Why is LatAm so dependent on commodity prices?

This year was full of ups and downs for the Latin American economy, if anything, it proved its intimate relation with the price of raw materials.

The leading argument to justify this year’s economic slowdown in LatAm is that the region’s economy came down along with the bust in the price of commodities. The truth is that the drop in the price of commodities affected LatAm in a particularly strong fashion, all because performance of the region’s economies is strongly linked to these. Why? Can we ever break away from dependency on commodities?

The main commodities which affect LatAm’s economy are usually corn, soybeans, copper and oil. The latter of which still struggles to pick up its price, with a catastrophic effect on the Brazilian and Venezuelan economies, and less notably so on others in the region.

Mauro Guillen, a professor business management at Wharton University believes that many LatAm countries have “become addicted to commodities. During the 1950s, 1960s and 1970s, they tried to separate themselves from the commodity cycle by investing in manufacturing”. This process, implemented through import substitution industrialization, eventually led to the Latin American debt crisis, or the ‘lost decade’.

Since the process of cutting themselves away from the dependency on commodities failed miserably, as their indebtedness skyrocketed, Latin America started turning to commodities once again, partly to recover financial stability and partly to restore creditor confidence to resume borrowing.

The obsession with commodities which stemmed after the debt crisis stays strong to this day, so much so, in fact, that one of the main reasons keeping commodity prices low at the moment is the sheer excess of supply in the market. The US is going strong to achieve their highest yearly corn yield in history, and in Chile, copper producer Antofagasta expects excess copper to last two to three years. The markets are simply too saturated for prices to pick up at a reasonable rate.

Additionally, Lourdes Casanova, from the Institute of Emerging Markets at Cornell University School of Management, further assures that a bounce back in the price of commodities should not be expected in the near future, as global growth has slow down on account of India and China.

In order to break away from this dangerous addiction, Guillen assures, you have to ‘invest in education and infrastructure’ as well as ‘set up a regulatory framework in such a way that you are attracting investments.’ These are long-term solutions, and Latin America has always been too eager to take advantage of momentary booms on commodity prices to strategize upon changes in the long-term.

Another important aspect Latin American governments must work upon is their response to the boom and bust of commodities. Too often do countries in LatAm take commodity price booms as a reason to increase spending beyond levels that would be reasonable under normal conditions, instead, they should take commodity price booms as an opportunity to cut back on debt and increase spending accordingly.

The silver lining to all this seems to be that some countries are already moving away from commodities and into manufacturing. Mexico leads the way, as NAFTA provided it with the regulatory tools and the incentives to develop a manufacturing sector, it also gave it freer access to huge market north of the border. Guillen also proposes Colombia as the next in line to leave commodities behind, but is not too ecstatic about the prospects in Chile and Brazil.

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