COVID-19 in Latin America: Promoting entrepreneurship and reducing social vulnerabilities

By Jorge Arbache, Private Sector Vice-President, Development Bank of Latin America (CAF)

This blog is part of a series on tackling COVID-19 in developing countries. Visit the OECD dedicated page to access the OECD’s data, analysis and recommendations on the health, economic, financial and societal impacts of COVID-19 worldwide.

Vendor in Quito, Ecuador. Photo: teranbryan_ecu/Shutterstock

Statistics show that economic growth in Latin America is highly volatile, with periods of acceleration and collapse. This dynamic hides perverse implications. The combination of low growth persistence with high-growth volatility is associated with greater risk aversion, which in turn encourages financial speculation and firms to invest in lower risk, but also lower social return projects. Additionally, poverty and other social indicators are also very sensitive to the harmful combination of short growth spells and high volatility.

Indeed, empirical evidence shows that social indicators improve during periods of acceleration and worsen during periods of slow growth. In other words: they are pro-cyclical. However, more relevant than the sensitivity to volatility is the asymmetric reaction of social indicators to the economic cycle, because social indicators are more sensitive to periods of deceleration.

The growth rate of the Gini Index, for example, tends to worsen much more during periods of deceleration and, as a consequence, the concentration of income deteriorates rapidly during periods of stagnation, but recovers only slowly during periods of growth. A similar situation occurs with the participation of young people in the labour market, the unemployment growth rate, poverty, percentage of school dropouts, among other relevant social indicators.

This asymmetric relationship helps to explain why various social indicators have advanced slowly in the past decades — especially in the 80s and 90s — and is behind the still highly uneven income distribution in the region. It also suggests that, from the perspective of the poor, sustained growth is as important as high growth rates.

There are many factors behind the asymmetric reaction of social indicators to growth volatility in the region. One is inflation, which tends to be higher during periods of deceleration and erodes income, especially affecting the most vulnerable groups. Other factors include the deterioration of public services such as education and health, as well as the worsening of labour market conditions. The concentration of assets (land, real estate, financial assets and others) and the limited access of the poorest to credit, insurance and other financial instruments also contribute to explain that asymmetry.

It is unlikely that the current crisis will lead to a high inflation scenario. However, the crisis has unique characteristics that are potentially even more harmful to the vulnerable than the previous ones. In addition to the credit crunch, the enormous difficulties brought by the crisis for micro, small and medium-sized enterprises, added to the challenges faced by informal and self-employed workers, are likely to have at least three important effects.

The first is related to the situation prior to COVID-19. Many countries in the region were already experiencing fiscal, economic and social difficulties, with low economic growth and rising poverty, and still high numbers of informality and inequalities. The COVID-19 crisis is exacerbating an already weak economic and social environment.

The second effect is that new technologies of production and management are becoming increasingly popular and “technological commoditisation” is leading firms — even in developing countries — to adopt new labour-saving technologies. The COVID-19 crisis has accelerated this trend.

The third effect is that in a context of relatively higher mortality of firms with higher costs, lower productivity and competitiveness and that are more labour-intensive, one may expect to see changes in the composition of sectors and in the profiles of firms that remain active post-crisis. It is no exaggeration to expect that the “representative firm” that entered the COVID-19 recession will be different from the one that will leave it. Furthermore, firms entering the market in the immediate post-crisis period will benefit from lessons learnt from the crisis, which will in turn reinforce the shift towards even more labour-saving technologies and activities.

Therefore, we should expect to see an economic recovery along with a combination of high structural unemployment and high labour informality.

There has been much social progress in recent years in Latin America, but it is still too early to let our guard down, especially when considering the new challenges, risks and uncertainties — internal and external — that surround us at this moment.

Responding to the COVID-19 crisis and protecting achievements in social indicators require at least four sets of policies. First, to expand the emergency social protection networks, strengthen employment programmes and expand entrepreneurship, training and professional education programmes. The creation of universal basic income programmes should also be considered.

Second, micro, small and medium-sized enterprises should be supported with credit lines, guarantees, rescheduling of tax payments and other instruments that help them to continue to resume economic activity and keep their employees during lockdowns.

Third, policies that reduce the exposure of the most vulnerable groups to periods of growth deceleration, combined with policies that increase their access to the benefits generated during periods of growth acceleration. Anti-cyclical social policies and better public services are some examples.

Fourth, policies that promote not just sustainable, but sustained growth. They should minimise the economy’s exposure to external shocks, strengthen credible fiscal and monetary policies, tackle constraints to growth — such as low labour productivity and infrastructure bottlenecks — and increase competitiveness. These policies should also aim at developing technologies and industrialising the region’s comparative advantages, in areas such as mining, oil and gas, agribusiness, proteins, biodiversity, forests, clean energies and others.

Current economic deterioration jeopardises not only social achievements, but also efforts to reduce the huge gaps that separate social indicators in Latin American countries from those in rich countries. In other words, on top of the possible increase in internal inequalities, we could witness an increase in inequalities between countries, which would be another major setback.

In response to the outbreak of the pandemic, CAF – Development Bank of Latin America provided emergency credit lines to support its member countries in the immediate fight against the health crisis, as well as broader lines of budget support. The Bank is also supporting national development banks with new financial and non-financial resources and instruments to help micro, small and medium-sized enterprises as well as other critical sectors. CAF is also supporting microfinance institutions, among many other measures that will directly and indirectly help the vulnerable groups in the region.

However, the road ahead will be long, and what Latin American countries need now and above all are co-ordinated efforts to mitigate the deterioration of social indicators and strengthen sustained economic recovery policies. Failing to address the collapse in social conditions may generate political reactions with uncertain, possibly negative implications for the development of the region.