Latin America's Economic Future: Can the Region Become an Engine of Economic Growth?

By Dialogue Staff
July 6, 2010

“Developing countries could be rescued by developing countries as a whole,” said a senior official at the World Bank in an afternoon discussion at the Dialogue on July 6, 2010. Otaviano Canuto, vice president of the World Bank and head of its Poverty Reduction and Economic Management network (PREM), and Marcelo Giugale, director of PREM, led a discussion on the “negative legacy” of the crisis in the developing world and prospects for the region to become an engine for economic growth. The following summary reflects the views expressed in their presentation.

When developed countries were hit hard by the financial crisis, economists expected developing countries to follow—leading to a “reverse coupling” phenomenon in which contracting developed economies dragged down the growth in developing economies.  Instead, developing countries proved resilient to recession. Their economies, with the exception of some in Eastern Europe, continued to grow—independently of developed countries. Have developing economies “switched over” to a new growth track?  

Conventionally, growth in developing countries has depended on the strength of developed economies. Today’s economic outlook for developed countries ranges from subdued to grim. Advanced economies face significant hurdles to emerge from the crisis and overcome anemic growth rates. Whether and when demand in developed countries will recover sufficiently to boost growth in the developing world remains to be seen. In all likelihood, the legacy of the financial crisis will cripple advanced economy growth trends due to several factors: fiscal consolidation necessitated by soaring debt-to-GDP ratios, deterioration of household balance sheets and consequent weak private consumption, higher costs of financial intermediation stemming from new regulations, and a weak jobless recovery leaving high rates of unemployment. 

On the other hand, several trends support an autonomous growth trajectory in developing countries, vis-à-vis advanced economies. The process of trade and structural change in developing economies, which absorbs surplus labor and enhances productivity, is still underway at various stages across different regions. Trade among developing countries has long been expanding. Production value chains, with China as a hub, constitute a significant portion of trade in Asia, and hence exports to the rest of the world. Such vertically-integrated trade patterns have fueled the pace of technology transfer to developing countries; continued diffusion offers potential for further gains. The low degree of leveraging in most of the developing world creates scope for much-needed infrastructure investment, for which marginal returns are high. For instance, decreased transportation costs make supply chains more viable. Finally, poverty has been declining for some time, on a trajectory strong enough to withstand the crisis.

Latin America fared relatively well during the worldwide meltdown—its banking systems held up, principally because they are old-fashioned, not overly leveraged, or engaged in non-traditional activities. Moreover, banking reforms implemented in the wake of past banking crises served the region well. For the first time, governments were able to implement countercyclical fiscal stimuli, boosting their economies and reducing recession. Latin America has new-found legitimacy on a number of fronts: its economic performance in the midst of the global downturn; Brazil’s incipient superpower status; and the respect enjoyed by several Latin American ex-presidents on the international stage. “The region now enjoys a (modest) place at the world table,” Giugale noted.

Direct transfers to the poor, together with remittances flowing in from workers abroad and a stable macroeconomic environment, have helped Latin America significantly reduce poverty levels and chip away at egregious socioeconomic inequality, which had for so long come to define the region. The middle class is growing apace.

With growth comes a louder call for government responsibility. Corruption still plagues Latin American institutions, but the contract between the state and its people is growing stronger. Increased government transparency can help build trust among populations, and citizens will be more inclined to cede governments power to collect higher taxes.  Governments could deliver better services and run a more robust and efficient state, breaking the cycle of citizens who pretend to pay taxes and governments who pretend to provide services.

Social policies have moved in a positive direction, targeting equity rather than equality. In other words, the focus has shifted to providing equitable opportunities to all. One important positive externality of the proliferation of conditional cash transfer programs is the establishment of logistics to reach the poor (i.e. bank accounts, contact information, etc), thereby incorporating them into increasingly inclusive societies.

Yet in order for economic growth in Latin America to reach higher levels, Giugale contends that the region needs a “new brand,” not new free trade agreements. Penetration of Latin American goods in the world market reaches only 5 percent. (Over the past several decades, Asia’s share has quadrupled from 5 to 20 percent, while Latin America’s has remained stagnant). Innovation in Latin America is insufficient and the region’s total factor productivity relative to that of the United States is declining, while Asia’s is rising. The possibility of facing appreciated currencies relative to a weak dollar increases the urgency for productivity-enhancing reforms in Latin America.

With appropriate policies, the region’s problems appear surmountable. The outlook for future growth is positive. Canuto and Giugale warned, however, that inadequate education systems; the possibility of a natural resource curse; crime and violence; and a possible sovereign debt collapse or rating downgrade in a G7 country, all present risks to Latin America’s continued economic success.