1. NS3040 Winter Term 2015 Latin American Challenges

2. Overview Guillermo Ortiz, The Challenges to Achieving Sustainable Growth in Latin America, Brookings, November 2014 Main points Initial economic recovery after the 2008-09 global recession has been disappointing After strong growth before the crisis the pace of growth has slowed to rates considerably in recent years Over time the region’s share of world GDP has dropped to 8.6% down from 11.4% in the 1980s Fundamental for the region to undergo a supply-side structural reform agenda and achieve a sustainable path of higher growth rates similar to those right before the crisis 2

3. % World GDP (ppp) 3

4. Progress in Last Decade I Improvements in Latin America During Last Decade Many positive signs in recent years From 1990-1995 average annual inflation rate in LA over 200% Average inflation since 2010 around 6% Major improvements in debt structure and balance of payments Total public sector debt peaked at 62% GDP in 2003 Declined to around 37% by 2012 Similar pattern for external sovereign debt Reserve accumulation has increased significantly Nine largest economies accumulated equivalent of 16% of GDP in international reserves during 2003-2011 4

5. Progress in Last Decade II 5

6. Progress in Last Decade III Means some of the traditional components that hurt Latin America in the past Large current account deficits and Huge exposure to sudden stops have substantially improved over the last eight years As a result balance sheets of most Latin American countries much stronger compared to a decade ago Reflected in spreads of Latin American Debt About half of what they were a decade ago Significant milestone for region For first time in very long time able to implement strong countercyclical monetary and fiscal polices in response to extreme external shocks 6

7. Progress in Last Decade IV 7

8. Progress in Last Decade V Macroeconomic progress largely unprecedented and in start contrast to the 1990s In the 1990s High levels of indebtedness Currency mismatches Poorly capitalized financial systems Tended to amplify external shocks and limit countercyclical policy intervention As a result growth performance from 2003 to 2013 has been substantially better in most countries The average growth rate of 4% per year almost twice the rate in the 1980s and 1990s 8

9. Progress in Last Decade VI 9

10. Reasons for Progress I Heterogeneity and Reasons Behind Latin America’s Improvements Major economies of Latin America with exception of Mexico are commodity exporters (57% of total exports) Improvements in Latin America over last decade were to a great extent due to very favorable external condition Increasing external demand led by advanced economies and China created favorable terms of trade for most Latin American countries After advanced countries relaxed their monetary policy stance these countries became very attractive for large capital inflows in search of higher yields 10

11. Reasons for Progress II 11

12. Reasons for Progress III 12

13. Reasons for Progress IV Domestically, labor accumulation played an important role in output growth Factor accumulation accounted for 3.75% of annual GDP growth in 2003-2012 Capital accumulation from global capital inflows into financially integrated commodity exporters also played a part. Today – external conditions are no longer as supportive as they used to be Episodes of renewed volatility have exposed certain vulnerabilities in Latin America 13

14. Challenges Ahead I The New World In recent years Latin America has experienced a rather complex cycle Global economic conditions are not as favorable as they used to be Means that commodity prices are declining The reduction in monetary stimulus measures in some of the developed economies is reversing the flow of money Latin America attracted Many Latin American economies facing a cycle of lower growth and higher inflation Particularly those that have followed unorthodox polices and implemented no structural reforms 14

15. Challenges Ahead II Problems Lower commodity prices will lead to lower government revenues Public spending as a share of GDP has increased staidly since the financial crisis even though revenue growth has slowed At same time pressures on expenditure are growing Higher interest bills Critical infrastructure needs and Demands for better public services Some supply constraints are starting to arise Growth of physical capital expected to moderate as global interest rates rise and commodity prices stabilize Contribution of labor will be constrained due to low unemployment rates and an aging population 15

16. Challenges Ahead III In the longer term increasing growth will be a major challenge Since 1980 Latin American income per capita relative to the U.S. has decreased by around 20% During the same period developing Asia and the ASEAN- 5 economies have increased their level of income per capita relative to the U.S. by 365% and 150% respectively Inter America Development bank found that total factor productivity (TFP) is by far the most important determinant of the income gap between regions and the U.S. Significantly TFP in Latin America declined by around 30% relative to the U.S. between 1980 and 2007 In emerging Asia TFP increased by about 20% 16

17. Challenges Ahead IV 17

18. Challenges Ahead V In Latin America a significant misallocation of resources has caused low TFP IDB found just a gradual adjustment in the allocation of resources to that of U.S. efficiency would have: Translated into a gain of 50-100 percent in TFP and An additional 1% of annual GDP growth Based on WEF data Latin America leads Central and Eastern European countries in macroeconomic environment and business sophistication. In terms of institutions, infrastructure, health and education, labor and goods markets, financial sector development, technological readiness, and innovation lags these regions 18

19. Challenges Ahead VI To rectify situation Latin America needs to implement structural reforms Implies Strengthening the institutional framework to secure property rights and eliminate corruption Reforms should be focused on developing infrastructure Promoting deeper and more efficient financial markets Increasing the quality of education Further developing labor market and Investing more in innovation and technology In short countries must maintain the macroeconomic and financial stability achieved in past decade At same time press ahead with structural reforms Allow region to escape the middle income trap 19