Latin America and the

Middle-Income Trap
Nora Lustig
Samuel Z. Stone Professor of Latin American
Economics, Tulane University
Non-resident Fellow CGD and IAD
China Center for Economic Research
National School of Development, Peking University
Beijing, May 31 and June 1, 2010

The views expressed in this paper are the views of the author(s) and do not necessarily reflect the views
or policies of the Asian Development Bank (ADB), or its Board of Directors or the governments they
represent. ADB does not guarantee the source, originality, accuracy, completeness or reliability of any
statement, information, data, finding, interpretation, advice, opinion, or view presented, nor does it make
any representation concerning the same.
 Latin America: a snapshot
Two main problems:
• Lackluster growth since 1980s=> no convergence with advanced
economies (see map of four speed world; source: Kharas, 2009)
• Persistent high levels of inequality and a relatively small middle
class. Long standing injustices gave rise to a resurgence of radical
leftist regimes (Bolivia, Ecuador, Nicaragua and Venezuela)
However, in the last decade:
• Resource rich countries in LA grew fast(er) thanks to commodity
boom during 2003-2008
• Inequality has declined in most countries
Also,
• Inflation, balance of payments fragility, financial sector
vulnerability and broad fiscal imbalances seem to have been
overcome (although not everywhere)

2
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4
●Horizontal axis=rate of growth of GDP 1950-1980; vertical axis=1980-2008.
Source: Palma, forthcoming.
5
 Latin America: phases of growth
Several phases in the economic evolution of Latin America can be identified in the
post-war period:
• state-led import substitution industrialization, which lasted until mid-1970s. It
was characterized by high rates of growth, slightly above the world average,
led by the expansion of industrial production, particularly in the larger
countries of the region (like Argentina, Brazil and Mexico).
• Public debt-led growth, between mid-1970s and 1982. Latin America grew at a
higher rate than the rest of the world but at lower rates of GDP per capita
growth than in the previous era. Growth was based on a soaring external debt
that brought about a major crisis in 1982, opening the lost decade of the
eighties.
• Debt crisis and Washington Consensus reforms, 1980s and early 1990s. Latin
America’s growth collapsed; gave rise to the so called lost decade.
• Foreign capital-led recovery, 1990s until the Asian crisis at the end of the
decade/US recession early 2000s. Growth recovered in the nineties but at
rates that were just enough to avoid losing more ground in the international
economy.
• Commodity-boom led growth, 2004-2008. Growth increased as a result of the
bonanza created by the boom in commodity prices, which ended with the
crisis of September 2008.
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azil, Mexico, Colombia and Chile: relative productivity gaps with the US

●com=commodities (primary sector); agr=agriculture, forestry and fishing; min=mining

and quarrying; mf=manufacturing; and serv=services. ●Each line is an index number
(1950=100 for Brazil, 1980=100 for the rest) of the ratio of labor productivities between
the respective country and the US (each in real terms and domestic currencies). An
increase implies ‘catching up’ with the respective labor productivity in the US, and a
decline a falling behind. 3-year moving averages; due to sharp fluctuations, in mining
Colombia’s is a 5-year one.
Source: Palma, forthcoming. 11
Latin America’s Lackluster
Growth
The Case of Mexico

12
 A closer look at Mexico
(Lustig, 1998; for inequality, Esquivel, Lustig and Scott,
2010)
Following the onset of the debt crisis in 1982, Mexico
changed its development strategy:

• From inward-looking to outward-oriented:

– barriers to international trade and foreign investment were
reduced sharply

• From an interventionist state to a market-based

approach:
– Dismantling of industrial policy
– Privatization
– Deregulation

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Twenty five years later, results are mixed…
• Macroeconomic stability: +
– Inflation under control
– Greater ability to withstand external shocks
But extremely vulnerable to the US business cycle

• Economic growth: -
– GDP growth has been lackluster
– Productivity has not increased beyond the sectors
integrated with the global economy
• Poverty and inequality reduction: -/+
– Poverty in 2004 almost the same as in 1984
– Inequality higher in 2004 than in 1984; regional disparities
exacerbated
– Inequality declined between 1996 and 2006; signals a new
trend in labor markets and government spending 15
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 Convergence
• No evidence of convergence with US

• Differences in productivity between US and

Mexico explain more than 80% of
divergence in income per capita

(Easterly, Fiess and Lederman, 2003)

20
 Real GDP per capita in relation to leading regional economy

65%

Mexico
60% Portugal

55%

50%

45%

40%

35%

30%

25%
1960

1962

1964

1966

1968

1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000
Source: World Bank, Global Development Network Database. Leading economy for Mexico: US; for Portugal: UK-Germany-
France average.
21
 Market-oriented reforms and NAFTA were
expected to contribute to Mexican growth
through its impact on:

• A more efficient allocation of resources

• Access to state-of-the-art technology
• Economies of scale (access to largest
market)
• Competitiveness enhanced
• Boon to private investment
• Credibility of gov. policies enhanced
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 Table 8.2. Export growth (average annual rate in percentage).
Mexico and selected developing countries

1982-1993 1993-2005

China 6.9 18.3

South Korea 10.9 14.4

Turkey 7.0 1/ 11.7

Mexico 5.8 11.1

Brazil 8.0 9.3

Malaysia 12.3 9.2 2/

Argentina 3.7 8.0 2/

Chile 8.4 8.0

Thailand 14.5 7.5

1/ 1987-1993; 2/ 1993-2004
Source: World Bank, World Development Indicators (on line)

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 Table 8.3. Share of international trade in GDP (percent).
Mexico and selected developing countries.

1982-1984 2001-2005

Malaysia 107.0 213.0 1/

Thailand 47.7 131.2

South Korea 67.7 75.0 1/

Chile 45.3 69.6

Turkey 30.3 61.6

Mexico 27.0 58.2

China 22.0 53.3 1/

Argentina 14.3 36.0 1/

Brazil 19.0 30.8

1/ 2001-2004
Source: World Bank, World Development Indicators (on line)

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 Beginning of Trade Beginning of
100 Liberalization NAFTA

80

60

40

20

0
1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006

Agriculture Manufactures Oil Exports

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Results have been disappointing in terms of
growth, however

– GDP growth per year:

• 1960-79: 6.5%

• 1980-2003: 2.6%

• 1996-2003: 3.5%
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 Total Factor Productivity
• Declined at a rate of 0.5% a year between 1980-
2003, when GDP grew at 2.6 per year
• Explains two-thirds of the decline in the rate
of GDP growth (reduction of 3.9 percentage
pts. Comparing 1980-2003 to 1960-79) (Faal,
2005)
• Since NAFTA, TFP growth improved, but little:
– Grew at 0.7% between 1996 and 2003
– Contribution to overall growth 20%

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• Market-oriented reforms did not generate the expected
boost in growth

• Two views:

– Reforms did not go far enough: energy, labor, social

security, education, institutional reforms

– Reforms have been part of the problem (badly

implemented or bad ideas):
• low public investment (especially in infrastructure),
• low credit levels to private sector,
• monopolistic structures in key sectors (telecom, banking),
• dismantling of industrial policy,
• deterioration of education system and
• an “expensive” peso

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 Latin America: a snapshot
• Persistent high levels of inequality and a
relatively small middle class. Long standing
injustices gave rise to a resurgence of radical
leftist regimes (Bolivia, Ecuador, Nicaragua and
Venezuela)
• However, in the last decade inequality has
declined in most countries
• Lopez Calva and Lustig (2010) Declining
Inequality in Latin America: a Decade of
Progress? Brookings Institution Press and UNDP;
Argentina (urban), Brazil, Mexico and Peru
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High Inequality in LA: Gini Coefficient
by Region (in %), 2004
(based on Ferreira and Ravallion, 2008)
60.0

55.0 53.2

50.0

44.7
Gini coefficient

45.0

38.9 38.9 39.1

40.0

35.0 33.6
32.2

30.0

25.0

20.0
High Incom e Europe and South Asia North Africa East Asia and Sub-Saharan Latin Am erica
Central Asia and the the Pacific Africa and the
Middle East Caribbean

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Change in Gini Coefficient by Country: circa 2000-2006
(in percent) (striped bar means change not stat.
significant)
4.0

3.0
2.2
2.0

0.9 1.0 1.0

Gini Coeficcient

1.0
0.1
0.0
-0.2
-0.6 -0.5
-1.0 -0.7
-1.0 -0.9 -0.9 -0.9
-1.1 -1.0 -1.0 -1.1
-1.4
-2.0

-3.0
-3.1
-4.0
Bolivia
Ecuador

El Salvador

Uruguay

Costa Rica

Nicaragua
Brazil
Paraguay

Chile

Panama
Argentina
Mexico

Total 12 countries

Total 17 countries
Dominican Rep.

Venezuela

Guatemala

Honduras
Peru

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 Explaining the decline in inequality:
Education and Returns to Education
Proximate determinants:
• Labor and non-labor income inequality declined
The decline in labor income inequality can be attributed
to:
• Sharp decline in inequality in the distribution of stock
of education (years of schooling)
• A decline in the share of workers with no education,
incomplete primary, and primary only
• Decline in the relative returns to tertiary education (a
narrowing gap of the skilled-unskilled gap)

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Why has inequality in labor
incomes declined?
In the race between skill-biased
technological change and
educational upgrading, in the
last ten years the latter has
taken the lead
(Tibergen’s hypothesis)
37
 Why has inequality in non-labor
incomes declined?
• In the four countries government transfers to
the poor rose and public spending became
more progressive
• In Argentina, the safety net program Jefes y Jefas de
Hogar.
• In Brazil and Mexico, large-scale conditional cash
transfers => can account for between 10 and 20
percent of reduction in overall inequality. An effective
redistributive machine because they cost around .5%
of GDP.
• In Peru, in-kind transfers for food programs and health.
Also access to basic infrastructure for the poor rose. 38
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