Latin American economies could fall into recession by 2030

06 October 2017 8 min. read

GDP growth in Latin America has largely been driven by improved employment rates, however demographic changes are likely to see this growth decrease in coming years, with regional economies standing to enter recession by 2030.

In line with other developing regions across the globe, Latin America has enjoyed strong levels of growth over the past 15 years. However, the steady climb in regional GDP lagged behind that of the average for the developing world.

'Where will Latin America's growth come from', a new report from management consulting firm McKinsey & Company has explored the key trends affecting growth in the region over the past fifteen years, as well as key bottle necks for future growth as changing demographics, among others, comes to affect the potential output of the region.

GDP growth per region, 2000-2015

Compared to other regions, Latin America's growth has remained relatively subdued. Over the 15 years since the turn of the century, it averaged annual growth of 2.9%. The average compound annual GDP growth for the developing world stood at 5.6% between 2000-2015, however, placing the group well below the average.

Even compared to the explosive growth seen elsewhere in the developing world, this is relatively poor. Investment in Greater China over the same spell helped the nation average 9.4% growth annually, and saw the region rocket to become one of the world’s largest economies. South Asia also burst into a spell of robust growth, averaging 6.7% annually.

Sub-Saharan Africa came in slightly below the average for the region, with 5.1%, as Africa as a whole sees equity capital markets pushing $45 billion in investment since 2012. South East Asia, meanwhile, saw growth of 4.9%. The regions closest to the growth rates of Latin America were Eastern Europe and Central Asia at 3.3%.

The developed world meanwhile, saw an estimated average growth of ~1.6%, with Australasia and North America above the mark, at 2.9% and 1.8% respectively, while Western Europe and Japan and South Korea flagged behind on 1.3% and 1.2% respectively. While these figures are significantly lower, this is in part because the respective economies are well developed, with little room for further expansion, subsequently.

Employment growth generates ~80% of GDP in Latin America

While Latin America did grow at a quicker rate than those developed nations then, the moderate growth enjoyed by the region does not tell the complete story. Much of the growth in Latin America is the result of labour input increases, rather than the expansion and development of industries, while improvements in productivity added 22% of the total growth. Productivity growth during the period stood at 0.6%, well below that of the closest comparable developing region, the Middle East, where productivity growth stood at 1.1%.

The region’s share of GDP growth varies considerably with regions such as Western Europe, North America and Asia, where productivity as a contribution to GDP growth stood at 51%, 69% and 86% respectively.

Slow productivity growth key challenge for regionIn developing countries the relationship between productivity growth and wage growth is relatively tight, with the GDP of such nations standing at 4.2% on average and developing country productivity growth at 3.9% on average.

In Latin America, the relationship followed a similar trajectory, although further apart, with GDP growth per capita at 1.6% while productivity growth stood at 0.6%. Raising this second element in the region, according to the firm, has the potential to further boost the region’s GDP growth and incomes.

The current trend of GDP growth for Latin America is likely to be unsustainable in the long-term. Demographic changes in particular will see labour growth as a share of GDP decrease in time, as birth-rates begin to fall, and as employers consider reducing workforce size as a quick route to reduced production costs and increased profits. Without a corresponding increase in productivity growth, McKinsey claim the region is likely to see GDP growth rates fall between 35-50% over the coming fifteen years.

Changes in GDP growth from changes in demographics

Colombia was projected by a conflicting study performed by Big Four consultancy PwC to be a country with a strong economic future. That study suggested that in contrast to its neighbours, whose economies have suffered from various political upheavals along with economic sanctions and punitive debt levels, Colombia’s economy had enjoyed positive growth over the past seven years. As a result, the nation was therefore said to have the potential to become not only the fastest growing nation in Latin America, over the coming decades, but to be one of the developing countries forecast by PwC to overtake G7 economies by 2030.

In McKinsey's report however, Colombia is projected to be the hardest hit region, with a 50% drop in GDP growth for the years to 2030, from 4.3% to 2.1%, as a result of a decrease in employment growth – largely due to shrinking birth-rates, which are set to fall from 2.07 children per woman on average in 2000 to 1.77 by 2050. Argentina and Brazil are also projected to see significant dents in their respective GDP growth potential, with both countries offering low productivity growth rates to 2030 while employment growth is set to halve.

The Brazilian economy is currently thought to be in a state of stabilisation. Although incumbent President Michel Temer faces domestic criticism, with his administration labelled a “coup government” by opposition parties having been in office for a year without winning an election, corporations have treated his term in office as a major opportunity, following his pledge for a sustained period of major privatisation. However, Temer himself currently faces charges of corruption after a court decision at the end of June 2017, and so a continued spell of crisis, arising out of this, meaning a further downturn in the nation's economy by 2030, would perhaps not come as a surprise.

Peru is by far the most insulated from demographic changes affecting the region. The country remains out ahead in terms of productivity growth – at 3.2% on average – while employment growth will fall less steeply than in other regions, from 2.1% to 1.6%.

Latin American productivity by sector relative to the USWhen considering productivity in the wider Latin American economy relative to that of the US, the research meanwhile reveals that professional services firms are the most productive components of the economy, although still well below that of US counterparts, at 46%. Construction follows at around 34%. Manufacturing, trade and tourism and transportation are, however, found to be relatively weak with respect to US counterparts, at around 26%. Around 40% of the work force works in employment that is significantly unproductive. One segment stands out is the mining industry, which is close in productivity to that of the US.

Seeking further foreign manufacturing investment to up productivity in the economy may only exacerbate the situation however. According to figures published by the World Economic Forum (WEF) ahead of their annual meeting in Davos in 2016, Latin America remains the world's most unequal region, with governments across the region desperate to attract multinationals from overseas granting overly generous discounts on income tax rates. The effective tax burden for multinational companies was subsequently found to be roughly half that of domestic firms.

The WEF also cited massive rates of tax avoidance and evasion on the South American continent as a crippling burden on the growth of nations' GDPs. The Economic Commission for Latin America and the Caribbean (ECLAC) meanwhile estimated that evasion and avoidance of personal and corporate income tax cost Latin America more than $190 billion, or 4% of GDP, in 2014. With an unelected government in Brazil presently ramping up tax cuts and cutting public spending in infrastructure, while pro-market and anti-tax changes in government seem set to continue across the region, this is a disparity which remains unlikely to be addressed, suggesting McKinsey's predictions of falling GDP may well be prescient.