Latin America Must Break The Commodity Curse

The death of Hugo Chavez, who propped up Venezuela with oil profits, is another reminder that Latin America needs to look for economic development beyond natural resources.

Aluminium mining in Brazil
Aluminium mining in Brazil

SANTIAGO - There are a lot of Latin American countries complaining about their overvalued currency, which strips them of competitively in the export market and allows their markets to be invaded by cheap imports.

One of the problems is Latin America’s built-in treasure. The region is rich in natural resources, and the current economic boom in Latin America is largely thanks to the high prices for many of the commodities that Latin America exports.

At the moment, over 90 percent of Latin Americans live in countries that are commodity exporters. That number includes Mexico, which has managed to diversify its economy but continues to rely on petroleum exports for a large portion of government revenues.

The truth is that the economic history for many countries in Latin America is closely connected to the rise and fall of commodity prices. In Ecuador, for example, there is the cacao era, the banana era and the oil era. In Chile, miners at the beginning of the 20th century rode the riches of the saltpeter (a key ingredient in fertilizers) boom, but the prices crashed in the 1920s as it was replaced by synthetic ingredients. That brought poverty and political instability to the whole country until world demand for copper brought back relative prosperity.

Latin America’s dependance on commodity exports also explains why the region suffered so little during the 2008-2009 global financial crisis. When the rich countries entered an economic recession, Latin America was able to keep growing thanks to the demand for raw materials from China.

The rise of China and other developing countries over the past decade, together with the stable demand from developed countries, has kept commodity prices shooting upward, flooding our countries with dollars. This abundance has helped the dollar become even cheaper, making imports easier. But this, of course, has made it harder to export products that are not raw materials.

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Photo Leandro's World Tour

Even if the local currency was not rising, when you can produce one raw material and sell it at a high margin, countries will often concentrate on doing just that and fail to look for other options. That situation creates a disincentive for diversification and innovation in a vicious cycle that seems destined to make us ever more dependent on raw materials.

That is the phenomenon that economists call the commodity curse. But being rich in natural resources does not necessarily mean that you have to be dependent on them. There are developed countries like Australia, Canada, Finland, Norway, New Zealand and even the United States that are also rich in natural resources but are not dependent on them. Those countries have managed to industrialize and diversify their exports.

In Australia, Canada, Norway and New Zealand natural resources make up a similar proportion of the national GDP as in most Latin American countries. But in Latin America, natural resources make up about 24% of the government revenue, while in the above-mentioned countries they make up an average of 9%.

What is it that Canada, Norway and New Zealand have that Brazil, Colombia and Venezuela don’t?

One difference is the quality of the institutions and the strength of the institutional brand, with clear rules and transparency. When there is only one big fountain of wealth, it is very tempting to siphon a little off. Strong public institutions make it harder for that to happen.

Another difference is the savings rate for income generated from the natural resources. The savings rate in Norway, for example, is 38% of the GDP, while it is only 17% in Brazil and 19% in Colombia. If income from natural resources is saved, it can be used to invest in other industries and to diversify the sources of wealth, or to insure against drops in commodity prices, which is certain to happen sooner or later. But if all of the income is spend immediately, the country will just be less rich for the next generation.

Saving means reducing public spending, something that Latin American governments have been very hesitant to do. But it needs to be done, because excessive government spending sprees always end with restrictive monetary policies that push up interest rates. That in turn attracts dollars to our markets, makes the price of our currency rise and once again makes our exports less attractive internationally.

The third difference between rich countries with large natural resource deposits and Latin America is public policies that create incentives for industrialization. Latin American countries should institute public policies that encourage development of industries that complement their natural resources. Countries that are rich in oil should develop more oil refineries, countries rich in agricultural products should develop their food processing industries, and countries with a lot of mines should focus on mining technology and consulting.

One final difference is the quality of the educational system. Students in Australia, Canada, Finland, Norway and Sweden get much higher scores on international standardized tests than Latin American students do. Our countries should institute, once and for all, real reforms that concentrate on the quality of education for our citizens.

This is all much easier to say than to put it into practice. But the problem is not what we produce, it is how we produce it. Abundance itself is a resource, and must be managed as intelligently as possible.

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