NS4540 Winter Term 2018 Latin America: Middle-Income Trap Federal Reserve Bank of Chicago, Strong Dollar Weak Dollar

Overview I “Latin America: Locked up in the Middle-Income Trap?” Rabobank, September 28, 2015 Main points: While some progress made during the commodity boom, Latin America’s long-term success in achieving income convergence with the U.S. has been disappointing Labor productivity and total factor productivity growth were generally low to negative during Latin America’s commodity boom Institutionally Latin America scores about average, with significant differences within the region. Chile remains the best performing country, but has seen its lead erode

Overview II Latin America scores relatively poorly in terms of: Quality of infrastructure Education, and R&D spending In several countries the level of (technological) complexity may have fallen during the commodity boom Overall, Latin American countries have not managed to break out of the middle income trap As commodity exports are no longer boosting growth countries are facing both strong incentives, and a more urgent need to undertake structural reforms.

LA: Disappointing Growth I Long-term growth in Latin America disappointing When growth relatively high during first decade 21st century – most countries in region narrowed per capita gap with US Over long-run region has had virtually no convergence with the US The income gap between the US and Latin America has remained more or less the same since 1950 In certain sub-periods – 70s and 80s gap even increased Over period as a whole Argentina and especially Venezuela turn out to be spectacular failures Only Chile and Costa Rica score relatively well Their per-capita incomes increased from 33% and 20% respectively of US level in 1950 to 43% and 28% in 2015 Lack of real success stories in Latin America is remarkable

LA: Disappointing Growth II

LA: Disappointing Growth III

Challenge of Productivity Growth I Should relatively high levels of economic growth in first decade this century be viewed as a tipping point? To determine if convergence of first decade 21st century could return after recent slump – need to look at underlying growth patterns Many countries labor has strongly contributed to growth in recent decades However as employment levels have risen, and with many countries facing demographic ageing in not-too- distant future labor likely to contribute less to growth than has done in last 15 years

Challenge of Productivity Growth II

Challenge of Productivity Growth III In long run income convergence can only be achieved through higher labor productivity In this sense LA has achieved some progress However progress small compared with that made elsewhere – especially Asia Within region Chile, Uruguay, and recently Ecuador and Peru performed well by international standards During boom, investment picked up in most LA countries – helped labor productivity during this period However traditionally both savings and investment in LA low as a percentage of GDP

Challenge of Productivity Growth IV

Challenge of Productivity Growth V

Challenge of Productivity Growth VI For longer-run growth trend total factor productivity (TFP) is particularly relevant TFP indicates how much can be produced with given inputs of labor and capital – an indicator of an economy’s efficiency TFP growth is particularly important for countries that want to transition from middle income status to high income status Unfortunately LA’s recent TFP growth has been dismal TFP growth has been absent or even negative in the past decades Almost all Latin American countries score unfavorably h Uruguay, and lesser extent Bolivia, Guatemala and Peru do relatively well

Challenge of Productivity Growth VII The biggest economies Brazil and Mexico had zero or negative TFP growth. However in Brazil the agricultural sector had annual TFP rates of 2.55% between 1985 and 2006 In most other Latin American countries productivcity growth in the agricultural sector has been high by developing-country and emerging-market standards

Challenge of Productivity Growth VIII

Challenge of Productivity Growth IX

LA Structural Growth Impediments To further assess LA’s long term growth prospects must look at its institutions Institutions have been shown to be an important determinant of longer-run economic performance Institutionally Latin America scores close to the global average as a region Unfortunately region’s rule of law and control of corruption scores clearly behind the global average

Institutions I

Institutions II

Business Environment I To assess growth potential can also look at the attractiveness of the business environment. World Economic Forum – business environment in LA has improved somewhat since 2006/2007 However other regions have progressed more rapidly LA has turned from one of the most attractive parts of the emerging and developing world into the second least attractive after sub-Saharan Africa In LA Chile has become less of an outperformer in recent years, but still remains the most attractive country ahead of Panama and Costa Rica Brazil also scores relatively well on the Global Competitiveness Index Might be explained in terms of large size of domestic market Venezuela, Paraguay and Guyana have the lowest score on its index.

Business Environment II

Business Environment III

Human Capital Constraints I Improving long-term prospects and productivity requires raising the skill level of the population LA needs to overcome several challenges First R&D expenditures have been rising but still less quickly than average for all low income and middle income countries Brazil does relatively well in this respect. Second lack of adequately educated workers According to World Bank a high percentage of employers in LA and Caribbean identify lack of an adequately educated workforce as major constraint. Most pressing in Brazil, Suriname, Argentina and Paraguay

Human Capital Constraints II

Human Capital Constraints III

Human Capital Constraints IV

Human Capital Constraints V While significant progress has been made quality of education a problem in many LA countries, and Inequality in access to education also remains a concern These human capital and technological constraints limit ability of countries to diversify and increase productivity Export complexity of an economy can be used as an indicator to assess to what extent countries have been able to make a structural transformation and Have been able to move up the value chains Latin America scores somewhat better than all emerging markets and developing markets as a group However complexity has not growth in recent decades Several countries – Brazil, Argentina and Peru have experienced declining levels of economic complexity over the past few decades

Human Capital Constraints VI

Infrastructure I Many countries in the region cut back on infrastructure investment during the 1980s debt crisis and In most countries infrastructure investment has remained insufficient ever since This increases costs of doing business. While logistics costs account for just 9% of GDP in high income countries –may take up to 16%-26% in LA and the Caribbean Worldwide Brazil and Colombia have the highest costs for international container traffic Probably due to the institutional problems, Latin America’s infrastructure problem also extends to digital area Region far behind developing Asia in access to internet

Infrastructure II Insufficient supply of infrastructure also mitigates regional trade integration as transport costs often as high for intra-regional trade as for extra-regional trade According to FAO more than 50% of fruit is lost or wasted before it reaches the final destination. In general Latin America’s exports tend to be logistics-intensiuve or time-sensitive Means improving infrastructure efficiency is likely to have substantial benefits Doubloing annual investment in infrastructure from 2.5% of GDP to 5% of GDP counld increase potential annual GDP by no less than 2% per year Infrastructure investment was particularly low in Mexico and Uruguay at 1% to 2% of GDP 2008-2011 In Bolivia and Peru relatively high at aroun d 4% of GDP

Infrastructure III

Infrastructure IV

Conclusion I No signs that Latin American countries can return to high rates of growth experienced in first decade of 21st century As whole, region seems to have been able to improve its business environment and the and the quality of its infrastructure and increase R&D expenditure Progress has been less rapid than elsewhere Institutional, human capital and infrastructure challenges probably also explain why region’s economic complexity has remained stagnant or in a few cases reversed in past decade

Conclusion II While huge differences between countries with Chile, Uruguay, Costa Rica and Panama often scoring relatively high Venezuela and Paraguay scoring relatively low No clear indications that even the best scoring countries will break the middle income trap Perhaps end of commodity boom will turn out to be a blessing in disguise Now that commodities no longer boosting growth the need to undertake and therefore also incentives to undertake structural reforms to boost Latin America’s growth has grown.