ANALYSIS: Why Latin America struggles to grow

By Noah Smith, Bloomberg News

Editor's note: This article originally analyzed sub-Saharan Africa as well as Latin America but was edited to cover only the Latin American region.

NEW YORK — The great macroeconomist Robert Lucas once uttered a memorable quote about the mystery of economic development: “Is there some action a government of India could take that would lead the Indian economy to grow [more rapidly]. If so, what, exactly?... The consequences for human welfare involved in questions like these are simply staggering: Once one starts to think about them, it is hard to think about anything else.”

In the last few decades, many poor countries have experienced bursts of rapid growth. Everyone knows about Asia, but many people believe that Latin America — as well as subSaharan Africa — have been left behind. This is false. Especially since the year 2000, countries in these two regions have been getting much richer.

Some countries, such as Argentina for example, are already at middle-income level. Others, like Ethiopia, remain poor. But almost all of these countries have seen substantial economic progress in the past 15 years or so.

However, not all growth is created equal. Harvard economist Dani Rodrik has been examining these countries closely, in order to evaluate the quality of their growth. In a new paper with Xinshen Diao and Margaret McMillan, he breaks poor-country growth down into two sources.

The first source is within-sector productivity growth. This happens when a country gets better at something, like farming or manufacturing electronics. More productive industries benefit the domestic economy too, and they also allow a country to retool in the face of shifting global demand. But if within-sector improvement is the only source of growth, it means the economy isn't doing a good job of moving resources to more sectors that create more value.

The second source of growth is structural change. This happens when the economy shifts from low-value-added sectors to high-value-added ones. An example is when the U.S. went from manufacturing clothing and furniture to building semiconductors and airplanes. Structural change is important and good, but if that's the only thing driving growth, it's dangerous, because demand shifts could undo some of the progress.

While the Asian growth story has been so strong because those countries have usually had both of these positive forces at work, Latin America has worrying deficiencies. There, most countries haven't had much positive structural change — their industries are getting better at doing what they do, but there is no movement of resources from low-value to high-value sectors.

Why do these deficiencies exist? In Latin America the big problem might be that the region isn't well integrated into the global trading system. As Mr. Rodrik notes, Latin America's manufacturing industries have gotten steadily better, but because of overvalued exchange rates and competition from Asia, relatively few countries want to buy Latin American-made products. Instead, the world has mostly been interested in using Latin America as a source of raw materials.

In order to keep growing, countries such as Brazil, Argentina and Colombia need to find some way to shift toward exporting more important and valuable products. Pushing down exchange rates might be a start. They also should focus on making their economies more flexible, to allow better reallocation of resources. That might involve reducing government protection for well-connected companies and industries.

Latin America indeed faces economic challenges — it's all about shifting resources. If it can meet those challenges, the outlook for one of Earth's poor countries will be bright.

Noah Smith is a Bloomberg View columnist. He was an assistant professor of finance at the State University of New York at Stony Brook in Stony Brook, N.Y., and blogs at Noahpinion. He also has been an economics PhD student at the University of Michigan, an academic editor in Japan and a physics major at California's Stanford University.  He can be reached at [email protected]

This column does not necessarily reflect the opinion of Bloomberg L.P. and its owners or its editorial board.