Growth in Latin America and the Caribbean has weakened significantly over the last few years. Part of this weakness appears to be here to stay, and IMF economists have marked down medium-term growth projections. This story sounds eerily familiar, given the region’s past difficulties to improve its comparative growth performance.
Abstracting from the “golden decade” from 2003 to 2011, when rising commodity prices powered a strong expansion, why has the region been unable to sustain sufficiently high growth rates to catch up with more advanced economies? Part of the answer is Latin America’s modest success in branching out into more sophisticated—or complex—goods.
A complex factor
Recent research led by Ricardo Hausmann and Cesar Hidalgo has put forward the concept of economic complexity as a key determinant of long-term growth and development. Economic complexity is meant to capture the productive knowledge of a country, as inferred from the breadth and sophistication of goods that a country exports. More complex economies tend to export a wider range of goods, and these goods tend to be more sophisticated. Given Latin America’s considerable reliance on commodity exports, it is tempting to think that lack of diversification and complexity is a major roadblock to stronger growth.
What does the empirical evidence say about this argument? Is the region actually less complex than others? How big a handicap is this? And what can be done about it? We analyze these questions in our latest regional outlook.
Consistent with Hausmann’s main hypothesis, more complex economies on average have higher levels of income per capita. Data also show that Latin America and the Caribbean are far less complex than advanced economies or the newly industrialized Asian economies, which arguably represent the most successful examples of economic catch-up and development over the past four decades. In addition, complexity has been stagnant or trending down in Latin America and the Caribbean since 1970, although the region looks no worse than the broader group of emerging economies.
Do these complexity statistics simply reflect current levels of prosperity, or can they tell us anything about future growth trends as well? Research by Hausmann and coauthors suggests that complexity indeed helps to predict long-run growth of GDP per capita. We have revisited this issue, considering several econometric extensions and using a large panel of more than 100 countries between 1970 and 2010. Our results confirm the importance of complexity as a predictor of long-run growth, alongside other relevant variables, such as demographics, commodity exports, and indicators of macroeconomic stability.
We then applied these results to gauge the quantitative implications for different countries in Latin America and the Caribbean. The variation in complexity levels observed across the region can account for differences of almost a full percentage point in annual per capita growth. In other words, if we abstract from other determinants of growth, the most complex economies in the region (like Mexico and Brazil) would outpace the less complex ones by a full percentage point every year.
However, the growth dividends from complexity can be offset by other variables. For instance, each year of macroeconomic instability can reduce GDP per capita growth by a cumulative 2 percentage points over the course of a decade. Higher dependency ratios can also meaningfully reduce growth, which draws attention to the demographic trends in the region over the coming decades.
What are the policy implications for Latin America and the Caribbean from our findings and the related literature?
- Complexity matters for long-term growth, but increasing it alone is not sufficient. In particular, policymakers will also need to maintain their focus on preserving macroeconomic stability.
- Swift progress on structural reforms should remain a priority. Latin America and the Caribbean continue to lag behind in several policy areas closely associated with economic complexity (infrastructure, education, and market openness). Faster progress in these areas represents the most natural way to support higher complexity and growth.
- Meanwhile, a renewed push for activist development policies needs to be handled with caution. While the discussion of new strategic approaches in this area is welcome, a more systematic understanding about the costs and risks associated with such policies is necessary before scaling them up. Indeed, earlier experiences with industrial policies send a cautionary note, especially for countries in which governance and institutional quality are still lagging behind.
- Even so, complexity research can help countries to better understand their comparative advantages and assess the potential for knowledge upgrading. Insights gained from cross-country data could be used, for instance, to inform trade and investment negotiations in ways that best leverage a country’s knowledge base.
In sum, complexity appears to be an important determinant of long-run economic growth as well as a useful lens through which to analyze the development of countries’ productive capacity.
Filed under: Advanced Economies, Asia, Economic outlook, Economic research, Emerging Markets, Employment, Finance, Financial Crisis, Fiscal policy, Government, growth, IMF, International Monetary Fund, Latin America, Reform Tagged: | Brazil, Caribbean, commodiity prices, commodity exports, education, infrastructure, investment, Latin America, macroeconomic stability, Mexico, Regional Economic Outlook: Western Hemisphere, trade