BEYOND COMMODITIESThe Growth Challenge of Latin America and the Caribbean

April 2015

By Jorge Thompson Araujo, Markus Brueckner, Mateo Clavijo, Ekaterina Vostroknutova, and Konstantin M. Wacker

or Latin America and the Caribbean, the 2000s were the decade of smooth economic sailing. Tailwinds from the world economy—high commodity prices and low interest rates—helped propel export expansion and

raise incomes. Growth-promoting reforms by the region’s governments gave a roughly equal boost. The growth was particularly pro-poor. People in the bottom 40 percent of the income distribution consistently gained in wealth faster than the region’s average, making progress towards the twin goals of poverty eradication and shared prosperity.

The overall strong performance had another welcome e�ect: It put the region and its 600 million people back on a path of convergence with income levels of the United States, after years of losing ground. Now the commodity “super-cycle” is winding down and world �nancing conditions are turning less favorable. Growth has slowed in the region. The key challenge is how to restore the performance of the last decade in the absence of a favorable external environment. Thus, it is vital to identify and understand the factors that drove growth in Latin America and the Caribbean in the past decade, so that informed policy decisions can keep the region on an upward course. Questions include: How did growth drivers in the region change? How did they di�er country-to-coun-

try? How did the global economic situation a�ect the region’s economies?

A new World Bank study, “Beyond Commodities: The Growth Challenge of Latin America and the Caribbean,” provides answers to these and other vital questions. Its authors are Jorge Thompson Araujo, Markus Brueckner, Mateo Clavijo, Ekaterina Vostroknutova, and Konstantin M. Wacker.

Introduction

Source: WBG sta� calculations and WDI. Data shows the per capita GDP in PPP relative to the US.

Income levels are again converging toward those of the US

0%

5%

10%

15%

20%

25%

30%

SASSSAMNAECAEAPLAC

2012

2010

2008

2006

2004

2002

2000

1998

1996

1994

1992

1990

1988

1986

1984

1982

1980

F

2

Source: WBG sta� calculations, Haver Analytics, Wacker et al. (2014). LAC growth is an (unweighted) average of 32 LAC countries.

Growth, commodity prices and favorable �nancial conditions moved in near lockstep in the 2000s.

-2-101234567

LAC growth

2013

2012

2011

2010

2009

2008

2007

2006

2005

2004

2003

2002

2001

2000

1999

-0.25

-0.20

-0.15

-0.10

-0.05

0.00

0.05

0.10

0.15

US Financial Conditions (RHS)

Commodity Price Change (RHS)

Commodity export prices, both for energy and non-energy products, began to rise in the early 2000s, stoked by expanding world demand. Late in the decade, the United States implemented policies to keep interest rates low and liquidity high as a response to the global �nancial crisis, creating spill-over e�ects to the world in the form of lower borrowing costs and capital in�ows into emerging markets. Both of these trends helped spur growth in Latin America and the Caribbean. As prices rose, commodities’ share of the region’s exports rose from 40 percent in 2000 to 54 percent in 2012. The boom also altered net commodity exports’ share of GDP—it rose from 38 percent to 61 percent in the period. Resource-rich countries were particularly buoyed. Average GDP per capita adjusted for purchasing power during the 2000s in Venezuela, Guyana and Chile, for example, rose more than two percentage points per year due to the positive terms of trade. However, some economies were left out. External conditions acted as a slight drag on growth in Costa Rica and El Salvador, for instance.

Some economists believe that reliance on the easy revenue of commodity exports can undermine development of more stable industries such as

manufacturing and reduce pressure for di�cult structural reform. Though e�ects varied country by country, the report concludes that the region as a whole escaped most of the potential downsides of the commodity boom.

Favorable world conditions added about 5 percentage points to the region’s per capita GDP growth1 from the late 1990s to the late 2000s.

1. GDP per capita in this report is adjusted for purchasing power.

3

To greater and lesser degrees, countries in the region have taken on the often politically painful task of developing growth-enhancing infrastructure and undertaking reforms in the �nancial sector, education, and government agencies. By heightening e�ciencies and improving worker skills, these steps can foster growth. Overall, this e�ect was particularly strong in countries where positive world conditions had relatively lighter e�ect during the decade, such as Mexico, Nicaragua, and Brazil.

The decade’s main reform programs went beyond those of earlier periods, when the focus was on stabilization, such as containing in�ation and currency volatility. In previous times, stabilization measures played a direct positive role in growth, but in the past decade they have had a much smaller direct impact, the study found. Their role now is to create an environment in which other engines of growth can kick in—widespread hyperin�ation has been tamed, for instance,

smoothing the way for new development. Though most countries had “put their house in order” concerning stabilization by the 2000s, further progress in this �eld by countries such as Mexico, Uruguay, and Nicaragua fostered growth over the last decade.

Chile had special lessons for the region in demonstrating how growth drivers evolve. While the country has long been seen as a paragon of structural reforms, the new study suggests that in the 2000s the lingering e�ect of “initial conditions,” plus positive conditions abroad, were the primary drivers. Only 0.5 percent per year of GDP per capita growth could be traced to reforms and none to stabilization policies. In some countries, backsliding on reforms hobbled growth—St. Kitts and Nevis, Jamaica, Grenada, St. Vincent and the Grenadines, and Dominican Republic were the top �ve countries creating this drag.

Panama was the region’s growth champion, with average annual per capita expansion of 5.1 percent between 2000 and 2012, followed by Peru at 4.6 percent. No single set of factors underlay the performance of di�erent countries in the region. Though commodity producers bene�ted from higher exports, that does not explain strong performance in countries such as resource-poor Costa Rica and St. Vincent and the Grenadines, nor the lackluster numbers of Venezuela, Guyana, and Paraguay. Countries such as Peru, meanwhile, enjoyed a lift both from commodity prices and domestic reforms. In sum, factors such as export income, governance quality, labor force

participation, and growth-enhancing reforms combined in a di�erent mix in each country to a�ect economic performance.

There were some disappointing results, however. Bahamas contracted by an average one percent per year, while Haiti, scene of 2010’s horri�c earthquake, shrank by half a percent per year. But overall it was an upbeat decade for Latin America and the Caribbean. And the disparities in economic expansion speed were on average less pronounced than before the 1990s—the community of countries was increasingly “growing together.”

Growth-promoting reforms gave roughly as big a boost to the region’s economy as positive world conditions.

New “growth stars” such as Peru and Colombia emerged in a region where rates of expansion varied widely.

4

The report does not forecast the region’s future growth rates, but it does calculate hypothetical rates if factors that are now shaping its economy—commodity price move-ments, education improvements, and in�ation, for exam-ple—continue as before in the 2011-2020 period. The aim is to deepen understanding of the past decade.

If current trends continue, the model used for this study suggests that GDP per capita adjusted for purchasing power in the region would grow at 2.3 percent, slightly faster in the century’s second decade than in its �rst. Likewise, annual growth of 2.6 percent would prevail in South America, slightly slower than in the previous decade, and 2 percent in Central America and the Caribbean, slightly faster. The fastest growers per capita in the region would be Panama, Peru, Costa Rica, and Honduras, all at more than 4 percent. Haiti and Jamaica would be the only countries with declining GDP at purchasing power parity.

The analysis also examines what would happen if external forces—commodity prices and terms of trade—stopped improving, while domestic factors remained the same. In this scenario, the overall impact would not be dramatic: the region would grow at 2.2 percent per year, rather than 2.3 percent. But for major commodity exporters, the impact would be signi�cant. Chile’s annual growth forecast would drop by 0.6 percentage points to 2 percent, while Peru’s would slow by 0.4 percentage points to 4.1 percent.

The report also engages in “benchmarking.” This exercise calculates what rate of per capita income a country would have achieved had it been a top regional performer in a particular variable that a�ects growth, such as in�ation control, education and infrastructure development. The results can shed light on where policy makers can achieve the “biggest bang for the buck” in raising income levels.

Each country has a different path to sustaining growth going forward. Comparing countries to best performers in the region can help identify reforms that would have optimal impact on growth.

Source: WBG sta� calculations based on Brueckner (2014).

Growth-promoting reforms and stabilization e�orts

1

0.8

0.6

0.4

0.2

00 0.2 0.4 0.6 0.8 1

Structural policy index (0 lowest, 1 highest)

Stab

ilizat

ion po

licy i

ndex

(0 lo

west,

1 hi

ghes

t)

Argentina

Venezuela

Bolivia

Peru

Brazil

Chile

Uruguay

St. Kitts & NevisColombia

GrenadaPanama

El SalvadorGuyana

Guatemala

Costa RicaParaguayNicaraguaHonduras

Haiti

Dominican R.

Jamaica

Ecuador

5

One important �nding: Countries can score at the top on structural reform or on stabilization, but not both at the same time. In the following �gure, any country that led the list on both would be graphed at the upper right-hand corner, yet no country took that spot. This highlights that di�erent countries have di�erent policy needs going forward.

For example, Argentina, Dominican Republic, Ecuador, and Venezuela, stand out as countries that had a lot to gain from better in�ation control. Argentina, for instance, could have achieved a 12 percent higher GDP level if in�ation control

had been as e�ective as it was in the region’s top performer in in�ation control, Panama.

Concerning growth-enhancing reforms, Guatemala and El Salvador would have the region’s largest gains if their numbers for years of schooling were on par with Brazil’s, the region’s top achiever in that measure. Nicaragua, Paraguay, and Honduras, meanwhile, had the most to gain if their infrastructure development performance were top-rated. In infrastructure, a pattern appeared: countries with lower per capita income have the most to gain by closing the infrastructure gap.

Each country has a different path to sustaining growth going forward. Comparing countries to best performers in the region can help identify reforms that would have optimal impact on growth. (Cont.)

0

2000

4000

6000

8000

10000

12000

14000

Urug

uay

Pana

ma

Peru

El Sa

lvado

rGu

atem

alaBo

livia

Colom

bia

Hond

uras

Nica

ragu

aCh

ileUr

ugua

yM

exico

Braz

ilCo

sta Ri

caPa

ragu

ayJa

maic

aAr

gent

ina

Ecua

dor

Dom

inica

n R.

Vene

zuela

0

5

10

15

20

Source: WBG sta� calculations based on Brueckner (2014).

The potential pay-o� for top-ranking performance in infrastructure

The potential pay-o� of top ranking performance in in�ation

0

2000

4000

6000

8000

10000

12000

14000

Urug

uay

Costa

rica

Arge

ntin

aBr

azil

Chile

Colom

bia

Jam

aica

Mex

icoPa

nam

aEl

Salva

dor

Vene

zuela

Ecua

dor

Dom

inica

n R.

Guat

emalaPeru

Boliv

iaHo

ndur

asPa

ragu

ayNi

cara

gua 0

5

10

15

20

Actual GDP p.c. Hypothetical GDP p.c. % increase counterfactual - actual (rhs)

6

As the commodity boom winds down and U.S. policy makers hint at raising interest rates, the countries of Latin America and the Caribbean can turn their attention to domestic drivers to keep growth going. Pro-growth reforms have had strong positive impact to date. If pressed further, they hold the promise to deliver even greater results for sustained expansion and poverty reduction. In each country, policy makers may want to study closely what combination of reforms makes the best sense for the local economy. Countries that are backsliding on existing e�orts can look to gains in the long term if they return to the course that they began.

At the same time, established stabilization measures, which have done so much to plant the seeds for the recent years’ expansion, should not be neglected. A sound macro-�scal framework remains a pre-requisite for sustained growth. It can also help soften economic shocks, as it did in helping the region weather the world crisis of 2007-2008 with relatively little disruption.

Charting a course for national economic growth is complex. The most important conclusion of this report is that the external factors that promoted growth in the past cannot be counted on for the future. However, countries can look inward for growth while a friendly world economy is still giving a boost.

The report employs extensive empirical modeling to identify economic, political, and social drivers of growth in GDP at purchasing power parity income in Latin America and the Caribbean. It quanti�es individual drivers’ impact at the regional, sub-regional and national levels. The study expands on the literature on cross-country regressions as an empirical strategy for identifying the determinants of growth, drawing in particular on the econometric approach of Norman Loayza, Pablo Fajnzylber, and César Calderón in their 2005 work, “Economic Growth in Latin America and the Caribbean: Stylized Facts, Explanations, and Forecasts.”

Team members analyzed panel data from the 1970-2010 period for 126 countries. To smooth out short-term e�ects, the model worked with �ve-year averages. Among the factors measured for impact on income were schooling, trade openness, telephone line density, size of government, in�ation, exchange rate, and the commodity price index. To separate out the impact of domestic policy initiatives from the general lift provided by world conditions, the model uses a country-speci�c commodity export price index to �lter out commodity windfalls. Data from countries outside the region served to allow comparisons with the rest of the world.

Researchers also used the dataset to extrapolate growth performance of individual countries for the 2011-2020 decade, based on two scenarios: that current conditions would continue, and that external conditions would stop improving while domestic conditions remained the same. In another application, the model generated hypothetical income levels that countries could achieve if they matched the standing of regional leaders in such variables as in�ation control and infrastructure development. As any analysis based on cross-country regression methodology, however, this study assesses broad relationships between the variables, but cannot substitute for speci�c and more detailed analysis at country level.

Conclusions

Modeling drivers of economic growth

7

The World Bank

1818 H Street, NW,

Washington, DC 20433, USA.

www.worldbank.org