The Growth Trap in Latin America
Brazilian entrepreneur, Pres., CEAL Conselho Empresarial da America Latina – Brazil
The global situation is at a new turning point. In the U.S., growth is expected to decline by 2020, Europe is already forecasting a turning point in 2019, and China’s growth figures are expected to decline, but the truth of these numbers is doubtful. Latin America in this scenario offers growth but with many doubts in its consistency. With Brazil in recovery, the numbers will be lower than expected, as well as in Mexico. The question that many analysts and economists ask is why is it that in Latin America, with its very favorable potentials and indicators, FDI/GDP rates compared with the rest of the world, inflation, indebtedness, consumer market, etc; why its indicators are still very low?
Recently, the 12th edition of the Latin American Economic Outlook (LEO) was published, as well as the ECLAC Development in Transition¹, and Fiscal Panorama 2019². In Brazil, almost at the same time, the father of the Real Plan, economist Lara Resende³, published a very audacious document in which he questions many of the economic policies he and his team defended for so long, showing that in the last two decades the result was disappointing.
Did economic orthodoxy fail to work?
When someone who defended and implanted it as a mantra points it out, it draws attention.
The ECLAC reports show something similar. Transition development shows that multidimensional challenges have been a growth trap. The vectors related to competitiveness, productivity, social, institutional and environmental vulnerability have made public policies old against productiveness. The agenda of changes needs to face new realities, and therefore innovations in the agendas are needed to get out of the crossroads where efforts fail to achieve results. The fear of new unorthodox adventures, so failed in the past, enters the equation. On the other hand, the fiscal panorama presented shows the enormous progress of the digitalization of the economies, but the current fiscal and monetary policies are not coherent with these digital evolutions. They inhibit the new and strengthen unproductiveness.
This is what we call the growth trap in a world of profound change.
More and more efforts are made to be more competitive without considering the changes that are taking place in economies and customers.
Efficiency increases but effectiveness remains low.
In the first competitiveness context, it is necessary to recognize that exchange rate is the more relevant factor for the international pricing of products and services. The country that does not take care of having a competitive exchange rate in the long term, will have its economic effectiveness compromised. The best example is in Brazil, where the Real/Dollar exchange rate at the beginning of Lula’s government was around R$4 = US$1, in 2013. Today, 16 years later, the exchange rate in Brazil is around R$3.9 = US$1, that means that in these 16 years it did not compensate the inflation of the U.S. dollar. If the United States’ 16-year inflation were offset, the Brazilian currency should have been adjusted by 38%! That is, it would be at R$5.3 = US$1. Brazil started losing 38% of competitiveness, which would need to be compensated by the productivity of its economy. Monetary easing in the U.S. and the EU has meant that countries, except for China, have had their currencies valued, and they continue to practice this mechanism year after year. The Central Banks of Latin America were not unhappy with these measures because it helped them fight against domestic inflation, which remains at very low levels. Added to this, Latin American countries seek significant monetary reserves to ensure their credibility. These reserves, in most cases, are applied in strong currencies such as the U.S. dollar and sometimes the Euro. The interest received on these investments are lower than the interest paid in domestic currency for the domestic debt, placing the “loading loss” of the reserves as a deficit in relation to the interest paid internally.
Economist and Professor Octavio de Barros⁴, has stated in various articles that global digitalization has a deflationary effect on world economies, meaning the global economy needs to be careful not to systematically enter in situations of stagflation (which has been observed in the European Union).
These effects will have to be offset by the productivity of each country.
Productivity is one of the central factors in the focus of macroeconomics. Traditionally it measures the degree of efficiency with which a given economy uses its resources to produce goods and services. In the calculation of productivity, there are the total productivity factors (TPF) that aim to indicate the efficiency with which the economy combines the totality of its resources to generate the product. Its construction is far from trivial, especially when we associate it with technological progress, labor and capital participation, price variation, condition and skills of the worker. It shows that the values that a society opts for political issues, results in higher or lower productivity by allocating resources to meet these objectives (health, safety, environment, education, etc.). The depletion of this model shows when microeconomic productivity is no longer related to macroeconomic productivity and socio-environmental factors are added to factors related to logistics, infrastructure and increasingly complex macroeconomic environment (laws and regulations).
The relation of capital, also in credit and investments, makes TPF more complex. The concepts that overlap in the economic debate are less about the efficiency (level of objectives achieved with minimization of resources) and more about the effectiveness (achievement of desirable objectives, economic, sociological, ecological, etc.). The performance of the economy’s ability to achieve predefined real objectives (growth, CO2 reduction, employability, poverty, well-being, etc.). In the OECD “Manual” (2001) we find the old way of evaluating productivity, which, as explained, is no longer enough to compare and express new public and global policies. The best example of this is in the measures that the Latin American states are taking in the redefinition of their health and welfare systems. The dichotomy of productivity in the old concept needs to be updated, including the social and political concepts that involve these issues.
The above considerations, substantiated by the LEO and ECLAC’s Fiscal Panorama, show how urgent it is to revise economic and fiscal policies to be effective and not only efficient.
The exchange rate issue needs a long-term solution, a possibility beyond interregional measures is the Reform of the WTO, where this theme needs to be addressed, perhaps in a model of “currency snake” as the anticipated Euro. (Note the U.S. has already included this concept in the new USMECA). Foreign exchange reserves, whose load in hard currencies for the Latin American countries is negative, can be used as a weighting instrument for export/import insurance or for performance bonds in public investments and PPPs, increasing competitiveness.
In the tax areas, it is necessary to review the taxation systems considering the progress of the digitalization, in the sense of strengthening it and not weakening it. Offer a differentiated taxation to the bio-economy where Latin America has an international comparative advantage.
It is important to recognize that Latin America, especially South America, has long productive chains (similar to the U.S.), and the value of additionality must be respected by the value-added chain in the tax burden for lower VAT on inputs in the beginning of the channel, and higher in products with high added value.
Recognize that digitalization is here to stay, and the related infrastructure needs to be competitive, such as energy, telecommunications, optical fibers, innovation, among others. New policies are urgent!
Integrating the region is to share effectiveness, increases results and increase solidarity, reducing extreme poverty and increasing well-being, sustainably.
There is no more time to lose to get out of our growth traps.
April 7, 2019 Latin Trade