The vulnerable Latin American middle class

Patricio Navia @patricionavia

Buenos Aires Herald, April 1, 2014


As Latin America is expected to grow at a meagre 3 percent in 2014, the high expectations that millions in the region have to consolidate their recently acquired middle-class status will go unfulfilled. After several years of strong economic growth, Latin America will go through troubled times in 2014. Because the mismatch between high expectations and a less auspicious reality inevitably feeds discontent, Latin American governments should fasten their seat-belts as their countries prepare to enter choppy air.


Latin America’s historical problems have been associated with its high dependence on the world’s economic cycle. As they are export-oriented, Latin American countries do better than the world average when the cycle is positive and demand for raw materials grows fast. In recent years, demand for commodities, driven mostly by growth in China, has benefited all of Latin America. The terms of trade — the relative price of exports in terms of imports — have been positive for the subcontinent. Thus, the problems of foreign debt, so common in the 1980s, have mostly vanished as Latin Americans ran trade surpluses for several years.


The rapid economic expansion has allowed governments to better fund social programmes and to increase public-sector payrolls. Governments have made commitments to permanent funding for expanded social programmes that aim to combat poverty and reduce inequality. Not surprisingly, the abundant access to resources has helped incumbent governments stay in power in many countries. In Brazil, the Workers’ Party came to power in 2002 with Lula and is bound to win its fourth consecutive election later this year. In Argentina, the Peronists, with Néstor and Cristina Kirchner, have ruled over the longest period of uninterrupted democratic rule under a single party in the nation’s history. With the exceptions of Honduras in 2009 and Paraguay in 2012, Latin American countries have seen an unprecedented period of democratic stability.


However, when the global economic cycle turns negative, they suffer from their excessive exposure to world markets. As their exports lose value, the terms of trade become less favourable for Latin America. Often, that leads to trade deficits and forces governments to borrow abroad to finance their trade imbalances. Though currency depreciation can have positive effects as exports become more competitive, the fact that the value of imports rises with depreciation puts additional pressure on the trade balance.


The logical thing to do when the world economy takes a dive would be to introduce more fiscal discipline. However, governments are often constrained on how much spending they can cut. Those who promised pensions, social programmes, poverty alleviation initiatives, cash transfers and other entitlements take them for granted. Moreover, as the economy cools down, unemployment normally increases and the wait lists for social programmes and poverty alleviation initiatives get longer. Precisely when governments find themselves in a position where cutting spending is the most sensible thing to do, social pressures to actually increase spending rise.


In the past, governments have yielded to popular pressure and have increased spending, further eroding fiscal imbalances and digging themselves into deeper trouble. Governments tinker with fiscal policy hoping that when the winds of economic recover blow strong again, they will regain a sounder fiscal policy footing.


Naturally, adopting counter-cyclical policies during the good years would help governments prepare for the bad years. Saving for a rainy day would be the wise thing to do when the world economy is growing. Yet, given the high levels of inequality and widespread poverty in many Latin American countries, convincing voters who have always been under the rain to save for a rainy day is a tough thing to do. Thus, most governments end up unable to prepare for the inevitable down-turn that will eventually happen.


In recent years, the rapid economic growth has fed high expectations in Latin Americans. Millions have been lifted out of poverty and have joined the ranks of the middle class. Granted, it is an admittedly vulnerable middle class, but it is good enough for people to get a taste of middle-class status and it is an expectation boost for millions who want to leave poverty behind.


Nowadays, the world economic winds are no longer so auspicious for Latin America. A handful of countries, such as Chile, are moderately prepared for the rainy days, but most countries are ill-prepared. As their economies slow down and millions begin to realize that their high expectations will not be fulfilled, social and political discontent will increase. Those who have joined the ranks of the middle class will resist being thrown back down below the poverty level. They will put pressure on their national governments to provide them with a safety net precisely when governments will be most constrained to increase social spending.


The road ahead will not be smooth. The old story that Latin America suffers from a permanent pro-cyclical condition will once again emerge as a shocking reality for millions of Latin Americans.