Why does Latin America have a growth problem?

In our latest insight piece, we examine the factors holding back Latin America’s economic potential.

Economic projections for Latin America this year are downbeat: Our analysts expect the region’s GDP to expand a mere 2.5%. Eastern Europe, which is reeling from the impact of the war in Ukraine, is the only emerging market projected to fare worse. This underwhelming performance is hardly a flash in the pan: In the decade to 2020, growth in Latin America averaged just 1.0%, by far the lowest among emerging markets. Over the same 10-year period, Asia’s GDP grew 5.5% while Sub-Saharan Africa’s rose 3.5%. So what is holding Latin America back? A complex cocktail of inequality, weak human capital and poor governance are partly to blame.

 

First, inequality: Latin America is the world’s most unequal region, as measured by the World Bank’s Gini Coefficient data. This feeds through to frequent social unrest—such as that observed in Chile in 2019, or more recently this year in Ecuador and Peru. Inequality is likely also a factor behind the continent’s high level of crime: the countries with the world’s highest murder rates are in Latin America. Social unrest and crime disrupt economic activity and curtail investment intentions.

Second, human capital. While Latin America has made huge strides in recent decades in improving access to education, the quality of provision is still lacking: The region performs poorly on the OECD’s PISA tests, which measure educational attainment by country. This lack of human capital is stunting the development of advanced manufacturing and services sectors, and keeping Latin American economic prospects chained to the commodity cycle.

Finally, governance. Latin American countries have mostly adopted presidential political systems closely modelled on that of the U.S. However, the plethora of parties present in legislatures—unlike in the U.S.—frequently frustrate leaders’ economic agendas and serve to block reforms. The region has been gripped by populist policymaking for decades—leaders such as Chávez in Venezuela, Cristina Fernández in Argentina and Bolsonaro in Brazil are prominent examples.

These three problems are intertwined: Higher inequality feeds into lower educational attainment, which in turn affects the quality of governance. Poor governance itself drives greater social unrest, in a negative feedback loop. Moreover, Latin America has a higher GDP per capita than economies in many parts of Central and South Asia and Sub-Saharan Africa. This limits the potential for easy catch-up growth with the rich world; low hanging fruit providing quick boosts to GDP, such as urbanization and universal primary education for instance, have been largely exhausted.

So what about the future? For now, the analysts that we poll are not overly optimistic: They expect GDP growth in Latin America to remain well below that of other emerging markets to the end of our forecast horizon in 2026.

Insights from our analyst network:

On investment, the EIU said:

“We think that perceived weaknesses in the business environment will constrain Latin America’s prospects for FDI going forward, amid a high level of political risk in the region (reflecting dramatic political shifts at the ballot box over the past two years). Although the first-quarter data clearly show Latin America’s potential, we assume that FDI flows will taper off for the next few quarters as the supply of funds dries up, commodity prices ease from their recent peaks and concerns about political risk in Latin America come to the fore.”

 

 

 

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.

Author: Oliver Reynolds, Economist

Date: August 12, 2022

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