The 2010s: Latin America’s Fleeting Opportunity

It is comforting to hear so many commentators agree that the 2010s will be Latin America’s decade. For Latin America, the Global Recession was a small bump on the road, affecting growth rates for only a few quarters. Several countries in the region are now growing at China-style rates. But countries will not be able to sustain annual GDP growth rates above 5 percent for too long. Lifting the constraints on potential output growth is really the challenge of the decade.

There is one very good reason to be optimistic. Much of the recent performance in the region reflects the adoption of new paradigm. Perhaps with the only major exception of Venezuela, Latin American governments –from all sides of the political spectrum– have embraced what could be called the “Latin American Consensus.” Its basic pillars are macroeconomic stability and effective redistribution.

Macroeconomic stability is now a policy imperative. Politicians understand that keeping inflation low is good not just for the economy but also for their own electoral interests. Public-debt sustainability is also part of the consensus. Fiscal populism is no longer rewarded, at least in the countries that are more integrated with the global economy. The interesting change here is also political. Mainly as a result of the devastating effects of the crisis of the late 1990s, politicians were willing to accept rules that constrain fiscal options. Delivering fiscal primary surpluses is now a viable outcome for governments. This was not the case a decade or so ago.

The second pillar is a renewed agenda on social policies and the reduction of inequality. Calls for redistribution have always been part of governments’ rhetoric in Latin America. The difference this time around is that democracy is working: politicians need to reduce poverty and expand the middle class to succeed. Given this goal, there is a very healthy technocratic debate not on whether redistribution is good or bad, but on whether the policies and programs are more effective to achieve it. Impact evaluations of social programs are now frequent and have contributed to improvements in the way social interventions are designed and implemented.

If this policy framework is preserved, there are good arguments to expect that the 2010s would be a transformational decade, not just in terms of per capita income growth, but also in terms of the reduction of poverty and inequality. Needless to say, the virtuous circle of growth and equity will have important ramifications on institutions, with stronger democracies being a key ingredient. This is also part of the new paradigm.

But this is no time for celebration. The new paradigm is there, but it is still vulnerable. The basic policy framework needs further consolidation. Fiscal sustainability is still a work-in-progress for the majority of countries. Public debt is excessively high, fiscal policies are still too procyclical, and even worse, very few countries collect enough tax revenues. On social policies, successful interventions are more the exception than the rule. What governments have done is to create new (and better) programs, like conditional cash transfers, but not phased-out the old and ineffective ones.

But the main reason for concern is external. In all fairness, not all progress in recent economic and social outcomes is home-made. In the past few years, the region has had excellent tail winds. Reaching a consensus on the need to be responsible on macroeconomic and social policies is easier when external conditions are favorable. The real test is yet to come.

In other words, the region needs to make sure that the new paradigm is less dependent on good news from China.

China is currently fueling Latin America’s economic growth through three main channels: improved terms of trade, expanding export volumes of primary goods, and access to cheap global capital. On all three fronts there are reasons for concern.

Based on the historical experience of other countries, it is predictable that China’s demand for commodities will not continue to grow at the rates it has shown in the past. Historical evidence suggests that the intensity in the use of primary goods falls with the level of income and the degree of urbanization. If this evidence is to serve as a guide, Latin America needs to quickly address the future consequences of slower demand for its natural resources, precisely when the region is betting heavily on the expansion of these sectors.

A more fundamental source of concern has to do with low domestic savings. Chinese savings are currently providing Latin America with the opportunity to sustain high investment rates. But here too there is evidence suggesting this may change. China has an aging population that will soon begin to withdraw heavily against accumulated savings as workers retire. Also, as the Chinese government prepares to implement public programs to support health care and pensions, it is likely that Chinese households will have less reason to maintain their high rates of savings. Historical trends from Japan and South Korea show that as their economies became richer, household savings began to steadily decline.

Latin America will be able to seize its unique opportunity by first recognizing that the current favorable external conditions are transitory. The region must utilize the current availability of resources by finding ways to invest in areas with high dividends and the capacity to sustain economic growth into the future. There are no silver bullets, but education, infrastructure and innovation are at the top of the agenda.

Education has the double dividend of reducing inequality while increasing economic efficiency.
The 2009 OECD PISA evaluations on education quality around the world indicate that none of the Latin American countries surveyed are at or above the world average in reading, mathematics or science, and most are significantly lower than the average. Narrowing the gaps in enrollment across population, especially in secondary and tertiary education, and improving quality across the board should be first priority.

The 2010s can be the decade of Latin America’s growth and transformation if the region is able to seize the unique and fleeting opportunity it faces. There is no time for complacency. What governments should do is to prepare for the next stage, when the expansion of the domestic market and endogenous forces will need to play a role if the growth momentum is to be sustained.