Historically, experts have often characterized Latin America as a region with poor economic features: hyperinflation, fiscal populism, and costly industrial policies rife with corruption are just a few examples. However, experts are beginning to change their tune. In fact, many analysts are referring to the 2010s as Latin America’s decade. Last year, The Economist ran a special report, where the magazine turned the hemispheric map upside-down under the label “Nobody’s Backyard,” suggesting that the region had learned from its previous mistakes and is entering a brighter phase. Although predicting the future is always dangerous, especially in a place where so many booms have ended in severe crises, the argument that Latin America is entering a decade of considerable opportunity does have merit. There are three interconnected reasons to make this point:
A window of demographic opportunity is emerging with the decline in the dependency ratio, which is the ratio of young and old individuals to the working age population (15-64). A recent World Bank study on Brazil’s calculates that the bottom of the dependency ratio curve will be reached in 2020. This means that the size of the workforce in relation to the rest of the population will begin to shrink after that period, putting greater financial pressure on households. Although the speed of Brazil’s demographic shift is unprecedented, United Nations’ projections more generally indicate that the dependency ratio will flip for the region in 2025. With fewer dependants between now and that date, as well as better employment prospects, the present decade opens the possibility of accumulating greater savings while providing better schooling opportunities for the youth.
2. China’s economic growth
Right now Latin America is cruising because of the tail winds from China. Although competition in manufacturing is harsh, economic growth in China has created an intense demand for commodities, pushing up Latin America’s terms of trade and export volumes. While we do not know how long this boom is going to last, there are reasons to believe that the end is approaching. China’s population will reach a level of income typically associated with a greater demand for services that are less natural-resource intensive than infrastructure, housing or heavy industries. There are those who argue that India will take the lead in the demand for commodities. This is certainly possible, as India will become more urbanized and construction is likely to accelerate. However, it is also clear that India’s economic structure is based on services that are also less intensive in the use of commodities. Latin America should hope for the best in terms of commodity demand but plan for the worse, which means a decline in commodity prices, resulting from not only weaker demand growth but also large increases in supply as current investments in natural resource extraction begin to mature. In the meantime, while commodity prices remain high, Latin America needs to pave the way for future development opportunities. This means that crucial investments need to take place, mainly in human capital and research and development activities. In other words, commodities should be transformed into neurons.
3. Global savings and liquidity
Latin America has recently kept investment rates above historical levels, mainly because external savings have been available. Domestic savings are low and will constrain economic growth. To count on abundant and inexpensive foreign capital to steadily fund investment is dangerous and unrealistic. One reason is that China’s saving rates are expected to decline as living standards increase. It is also important to note that monetary policy in the U.S. has kept global interest rates at very low levels and that may change with inflationary pressures rising in the U.S. economy. Latin America may be forced in the future to rely more on its own savings, and the next few and favorable years are undoubtedly a great opportunity to make this transition.
Whether Latin America can seize the moment and take advantage of this extraordinary chance to speed-up prosperity is still an open question. What is certain though is that there is no time for complacency or self-gratification.
Rather than enjoying the good times with additional consumption, Latin American countries should be thinking about increasing savings and investment. Favorable external conditions provide some freedom and opportunities to make tough decisions and thus tackle broader structural problems. Among those decisions, top priorities should include investing heavily on education and innovation. These policies are essential to diversify production and expand the domestic market.
All in all, building state capacity should be at the center of the agenda. This means that states must be able to deliver public goods effectively and efficiently, and guarantee security and opportunities for all citizens in an increasingly open and competitive world. Revenue from the current boom must be invested in modernizing and upgrading the Latin American state. A good and natural starting point is to develop better tax administrations, judicial systems and police forces, as these are all prerequisites for development.
Investing in state capacity requires time, political will and resources. If Latin American leaders focus on this task ahead, this will be a transformational decade indeed. Otherwise, it will simply be another cycle of high and unsustainable consumption, a wasted opportunity of which the region has seen plenty in the past.
Mao Zedong did not see the value of reform and opening up. The China part of Nixon’s 1967 Foreign Affairs article suggested an implicit bargain that provided the conceptual basis for China’s new direction after 1978. That bargain was if China focused on domestic development and didn’t threaten the security of its neighbours, the United States would help.