Latin America’s Barriers to Growth

ADRIANA ARREAZA – CARACAS – Latin America is expected to emerge from recession this year. But the region should not be overly optimistic. While economic growth is rebounding, it remains below 2%, on average. And in a global environment plagued by uncertainty, the balance of risks is not tilted in Latin America’s favor.

The region’s economy is highly sensitive to global developments. In past decades, external tailwinds underpinned high growth rates; now, external headwinds are hampering growth for a second consecutive year, such that Latin America is underperforming any other emerging region.

Still, 2017 will be better than 2016, when economic performance suffered as a result of China’s slowdown and anemic recoveries in most advanced economies. Fears that Chinese GDP growth would continue to decelerate created shockwaves in financial markets and drove down commodity prices and asset prices in emerging markets. And while investors’ concerns dissipated somewhat as China’s economy stabilized over the course of the year, capital still continued to flee emerging markets for safer havens.

The United Kingdom’s “Brexit” referendum in June, and Donald Trump’s election as US president in November, only created more uncertainty and market volatility. Changing dynamics in the global economy made external financing more expensive. And, as Latin American countries’ currencies weakened, its external and fiscal accounts were stretched thin, narrowing the scope for countercyclical stimulus measures.

But the region is quite heterogeneous, and the severity of external shocks in 2016 varied considerably, depending on countries’ exposure and policy response. Some countries experienced unexpectedly intense economic shocks. Argentina and Ecuador slid into recession, while recessions deepened in Brazil and Venezuela. But other Latin American countries continued to grow, albeit at a disappointing pace.

Through all of this, labor markets suffered: unemployment increased and the quality of employment deteriorated. More workers were forced into informal jobs or self-employment, and real wages fell, owing to higher inflation, depreciating currencies, and certain idiosyncratic supply-side shocks. As households’ purchasing power declined, the number of people in poverty most likely increased.

But 2016 was not all bad news. As the year progressed, macroeconomic imbalances started to ease. By the third quarter, the rate of inflation was falling in several countries, particularly those with inflation targets, and Brazil and Ecuador’s recessions seemed to be bottoming out. Moreover, many countries’ current-account deficits continue to narrow, though this probably reflects import contraction, not export growth.

To maintain and build on the notable social gains achieved in the first decade of this century, Latin America needs stronger, more sustained growth. That is why the region’s leaders should look beyond cyclical and external factors, and address structural problems that are limiting long-term productivity growth.

Half of Latin America’s population is still informally employed and performing low-productivity tasks. This has left the region trapped in a vicious circle: productive firms cannot expand for lack of human and financial resources. When productive firms do not grow, the supply of good jobs cannot keep up with demand, forcing workers to take refuge in the informal economy, and the cycle continues.

A recent study by CAF–Development Bank of Latin America found that far too few working-age Latin Americans (comprising 67% of the overall population) possess the skills that the labor market requires; and only a small fraction of the self-employed have the skills needed to become successful entrepreneurs. Like most workers, those managing their own businesses are more likely to remain in the informal economy, where they have little chance of creating highly productive firms that can grow quickly.

Misallocated resources are a significant drag on Latin American growth. There is too much capital and labor stuck in low-productivity sectors, and not enough left over for more productive firms and activities. Just imagine how much productivity suffers when half of the population is performing routine work far from the technology frontier; then imagine how much more it suffers when there is too little innovation and technological adaptation and diffusion ever to move that frontier.

To break their vicious circle, Latin American countries need to close infrastructure gaps, improve access to credit, enhance state capacity, and reduce institutional barriers that are impeding resource allocation and innovation. But, perhaps most important, they need to improve their workers’ qualifications and skills.

Now that globalization appears to be coming to a halt, and international trade is losing momentum, Latin America cannot count on global growth to fuel its own economic performance. Instead, it will have to look inward, by taking advantage of regional trade opportunities and strengthening its human capital.