Latin America’s Commodity Windfall

BUENOS AIRES – Latin America is experiencing an exceptional boom, owing to soaring income from exports of natural resources. But is the region making the most this opportunity? Have these funds been used as effectively as possible?

With the exception of Central America , rising commodity prices have improved the external accounts and fiscal positions of Latin American countries. Revenue from natural-resource exports represented 25% of total income in the public sector in 2008. In Venezuela , Bolivia , Ecuador , and Mexico , it exceeded 40%. This comes to around 7% of GDP in these countries (more than 11% in Venezuela and Bolivia , and 8% in Ecuador and Mexico ).

To determine what should be done with this windfall, it is important to know whether the increase in commodity prices is likely to be permanent or transitory. If the latter, the best course of action would be to save the additional income or use it, as a second-best option, to reduce the national debt. If the increase were considered permanent, however, it would make sense to increase spending or reduce tax pressure.

The choice will depend on the characteristics of the country. There would be more reason to reduce taxes in Norway , for example, than in Latin America , where the general course would be to increase spending.

It is reasonable to presume that the commodity boom’s positive effect on Latin America’s terms of trade will last for an extended period – perhaps 10-15 years – but that it will not be permanent. Moreover, it could be argued that if more knowledge is not added to exports, it will be hard to achieve sustainable economic development based on natural resources.

Given this, it would be wise to spend at least part of the windfall on improving the capacity to innovate, which is essential for a long-term growth beyond the fluctuation of international commodity prices. That means investing in education and building incentives to increase productivity through changes in products, processes, or organization.

So what happened to the additional revenues derived from the commodity boom of recent years? Some of these funds were aimed to improve countries’ fiscal balance. While the primary deficit (before interest payments) in 2002 was similar among countries with and without important natural resources, in 2007, the former showed a surplus equivalent to 3.8% of GDP – compared to 1.6% of GDP for non-commodity-exporting countries.

As a result, public debt fell to 28% of GDP region-wide in 2008, from 51% in 2003. Fiscal consolidation was not, however, the result of formal fiscal rules. While several countries established legal limits to control spending, deficits, and debt, in some cases –for example, Argentina , Ecuador , and Venezuela – such laws were not enforced.

In addition to reducing debt, Chile used its additional revenues to increase the resources of two fiscal funds: when the recession began, there were more than $22 billion in assets in both funds. Despite imprudent fiscal management, Venezuela , too, maintained considerable resources in specific funds ($11 billion at the end of 2008). Ecuador and Colombia , by contrast, eliminated their stabilization funds in 2005 and 2008, respectively.

Beyond improving public accounts, a large part of the revenues from high commodity prices were used to increase public spending, although this proportion varied from country to country. At one extreme stands Argentina , with the largest increase in public spending relative to GDP in Latin America (almost ten points). At the other extreme are Chile , Costa Rica , and Uruguay .

Since there is no attribution in countries’ fiscal accounts of income from products linked to natural resources, we can only hazard a reasonably informed guess about how that spending was allocated. Between 2001-2002 and 2007-2008, social-welfare spending in countries with abundant natural resources increased by around 55% in real terms, with spending relative to GDP rising by nearly 3.5 percentage points. Therefore, on a regional level, a large part of the additional resources were used to increase public spending, especially for social security, health, and education, in that order.

In some countries there were also increased subsidies. Argentina , for example, increased subsidies for energy and transport to the equivalent of 3% of GDP. Something very similar occurred in Ecuador and Venezuela throughout the decade. In contrast, spending for other objectives – for example, research and development on new products and processes – increased very little.

In short, Latin American countries have used their additional export revenues to pay down debt and increase social spending. Both were necessary, but, with few exceptions, the region is not using the commodity windfall to do what it must: improve technological capacities sufficiently to ensure that future economic growth does not depend entirely on the fickle furtunes of finite natural resources.

José Luis Machinea, former Executive Director of the Economic Commission for Latin America and the Caribbean (ECLAC) and former Minister of Economy of Argentina, is Dean of the School of Government, Torcuato Di Tella University, Buenos Aires.

Copyright: Project Syndicate, 2011.
www.project-syndicate.org