors sought the higher yields on land, property, equities, bonds, and bank deposits that were attainable in emerging markets after 2008, capital inflows to Latin America tripled, boosting asset prices, credit, and aggregate demand.

Now, with the prospect of rising interest rates in the advanced countries causing a reversal of capital flows, the economic picture has come into full view – and it is not nearly as bright as it previously appeared. Once foreign investment and higher commodity export prices are excluded from the growth calculations, Latin America’s recent economic performance barely exceeds its unexceptional historical average. A similar point can be made about improvements in the region’s total factor productivity.

While standards for students in the region’s upper socioeconomic quintile rose over the past decade, there was little change in the lower quintile, where 70% of students failed to reach the most basic levels.

A more telling indicator of progress – or lack of it – is the minimal improvement in education. According to a recent survey of 65 mainly emerging countries worldwide by the Program for International Student Assessment (PISA), which ranks countries by their education standards, around half of Latin American 15-year-olds performed below the basic levels in math, science, and reading comprehension. While standards for students in the region’s upper socioeconomic quintile rose over the past decade, there was little change in the lower quintile, where 70% of students failed to reach the most basic levels.

In other words, half of all students in their final year of compulsory education, before entering the workforce, lack the minimum skills required by employers. For many graduates, these gaps will never be bridged in later life.

The weakness in Latin America’s education systems reinforces a less rosy view of its economic success in recent years – one that attributes strong performance mainly to favorable external conditions, not improved productivity. Indeed, if measured by skill levels rather than income, the region’s social and economic achievements – including the much-vaunted expansion of the new middle class – are far more tenuous than previously assumed.

The consequences of an uneducated labor force are alarming. Workers are either forced into the informal sector, where basic workplace protections are absent, or they become reliant on state handouts, creating fertile ground for populist politicians and criminals. The boom did little to reduce crime, and may even have contributed to it by attracting those who felt unfairly excluded from the rising prosperity around them.

The region’s economies are now cooling and incomes are flattening, and low-cost capital inflows will no longer encourage public- and private-sector consumption. Tougher economic conditions in Latin America, and in the world economy generally, will eventually force spending back into line with earnings, causing economic upheaval, rending the social safety net, frustrating hopes of a better life, and leading inevitably to social unrest.

If this scenario is to be avoided, political leaders must take a long view of economic growth. Essential to this is an understanding that a fair and prosperous society needs young people who are educated to the standards required of a modern workforce. If a good education remains the preserve of the elite, no amount of irrational exuberance will be able to mask the long-term threat to economic growth and political stability.