World growth is likely to be suppressed below potential for several years to come, but Latin America and the Caribbean can escape this global outlook and boost growth significantly by adopting appropriate structural reforms, according to the Inter-American Development Bank’s annual macroeconomic report, released at the IDB annual meeting.
The report, “Rethinking Reforms”, argues that if countries across the region embrace reforms that are tailor-made to their particular institutions and situation, regional spillovers will give an additional considerable boost to growth.
“We are expecting moderate growth in the region for several years and even if there is room for counter-cyclical fiscal policy, countries should refrain as fiscal space has also diminished,” said Santiago Levy, Vice President for Sectors and Knowledge for the IDB. “It’s crucial for countries to consider more structural measures to boost growth.”
The report notes that the region is likely to grow just 3.9% annually over the next five years, nearly one percentage point lower than the 4.8% registered before the Great Recession which began in 2008. Slower growth in world trade and a decline in commodity prices are expected to dampen consumption and investment in Latin America and the Caribbean (LAC).
Fiscal space has shrunk in the last year, and both fiscal and monetary policy space is lower now than compared to the pre-crisis period, as spending has continued apace even as growth has risen to close to potential given the state of the world economy. There is a danger that the counter-cyclical policies used so successfully to counter the global recession will be seen as expansionary rather than truly cyclical. “It is not a question of using fiscal and monetary policies today to counter a negative shock and bring growth in the region up to its potential,” said Jose Juan Ruiz, the IDB Chief Economist. “We need to find measures to increase our potential rate of growth.”
The report notes that currencies in the region have appreciated, potentially affecting exports and growth. Appreciations have likely been fuelled by a combination of factors, including high commodity prices, strong capital inflows given attractive investment opportunities, as well as the expansionary monetary policies and Quantitative Easing (QE) policies of Central Banks in advanced economies. Whatever the causes, countries should consider policies to address these concerns. An optimal mix may be adoption of a somewhat tighter fiscal policy, which then allows for a looser monetary policy, assuming that inflationary pressures can be kept under control.
However, additional measures are needed to boost growth. The report argues that the time has come to reignite the region’s reform agenda. “Latin America and the Caribbean have the economic resources to grow much faster, but there is a need to allocate those resources more effectively,” says Andrew Powell, the Principal Advisor in the IDB Research Department and coordinator of the report. If the region could increase the efficiency of how it deploys its resources to the efficiency of the US over 10 years, then productivity would be 20% higher and growth would be increased by at least a full one percent per year over that decade for the typical country.
There are many areas in which countries may wish to focus reform efforts, depending on their particular needs. Recent Bank publications have included recommendations on education and tax reforms. The 2013 Latin American and Caribbean Macroeconomic report calls for a full country-by-country diagnostic on the best ways to enhance efficiency. The report focuses on two key areas of reform that hold considerable potential to impact productivity and growth: labor market reform, and investment in infrastructure.
In those countries where informality rates are high-labor market reform should address this issue. The LAC region has very high rate of firm and worker informality, with an estimated 56% of the employed working informally. Measures to combat informality, to encourage companies to become formally registered, could lead to the establishment of larger, more efficient firms, with lower employee turnover, better worker-training, and enhanced access to credit. The resulting increases in productivity could have a large payoff in the form of greater economic growth.
The LAC region puts just 2.5% of GDP into infrastructure investment; if this were doubled annual growth could increase by as much as 2%. Higher investment requires both higher, long-term savings and a regulatory framework to attract the private sector. Current levels of savings in LAC are stuck at close to 18% of GDP while those in Emerging Asia are roughly double that figure. Countries should promote savings in domestic currency by pursuing pension, social security and tax reform. At the same time countries should work on improving regulations and institutions to attract greater investments. Public-Private Partnerships (PPPs) may be one route forward. Governments may also consider shifting some current spending into capital expenditures on vital infrastructure.
Using a model based on data from 14 countries in the region, the IDB macroeconomic research team finds that there are economic spillovers across the region, so if all countries pursued a growth-inducing reform effort then there would be a considerable boost. If a typical country could achieve an increase in annual growth of about 1.5% through its own reforms, then a region-wide effort could bump that increase to 2.3% due to trade and other interactions, lifting the projected growth in the region to more than 6 percent, somewhat higher than projected growth rates for the countries in South East Asia.
“There are also risks to the outlook for world growth,” said Powell. “And if there are bumps on the road to recovery in Europe or further fiscal policy uncertainty in the US, there also would be reduced space for monetary or fiscal responses in the advanced economies; the world could even be on the doorstep of a Great Suppression”. The report suggests that for Latin America and the Caribbean, a country-by-country, tailor-made reform agenda that is implemented across the region would be valuable to counter that risk.