Latin America Hangs On to Its Economic Gloom
The old joke about Brazil is that the South American giant is the country of the future and always will be. The same might be said for Latin America as a whole.
This year, once again, Latin America is shaping up as an economic disappointment. Brazil’s economy likely shrank slightly in the year’s first half, and Mexico’s didn’t grow at all. Argentina is now tumbling toward another episodic financial crisis.
Then, of course, there is Venezuela, which won’t have much of an economy left after it shrinks another 25% to 35% this year. In the past six years, about two-thirds of its annual economic output has vanished, the second largest such decline for any country on record, according to the Institute of International Finance.
“It’s been a very gloomy start to the year, with everyone rushing to downgrade their expectations for the region,” said Edward Glossop, chief economist for Latin America at Capital Economics.
The International Monetary Fund expects regional growth of just 0.6% this year, having started the year with a forecast of 1.4%. That compares with its global growth forecast of about 3.2%.
The reasons for the disappointment vary. In Mexico, for instance, businesses are wary of investing thanks to President Andrés Manuel López Obrador, who spooked investors by doing things such as canceling Mexico City’s partially built airport. Threats of tariffs by President Trump haven’t helped.
But the failure of Latin America to grow has deeper roots. For the past five years, the region’s economic growth averaged just 0.66%—well below the global average. From 2000 to 2016 the region grew 2.8% compared with 4.8% for 56 other emerging economies excluding China, according to a study by the McKinsey Global Institute, despite a boom in commodity prices that lifted growth.
In other words, Latin America is becoming relatively poorer with each passing year compared with the rest of the world. Nevermind that Argentina was once far richer than Italy and Venezuela wealthier than Spain.
Making matters worse, the region didn’t grow amid a benign global environment of steady growth and cheap credit that may not last. Signs point to a slowdown in the U.S. economy and elsewhere. The IMF is projecting 2.3% regional growth next year for Latin America, but the risks seem firmly on the downside.
South America, which still relies heavily on exporting raw materials such as oil, soybeans and metals, is suffering the hangover from the China-driven commodity boom during the 2000s, when growth and incomes rose.
Countries such as Chile, Peru and Colombia managed their finances prudently during the boom, and have managed to grow as China slowed and the boom ended. Populist governments in Brazil, Argentina and Venezuela didn’t save any of the windfall. And they spent even more by printing money or taking on debt or both—the equivalent of a fiscal fiesta. All three have been mired in recession or crisis.
Argentina’s predicament shows how difficult it is to emerge from the bust end of a boom. After taking power in 2016, President Mauricio Macri started cutting budget-busting subsidies for electricity and transport, but took a gradual approach and borrowed heavily to cover the remaining gap in finances.
In the hopes of nudging growth, his administration in late 2017 loosened its inflation targets and leaned on the central bank to lower interest rates. The moves eventually caused a run on the peso that sent interest rates higher than ever, resulting in the economy tanking and the country begging for help from the IMF.
Now voters appear set to return the spendthrift Peronist political movement to power in October elections. In a desperate bid to stay in power, Mr. Macri turned to the Peronist playbook: He scrapped a sales tax on food and temporarily froze fuel prices.
Many economists now expect Argentina to default on its debts again, as a steep recession reduces government revenues.
“Adjustment is what happens after the populist experiment. And it’s hard to be popular presiding over that,” said Alberto Ramos, chief economist for Latin America at Goldman Sachs.
Brazil, for one, is trying to overhaul its sleepy economy. The government of President Jair Bolsonaro is close to final passage of a pension overhaul bill that should prevent the country from going bankrupt in years to come. Now, it is trying to ease regulations and stifling bureaucracy that currently earns the country a place of 109 out of 190 nations in the World Bank’s Ease of Doing Business ranking, right between Papua New Guinea and Nepal.
But it won’t be enough. Far deeper change is needed if Latin America hopes to overcome challenges that include low rates of productivity growth, the world’s highest rates of inequality and crime, weak institutions, corruption and below par educational systems.
Boosting productivity is key, especially with fewer younger workers entering the workforce and more retirees. According to consulting firm McKinsey, 72% of the region’s economic growth between 2000 and 2016 resulted from the expansion of the labor force, whereas productivity gains were one quarter the pace of other emerging markets. Given lower fertility rates, that demographic effect will wane in coming years.
“All these countries are moving into phase where there will be fewer people entering the workforce and at a relatively low skill level,” said Monica de Bolle, head of Latin American studies at Johns Hopkins University. “And there’s a lack of strategies to address that challenge.”
Mexico’s government recently canceled an education overhaul aimed at ensuring teachers at public schools get hired based on merit and not connections to the local teacher union. That won’t likely help students’ test scores, where Mexico ranks last in the Organization for Economic Cooperation and Development.
Another problem is that some of Latin America’s biggest economies such as Brazil and Argentina remain largely closed to trade, protecting inefficient domestic firms from competition. Even in Mexico, which is opened to trade, a handful of large companies still dominate the economy, suffocating competition and innovation.
In a recent paper, Augusto de la Torre, a former chief economist for the region at the World Bank, said a key factor for countries to converge to richer nations is how successful they are in gaining presence in international markets by exporting commodities, manufacturing or services such as tourism.
The data bear this out. Before World War II, Latin America’s average income was about 40% of the U.S., on a par with Southern Europe and more than double Southeast Asia.
After World War II, when Europe banded together in a common market and Asia began focusing on exports, those two regions leapfrogged Latin America, which tried to create its own manufacturing base through an industrial policy known as import substitution.
Today, Latin American average income has fallen to below 30% of the U.S. average. Southern Europe’s has grown to more than 50%, and Southeast Asia has risen to roughly 45%.
In 2005, Brazil and Argentina were joined by Venezuela, Uruguay and Paraguay in sinking a U.S. proposal for a hemispheric free-trade deal.
Now, those countries minus Venezuela have agreed to a potential deal with the European Union. And Brazil’s leader says he wants a trade deal with the U.S.
The Mercosur-EU deal, however, faces many hurdles, not least a new possible government in Argentina that is, once again, anti-free trade. And with the Amazon rain forest currently beset by fires, many set by ranchers and farmers to clear land, some European countries like France say they won’t approve any trade deal with Brazil unless Mr. Bolsonaro’s administration shows it is committed to protecting the forest.