AUGUSTO DE LA TORRE: Unwise to keep counting on tail winds
Going forward, it would be unwise to count on tail winds; they will likely weaken, become more volatile, or both
Latin Americas key challenge for the next ten years is hidden in the belly of its great achievement of the past ten. If the great achievement was growth with social equitya magical combination that had traditionally eluded the regionthe challenge is productivity and competitiveness, key to make the achievement more than a one-off success.
Since 2003, the Latin American economy expanded robustly even as poverty fell sharply, upward mobility became a reality, and income inequality decreased. This was not just because of the strong tail winds of high commodity prices and abundant capital inflows. Good policies, particularly in the macro-financial and social inclusion fronts, also made crucial contributions. But the tail winds facilitated things immensely: growth with equity could be had with relatively little effort. Going forward, however, it would be unwise to count on tail winds. They will likely weaken, become more volatile, or both. Much more effort will be required per unit of additional gain.
Unsurprisingly, the past successes have pushed expectations to record highs. And there is a risk that satisfaction with the great achievement turns into complacency. But this would be wrongheaded. A bit of digging into the core of the great achievement suffices to make this point.
Consider first poverty reduction. It was the result of pro-poor growth combined with a much improved (targeted) social assistance. In most of Latin America, the labor-related income of the poorer population grew much faster than the average per capita income. This meant that, as the total economic pie was expanding, income was being redistributed proportionately more to the poor, who have a higher propensity to consume. Thus, real consumption expanded faster than real income in much of the region and growth, particularly in South America, was largely a consumption story supported by strong tail winds.
Growth did not set into motion a clear savings-investment virtuous circle, however. It may actually be a good thing that it didnt, as that may have significantly reduced the gains made in the social equity front. For a region deeply scarred by a long history of horrendous inequities, the rise in aggregate consumption associated with the massive flow of people out of poverty was arguably a preferable path to follow than a sacrifice of consumption in order to build growth capacity for the future.
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But where will growth come from in the future as tail winds soften or dissipate? Foreign savings can only help so much, and at the risk of adding to volatility and making local currencies less competitive. And domestic savings may remain constrained for a while, not least because of political economy dynamics in societies that are as democratic as they are (still very) unequal. To continue on the path of growth with equity, therefore, the emphasis has to be squarely on productivity-enhancing reforms.
Consider now the other dimension of the great achievement: income inequality reduction. Mostly, it reflected a decline in wage income inequality which, in turn, was driven by a rather unexpected reduction in the returns to education. Now, a fall in the education returns could augur well for future growth if it was due to a strong rise in the supply of more educated workers, one that vastly exceeded the demand. But things are unfortunately not so rosy.
While the supply of education indeed rose in Latin America with significant expansions in coverage, the quality of such education leaves much to be desired. It appears that the notable expansion of coverage was accompanied by an increasing dispersion in the quality of education centers, pushing downwards the average quality, especially at the tertiary level. Moreover, the evidence clearly suggests that the recent trend of declining returns to education is, to a significant extent, a demand-side story.
By and large, it seems that the (non-commodity) economic sectors that are growing the fastest in the region tend to be sectors that are relatively less intensive in skills. As a result of the commodity price and capital inflow bonanzas (and the associated appreciation of the real exchange rate), the region seems to be specializing in non-tradable economic activities that happen to be, at present and on average, of relatively low skill content and, hence, low productivity. Again, as with poverty reduction, when we dig into the core of income inequality reduction we come face to face with the regions productivity challenge.
In sum, to make the great achievement of a decade of growth with equity a sustainable story, Latin America has to crack the productivity nut going forward.
Augusto de la Torre is chief economist for Latin America and the Caribbean Region at the World Bank.