In the aftermath of the leftist “Pink Tide” and a decade-long commodity boom, Latin American governments now face risks that threaten the prospects of a still-fragile middle class.
In the first decade of the 21st century, Latin America was characterized by profound social and economic transformations that elevated the region’s middle class.
This was a result of sustained, above-average economic growth, as well as sharp declines in poverty and inequality levels. Approximately 63 million people were lifted out of poverty during the period of 2001-2011—rather enviable, as most of the developed world suffered through the Great Recession.
The rise of this new regional middle class can be attributed to two factors: the commodities boom, and government policies aimed at tackling poverty and inequality. On the one hand, the surge in both commodity prices and supply propelled global trade and export revenues. This was particularly important since the region is historically reliant on extractive activities and primary goods.
Additionally, the rise of China as a newly industrialized country further bolstered economic gains. In turn, this helped finance Pink Tide social programs, particularly conditional cash transfers such as Bolsa Familia in Brazil and Oportunidades in Mexico, which addressed issues in education, healthcare and other sectors. Overall, economic growth explained about 74% of middle class growth whilst income redistribution policies explained the remaining 26%.
Source: Pew Research
From 2013, however, the slowdown became apparent. Capital influxes were less abundant, commodity and oil prices fell, credit for public and private consumption started drying up, and China’s growth decelerated.
Countries with heavy social spending and little fiscal prudence dipped into recession (including Brazil, Argentina, and Venezuela), whilst more prudent governments maintained above-zero growth but still suffered economic shrinkage (such as Colombia, Chile, and Peru). As a result, the IMF projected a disappointing 0.5% regional growth for 2015 with no immediate recovery.
Prospects for the middle class, challenges for the government
What does this all mean for the middle class? It is arguably a concerning landscape.
To the extent that there have been major gains in inequality amelioration, the bulk of those who benefit remain low income-earners even if they can now be classified within the middle class. Only 36 million Latin Americans have gone into the middle and upper-middle income categories, much less that those 63 million barely out of poverty.
This means that its fragile position does not effectively guarantee insulation from falling back into poverty, as a recent report by CAF Development Bank of Latin America highlights. This is undoubtedly a huge challenge for incoming right-wing governments, as the need for fiscal prudence vis-à-vis mounting debt will likely force budget cuts and resource redistribution amongst sectors.
In other words, social spending levels will be difficult to maintain given the scarce resources. This is particularly critical for those middle-income earners at the lower tail of the distribution, who tend to rely more on social programs, public services and job creation. At the upper tail, more sophisticated needs can be catered for by the private sector, albeit the demand for more stable, transparent institutions can become a source of deep discontent.
On the other hand, immediate gains from investment will also be more difficult to achieve. Given the weak infrastructure and minute R&D investment endemic to Latin America, the region has yet to secure a solid base for SMEs and business creation.
Trade revenues are no longer high enough to compensate for weak tax collection systems, export economies are not diversified enough and rising debt to GDP ratio does not ensure a steady influx of foreign capital. On top of this, average household debt per capita has increased significantly — such as in Brazil, where it adds up to 46% of disposable income.
This means that there is little margin to maneuver in scenarios such as falling real wages and unemployment, which will only further complicate the landscape. Indeed, analysts have forecasted that 14% will fall back into poverty in the coming years.
It is important to note that, while the forecast is grim, Central America and Mexico could prove to be more resilient as the US recovery and subsequent trade relations may support continued growth. For South America, this could represent a decisive move towards further regional integration and a reinvigorated pro-market attitude.
Why does this matter? Policy implications for the future
Evidently, the need for new growth engines and reforms is crucial if gains for the middle class are to be maintained. As mentioned above, weak tax collection systems are a big structural problem that shed light on economic informality and the need for fiscal reform.
Similarly, the expansion of safety nets and job creation through SMEs could prove to be successful tools to insulate the middle class from falling back into poverty. Having said this, a genuine long-term strategy for strengthening the regional middle class requires a genuine commitment to long-term policies beyond presidential tenures and populist promises — something Latin America has long struggled with.
All in all, a strong middle class within Latin America would represent not only reflection development progress, but political and economic opportunity at the macro, governance-level. Such a development could act as buffer against radical and populist political views, while also helping the region become an attractive market for investment.
While challenges and opportunities remain in Latin America, the landscape looks difficult for both the winners and losers of the previous decade.
