Global economy supplement: South America's shift

The year 2015 may prove to be a humbling one for South America. In the next 12 months, there will be elections in Bolivia, Uruguay and Argentina, and many incumbent parties will win re-election—just as in Brazil’s recent election. Politicians are still benefitting from the effects of external economic trends, which in the 10 years leading up to 2013 delivered something of a golden decade for the continent. But that trend is set to change.

Economic growth in Asia during the 2000s and the expansive policies in China and the United States following the financial crisis, led to a unique combination of commodity price strength and low interest rates. This boosted growth in the so-called “Brazilian Cluster” of South American nations: those countries that are net exporters of commodities to other emerging economies and which have limited trade links to developed markets. By contrast, the so-called “Mexican Cluster” of nations—those dependent on trade with developed countries and which are importers of commodities—fared less well. Now, as US growth improves and commodity prices decline, there is likely to be a reversal of fortunes between these two clusters.

The eurozone is trying to head off deflationary pressure, the US is beginning to move towards interest rate normalisation and China is attempting to develop a more service-oriented economy—all of these factors are slowing demand for commodities and Latin America will feel this reduction in demand. The region only has itself to blame. A decade of unique external circumstances led to strong growth and substantially improved social conditions. But governments failed to capitalize by conducting institutional reform, or forging effective regional trade agreements; governments were even weaker on educational reform, and on increasing investments in technology.

Now, US-linked economies (such as Mexico and Colombia) are set to perform better than Asia-linked countries (such as Chile, Peru, and Brazil)—without a recovery in Asian demand, the outlook is dim for these latter nations. In a way, the pattern of the two-speed global economy is replicated in South America. Argentina suffered from high-profile financial disorder during 2014 and its overextended social spending acted as a drag on growth. Venezuela’s political and economic outlook is even more uncertain, as the austerity measures necessary to compensate for lower oil revenues would require strong social and political support.

The case of Bolivia stands out, not only for the government’s tight control of public finances and inflation, and its strong balance of payment situation, but also for the unexpected rise in foreign investment after the partial nationalisation of its energy sector. Paraguay has also enjoyed the benefits of being financially insulated from global markets and an improving business climate.

The region has enjoyed easy credit conditions on account of generous monetary policies by central banks in developed economies. But changes in those conditions have left some South American countries—Venezuela, Argentina and recently Brazil—with little room for manoeuvre. These nations have undergone a deterioration of their fiscal balances.

There are social consequences for this, as the conditions enjoyed during the golden decade, characterised by economic wellbeing and social mobility, come under threat of decline, notably again in Venezuela, Argentina and Brazil. Although, until now, inertia has been enough for incumbent parties to win re-election, they will find it increasingly hard to maintain their strong appeal.

As employment levels are high and excess capacity is limited, there is little scope for a pick-up in growth without generating further macroeconomic imbalances. Unless the rest of the continent carries out the kinds of structural reforms seen in Mexico and Colombia to promote competitiveness, economic performance could continue to disappoint, which would in turn put at risk the region’s social advances.

In the short term, productivity weakness must be tackled, or else there is a risk that South America’s so-called “golden decade” will come to be seen as an anomaly, after which the region will sink back into former levels of long-term weaker growth. Hopefully, the expected recovery in developed economies will allow Latin America to avoid a toxic combination of lower growth and social unrest.

The time has come to lift growth the harder way, via increased investment—and in South America, not everyone will be able to take the strain.