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LAC's Long-Term Growth Requires more than Current China Links

September 20, 2011

Region Remains Steady in Midst of Global Turmoil

Washington D.C., Sept. 20, 2011 – Robust growth over the past decade in Latin America and the Caribbean (LAC) has had one new, key driver: China. The region’s relationship with the Asian giant has proved to be a critical source of stability, both during the global economic crisis of two years ago, the greatest since the Great Depression, and even the current market turmoil that is rolling across Europe and the United States.

So far growth forecasts for LAC have remained positive between 3.5 and 4.5 percent for 2011 and 2012 and inflation rates are expected to stat between 6 and 7 percent this year. Perceptions of sovereign risk continue to be relatively low for the region. In fact, in an unprecedented development, markets now perceive that the sovereign debt default risk of several countries in LAC—including Chile, Colombia, and Peru—is lower than that of France.

While the consequences of the current global uncertainties are largely out of the region’s control, it is no time to remain idle. One central question for the region today is whether it can make the most of its relationship with China to turn its recent vigorous recovery into sustainable robust growth for the future. To better understand such prospects, the World Bank’s Chief Economist’s Office for the region has issued a new report, Latin America and the Caribbean’s Long-Term Growth: Made in China?

The study takes an in-depth look at the China-LAC relationship, particularly as it compares to Japan’s interactions with East Asian economies from the 1970s to the 1990s. The report concludes that China’s role in Latin America will need to adapt and evolve if it is going to have a lasting, positive impact.

“There is little evidence that China can play a role in fostering productivity growth for Latin America and the Caribbean,” according to the World Bank’s Chief Economist for the region, Augusto de la Torre. “In this new context of lackluster economic performance in the U.S. and Europe, one key question is whether LAC can leverage its deepening connections with China and turn it into an important source of long-term growth.”

The golden years of the East Asian Tigers were characterized by large flows of intra-industry trade and foreign direct investment from Japan, with significant distribution of technology and knowledge more broadly. The first decade of China relations with Latin America have lacked much of that promising exchange.

China has become the principal trading partner for some large LAC countries. Trade between China and these nations, has revolved around the exchange of the region’s abundant natural resources for low-tech goods from China that are labor-intensive to produce. This type of trade typically limits the potential gains from technology and knowledge sharing.

That is not to say that there have been no gains from the commodity boom in the region, the report emphasizes. Some bright spots show that certain commodity sectors in LAC are benefiting from technological innovation and generating local, quality employment. Extensive networks of local businesses in Peru and Chile, for instance, are benefiting from their ties to mining extraction and salmon farming, respectively, while agricultural producing countries in the Southern Cone have showed new technology deployment and productivity gains.

Until these favorable conditions become more widespread, however, it is difficult to expect that the region will finally begin narrowing the gap with advanced nations. LAC’s growth performance over the 20th century was rather dismal – with per capita income remaining largely steady at 30 percent of the U.S. In contrast, East Asian countries saw their per capita income, which was only about 15 percent that of the U.S. in the 1960s, rise sharply and steadily to reach more than 70 percent of the U.S. by 2010.

The very fact that the region is confronted at this stage with inflationary pressures arising from strong economic activity is a clear reminder that the region tends to bump against “structural speed limits” at comparatively low growth rates.

While the high-performing economies of emerging Asia can sustain annual growth rates in the 6-9 percent range without inflationary consequences, in most of LAC the non-inflationary growth rates that can be sustained over long periods hover below 5 percent.

Some of the factors that help explain these differences in growth potential include:

  • LAC’s road density has declined 15 percent since the 1980s, while it has expanded 30 percent in the Asian countries.
  • LAC’s electricity installed capacity was about 17 percent below that of the Tigers in the 1980s. Now it is almost 50 percent below.
  • LAC’s percentage of population with tertiary education has risen from 9.5 percent in 1990 to 14.2 percent in 2009, but it pales relative to the Tigers, which has gone from 10 to 20 percent in the same period.

On the other hand, De la Torre explains “LAC has developed vibrant democratic systems that in the long term can contribute to ensure that progress in these key areas is sustainable.”

In addition, some of the key external conditions to raise LAC’s growth rate sustainably above the world’s average are in place: large and growing countries with strong demand for LAC exports; high commodity prices; and low world interest rates. Seizing the opportunity on this favorable environment will require a well-designed and adequate policy mix that maintains macro-financial stability while fostering productivity, the report concludes.

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