Getting ready for the next wave: Towards a more dynamic and inclusive Latin America

Latin America and the Caribbean enjoyed a decade of strong growth between 2004 and 2013. Growth averaged 3.8% and in some years over 5%. They were helped along by growth in China and other emerging economies that raised demand and prices for exported commodities such as food, metals and fuels.

This led to an extraordinary easing of financial conditions, especially after the global financial crisis. Latin America was riding good times. However, the extraordinary external conditions blurred the true state of the region’s domestic supply and demand situation. Now the good times are over – at least for a while – and it is easier to check out the true shape of the regional economy.

Latin America grew in 2014 at the slowest pace in five years – lower than the OECD for the first time in a decade. There is concern that the low growth rates of around 3% forecast for next few years are not indicative of a temporary slowdown but rather of lower growth potential.

Productivity growth remains modest compared to that of the OECD countries and other emerging economies. The productivity gap between the majority of LAC countries and the most developed economies is increasing, while Asia’s has closed. With the exception of Chile, Uruguay and a few Caribbean countries, most economies in the region are stuck in the “middle-income trap”.

In 2011, commodities accounted for up 60% of the region’s goods exports, up from 40% in 2000. While commodity exports increased, Latin American economies substituted locally made goods for imports, contributing to a slowdown in regional manufacturing. Industrial policy can be a key factor in driving economic modernisation, as emerging Asian economies and OECD countries have shown. The region needs to address supply-side bottlenecks. In particular, the growth of small- and medium-size enterprises is constrained by difficult access to financing and services, particularly the high cost of long-term credit. Public policies could have a transformative effect, particularly by freeing up financial resources by expanding the growing role of development banks.

Improved infrastructure and logistics could help bolster structural change and strengthen regional integration. In Latin America, 57% of exports consist of perishable or logistics-intensive products, three times more than the OECD average. In addition, elevated transport costs significantly limit regional integration. The level of intraregional trade in Latin America is only around half that in the EU or Asia. Better roads, railways, ports and airports are essential. “Soft” solutions are also needed like integrated logistics policies; modern storage facilities; efficient customs and certification procedures; improved use of information and communication technologies; and greater transport competition.

The region needs more skills and innovation to better integrate into the shifting wealth process. Latin American firms are three times more likely than south Asian firms and 13 times more likely than Pacific-Asian firms to face serious operational problems due to a shortage of human capital. The car and machinery industries are particularly affected. Vocational education and training, as well as the ties between higher education institutions and the private sector must be strengthened. Efforts to build human and physical capital should be accompanied by greater innovation.

Growth helped to dramatically reduce poverty, but profound socio-economic inequalities are still evident. Poverty still affects 28% of Latin America’s population, about 164 million people. Latin America remains the world’s most unequal region; the income gap between the richest and the poorest 10% is 27 to one in Mexico and Chile.

One of the most important recent trends has been the surge of an emerging middle class. They are not in a situation of poverty and they represent a growing source of consumption. But many remain vulnerable to loss of employment, health problems, or to income falls after retirement. One of the most notable vulnerabilities of this emerging middle class is its high labour informality. In Latin America, 5 in 10 middle-sector workers are in the informal sector, just slightly below the average across the workforce.

Education and skills should be a driver of economic growth, but also of social inclusion and equality. Latin America has taken great strides, raising the average number of years children spend in school from 8 to 13, compared to 17 in OECD countries. This is thanks to a significant budgetary effort that has pushed education spending averages up to 5% of GDP, just below the OECD’s 5.6% rate. Despite this progress, the gulf between the performance of Latin American secondary students and those in OECD countries is still equivalent to more than two years of schooling according to the 2012 PISA tests. Access and performance also remain highly unequal by income and gender.

Latin American governments must act now to deliver better public services. Current gaps, especially in education, infrastructure and innovation, act as a brake on economic growth and well-being throughout the region.

Fiscal reform is a necessary condition of real change in the capacity of Latin American and Caribbean states. This does not only mean being thrifty with existing resources, but also generating long-term, stable government revenue. In general, taxes are not high; the region collects 21.3% of GDP vs. 34.1% in OECD. Many people in the informal sector don’t pay, and the affluent don’t always contribute much more than the poor.

The emerging middle class can be key players in a renewed social contract. Over 60% of Latin American citizens support democracy but only 41% are satisfied with the way it functions, according to a 2011 Latinobarometro poll. This explains the mobilisation of citizens in Argentina, Brazil, Chile, Mexico and other countries demanding measures to fight corruption, more reliable public transportation or better education. The middle sectors consider themselves losers in the fiscal bargain and are less willing to pay taxes or support fiscal reform. But this can be changed.

The current political context presents an excellent window of opportunity for bold and ambitious reforms for a more dynamic and inclusive Latin America. After 14 presidential elections from 2012 to 2014, held in a highly stable climate, the region has the political space to put forward far-reaching reforms. In this context, cooperation between the Community of Latin American and Caribbean States and the European Union will be beneficial for both, particularly in the exchange of policy experiences. Trade and investment between them have been increasing and creating wealth on both sides. The EU can learn from the experience of CELAC countries in dealing with debt and financial crises, CELAC countries can find inspiration from EU efforts to spur growth. The EU’s great regional integration programme is an invaluable experience which CELAC countries can draw on.

Next times the good times come around, let’s hope the region will be in even better shape to ride the wave.