After a strong recovery in 2004, Latin America's outlook for 2005 is positive. Growth rates have been restored at acceptable levels. Trade and capital flows have increased, inflation has fallen, and fiscal and financial conditions are under control in most countries. Following four years of stagnation and instability, there are reasons to be optimistic.
Nonetheless, it is prudent to be cautious in interpreting these results. In part, they have been bolstered by favourable international conditions, including the dynamic performance of China, the recovery of the US economy, stronger commodity prices and increased stability in financial markets.
Obstacles
In reality, the region continues to suffer from internal and external vulnerabilities that constitute formidable obstacles to the implementation of a successful development agenda. Not only does poverty remain excessively high and social conditions inadequate, but the region has lost economic importance in global markets.
In the last five decades it has fallen from second to fifth position, just above Africa and the less developed Asian countries. Several reasons explain this decline, including poor competitiveness, low domestic savings, weak institutions and high income inequality.
Urgent need
To reverse this situation there is an urgent need to attain high and good quality growth that is inclusive, broad-based, and respectful of both cultural diversity and the environment.
These are necessary requirements to narrow the economic and social gaps and fight poverty in a sustainable manner. Furthermore, the reduction of poverty and inequality should not be viewed as a spillover process, a consequence of growth, but rather as a concomitant and simultaneous phenomenon.
In order to achieve high quality growth, it is necessary to invest in the efficient accumulation of capital in all its different forms: physical, financial, natural, social and human. At the same time, productivity should be boosted mainly through innovation and technological upgrading.
Also it is crucial to attain an adequate balance between market forces and state intervention which takes into account the existing degree of competition, externalities, social priorities and fiscal and financial constraints.
In order to attain effective results in the context of this strategy, a deeper and improved integration into the global economy is also crucial. This should be based not only on greater access to global markets, but also on changes in the region's investment, production, trade and financial flow patterns.
Despite important trade reforms in the last decades, the region's weight in world trade has decreased, and exports continue to be characterized by limited diversification, high volatility in terms of trade, and relatively low intra-regional trade. Furthermore, financial flows, including foreign direct investment, remain volatile, and trade barriers to Latin American exports remain high, both within and outside the region.
Global market access
Better participation of Latin America in global markets requires greater market access and the reduction of protectionism in industrialized countries. To achieve this, the region should take advantage of the various different processes under negotiation: multilateral rounds, preferential agreements, deeper regional integration and greater diversification of the region's trading partners. These different routes are not mutually exclusive and present differing risks and opportunities: each country must assess what is the best mix in the light of its political and economic situation.
One important element of such a strategy is opening the economy to FDI, not only as a source of long-term financing, but also as a source of innovation and a provider of important goods and services that boost overall competitiveness. A comprehensive strategy to attract and host good quality FDI is an effective tool to incorporate countries into global production processes by taking advantage of technology, communications and access to new markets for high value-added sectors.
At the same time, greater participation in global markets requires a change in production patterns so as to better exploit the region's comparative and competitive advantages. Although changing production patterns are a considerable challenge, the region needs to reconsider its diversification strategy.
New evidence
The predominant view has been that the relative abundance of natural resources has hindered development and, therefore, that the region should diversify its exports away from such commodities. However, recent evidence suggests that slow regional growth is more the result of its excessive export concentration than the nature of its exports.
Moreover, resource abundance does not appear to imply export concentration necessarily. Countries such as Chile, New Zealand, Australia, Finland and Norway, among others, have successfully based their growth strategies on the production and export of primary goods.
Therefore, a key element to improve Latin America's participation in the global economy is to put into practice an efficient diversification strategy based on sectors in which the region enjoys comparative advantage. This implies fostering productivity through the use of knowledge-intensive technologies and innovation.
Should the region aim to improve its production and trade patterns, actions must be undertaken to increase the efficiency and productivity of its natural resource industries, stimulate production and exports with higher value added, and promote clusters development.
First step
As a first step, regulation in the natural resource sector needs to be improved in order to offer clear and stable rules for investors while simultaneously ensuring sustainable development. Governments should support this strategy by assigning priority to investment, financing, research and technical cooperation in the key areas of infrastructure, education and human development, technology and innovation, financial systems, international promotion and marketing.
One particular area in which Latin America fares poorly compared to other regions in the world is the quality of its business environment. If the region is committed to improving its integration into the global economy, it needs to improve its investment climate by adopting competitive, consistent and credible rules of the game, realistic and equitable taxation systems, labour legislation that does not deter investment, and incentives to the development of clusters in order to attract domestic and foreign investment.
To increase productivity and employment, regulations should be directed towards fostering the efficient functioning of labour markets, instead of focusing on social goals that should be left to social policy. At the same time, the educational system should be better suited to productive needs, in particular with respect to training mechanisms. Governments should encourage firms to train their workforce themselves, given that they are in a better position to know what their real needs are.
Fundamental
Improving the region's integration into the global economy should be a fundamental component of a comprehensive long-term development agenda. To that end, countries should build social support and consensus among the principal actors in society; in particular, they should promote a strong partnership between government, private sector, academia and other social and political actors.
Striking an appropriate balance between the roles of the market and the state is also fundamental. New institutional mechanisms, such as public-private partnerships, should be adopted to promote increased investment in infrastructure and other strategic sectors, and to attract FDI in a way consistent with such a strategy.
As already stated, the promotion of social inclusion to ensure a fair distribution of the benefits of growth should also be a key element of a successful development strategy and an important instrument to build social consensus around the strategy. Explicit and more efficient social policies need to be implemented to create employment and other opportunities for the poor and excluded, and to enhance their voice and participation in the political process.
A socially inclusive strategy should be based on the creation of opportunities (through access to property and providing micro-finance and credit to small and medium enterprises), the preservation of social safety nets, the establishment of counter-cyclical funds to mitigate the impact of economic downturns, and the adoption of medium- and long-term policies to strengthen human and social capital.
Enrique Garcia is president and chief executive of Corporacion Andina de Fomento (CAF).