During the last three years, Latin America has experienced an economic boom without precedent. Growth has been strong, inflation is under control, and international reserves have increased steadily. The 2004-2006 period has been the best three years for Latin America’s economies since the early 1960’s.
This bonanza has largely been the result of an extraordinarily positive international environment. Commodity export prices are at record levels, global liquidity has been ample, and international interest rates have been low.
Yet, despite this good news, the continent’s politics have turned upside down, calling into question whether economic success can be sustained. An increasing number of Latin American countries have elected left-wing presidents who criticize market reforms and globalization. Colombia recently bucked this trend, and it now appears that the leftist candidate in Mexico’s presidential election, Andrés Manuel López Obrador, was narrowly defeated. But voters have catapulted left-wing politicians to power in Argentina, Bolivia, Brazil, Chile, Costa Rica, Ecuador, Peru, Venezuela, and Uruguay, while López retains the ability – and perhaps the will – to mobilize his supporters.
The main concern is that left-wing politicians will implement populist policies that will generate large fiscal deficits, high inflation, and, eventually, currency collapses. External crises have a long history in the region. Since the 1970’s, Latin American countries have experienced, on average, 1.6 balance of payments crises per decade; some of the better known include the Mexican crisis of 1994-95, the Brazilian crisis of 1999, and the Argentine crisis of 2001-2002.
The economic consequences of these crises have been gigantic. On average, each of them cost the Latin American countries 12% of GDP.
However, concern about populist policies is not fully justified. The current crop of left-wing political leaders is different from the populist “ caudillos ” of the past. They understand that macroeconomic imbalances – and, in particular, inflation – are costly and lead to frustration. Even Venezuela’s Hugo Chávez – the most vociferous of them – understands the importance of maintaining macroeconomic stability.
Moreover, in recent years, Latin American economies have gone through important economic transformations that have increased their resilience. Chief among these changes has been the adoption, in most countries, of flexible exchange rates and reduction of external debt, particularly government debt. These structural changes have put most Latin American economies on a sound footing, reducing their vulnerability to external shocks, such as deceleration in world economic growth, higher international interest rates, and lower commodity prices.
But greater macroeconomic stability does not mean that everything is fine. The main weakness of Latin America’s economies is that they will be unable to generate the type of rapid and sustained growth required to create jobs and reduce inequality and poverty.
Generating the rapid long-term economic growth that Latin American countries need requires that they fulfill three conditions. First, they must accumulate capital, which implies a high savings rate that will help pay for new machines, equipment, and infrastructure. Second, they need to use their workforces efficiently, which requires modern labor legislation that encourages employment of women, the young, and senior citizens. Finally, they need to attain a rapid rate of productivity growth, which can be achieved only by ensuring a high-quality, broadly accessible educational system.
The vast majority of Latin America countries do not fulfill any of these requirements. At 19% of GDP, national savings rates are very low – indeed, much lower than in Asia – and labor legislation is antiquated, discouraging efficient use of human capital, while productivity growth is meager. Indeed, students from Latin American countries consistently score at the very bottom of international achievement tests such as the Program for International Student Assessment (PISA) and the Third International Math and Science Survey (TIMSS).
The main challenge for Latin America’s new leaders, whether of the left or the right, is to implement reforms that will accelerate growth. The continent needs measures that are designed to encourage savings and investment, improve labor utilization, and upgrade failed educational systems. Only if growth is significantly faster over the long run will living standards for the vast majority of the region’s voters begin to rise.