Improving the Outlook for Latin America and the CaribbeanRemarks by John Lipsky, First Deputy Managing Director, IMF
Fourteenth "LAC Meets the Market" Conference
World Bank, April 13, 2007
Thank you for the invitation. This is not my first participation at a "LAC Meets the Market" conference but my first in my new role. I want to take the opportunity to pay tribute to Guillermo Perry's intellectual leadership and contribution to the Bretton Woods institutions.
There's no doubt we've had good economic performance in Latin America in recent years. The last three years were the most vigorous three years of activity in the Latin America and Caribbean region since the 1970s. As is often the case, this is partly 'good luck' and partly 'good policy'. But regardless of where you make the split between the role of the favorable environment and the role of policy improvements, I would argue that it's too soon to be satisfied with the results.
- First, growth in Latin America has been below that of many other regions.
- Second, productivity and investment rates have to be raised to make these growth rates sustainable.
- Third, the region has to address legitimate concerns about the distribution of income in a way that also helps to deliver stronger growth.
Let's start with the facts about the region's recent economic performance.
- In 2006, output grew at an average rate of 5½ percent. Happily, about a third of the countries in the region experienced growth rates of 7 percent or higher, with several countries growing at their fastest pace in many years.
- While the expansion has been broadly shared by many countries, there were outliers. In particular, commodity producers, and some countries rebounding from crises, have experienced the sharpest rise in activity. Very important economies, like Brazil, have however lagged behind the regional average.
Now, some of the region's growth is due to `good luck' in the form of a favorable external environment-strong global growth, high commodity prices, ample access to international financing, and low borrowing spreads.
But `good policy' also deserves some credit.
- Average inflation in the region has dropped from over 12 percent in 2002 to just 5 percent last year. So the region's maturing inflation targeting regimes seem to be producing results and helping.
- Fiscal positions have also improved; on average, primary balances have risen by a little over 3 percentage points of GDP since 2002, contributing to a sharp reduction in public debt ratios. External positions have also improved, with 2006 marking the fourth consecutive year of current accounts surpluses.
So, for sure there's been improvement in macroeconomic policies and, encouragingly, policy frameworks in most countries have proven to be resilient to political transitions.
What's the split between `good luck' and `good policy'? It's difficult, if not impossible, to be precise about this, but here's some suggestive evidence.
- Our staff estimates that the 200 basis points reduction in spreads in the region since end-2003 reflects improvements in domestic fundamentals and a more favorable external environment in roughly equal proportions. Our estimates attribute about 60 percent to domestic factors and 40 percent to external factors. Market perceptions that the region is less risky than in the past have some grounding in the increase in exchange rate reserves, the decline in sovereign debt to GDP ratios, and the decline in the share of debt denominated in foreign currency.
- Another way is to see whether policy improvements have made the region less vulnerable today than in the past to changes in the international environment. That's been tackled in our latest Regional Economic Outlook for the Western Hemisphere released just today. The main finding is that Latin America is fairly resilient to a variety of moderate external shocks, certainly much more so than about 10 years ago. So improved policies have helped. But that does not mean that the region is immune from the effects of changes in the environment. Far from it. It is still the case that shocks to world growth are passed on to Latin America roughly one-for-one. Similarly, a 100 basis point increase in the high yield spread is estimated to reduce growth in the region by about one percentage point.
So the agenda to reduce vulnerability to external shocks through further improvements in macroeconomic and financial policies and by diversifying exports needs to continue.
Moreover, as I mentioned at the outset, there are other reasons why it is far too early to declare victory based on the recent growth performance. Let me elaborate on each of these.
First, the region's economic has growth continued to lag much of the world.
- Take the 2006 performance as an example. Growth in developing countries outside of Latin America and the Caribbean was about 8½ percent-about 3 percentage points higher than in the region.
- Over the last three years, Latin America and the Caribbean has trailed developing countries by a similar margin.
Second, the performance of productivity and investment has been lackluster, raising concerns about the sustainability of the current performance.
- Investment in the region still averages only 20 percent of GDP, which is no higher than its peak in earlier expansions.
- Productivity growth has also been only slightly better than in previous expansions, despite the sharp improvement in the terms of trade enjoyed by the region. And to the extent that productivity has risen during the current expansion, this partly reflects cyclical factors.
- To grasp the challenge facing the region, it is useful to consider the region's productivity performance from a longer-term perspective.
- From 1990 to 2006, total factor productivity grew at about 0.8 percent per year. That's a full percentage point below the weighted average for other developing countries.
- Among the largest Latin American countries, Chile is the only country that has significantly overperformed relative to the average for the other developing countries since 1990.
Raising productivity growth and investment rates will require the region to continue with the familiar agenda of structural reforms. There's a lot of work to be done.
Third, the region faces a challenge in being able to address distributional concerns while also improving its growth performance.
- It's difficult not to be sympathetic to the region's desire to achieve faster progress in shrinking the large gap between the incomes of the rich and poor. There is no question that income inequality is still very high in the region, and many social needs are unmet.
- One of the key messages that I want to send today is that distributional concerns can be addressed in ways that also promote growth. This is discussed in the latest Regional Economic Outlook. Improvements in education and reforms that lead to lower structural unemployment could both raise growth and have beneficial effects on equity, for example by reducing the earning gap between the formal and informal sectors.
- There is also significant scope to improve equity in the region within the existing envelope of public spending. About half of public spending in Latin America is for the social sectors, and at 13 percent of GDP it is not an insignificant sum. However, as you know, a large share of social outlays, such as those for tertiary education and public pensions, primarily continue to benefit upper-income groups. At the same time, in some countries, spending that is highly beneficial to the poor, such as targeted social assistance programs, remain relatively low .
- The recent past bears witness to the conclusion that policies that maintain growth also are good for lowering income inequality. According to data from the Economic Commission on Latin America and the Caribbean (ECLAC), poverty rates have declined from 44 percent in 2002 to an estimated 38 percent in 2006. And though still high, income inequality has also fallen since the late 1990s, a rare development in Latin America over the last several decades.
So, the outlook for Latin America and the Caribbean region has been favorable but with some work it could be better still. I hope the region will take advantage of these good times to lock in a virtuous circle of reforms, growth, and better distribution of income.