Hugo Chavez, who died on March 5, lavished the Venezuelan people with oil earnings for more than a decade. As in so many other Latin American countries, natural resources were used to prop up an economy characterized by a plethora of imbalances and economic contradictions. Part of Latin America’s problem lies in its generous natural resources endowment – let’s call it the “commodity curse.” The region abounds with natural resources and the current Latin American countries’ economic boom can largely be attributed to the high prices of natural resources and other commodities that they exports. Currently, over 90% of Latin Americans reside in countries that are mostly commodity-dependent exporters. This figure includes Mexico which, despite having achieved remarkable success in diversifying its exports, still depends on oil export to finance the lion’s share of its state budget.
The undulations in the economic development of many Latin American economies are strongly correlated to the rise and fall of commodity prices. The economic history of Ecuador, for example, is highlighted with a cacao era, a banana era and the current oil era. The Chilean economy in the early years of the 20th century rode a high wave demand for nitrate of soda (a key ingredient in completed fertilizers), but prices collapsed in the 1920s as it was taken over by synthetic ingredients. This sudden change impoverished and destabilized the country for a little more than a decade until the global demand for copper went up. Another commodity-induce growth cycle was set in motion and brought relative prosperity to Chile.
Latin American countries’ reliance on commodity exports also accounts for the low turbulence in the region in the wake of the 2008-2009 global financial crisis. As the highly industrial countries were spiraling into a major recession, many Latin American economies continued to grow at impressive rates in some cases thanks to the ever-increasing Chinese demand for raw materials.
The booming Chinese economy and strong economic performance in the so-called emerging countries in the past decade, coupled with stable demand in developed countries, have pushed prices for most commodities through the roof, flooding Latin American states with dollars. This situation has helped keep the value of the dollar relatively low, facilitating imports, on the one hand, but making it harder for exporters of manufactured goods and services, on the other.
Even if in many countries the value of the national currency was not rising, they opted to keep on producing a single commodity and sell it with high profit margins instead of looking for other trading options. Such a policy is a disincentive to trade diversification and technological innovation and maintains Latin American economies in a vicious cycle that seems to condemn them to remain ever more commodity-dependent and uncompetitive.
Economists have comprehensively review all aspects of this phenomenon and even dubbed it “commodity curse.” However, being well endowed in natural resources is not necessarily synonymous with commodity-dependence and low industrial and technological development. Developed countries like Canada, Norway, Finland, Australia, New Zealand and even the United States are also rich in raw materials but their overall prosperity is not contingent on one or a combination of commodity products. Their governments and policymakers have made sustained industrialization a priority and diversified their exports away from predominantly raw material. The ratio raw materials export to GDP in Australia, Canada, Norway and New Zealand is similar to that of Latin American countries. Yet Latin America’s commodities make up about 24% of total revenue, compared with 9% in those four developed countries.
What are the main differences between industrialized Canada, Norway and New Zealand and emerging Brazil, Colombia or Venezuela?
One difference is the general efficiency and transparency of political and economic institutions in the “First World.” In their book Why Nations Fail, The Origins of Power, Prosperity and Poverty, published in March 2012, Daron Acemoglu and James Robinson have convincingly demonstrated that solid political and economic institutions (in brief, governance) are among top determinants of economic success and long-term development. In most Latin American countries, local elites have used all kinds of illegal operations and use financial and political trickery to appropriate for themselves a large share of the wealth at the expense of the people. When there are only a few – sometimes only one – sources of wealth, the temptation for local elites to siphon it off is irresistible. Strong public institutions and the rule of law act as an effective brake on this kind of behavior.
Another difference lies in the savings rate for income earned from natural resources exports. In Norway, for example, the savings rate is reported at 38% of GDP, while it is 19% in Colombia and17% in Brazil. Latin American governments are slow at setting aside funds that can be invested in the secondary or tertiary economic sectors and/or used as a cushion against drops in commodity prices, which are sure to happen at some point or another. If income is spent immediately and without planning, political leaders will leave a poorer country with fewer possibilities to the next generation.
In order to save public spending must be reduced, something that Latin American governments are reluctant to do. But the bull must be taken by the horns, as excessive public spending always result later in contractionary monetary policies which push up interest rates. That in turn lures dollars to money and stock markets, driving the value of regional currencies up and once again making Latin American exports less attractive on international markets. Many Latin American countries complain about how their currencies are overvalued, which has the effect of reducing their competitiveness on world markets and facilitating the flood of cheap imported products.
The third difference between commodity-rich countries having achieved the highest level of human and social development and Latin American countries is that the former have persistently created incentives for industrialization. Countries that have substantial oil deposits should build more oil refineries and petroleum-based industrial complexes; countries with diversified agricultural products should expand their value-added food processing industries; countries exploiting a lot of mines should invest in mining technology and consulting services.
The fourth difference is in the quality of education. Latin American students are always somewhere near the bottom ranks on international standardized tests, while Australian, Canadian, Finnish, Norwegians and Swedish students get much higher scores on these same tests. There is an urgency to finally implement education reforms across almost all Latin American countries, so that the quality of future workers will greatly contribute to economic development.
This is much easier said than done. The main issue is not what the South American continent produces, but how it produces. An abundance of natural resources is a blessing, but governments must make the most of it more wisely.
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