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Western Hemisphere
Regional Economic Outlook: Tale of Two Adjustments
May 2017
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Western Hemisphere
May 2017
[$token_name="PublicationDisclaimer"]
Against the backdrop of lackluster global growth in 2016, the world economy is seeing underlying shifts in its economic and policy landscape. Since last October, the outlook for advanced economies for 2017–18 has improved, reflecting better growth prospects in the United States, Europe, and Japan—alongside some rebound in manufacturing and trade and likely U.S. fiscal stimulus. With the anticipated change in the U.S. policy mix, including faster monetary tightening and a stronger U.S. dollar, market sentiment in advanced economies has improved and equity markets have been buoyant. Domestic financial conditions initially tightened in emerging markets, where growth prospects have worsened slightly, but market conditions have since noticeably improved. On balance, global growth is expected to rise modestly in 2017 and 2018 but with widely dispersed risks around this baseline. Longer-term uncertainty surrounds the direction and extent of shifts in U.S. policies. Global vulnerabilities include a rising tide of economic nationalism in major advanced economies—marked by higher antipathy toward trade, immigration, and globalization.
Alongside important shifts elsewhere in the global landscape, the economies of Latin America and the Caribbean are recovering from a regional recession in 2016. Activity is expected to pick up gradually this year and next, but the outlook is weaker than projected last fall, and medium-term growth remains modest at about 2.6 percent. Inflation is easing in many economies as the pass-through from past depreciations is fading. At the same time, risks to growth have widened in a setting of higher growth in advanced economies but also higher global policy uncertainty involving possible changes in the underlying direction of U.S. policies, a rising tide of economic nationalism in advanced economies, and potential tightening of financial conditions. In this challenging external context, countries should aim for completing fiscal and external adjustments to preserve or rebuild policy buffers. Charting a course toward higher, sustainable, and more equitable growth will also require strengthening structural reforms aimed at closing infrastructure gaps; improving the business environment, governance, and education outcomes; and encouraging female labor force participation to boost medium-term growth and foster income convergence.
External adjustment in Latin America is ongoing in the wake of large and persistent shifts in the region’s terms of trade. In the past, external adjustment to negative terms-of-trade shocks typically took place through a weakening of domestic demand and import compression (negative income effects) rather than stronger supply growth and export recovery, despite a real depreciation. In contrast, the ongoing adjustment reflects the increased use of exchange rate flexibility as a shock absorber. The real depreciation has led to a small boost to exports and a stronger reduction in imports than in the past, with demand shifting toward locally produced goods. Altogether, although the income effect still appears to be strong, the expenditure-switching effect seems to have become more relevant. These effects have alleviated the burden on domestic demand, thereby reducing the “sacrifice ratio” of external adjustment for flexible exchange rate regimes in Latin America. Moreover, with flexible regimes becoming more widespread, the cost associated with exchange rate rigidity has increased in the region, as common shocks have led to multilateral appreciation for less flexible currencies. The aggregate responsiveness of exports to real depreciation also masks differences within and across countries. In terms of global shares, export performance responds more significantly to changing relative prices for noncommodity products and for exporters that trade manufactured goods more heavily. Exchange rate flexibility can thus support structural policies aimed at shifting resources to noncommodity sectors.
Following a decade of strong capital inflows, Latin America is now experiencing weaker economic growth and financial inflows accompanying the end of the commodity super-cycle. Global factors, notably global commodity prices, are strongly associated with cyclical movements of capital inflows in emerging markets. This holds particularly true for Latin America. At the same time, country-specific structural factors, such as good governance and strong institutional and regulatory frameworks, play a key role in attracting inflows over longer time horizons. With regard to vulnerabilities, capital flows in countries with deeper financial markets and stable, large domestic investor bases exhibit lower sensitivity to external shocks, whereas a larger presence of foreign investors and more open capital accounts increase this sensitivity. Other policy dimensions, such as exchange rate flexibility, can also mitigate the vulnerabilities of capital flows to the region.
Migration from and remittance flows to Latin America and the Caribbean (LAC)—usually with the United States as the host economy—have major economic and social ramifications for the migrants’ home countries. This chapter examines recent trends in outward migration from and remittances to LAC, as well as their costs and benefits. Outward migration in isolation may lower growth in home countries through reduced labor supply and productivity, but the remittances sent home by migrant workers serve as a mitigating factor, both by serving as a large and relatively stable source of external financing, notably in Central America and the Caribbean, and by helping cushion the impact of economic shocks. However, the region’s dependence on remittances primarily from the United States can pose risks to macroeconomic stability for cyclical reasons and, more importantly, from possible changes to immigration-related policies. Targeted reforms in home countries can help reduce outward migration and the attendant adverse consequences. In particular, structural reforms, aimed at leveraging the pool of high-skilled and highly educated workers to foster economic diversification at home would likely reduce “brain drain.” Similarly, given the key financing and stabilizing roles played by remittances, policies aimed at reducing transaction costs and promoting the use of formal channels of intermediation merit support.
