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Elcano Report on Latin America

IPDAL releases the latest report from the Real Instituto Elcano, Spain’s main think tank, on the political and economic situation in Latin America.

According to the document from the Real Instituto Elcano, dated April 25, 2016, Latin America is facing an economic crisis, resulting from the fall in raw material prices and the slowdown in world trade.

After more than a decade of economic expansion sustained by the high price of raw materials, at the height of world trade and abundant liquidity, the change in the global economic context and the lack of progress in productivity led Latin America to a deep crisis with serious macroeconomic imbalances and which threatens the important social gains previously achieved.

According to the latest forecasts from the International Monetary Fund (IMF), in a context of widespread economic slowdown, the region’s economies will decline by an average of 0.5% this year and will only experience a small increase of 1.5% in 2017.

Figure 1 presents two different realities. On the one hand, the South American countries led by Brazil and its raw materials exporting neighbors are going through a particularly adverse period. On the other hand, the countries of Central America and the Caribbean, with Mexico leading, are coping with the situation in a more positive way. In any case, the North-South division is not the only relevant one. The countries of the Pacific Alliance, to which Bolivia should be added (whose economy will grow 3.8% this year), manage to maintain the average level (Mexico will grow 2.4%, Colombia 2.5%, Peru 3.7 % and Chile 1.5%). However, Mercosur countries, more dependent on exports of primary goods, are suffering a more pronounced fall. Finally, Venezuela is in free fall (its GDP contracted by 8% this year, after falling by almost 6% last year).

However, this slowdown or recession (depending on each case) should not generate deep financial crises as in the past. Currently, most countries have relatively low levels of external debt, high international reserves, flexible exchange rates with domestic demand better able to cushion the deterioration of the international situation, sufficiently capitalized banks and better macroeconomic policies. Furthermore, the lower growth does not translate into a significant increase in the unemployment rate, nor does it produce alarming capital outflows.
Finally, democracy has been consolidated in the region and, in most countries, we have begun to see peaceful government changes following transparent electoral processes. Even Brazil, which is experiencing a turbulent political moment due to accusations against President Dilma Rousseff.

The main risk of this economic slowdown centers on the frustration of the new middle classes in the face of the recessive environment, increasing social unrest that could end the great advances in reducing inequality, poverty and increasing social cohesion that have been made in the last years.

Permanent dependence on external factors
In recent decades, Latin American countries have made significant efforts to avoid being as affected by the international economic cycle as they were in the past. They have increased their per capita income, have diversified (with uneven success) their economies and have consolidated their middle classes with greater consumption capacity. However, its growth is still strongly dependent on what happens abroad, particularly the price of raw materials, international liquidity conditions and the dynamism of international trade.

As shown in Figure 2 , the price of basic products has collapsed, international trade has stagnated and everything indicates that the region is entering an Era of “normalization” of global monetary conditions, which in turn will lead to a phase of lower international liquidity, marked by the gradual rise interest rates in the US. As a result, currencies tend to devalue, fiscal deficits tend to increase (especially due to the loss of revenue due to the fall in raw material prices) and inflation tends to accelerate and exceed the targets set by Central Banks (in In any case, inflation is only a worrying phenomenon in Venezuela, considering that Mauricio Macri’s government in Argentina seems to be taking combat measures and that in the rest of the countries it is not uncontrolled). For all this, even if it is possible to avoid public debt problems and requests for international aid as existed in the past, most countries fear having to make major adjustments to rebalance their economies. The Real Instituto Elcano considers that when the political crisis is added to the economic crisis, as in Brazil and Venezuela, the latter becomes much more difficult to deal with.

The current slowdown follows an extraordinarily long period of prosperity, marked by rising commodity prices which, driven mainly by Chinese demand, remained at very high levels from 2003 until very recently (oil began to fall in 2014 and other raw materials a little earlier). This period was unusually long and intense. The real exchange rate, which improved, on average, 40% between 2003 and 2013 (with levels reaching 200% in the case of Venezuela due to the high price of oil and more than 90% in Chile due to the price of copper), is already more than two years moving in the opposite direction. Contrary to what is often thought, revenue management due to the high price of basic products in many countries has been quite favorable.

Until 2009, there was an improvement in the real trade relationship resulting from higher export prices in countries, leading them to save part of their extraordinary income and boost investments (many of them from abroad) on top of increases in public consumption. However, from that year onwards, China redoubled its commitment to public investment to cushion the impact of the Great Recession by further increasing global demand for raw materials, causing Latin American countries to begin increasing public spending. For the Real Instituto Elcano, the management of this growth has been better than on previous occasions and, if the high prices had not lasted so long, some of the macroeconomic imbalances that we are now observing could probably have been avoided.

Obligations that were not fulfilled

While most countries in the region were able to withstand the global recession of 2009/10, with less intense and shorter declines in growth than advanced economies, they are now seeing their growth contract: in 2016 it is predicted that developed countries and emerging markets are expected to grow 1.9% and 4.1%, respectively, while in Latin America a decline of 0.5% is expected.

This is due to two factors. On the one hand, unlike what happened in 2009, when countries had room for maneuver to carry out counter-cyclical policies of monetary and fiscal expansion, they currently have practically no possibility of implementing them. There is no fiscal space to increase public spending and reduce global liquidity which, combined with the depreciation of the currency and the increase in inflation, does not allow for positivity in the monetary field. Similar to what happened with Spain during the euro crisis, it seeks to adopt pro-cyclical policies (especially public spending cuts) while economies are in recession or slowdown.

The second factor is the insufficient focus on supply during the growth period. In recent decades, basic education levels have increased, reforms in the goods and services markets have been implemented, with the objectives of increasing competition and improving the functioning of the labor market, and fiscal reforms have been implemented that allowed the State to have more resources to finance public goods. However, the positive evolution of indicators relating to poverty, inequality and social well-being since the turn of the century has led to a convergence with developed countries, although less significant than that experienced by emerging countries in Southeast Asia.
The increase in productivity across the region in relation to developed countries is disappointing, as shown in Figure 5 . In this sense, labor productivity increased by 1.1% annually between the second half of the 1990s and 2013, well below that of Southeast Asian countries and even the USA (only Chile, Ecuador and Peru, the countries that recorded the largest increases in investment, could reduce the productivity gap with the US economy, and only the Peruvian economy recorded an increase in productivity similar to the Southeast Asian average).

The slow productivity growth is explained by the low level of savings and insufficient investment reflected in the Figure 6 , the limited expenditure on R+D (Research and Development) which, as shown in Figure 5 , involves the registration of very few patents (the evolution of which in recent years is practically zero, equal to the number of articles published in scientific journals), deficiencies in infrastructure (not only physical, but also related to new technologies, such as access to walking Largo), an external sector that is not very dynamic and outside global value chains, as well as a reprivatization of production, especially in countries that export primary products.

The rate of primary products in Latin American exports increased by almost 15 percentage points between 2000 and 2013, with the increase being even greater in South American countries, which added to those that started from a higher level led to these products accounting for around 60% of all sales abroad, while technological manufacturing as a whole barely reached 20%.

During this period of expansion, industrial development was sidelined by public authorities due to certain deficiencies in policies developed in the past (such as not focusing on comparative advantages or weaknesses in institutions). However, the stagnation of production observed in the region has led countries to reconsider a more active industrializing role, although the main problem lies in the concrete actions to implement so that the final result is positive, as there seems to be little doubt that some of the areas What should be focused on is the financing of productive development, education and training, taking advantage of opportunities for internationalization and support for business innovation. Regarding the latter, given the scarce expenditure on R&D by Latin American countries, the short and medium term challenge for various governments lies in providing investment in innovation and development that will allow technologies already developed to be adapted to specific locations.
A final weakness shown by Latin American economies during the “fat cow” era was the low level of regional integration, combined with the fact that in recent years the two historically most intense trade flows (Brazil-Argentina and Colombia-Venezuela) have weakened considerably due to political friction.

Countries will have to assess the extent to which their potential growth has been hampered by these years of accumulation of imbalances, in a context in which, in addition, the working-age population is decreasing. Although it is true that most countries are returning to growth rates prior to the great boom (except in the cases of countries like Brazil that are in a cyclical recession), the problem is that these growth rates are insufficient to continue promoting socioeconomic transformations. necessary and real convergence with advanced countries. The long-term challenges include improving structural policies. But, as happens so often, there are now no public resources to finance them.

In the current context of global economic slowdown, Latin America (and especially South America) is suffering a more serious crisis than other regions, unlike what happened in 2009. The origin of the crisis lies in the collapse of commodity prices. primaries, the drop in world trade and lower liquidity in international financial markets, which led to exchange rate depreciations, higher inflation and an increase in fiscal and current account deficits. Latin American countries, in general, are now better able to deal with this crisis than at the end of the last century thanks to their strong economic and political foundations, unable to implement counter-cyclical policies and have been forced to make strong adjustments to ensure the macroeconomic balance.

However, this time there is no risk of a “lost decade”, but rather a new cycle confronted with the strengths and weaknesses inherited from the growth season. In the period of economic prosperity, between 2003 and 2014, there were significant advances in the social field, but not in terms of productivity, partly due to the absence of effective industrial development policies. Although until 2009 most countries were able to successfully manage extraordinary revenues and allocate them to investment, subsequently they began to suffer from an illusion of perpetual wealth that led them to dedicate their income to public debt of a permanent nature that they are now unable to maintain, making it difficult to transition of the economic model.

Despite attempts to recover growth rates that allow them to continue converging with advanced countries that implement the necessary structural policies, the report considers that public authorities no longer have the space to carry them out.