Latin America: Learning the lessons of stagnation

As memories of galloping growth fade, it is time for tough thinking about the future

IN JUNE 2006 Luiz Inácio Lula da Silva, then Brazil’s president, went to Itaboraí, a sleepy farming town nestled where the flatlands beside Guanabara Bay meet the coastal mountain range. He announced the building of Comperj—the Rio de Janeiro petrochemical complex, a pharaonic undertaking of two oil refineries and a clutch of petrochemical plants. With forecasts of 220,000 new jobs in a town of 150,000 people, Itaboraí geared up for a boom.

Today it is almost a ghost town. Its straggling main street adjoins an unopened shopping mall and is punctuated by a score of blocks of flats and office towers, one with a heliport on the roof, all finished in the past few months and all plastered with “for sale” signs. “A lot of people bet on this new El Dorado in Itaboraí and it didn’t happen,” says Wagner Sales of the union of workers building Comperj.

What did happen? Private firms that were supposed to join Petrobras, the state-controlled oil giant, in investing in the petrochemical plants took fright when a shale gas boom in the United States slashed costs for their competitors there. Lula and his successor, Dilma Rousseff, burdened Petrobras with developing new deep-sea oilfields as a monopoly operator while also adding three other refineries. A corruption scandal and plunging oil prices hit the company hard. Comperj has been reduced to one small refinery; its completion date has been pushed back to mid-2016.

Luiz Fernando Guimarães, the secretary of economic development for the municipal government, reckons there are 4,000 empty offices in the town. Two years ago the mayor set out to re-market Itaboraí as a logistics centre. But its trump card—location near the meeting-point between a new motorway round Guanabara Bay and the main coastal highway—was wasted because the federal government of that “darned Dona Dilma”, as Mr Guimarães calls the president, has failed to build the last stretch to the town.

Itaboraí’s plight is echoed, albeit less dramatically, across Latin America. The rise in the prices of commodities—minerals, oil and grains—brought about by China’s industrialisation unleashed a golden decade for the region (or more accurately for the commodity-exporting countries of South America). Growth averaged 4.1% in the decade to 2012. In its train came a social transformation: 60m were lifted out of poverty, and the middle class swelled.

Now the good times are over. Latin America’s economy is screeching to a halt; it managed growth of just 1.3% last year. This year’s figure will be only 0.9%, reckons the IMF, which would mark the fifth successive year of deceleration (see chart 1). Not only has this surprised most forecasters, but Latin America has slowed more than any other emerging region. Many reckon it now faces a “new normal” of growth of just 2-3% a year. That would jeopardise recent social gains; already the fall in poverty has halted.

So what has gone wrong? Did Latin America squander its boom? An immediate explanation for the slowdown is the fall in the region’s terms of trade—the ratio of the price of its exports to the price of its imports. Having risen threefold between 2003 and 2011, commodity prices fell somewhat thereafter before plunging sharply last year. Since 2011 investment in the region’s economies has slowed; the IMF finds that it is closely correlated with commodity prices. Financial markets have responded accordingly, with the region’s main currencies depreciating by an average of 20% against the dollar since mid-2014 and most stockmarkets in the doldrums. The impending hike in the United States Federal Reserve’s policy rate will raise borrowing costs.

An end to expansion

In the past such abrupt reversals tended to cause panic and capital outflows. This time is at least partly different. Better macroeconomic policies, such as floating exchange rates and lower public debt, have allowed many countries to adjust smoothly. Chile, Colombia and Peru, which have handled their affairs responsibly, are still growing, but much more slowly. (So is Bolivia, whose leftist government has been relatively prudent.) Mexico, Central America and the Dominican Republic, which are net importers of commodities, are set to do better than average in the coming years.

Worst hit are countries that bungled their policies, to varying degrees. After an inflationary fiscal splurge, Brazil faces an inevitable adjustment: its economy will shrink by 1.2% this year according to the government, and unemployment is surging. Argentina is enduring prolonged stagnation and double-digit inflation. Venezuela faces a painful contraction of 7% this year and inflation of 95%, says the IMF. On the black market its currency has halved in value against the dollar since January.

“The boom was not completely wasted, but neither was it completely capitalised on,” Guillermo Perry and Alejandro Forero of the University of the Andes in Bogotá conclude in a recent paper. Most of its proceeds went on a consumption binge and imports. By contrast Asia’s expansion has been powered by manufactured exports, investment and infrastructure spending, increasing its potential for future growth.

But Latin America’s traditionally low investment levels did increase. Stronger and better-regulated banks and public finances and higher levels of international reserves meant that the region sailed through the great recession of 2008-09 with only a brief downturn. Yet that success went to the politicians’ heads. Many were too slow to withdraw the fiscal stimulus they applied. With the partial exception of Chile and Peru, no government now has scope to mitigate the slowdown through monetary or fiscal policy.

To return to faster growth, Latin America must address its chronic structural weaknesses. Put simply, it exports, saves and invests too little, its economies are not diversified enough and too many of its firms and workers are unproductive.

To make matters worse, the rise of China, and of the emerging world generally, over the past 15 years has exacerbated some of these problems, the World Bank concluded in a report published in May. China reinforced Latin America’s role as a commodity exporter while the relative weight of its manufactured exports diminished, the bank found. That is partly because of Latin Americans’ low savings rate (under 20% of GDP, compared with 30% in South-East Asia). The region has relied on drawing in foreign savings, which meant that its currencies appreciated during the boom more than they might otherwise have done, rendering many non-commodity businesses uncompetitive.

In the 1990s Latin America began to diversify its exports, selling a bigger variety of products. But that has reversed since 2000. Only a small and declining percentage of the region’s exports are of “complex” (ie, knowledge-intensive) products (see chart 2). This matters. Ricardo Hausmann, a Venezuelan economist at Harvard, has found a close correlation between the diversity and complexity of exports and subsequent economic growth. The problem Latin America faces, says Mr Hausmann, “is the things that could be there and are not”. Latin Americans “seldom talk about technology and innovation, so there are no new industries to take over from commodities”.

Put another way, Latin America’s problem is its failure to join what economists call “global value chains”—which are in fact mainly regional. Modern industry needs elaborate supply chains with parts coming from several different countries, but they are often neighbouring ones. Some 72% of the “foreign value-added” in exports from European countries is intra-regional, in other words it originates in other European nations; the equivalent for East Asia is 56% and for South America only 30%, according to the World Bank (see chart 3). Only Mexico is plugged in to these value chains, thanks to its economic integration with the United States.

Extracting more value from natural resources by applying technology is part of Latin America’s future. But the region also needs to develop new businesses, in industry and services. The IDB, in an influential report last year, called for “productive development policies”, in which governments try to foster such new enterprises.

From Bolivia with love—and frustration

Heavy-handed industrial policies have often failed in Latin America. Comperj in Itaboraí is just the latest example. The new approach calls for a lighter touch, to provide things—from training in specific skills, to new roads, or grants for innovation—whose absence may deter private investment. For example, Costa Rica’s investment agency helped to develop a surgical-devices industry by persuading an American firm to set up a sterilising service. Start-Up Chile offers a grant and visa to would-be tech entrepreneurs from around the world. It has survived, with tweaks, a change of government. The new administration realised it was a global brand; although few foreigners set up lasting businesses in Chile, local participants learned from their risk-taking approach. “We realised it was a very powerful tool to change the culture,” says Eduardo Bitrán of Corfo, Chile’s economic-development agency.

Over the past 15 years only one Latin American country has become an important node in the world trading system, notes Augusto de la Torre, the World Bank’s chief economist for the region. Mexico has joined global value-chains, diversified its exports and moved into more complex products. And yet Mexico’s economic growth (averaging 2.4% a year for 20 years) and productivity have disappointed.

One theory is that Mexico has too many monopolies, especially in services: the reforms undertaken by Enrique Peña Nieto, the president, may remedy that. Others cite a weak legal culture and contract enforcement, and violent crime, as factors that deter investment. The underlying problem is the gulf in productivity between large modern companies, mainly in the north of the country, and small, informal producers and the south.

The same goes for other countries. “The problem of Latin America is that it has not been able to replicate its better-performing regions nationally,” says Mr Hausmann. Doing so requires better transport, the upgrading of skills, more competition and the spread of technology. During the commodity boom, many governments could ignore that challenge. They can’t any longer.