How Strong is LAC’s China Connection?

Authors: Emily Sinnott & John Nash

 

For Latin American and the Caribbean (LAC), there has been a substantial shift from exporting commodities to advanced economies to trading instead with emerging economies. China, in particular, has become an important destination market, with its share of commodity exports having grown tenfold since 1990 (from 0.8 percent in 1990 to 10 percent of total commodity exports in 2008).

 

In our report on “Natural Resources in Latin America and the Caribbean: Beyond Booms and Busts?” we argue that one advantage of these changing trade patterns has been the important role that China’s demand for commodities played in the region’s economic rebound from the global crisis. While we are not alone in this view (see the CEPAL report on the drivers of the LAC recovery launched on September 2, 2010), there has been some anxiety in LAC that the region is going down the path of increased dependence on exports of raw materials with little value-added, while at the same time increasing its reliance on manufacturing imports from China.

The relationship between China and its LAC trading partners has not then always been smooth. To cite just two recent events: in 2010 Argentina introduced a series of anti-dumping measures against China and in 2009 negotiations between Ecuador and China over a hydroelectric investment broke down over proposed conditions of the loan to Ecuador.

 

So what are we to say of the future for a LAC specialized in natural resources? Our report indicates that such a future can be bright, if—and this has proved a big “if” going by past experience—countries can manage commodity wealth effectively.

 

The region’s natural resource wealth can be a growth opportunity both by providing governments with greater fiscal space and by serving directly as a key source of growth if properly managed. But this opportunity will only be realized if windfall earnings are managed judiciously within a long-term horizon, so as to avoid falling victim to the “natural resource curse,” as has sometimes happened in past cycles.

 

The downside risks of commodity abundance can be avoided, if commodity-exporting countries manage to save (via cyclically adjusted primary fiscal surpluses) a substantial fraction of the commodity-related revenue windfalls. In addition, some of the oft-cited concerns regarding commodity specialization may not hold across the board.

 

To start, let us present two figures that turn on their head commonly-put forward notions on the impact of natural resources on a country’s development.

 

Having more natural resource wealth is associated with higher income levels. A simple correlation between natural capital and GDP, both expressed in per capita terms, seems to confirm the intuition that natural resources contribute to income generation (figure below). Indeed, among the richest countries in the world are the top three in natural capital: Norway, New Zealand, and Canada. This overall positive relationship continues to hold for LAC countries.

 

 

Natural resources—even minerals—can involve high value-added activity that rivals that found in many manufacturing sectors. In a detailed study of international trade in metals prepared for this report, Benjamin R. Mandel of the Federal Reserve Board of Governors, Washington D.C. found that Latin America exports of metals products are differentiated, with intra-industry trade comparable to other sectors (including high-value-added ones) and with good potential to move from low- to high-value products. Metal products have a price dispersion—a measure of heterogeneity—comparable to that of footgear and headgear or plastics. This large heterogeneity in metals creates the potential for specialization in (and upgrading to) more desirable, higher-quality, higher-value varieties within product categories, as well as moving up the value chain to more processed products.

 

Overall, Latin America seems to have taken advantage of this potential for upgrading: its share of global markets in metals expanded by 175 percent between 1975 and 2004, an annual compound growth rate of 1.9 percent (figure below). Decomposing this increase in share by the stages of the metal production process shows that the overwhelming majority was in the intermediate and high-value-added categories. The share of both ore and unwrought products roughly doubled over the 30 years. But the share of worked products increased eightfold. Estimates based on value-chain classifications also show that much of the growth can be attributed to LAC moving toward production of more sophisticated and higher-value-added metal products.

 

 

In our report, we delve into this type of evidence to look at not only the “big picture” of the commodity curse, but also much of the report is focused on examining more specific channels, which might be called “commodity concerns.”  We broadly group these concerns into four sets:

1. One deals with the direct economic effects of commodity dependence and the implications for long-term growth.
2. Another deals with the interactions between commodity production and the rents it generates, on one hand, and a country’s institutions on the other.
3. A third deals with the macroeconomic challenges of managing the volatility of revenue flows, including the distributional implications at the household level posed by cyclical social spending.
4. And a fourth set is associated with potential negative environmental and social impacts.

 

Fortunately countries are increasingly savvier with commodities, leading us to believe that Latin America may be breaking the “natural resource curse” – a huge deal for a region where 93 percent of the population and 97 percent of economic activity is in countries that are net commodity exporters.