Innovation in Latin America: Potential Goes Untapped Due to Weak Economic Conditions

The weak economic performance seen this year in Latin America has accentuated the need to increase productivity as a key vehicle for more solid and sustained long-term growth. Supporting innovation is a crucial component in the productivity equation, and yet the outlook for this in Latin America is bleak: weak public finances are expected to reduce spending on research and development (R&D) even further this year. Although not all is gloomy and some gains may come from ongoing trade liberalization, Latin America will continue to lack the dynamism of its emerging-economy counterparts as little progress is expected on structural reforms that would grant all stakeholders the same opportunities to succeed.

The consensus is crystal clear among analysts and business leaders that innovation is key to increasing output and productivity, and is a crucial driver to sustainable long-term economic growth. However, measuring innovation in national economies is always tricky: the concept is intangible and not specifically measured by central banks or national statistical institutes. Nonetheless, international agencies, such as the United Nations Educational, Scientific and Cultural Organization (UNESCO) and the Organization for Economic Co-operation and Development (OECD) provide guidelines on how to measure innovation, incorporating variables like expenditure on R&D, incorporation of new technology, growth in labor productivity, number of patents per capita, as well as education standards. Moreover, the policy environment is equally vital. A solid competition policy, a stable contractual environment and an agile bureaucracy are more likely to encourage new entrepreneurs to invest in start-ups and existing players to raise capital investment to grow businesses.

Languishing hopes

Latin America has traditionally lagged behind many other regions in terms of innovation as a result of subdued R&D investment levels, low education standards and a weak policy backdrop. In the period from 2004 to 2009, a combination of free-trade agreements (FTAs) and improved export promotion policies created the initial conditions for innovation in Latin America. In that period, the region registered solid gains in exports of goods and services, which also enhanced competition and opened the gates for larger markets for innovative products and services. The result was the emergence of the region's largest multinational companies labelled “multilatinas”.

The five-year period up to 2009 provided stable public budgets in the region, which prompted many analysts and business leaders to expect that higher private and public investment in R&D would stimulate long-term growth rates. However, these hopes turned to disillusionment and bitterness when Latin America was hit hard by the global financial crisis and, in 2009, the region's economy contracted for the first time in 20 years. In 2010, the economy rebounded strongly, but GDP growth has decelerated steadily since then. GDP growth fell from 4.5% in 2011 to a meager 0.8% in 2014, before stagnating entirely in 2015. For this year, Latin America's growth prospects remain grim. The economic analysts FocusEconomics surveys on a monthly basis have reduced the region's 2016 GDP growth forecasts for 20 consecutive months and they now project that the economy will contract 0.5%. On top of that, data recently released by the United Nations World Intellectual Property Organization (WIPO) revealed that the number of patent applications for new inventions submitted by Latin American entities in 2015 was flat compared to the previous year. In contrast, in the same period, several Asian countries registered double-digit increases in the number of patent submissions. WIPO has attributed Latin America's recent dismal track record to its poor economic performance, with a plunge in commodities prices exacerbating fiscal pressures, which, in turn, cut the amount of resources that governments, businesses and universities could invest in innovation. According to the Organization, only 1,358 patent applications were registered in  Latin  America  in  2015,  which  substantially  contrasts  the  nearly 58,000 submissions registered  in  Europe  and the 60,000 in Canada  and  the  U.S. combined, and which represented only a fraction of the nearly 95,000 levels recorded in Asia as a whole. Within Latin America, Brazil, Chile and Mexico accounted for the lion's share of patent applications.

WIPO’s Global Innovation Index (GII) 2016 also showed that Latin America remains well behind other regions. According to WIPO, Latin America has been labelled as a region with important untapped innovation potential. Despite this, the Organization recognized that individual GII rankings, relative to other regions, have not steadily improved. None of the countries in Latin America has been considered “an innovation achiever” in recent years, which WIPO defines as a country that performed at least 10% higher than its peers given its level of GDP. Some such “achievers” are many economies in Sub-Saharan Africa, such as Kenya, Madagascar, Malawi and Rwanda. In Asia, Vietnam and India are clear examples of innovation achievers. Nonetheless, some Latin American economies, such as Chile, Colombia, Costa Rica, Mexico and Uruguay, achieved the highest regional GII results.

Challenging economic situation highlights need for R&D spending

Latin America’s difficult economic situation could prompt some governments to take action and improve the business environment in order to better the conditions for entrepreneurial activity. Under this scenario, since governments are no longer able to rely on high commodities prices to support economic growth, they would instead focus on the structural issues that have curtailed innovation and, consequently, economic growth.

A few of the regions key players have begun addressing the need to invigorate innovation. Mexico is a good example of country that is implementing a program of structural reforms in order to improve competition, productivity and the outlook for stronger potential GDP growth. In Argentina, the turnaround in the political landscape and the consequent change of government has triggered better prospects for an improvement in business conditions for the private sector. In Brazil, although the economy is experiencing considerable turbulence, tentative signs of improvement are emerging and Michel Temer’s temporary government is keeping the innovation agenda squarely on its radar. 

Aside from these examples, there are not many signs that governments in the region are committed to structural reforms to improve the conditions for innovation. As WIPO mentioned, it is vital for governments to overcome short-term political and economic constraints and cling to a longer-term innovation commitment. Data from UNESCO—the latest available are from 2012—confirm that spending on R&D in the region is significantly low. On average, most countries in the region spend less than 0.5% of GDP on R&D and expenditures come mainly from the public sector. In contrast, average expenditure in R&D in OECD countries and in developed economies ranges from 2.0% to 4.0% of GDP. It is important to note that, due to the economic cooling in Latin America, investment in R&D is likely to have fallen further at a time when the growth prospects for the region are not bright.

How can conditions for innovation be improved?

Considering the economic constraints in the region at the moment, governments across Latin America could take action to nurture entrepreneurship and innovation in various ways. Measures that could be taken to persuade investors to spend more on R&D in the region include strengthening competition policies, improving the contractual framework, cutting red tape and enforcing intellectual property rights. Meanwhile, the ongoing effort to increase trade liberalization both within and outside the region—the newly created Pacific Alliance and the Trans-Pacific Partnership if signed by Chile, Mexico and Peru—will encourage domestic businesses to target new fast-growing markets. However, conditions remain weak and the scenario reinforces the view that innovation is not only a strategy for risk-taking or for obtaining larger market shares, but for improving the policy environment, increasing investment in R&D and lifting long-term growth rates materially. The latest Consensus Forecast of 268 analysts from FocusEconomics projects that Latin America’s economy will rebound and expand 1.9% in 2017 and pick up some momentum toward 2020, when economic growth in the region is projected to rise to 3.3%.

Author: Ricardo Aceves, Latin America Senior Economist

Disclaimer: The views and opinions expressed in this article are those of the authors and do not necessarily reflect the opinion of FocusEconomics S.L.U. Views, forecasts or estimates are as of the date of the publication and are subject to change without notice. This report may provide addresses of, or contain hyperlinks to, other internet websites. FocusEconomics S.L.U. takes no responsibility for the contents of third party internet websites.

Date: October 20, 2016

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