Part of a continuing series on how Latin America can overcome a decade of slow economic growth.
If you’ve waited for that big file to download or had your goods take weeks to clear customs, you’ll understand how infrastructure holds back economic growth in Latin America and the Caribbean. The logistical costs in the region are double those of advanced countries in the OECD.
To compete in the global economy, the region desperately needs better roads, ports and energy grids. The urgency is even greater now. In the best of times, the economies of Latin America and the Caribbean struggle to grow. Our main forecasting scenario at the Inter-American Development Bank (IDB) estimates the combination of slowing growth in the U.S., China and Europe – plus a potential financial shock – could reduce annual GDP growth from a baseline of 2.5% in 2019-2021 to just 0.8%. An additional shock related to Brexit could pile on the negative impacts.
The region faces real risks, with higher interest rates, less capital flowing in and tight fiscal space. It is imperative that countries find ways to boost growth from within – in that, infrastructure will be a critical growth engine.
For starters, the region invests too little. We believe the infrastructure investment gap amounts to 2.5% of GDP, or $150 billion per year. It also lags in quality, ranking fifth out of six regions, only ahead of Sub-Saharan Africa. 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% of income distribution will lose 11 percentage points of real income over a 10-year period.
The question is how infrastructure can be improved amid high debt levels and tight fiscal budgets. A promising alternative is private investment. There are many private funds looking for more attractive yields. 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.
Policymakers know they need to invest more in infrastructure, but not necessarily in what kind of infrastructure. Should they roll out more fiber optics or build better sanitary systems, or some combination of both? Splurging on the wrong kind of infrastructure can do economic harm.
The interplay between economic growth and infrastructure is the focus of our latest Macroeconomic Report, Building Opportunities for Growth in a Challenging World. We looked at how Argentina, Bolivia, Costa Rica, Chile, Jamaica and Peru invested in energy, transportation, telecommunications, and water and sanitation. We found that, on average, failure to invest in adding new capital to existing stocks would cost the six countries approximately 15 percentage points in forgone growth if the gaps persisted over 10 years. Applied to the entire region, this is the equivalent of around $900 billion based on the current GDP levels.
We also looked at data from almost 70 countries to see how transportation, energy and construction affected labor productivity in industry, commerce or agricultural sectors. It turns out that labor productivity in agriculture, for example, would benefit from investments in all three infrastructure-related sectors – transportation, energy and construction. But this does not occur equally. A 1% increase in the productivity of transport would increase agriculture productivity by 1.2%, whereas a 1% increase in the productivity of utilities is estimated to increase agriculture productivity by just 0.5%. This means an avocado farmer in Mexico would benefit from both better roads and cheaper energy but would gain more from better roads. Getting this mix right can make the Mexican economy more productive overall.
Investments in the utility sector help make agriculture and mining more productive in the long run. Investments in transport are particularly helpful for agriculture. And investments in construction are relevant for productivity growth in all economic sectors, except for mining.
We are now exploring if the aggregate data gleaned from many countries also applies to any specific country, given its unique characteristics. The sector-level evidence from our world sample provides a roadmap in terms of what infrastructure investments are best for which economic sectors. Now we need to contrast this evidence with the country-specific data to confirm that these investment allocations are right. We are doing this on a pilot basis for Argentina, to help the country come up with well-founded infrastructure investment strategies. Once this exercise is completed, the final step is to look at a country’s public investment plans to see if they are aligned with the studies’ findings. In times of tight budgets, every investment dollar counts.
The potential payoff? If countries increase investment levels in these infrastructure sectors enough to close the gaps with developed countries grouped in the OECD, the economy-wide productivity growth could increase by 75% with respect to the historical average. This means the region’s per capita income could double twice as quickly as otherwise expected. This is a powerful way for countries to secure more growth in times of global economic headwinds.
Parrado is chief economist at the Inter-American Development Bank