Two Cheers for Latin America

Latin America and the Caribbean performed better during this crisis than might have been expected given its long history of boom and bust. However, the region’s GDP contracted 2.3 percent—in line with the world’s overall contraction—while developing Asia, the Middle East, and the middle-income countries in Africa all saw growth. Only Eastern Europe and Central Asia did worse. The crisis thus holds important lessons for Latin America¹—confirming the improvements in its macroeconomic management, but also underscoring the region’s persistent competitiveness deficit.

2009 Versus Past Recessions: Better, but Not Great

Three global recessions have significantly impacted Latin America since 1980². The 1982 recession triggered debt crises across Latin America, which led to a “lost decade” of growth. The 1998 emerging market crisis originated in East Asia but spread to Latin America, hitting particularly hard in 1999 and eventually leading to Argentina’s collapse. Though the 2001 recession affected advanced countries more than emerging markets, it also hit Latin America.

Latin America performed better relative to the rest of the world in 2009 than during the previous three recessions. Last year, the difference between Latin America’s contraction and that of the world was 0.1 percent—substantially less than the 0.7 percent, 1.3 percent, and 0.9 percent differences in 1980–1983, 1998–1999, and 2001–2003, respectively.

World and Regional GDP Growth in Recent Recessions

However, world GDP declined sharply last year in part because the financial crisis hit industrialized countries—its originators—hardest. Developing countries were less affected and, compared to other emerging markets, Latin America lagged significantly behind in 2009. Even putting China’s remarkable performance aside, developing Asia grew substantially more than Latin America, with Indonesia, Malaysia, the Phillipines, Thailand, and Vietnam together posting 1.3 percent growth. The Middle East and middle income countries in Africa also outperformed Latin America, growing 2.2 percent and 0.3 percent, respectively. Only Eastern Europe and Central Asia—which had attracted massive flows of volatile capital betting on the region’s convergence with Europe—did worse, with a contraction of 6.2 percent.

As always, the regional number also hides important differences across countries. Mexico, Jamaica, and others in the Caribbean and Central America saw the sharpest contractions, reflecting their dependence on the U.S. market. Countries with pegged exchange rates, including Venezuela, Ecuador, and El Salvador, also saw relatively large contractions, as did Argentina, amid political complications. Diversified exporters, notably Colombia and Brazil, did better, and Chile returned to growth in the second half of 2009.

It should be recognized that the region was responding to significantly harsher external shocks this time. Global trade contracted 14 percent in 2009, an unprecedented decline. According to the IMF’s hypothetical calculation, Brazil, Chile, Colombia, Mexico, and Peru “saved” 4 percent of GDP from the third quarter of 2008 to the second quarter of 2009 compared to what they would have lost had they responded to external shocks as they did from 1994 to 2002. Forecasts also suggest that Latin America’s recovery in 2010 will be more in line with world growth than it has been in previous upturns.

What Was Better This Time?

During past global recessions, Latin America’s high debt levels, dependence on foreign financing, and exchange rate rigidity reduced its policy space. This time, Latin America’s pre-crisis position was stronger and its crisis management better.

Pre-Crisis Positions

For the first time in the past three decades, Latin America met the crisis with a current account surplus, which averaged 0.9 percent of GDP in the five years prior to 2008. In contrast, Latin America’s current account deficit averaged -4.1 percent in 1980 and 1981, -2.9 percent in the five years prior to 1999, and -2.7 percent in 1999 and 2000.

The region’s debt level and composition were also better at the outbreak of this crisis, with its external debt down to 20.5 percent of GDP in 2008, lower than 28.3 percent of GDP in 1980, 36.5 percent in 1998, and 36.7 percent in 2000. In addition, the region held less short-term maturity debt.

Latin America’s foreign reserves had also grown prior to this crisis. On the rise since mid-2006, they reached enough to cover 9.9 months of imports in May 2009.

Crisis Management

Countries allowed their currencies to depreciate in an orderly fashion in 2009 and were therefore able to better manage their foreign reserves and to loosen monetary policy. Though reserves fell to 8.5 months of import coverage in December, they remain substantially above their ten-year pre-crisis average of 5.8 months. With increased exchange rate flexibility, monetary policy was also afforded more room; Brazil, Mexico, Colombia, Chile, and Peru were able to lower rates in 2009, rather than having to raise them as in the past. The region’s move toward increased exchange rate flexibility has clearly been a great step forward.

This crisis also saw the first use of countercyclical fiscal policy in Latin America. Peru implemented a $3.2 billion fiscal stimulus plan and Chile announced a $4 billion stimulus package, the largest in the region. Given their dependence on volatile commodity prices and still-limited access to financing, however, few other Latin American countries were able to do the same. Enacting fiscal stimulus could have hit investor confidence in their ability to repay debt. Going forward, countries across the region should establish the conditions necessary for enacting countercyclical fiscal policy.

The Competitiveness Deficit

There are many possible causes for Latin America’s failure to keep up with the best-performing developing countries during the crisis despite its improved macroeconomic management. The region’s persistent competitiveness deficit and its consequent inability to diversify its economy is clearly playing an important role.

Business Climate

Latin America currently ranks below every other emerging region (as well as the advanced economies) on the World Economic Forum’s Global Competitiveness Index, which measures how productively a country uses its resources. Based on its countries’ average ranking on the World Bank’s Ease of Doing Business Ranking, Latin America would also place 97 out of 183 countries in business climate—tying developing Asia (where income per capita—$1,970, excluding Bhutan—is much lower than Latin America’s $6,772) and lagging behind every other emerging region. According to these indicators, while reform priorities vary within the region, tax reform would improve the business climate of all of Latin America’s largest economies.

Competitiveness and Business Climate

Latin America’s institutions score particularly poorly on the Global Competitiveness Index. Based on its countries’ average rankings, the region’s institutions would come in 94 out of the 134 countries evaluated. According to the World Bank’s Governance Indicators, Latin America’s governance scores have deteriorated marginally, with Venezuela’s deterioration particularly stark. Across Latin America, political instability, violence, and limited rule of law remain notable weaknesses. Though Latin America, on average, still outranks emerging Asian countries in governance, their labor cost is much lower and their institutional quality is no longer far behind.

Governance*

Export Diversification

Though manufactures-exporters did see some of the region’s sharpest contractions last year, much of the region’s volatility remains linked to commodity prices, and countries in which exports are diversified did better. This was true within the region and globally.  

In terms of partners, this crisis hit countries most dependent on only one—the United States—hardest. Overall, Latin America depends more on the United States than any fast-growing emerging region depends on any other region, let alone country. Several Latin American countries, including Brazil, Peru, Chile, and Costa Rica, have already moved toward increased partner diversification, notably with China and inter-regionally. Others should follow suit—in terms of both partners and products.

Vera Eidelman is the managing editor of Carnegie’s International Economic Bulletin.

^{1 "Latin America" refers to Latin America and the Caribbean for the duration of the piece.}

^{2 The 1991 slowdown did not significantly impact Latin America, developing Asia, or the Middle East and is therefore not included in this analysis.}