Saving Latin America's Unprecedented Income Windfall

IMF Blog, May 20, 2013

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The commodity price boom beginning around 2002 produced large terms-of-trade shocks concentrated in the 1970s and the 2000s.
The recent boom is "sizable" and not much larger than the 1970s booms, but is considerably larger than booms in other regions; only comparable to oil-exporting countries in the Middle East and North Africa.
The associated income windfall in the recent episode has been much larger than in the past because of a higher degree of trade openness and a longer duration of the boom.
The recent boom raised income close to 15 percent per year (income has been 15 percent higher than it would have been without the terms-of-trade shock).
Country-specific windfalls:
- Venezuela: increase of 30 percent per year.
- Bolivia: increase of 20 percent per year.
- Chile: increase of 20 percent per year.
- Brazil: significantly lower windfall estimates (relative position noted).
- Mexico and Uruguay: terms-of-trade changes during the last decade do not qualify, under the authors’ definition, as booms.

Aggregate saving rates comparison:
- Median saving rate increased by about 4-5 percentage points of GDP in the recent episode.
- In past episodes, median saving rates increased by about 2-3 percentage points of GDP.
Investment behavior:
- Investment rose by about 5 percentage points of GDP in the recent episode, in contrast with past episodes.
- The increase in investment has contributed to a gradual weakening of current account balances.
Marginal saving rates (increase in saving as a proportion of the estimated windfall):
- Estimates indicate commodity exporters have saved less of the windfall in the recent episode than in past episodes.
- Latin America’s saving effort is low compared with countries with a similar income windfall (oil-exporting countries in the Middle East).
- Efforts to save the windfall have gradually declined following the 2008–09 crisis.
Composition of saving:
- A growing share of the windfall is devoted to domestic (physical) capital formation rather than to improving countries’ international asset position (increasing saving abroad).
- This compositional shift has affected post-boom real income differently than in past episodes and contributed to current account weakening.

Econometric evidence:
- A simple econometric exercise points to a high payoff from saving the windfall during the boom in terms of raising post-boom income.
- The composition of windfall saving matters: allocating the extra income to foreign asset accumulation appears to deliver higher post-boom income than when invested domestically.
- The result could reflect benefits of a stronger net foreign assets position or costs from misallocating domestic resources during the boom; the distinction remains an open question.
- This payoff from foreign asset accumulation seems to have been especially true for Latin America in the past.

The improved public and external balance sheets observed in the region may reflect mainly the sheer size of the income windfall from the latest terms-of-trade boom, rather than a greater effort to save it.
With signs of:
- further softening of saving rates,
- weakening external current account balances,

a closer look into saving and investment patterns may be desirable to secure higher post-boom income.

Policy-relevant considerations:
- Strengthen incentives or mechanisms to increase the marginal saving of income windfalls.
- Consider the composition of saving (foreign asset accumulation versus domestic investment) given its differential association with post-boom income outcomes.
- Monitor the post-2008–09 decline in saving effort and its implications for external balances.

Gustavo Adler, Nicolás Magud — May 20, 2013 (IMF blog post "Saving Latin America's Unprecedented Income Windfall")