Policy Article

The Five Apocalyptic Riders of Latin America

Kiel Focus

Info

Publication Date

After years of upswing, Latin America is again back in crisis mode. The crisis has affected political and economic hotspots of crises like Venezuela, Argentina, which is once again in a financial crisis, and one of the most income-rich countries on the continentleader: Chile. There are five typical and persistent fields of problems in Latin America.

After years of a commodity-based upswing, Latin America is again back in a “blues” mode. It ranges from political and economic hotspots of crises like Venezuela via the finance-stressed traditional client of the IMF, Argentina, to one of the two most income-rich countries in Latin America: Chile. Unlike in the Southeast Asian crisis of 1997 when inconsistent exchange rate regimes rose to the core of the problems, there is no monetary contagion effect in Latin America spreading fast from one country to the other. Instead, all countries suffer from five fields of problems which because of their persistence could be labeled the five apocalyptic riders of Latina America.

Labor Markets

The first rider can be called “segmented labor markets.” Latin America labor markets are notoriously closed as a result of long period of feudal rule and import substitution policies. A privileged labor market of public enterprises and private companies in the manufacturing sector often owned by foreign investors stands against a large sector of small companies with informally employed workers who find no access of the official labor market. Such segmentation furthers income inequality and drives inequality indicators beyond the extent which is typical for commodity-rich developing countries.

Capital Markets

The second rider can be called “volatile and open capital markets.” In times of crises, Latin American investors (foreign and local alike) never faced high barriers to use the US dollar as an escape currency and to transfer capital abroad. While in the past developing Asia was characterized by relatively open labor markets and closed capital markets, Latin America because of its relatively closed labor markets and open capital markets rapidly got stuck in situations of crises when capital fled the region. Mistrust in national currencies had been nourished by the historical experience of inconsistent and thus unsustainable currency regimes and supported high dollarization.

Fiscal Budgets

The third rider can be called “chronical budget deficits.” Latin American frequently failed to bring budget revenues and expenditures into equilibrium. Budget deficits have always been higher than in other developing areas. Deficits were financed by resorting to the inflation tax as evidenced recently in Argentina. The tax base is weak, the tax resistance is high and the tax administration is weak. On the expenditure side, subsidies are fixed though politically decided entitlements and provoke considerable opposition in the electorate when they are to be reduced either because of the pressure of foreign lenders and donors or because of own insight.

Commodities

The fourth rider can be called “commodity impact.” It is not a curse to own commodities and to extract them, but it is a curse if the volatility of commodity prices cannot be countered by genuine adjustment capabilities. During the commodity boom which was lengthened by monetary and fiscal expansion of the industrial countries and China beyond 2008, Latin America became a victim of the “dutch disease.” the commodity-driven real appreciation of the currency to the detriment of the noncommodity sectors. Given that such an appreciation is a temporary income gain, it has to be corrected once the price hike ends and a price baisse begins. Nominal depreciation under flexible exchange rates and wage decreases under fixed exchange rates plus tightened budgetary constraints are those adjustment measures which Latin American countries notoriously failed to apply due to strong political resistance.

Education

The fifth rider is of structural nature and be called “weak educational progress”. Latin America never succeeded to match the Asian progress in education and human capital formation and to modernize its global product supply. Its share in world’s merchandise exports fell from 4% in 2008 to 3% ten years later. Furthermore, Latin American countries rarely participate in international comparative tests on pupil’s achievement and gain low scores if they participate.

The current crises in the Andean states and Argentina can be attributed predominantly to the third and fourth riders but they originate also from the three others. Compared to the past, the consequences get harsher and have more cross-border negative implications: more push migration towards North America, excessive resource destruction and populist regimes. The risk that relatively stable countries like Chile and Uruguay will be drawn into such downward spiral has never been so high as today. It is thus the more important that partner countries will open their markets much more to the Latin American agricultural supply and that they will be prepared to pay not only for the exploitation of the natural resources but much more for their preservation.


Coverfoto: Photo by Cristian Castillo on Unsplash

The Kiel Focus series presents papers on current economic policy topics. Their authors are solely responsible for their content and their views or any policy recommendations they may make do not necessarily represent the views or recommendations of the Institute.