Secular Stagnation Heads South
As commodity prices come back to earth and the Federal Reserve’ gradual exit from quantitative easing leads to higher interest rates in the United States, Latin America’s economies face the challenge of sustaining growth. The region’s main economies recorded slower GDP growth in 2013, and much the same is being forecast for 2014.
It is pretty clear by now that an extraordinarily benevolent external environment, not a revolutionary policy shift, underpinned Latin America’s rapid growth in the years following the 2008–2009 global economic crisis. As long as the price of soy, wheat, copper, oil, and other raw materials remained stratospheric, commodity-rich countries like Brazil, Chile, and Peru got a tremendous boost; even Argentina grew rapidly, despite terrible economic policies.
But now “secular stagnation” — the concept du jour in US policy debates since former Treasury Secretary Larry Summers argued last November that the United States (and perhaps other advanced economies) has entered a long period of anemic GDP growth — may also be coming to Latin America.
The argument goes like this: high consumer debt, slowing population growth, and rising income inequality have weakened consumer demand and stimulated savings, while slowing growth in productivity and output itself has discouraged investment. So the “natural” rate of interest — the rate at which the demand for investment equals the supply of savings — has fallen, and arguably has become negative. But, because real interest rates cannot be strongly negative unless inflation is high (which it is not), there is a savings glut. With consumption and investment lagging, the US economy is bound to stagnate.
But how could such a situation apply to Latin America, where GDP growth is faster, interest rates are higher, and domestic demand is stronger than in the US?
Consider the region’s history. Until the recent commodity-driven boomlet, growth in Latin America was mediocre. The 1980s are known as the lost decade, owing to a debt crisis and massive recessions, while the market-based reforms of the 1990s did little to reignite short-run growth. From 1960 to 2007, only four countries in Latin America and the Caribbean — Brazil, Chile, the Dominican Republic, and Panama — grew faster than the United States. So meager growth in the coming years would be a return to Latin America’s historical pattern, not a deviation from it.
That brings us back to secular stagnation. Yes, Latin American countries’ average per capita GDP is only one-quarter that of the United States, so they should be growing faster than their rich northern neighbor. The question is how much faster. Stagnation in this context means a growth rate that is too low to ensure convergence toward US living standards within a reasonable period of time.
Unlike the United States, Latin American economies’ actual output is at or near potential, so growing more means investing more. Yet investment has been disappointing. And the region’s problem is not too much domestic savings, but too little. Latin American countries save 18 percent of GDP, on average, compared to 30 percent in fast-growing East Asia.
As a result, every time investment picks up in Latin America, it has to be financed with loans from abroad. Foreign investors are willing to live with the resulting current-account deficits, but only up to a point.
It took only a few words from Fed Chairman Ben Bernanke last May — announcing the eventual end of quantitative easing — for markets to lose confidence in emerging economies with current-account deficits near or above 4 percent of GDP. Brazil was the most prominent among the Latin American economies under attack, but analysts worried about similar vulnerabilities elsewhere in the region. As a result, now, as in the recent past, whenever foreigners get jittery, financing and investment in Latin America are curtailed, and growth suffers.
The scarcity of savings in the region reflects the weak incentives embedded in poorly designed tax and pension systems. But savings performance is also related to long-standing fiscal problems. To be sure, the fiscal stance improved in many Latin American economies in the years leading up to 2007, so countries like Chile were able to mount a strong anti-crisis fiscal response. But, as a 2013 Inter-American Development Bank (IADB) report makes clear, the fiscal stimulus was not always withdrawn in time when the crisis abated, so the fiscal position across the region today is weaker than it was in 2007.
The composition of government spending is also a problem. According to the same IADB report, investment accounts for only 16 percent of fiscal outlays, less than half the share in emerging Asia. So Latin America suffers from a longstanding infrastructure deficit, which acts as a drag on growth.
Even abundant domestic savings in the future would not guarantee higher investment. Firms’ eagerness to invest depends on how much additional output they can get out of that investment, and recent productivity growth in Latin America — as in the United States — has been disappointing.
Lagging productivity has many causes, but one is the failure to diversify local economic structures. Economies become more productive either by doing what they do more efficiently, or by shifting resources into new sectors in which productivity is higher — a process that can be observed (or not) by looking at export diversification. And the sad fact is that today most Latin American countries — Mexico being a notable exception — export pretty much the same goods that they exported a generation ago. That is yet another big difference between the region and East Asia.
So, can Latin American economies keep growing once commodity prices and world interest rates edge back toward normality? We in the region hope they can. But a return to stagnation is also a possibility — one that can be minimized only if policymakers acknowledge it and begin taking preventive action right away.
Andrés Velasco, a former finance minister of Chile, is a visiting professor at Columbia University.
Copyright: Project Syndicate, 2014.