Life after the commodity boom

ONE morning last month Louis Dreyfus, a big commodity-trading house, formally opened a new $10m storage depot i...

ONE morning last month Louis Dreyfus, a big commodity-trading house, formally opened a new $10m storage depot in the Peruvian port of Callao. Two of its six bunkers were piled high with 55,000 tonnes of fine brown dust covered by white tarpaulins_copper and zinc concentrate, awaiting blending and shipment. The warehouse is _a bet that Peruvian mining will continue to be competitive,_ says Gonzalo Ram__rez, a Dreyfus manager. That looks like a sound wager. Blessed with high-grade ores and cheap energy, Peru_s output of copper_already the world_s third-largest_will more than double in the next three years (see article), thanks to the opening of several low-cost mines.

But rather than marking a new dawn, this burst of investment comes at the twilight of the great commodity boom occasioned by the industrialisation of China and India. By providing an unprecedented boost to the region_s terms of trade (the ratio of the price of its exports to that of its imports), this handed many Latin American countries a bounteous decade

No longer. Oil and gas excluded, commodity prices are down by a quarter from their level of 2011, with prices of minerals falling by more than those of foodstuffs. After growing by an average of 4.3% in 2004-11, the region_s economies managed just 2.6% last year. Hopes of acceleration this year are being dashed. Brazil has had to raise interest rates sharply to contain inflation, and is unlikely to beat its 2013 growth of 2.3%. Mexico, although less commodity-driven than South America, is unlikely to do much better. Data suggest that Chile is growing at its slowest rate for four years. Even Peru, along with Panama the region_s star economy of the past decade, felt the cold draft: it expanded at 5% in 2013, down from an average of 7% since 2005.

To make matters worse, moves towards normal monetary policy in the United States have prompted jitters in Latin American financial markets since last May. Doomsters say that having squandered the boom in a consumption binge, the region_s traditional economic frailty will now be exposed as commodity prices fall.

The picture is more nuanced than that. Latin America saved and invested more of its windfall than in the past (though less than other parts of the world did), says Alejandro Werner, the IMF_s leading official for the region. The World Bank_s chief economist for Latin America, Augusto de la Torre, points out that the investment rate in the region, at almost 25% of GDP, has at last caught up with that in South-East Asia (though Brazil, at 18%, is a laggard).

Most countries have paid down debt and accumulated reserves; their banking systems are less dollarised than in the past. Floating exchange rates and inflation-targeting by more-or-less independent central banks mean that many countries can adjust by allowing their currencies to depreciate without triggering a downward spiral of inflation and devaluation.

Some countries have been less responsible than others. Venezuela, with a fiscal deficit of 12.5% of GDP last year, is paying the price of squandering its oil windfall. Argentina is moving towards more orthodox policies, and may just avoid disaster. There are a few caveats elsewhere, too. Having used fiscal stimulus to counteract the 2008-09 financial crisis, some governments (notably Brazil_s) were slow to tighten again. Santiago Levy of the Inter-American Development Bank notes that the region_s structural fiscal balance is better than in 1997 but worse than in 2007.

He also worries that currency depreciation could catch out Latin American companies that took advantage of cheap money to issue bonds abroad. The stock of corporate bonds that is vulnerable to depreciation risk in five larger economies (Brazil, Mexico, Colombia, Chile and Peru) amounts to $200 billion, he reckons.

The biggest threat to financial stability is a sharp slowdown in China. Miguel Castilla, Peru_s economy minister, notes that commodity prices are still above their average of the past ten years. Were China_s growth rate to dip below 7%, that would soon change. But he stresses that Peru, like Chile and Colombia, has scope to respond with fiscal and monetary measures.

More than economic instability, the worry for Latin America is low growth_the risk that 3% has become the new norm. Mr Werner notes that the halt in the rise in the region_s terms of trade has itself knocked a percentage point off growth. With full employment, and with the labour force and domestic credit both expanding less rapidly, Latin America must look more to productivity improvements to boost GDP. And that is its Achilles heel.

Productivity has improved a bit, but still lags behind Asia_s (see chart 2). The reasons for this shortfall date back many years. Although Latin Americans have more education than in the past, international tests show that they still do not learn enough in school. Mr de la Torre points, too, to a relative lack of innovation by Latin American firms of all sizes, to poor transport networks and to a lack of competition, especially in services.

Another big handicap is the large informal economy. In Peru, no less than 61% of the workforce works in the informal sector, according to the statistics agency. _It was an escape valve when Peru was a poor country, but it_s a problem now,_ says Piero Ghezzi, the minister for production.

To see why, take Mexico, where around half the workforce is informal. A new report by McKinsey, a consultancy, finds that, astonishingly, Mexican workers have become less productive over the past three decades despite numerous economic reforms. Output per worker fell from $18.30 an hour (in purchasing-power-parity terms) in 1981 to $17.90 in 2012.

The reason, McKinsey argues, is that Mexico has a dual economy. Productivity at large, modern firms, which are integrated into the world economy, has risen by 5.8% a year since 1999. But the productivity of small businesses (with ten or fewer workers), many of which are informal, declined from 28% of that of large firms (with 500 or more workers) in 1999 to just 9% in 2009. And small firms account for a big (42%) and growing share of the workforce.

Fixing the productivity problem is far more complicated than slashing the fiscal deficit. Assembling land, permits and finance for infrastructure projects can take many years in Latin America. Education reforms take a similar time to have an effect. Informality is a complex issue, as much cultural as economic.

But governments can no longer afford to put off reforms indefinitely. The risk the region faces is not the financial crises of old but rather the clash between low growth and the aroused expectations of growing middle classes. As the mass protests last June in Brazil suggest, it is a clash that could be politically explosive.

the Economist

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