Latin America will return to its old ways once the commodity boom comes to an end.
BY WALTER T MOLANO
As bankers, investors and government officials decamp for the snowy streets of Calgary to attend the 52nd annual Inter-American Development Bank Annual Meeting, there is a brimming sense of self-confidence in the frigid artic air. Latin America has not been as prosperous for more than seven decades.
The former backwaters of poverty, such as Brazil, Colombia and Peru, are now shining stars in the constellation of hot investment destinations. The airports of Santiago, Lima and Bogota, which were once full of arriving aid-workers, intrepid businessmen and fleeing refugees are now thronged with middle class families either deplaning to savor Latin America’s natural wonders or departing to visit the top destinations of the world. The region is a flurry of consumption, with armies of international retailers and luxury brands setting up shop. Fleets of new cars cruise the streets and byways of Latin America. Meanwhile, endless tracts of new homes are providing people with the latest in technology and taste. Amid all of this confidence, there is a feeling that Latin America has come into its own.
AFTER THE BOOM
Yet, when one takes a closer look past the new malls and building cranes, there is a sinking sensation that nothing’s changed. Despite all of the swagger and braggadociosness, the reality is that Latin America will return to its old ways once the commodity boom comes to an end.
Why such a pessimistic view? The answer is that, while the region enjoyed a very good party for the past few years, it did little to improve productivity. Total Factor Productivity (TFP) measures the change in output that is not caused by inputs. In other words, they are the increases in economic activity that were not produced by changes in labor and capital. TFP is a measure of a country’s ability to gain more efficiency through the better use of infrastructure, technology and education. Unfortunately, Latin America’s TFP remains a fraction of the U.S. A 2010 book published by the IDB, The Age of Productivity, showed that Chile was the Latin American country with the highest TFP. However, it was only 76 percent of the U.S.’s total factor productivity. Argentina’s was 63.5 percent, Mexico’s was 58 percent, Brazil’s 57 percent and Colombia’s 56 percent. Peru was really far behind, with only 37 percent of the U.S.’s TFP.
There are many reasons for the region’s low level of productivity. First, there is the poor infrastructure. The quality of a transportation grid plays an important role in allowing companies to effectively receive inputs in a timely manner and get their products to market. Latin American roads, railroads, ports and airports are horrible.
Another problem is the high concentration of small firms. In the United States, 54 percent of the firms have less than 10 employees. In Argentina, it is 84 percent and in Mexico 90 percent. The problem is that small firms often lack the capital necessary to secure the technology needed to boost the output of labor. In Latin America, firms with more than 100 employees often generate twice the output of those firms with a tenth of the staff. A third problem is the relative size of the service sector. Approximately, 61 percent of the labor force is employed in the non-tradable sector, confirming the insularity of Latin America.
The last two issues are access to credit and tax regimes. Although large and medium-sized firms have good access to credit, it is more difficult for smaller institutions. Likewise, Latin American tax regimes are known for their complexities, sapping company resources and forcing many firms to go into the underground economy.
SHORT TERM GAINS
In the short run, the surge in commodity prices and the appreciation of currencies is boosting living standards across Latin America. However, the region’s ability to squeeze more output out of its factors of production is the only way that it will be able to permanently increase wages. Most people believe that the global reintegration of China and India is producing a permanent shift in the demand for commodities. However, it is also making the region much more vulnerable to the vagaries of the Asian business cycle. Likewise, the Asian building boom will eventually come to an end, reducing its insatiable appetite for natural resources. Whenever this occurs, Latin America will come to a rude awakening. It will realize that the consumption boom did nothing to improve the region’s ability to sustain high levels of economic growth.
Unfortunately, this is not the first time that this phenomenon occurred. The empty shells of turn of the century mansions dot the various shorelines, jungles, deserts and altiplano of Latin America as grim reminders of previous times of high commodity prices, unimaginable wealth and forsaken opulence.
Walter Molano is head of research at BCP Securities.