By Eric Parrado, IDB Chief Economist
WASHINGTON, United States, Thursday April 18, 2019 – Even in the best of times, the economies of Latin America and the Caribbean struggle to grow fast. The outlook just got darker. We estimate the combination of slowing U.S., Chinese and European economies – plus a potential financial shock – would slow annual GDP growth from a baseline of 2.5 per cent in 2019-2021 to just 0.8 percent. Surprisingly, an additional shock related to Brexit could pile on negative impacts.
The region faces real risks, with higher interest rates, less capital flowing in and tight fiscal space. It is imperative that the region find ways to boost growth from within.
This is not new, of course. Challenges in boosting productivity through everything from tax to labour market reforms have been widely analyzed. There is one low-hanging fruit that is less understood: the need for more and better investment in infrastructure.
Latin America and the Caribbean invests too little in comparison to other regions, but also in relation to the region’s need to close large infrastructure gaps. The region ranks below all major regions, except Sub-Saharan Africa, in infrastructure quality. We have found deficiencies in crucial sectors like energy and transport when compared to advanced economies.
The challenge is to reverse this situation and support economic growth by raising productivity. The gains might be enormous. Our estimates show that if countries can increase infrastructure investment enough to close the gap with OECD countries, then overall productivity could grow by 75 per cent with respect to the historical average. This means the region’s income per capita could double in almost half the time.
The question is how infrastructure can be improved in a moment of high debt levels and tight fiscal budgets, a moment in which governments lack resources for public investment. A promising alternative is private investment. There are many private funds looking for yields above the international interest rate, and infrastructure projects can be a useful outlet for those funds considering the profile of risk and return. What is missing are ways of connecting the available supply of global financing with local demand.
Unfortunately, many countries in the region lack suitable frameworks to identify, select and develop complex infrastructure projects that combine public and private resources. And there is not yet an asset class that would help provide financing for infrastructure at different stages of the project’s life cycle. One step in the right direction is to attract institutional investors like pension funds, insurance companies and sovereign wealth funds that have the available resources and match them to projects that meet their need for long-term returns for their investments.
At the national level, countries could establish funds that issue infrastructure bonds to attract institutional investors. The proceeds would be invested in project-level Special Purpose Vehicles (SPVs), perhaps refinancing loans extended by commercial banks for the construction phase. Project risks would be carefully analyzed and managed. Our study goes into more detail how to resolve financing bottlenecks.
Investing better is the key to higher growth. This means directing investment to those infrastructure projects that best close gaps impacting productivity in other sectors of the economy, particularly in those with high growth potential.
We also found that failure to invest more in infrastructure hurts the poor the most, likely because they spend more of their income on infrastructure services. Without the necessary investments, households in the lower 40 per cent of the income distribution will lose 11 percentage points of real income over a 10-year period.
Infrastructure investments have multiplier effects on local economies and boost growth in trade partners. If a positive shock to infrastructure lifts GDP in Argentina, Brazil, Chile, Colombia and Mexico by US$13 billion from well-chosen infrastructure investments, regional growth could increase 0.5 per cent annually for three years.
Latin America and the Caribbean finds itself at a crucial moment, where growth prospects are mediocre, external risks are considerable, and domestic factors, like tight fiscal budgets, create significant challenges. Improving infrastructure is a way to help unlock the region’s potential and set its citizens on a path to greater prosperity.
Eric Parrado is Chief Economist at the Inter-American Development Bank.