Distributive policy

Industrial policy can save Latin America from its commodity trap

With record turmoil in parts of the global commodity market and prices for many commodities pushed higher, some see opportunity for commodity-exporting Latin American countries, while others see it as a blessing. mixed. But whether or not the region’s economies are benefiting from the latest commodity price boom, the region’s high inequality and the deep limits of past commodity booms should encourage policymakers to look beyond commodities as source of future economic growth.

The solution could take the form of an industrial policy. Countries must learn from the mistakes of failed industrial policy experiments over the past decades. But if a carefully coordinated and sophisticated industrial policy can be combined with innovation, education and social inclusion, the results could lift Latin America past its race to the bottom of the labor force. unskilled labor and exports of raw materials.

Why redistribution is not enough

In Latin America, the richest 10% bring in 54% of all income, making the region one of the most unequal in the world. Persistent income inequality has undermined socio-economic progress and led to social unrest, worsening political and economic instability in the region. The COVID-19 crisis has made matters worse for the poorer segments of the population. In the future, redistribution through taxation may not be enough to sustainably reduce income inequality in the region. Redistribution leaves larger barriers intact, including limited competitive advantage in high value-added sectors, heavy reliance on commodities, and a scarcity of jobs paying above subsistence levels.

In most Latin American countries, the initial distribution of income is so unequal that even major redistributive reform will not suffice. Redistributive tax reforms, while necessary, are unlikely on their own to reduce inequality rates to OECD levels, as this would require a rate high enough to have negative effects on economic growth and generate strong elite resistance.

Reducing long-term inequality in Latin America is also limited by the region’s high degree of commodity dependence. What a country produces and exports is important for improving income distribution. Most of the reduction in inequality achieved in the 2000s was the result of commodity-financed social spending, cash transfers and improvements in education, but did not address the region’s trade structure , which remains focused on commodities. The inevitable result was that these interventions could not be sustained after the fall in commodity prices from 2014, which led to the reversal of progress made over the previous decade.

Without economic diversification, there are clear limits to the extent to which inequality can be reduced.

Economic diversification has a central, but often overlooked, impact on inequality: it helps to stabilize and increase tax revenues without raising the tax rate, which in turn can fund poverty reduction programs and social transfers. It also expands employment opportunities for low-income groups who otherwise have limited options, potentially amplifying the positive impacts of policies such as conditional cash transfers.

The benefits of industrial policy

Improving income distribution requires a coherent industrial policy to generate demand for workers and their newly acquired skills. Market forces won’t do the job alone, and a growing body of evidence suggests that successful economic diversification is often guaranteed by government intervention.

Governments play a key role in overcoming market barriers to the emergence of new industries by catalysing the targeted accumulation of human capital, solving collective action problems in knowledge creation through support for research and development (R&D), by facilitating the access of national companies to foreign markets through trade support and quality control and the sending of market signals through price control mechanisms and public investments. These market signals could be tax breaks, subsidized credits, patient capital, as well as targeted infrastructure and skills development programs to promote investment in high-potential areas (with significant socio-economic benefits). economic) where investment has been sub-optimal.

Contrary to the popular narrative of a free market miracle, Chile has used industrial policy to promote its own diversification in recent decades. The emergence of high value-added salmon and berry industries can be attributed to public policies and the role of Fundación Chile, a parastatal agency that disseminated knowledge gained through R&D as a public good to promote investments in promising industries that cannot be developed by market forces alone. In Brazil, public support for R&D and technology transfer was essential for the development of internationally competitive aeronautical sectors.

Of course, government interventions also present risks and challenges, and Latin America’s own experience with industrial policy in the 1970s and 1980s was marked by notable failures. But there is no reason why the next wave of industrial policy in Latin America should repeat the mistakes of the past, with a few conditions. Institutional capacity to implement industrial policies needs to be improved, with a focus on mechanisms to adequately incentivize, monitor and evaluate companies that receive public support. Stronger links need to be built between businesses, universities and public bodies. This kind of implementation capacity is the main difference between East Asia’s successful industrial policy experience and the less successful one in Latin America so far.

Reducing inequalities with a two-tier industrial policy

The stakes are high for a good industrial policy. A policy designed in a non-strategic way could have harmful effects and increase inequalities if it focused exclusively on sophisticated activities that only create better jobs for a few highly qualified people, as in Costa Rica. Focusing exclusively on labor-intensive activities, on the other hand, would help reduce income inequality by providing better-paying job opportunities than in the informal or rural sectors to unskilled workers, but it does not would not contribute to the long-term upgrading of the national population. the economy (the make-up model in Mexico is an example).

The best option is a two-tier industrial policy, promoting both upgrading and skilled employment in high value-added activities, as well as unskilled employment through an initial expansion of labor-intensive activities -work. But such a strategy requires the deployment of an appropriate educational policy to avoid skills mismatches. It also requires ensuring that low-income groups can benefit from not only unskilled but also skilled employment opportunities in value-added activities.

The historical inability of Latin American governments to reduce inequality is closely linked to the strong relationship between wealth and political power. But even Latin American business elites should now see that reducing inequality by diversifying the economy through industrial policy is in their own interest. The rising cost of inequality in the region is undermining economic progress, exemplified by a wave of social unrest since 2018 that has led to political instability and loss of income and investment. The logic is simple: if the bottom of the social pyramid is too unstable and the top too heavy, the whole structure will soon collapse.

Lebdioui is a lecturer at SOAS, University of London, and directs the Canning House research program at the London School of Economics.

Key words: Raw materials, industrial policy, inequalities, redistribution

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The opinions expressed in this article do not necessarily reflect those of Americas Quarterly or its editors.