Stacking up: commodities, such as Chilean copper. account for half of South American exports

First, in March, an Argentine Pope; then, last week, a Brazilian appointed to lead the World Trade Organisation. Latin America, long associated with default, dictatorships and disgrace, seems to be riding high and enjoying its growing global clout.

Since 2003, the region’s $6tn economy has almost doubled its share of world economic output to 8 per cent. At the same time, the middle class has grown by 50m people while inequality has shrunk – a unique feat. For some, the region is now enjoying what Sir Martin Sorrell, head of advertising group WPP, hailed in 2010 as “the decade of Latin America”.

But now, in the fourth year of its decade, Latin America, lulled by recent success, risks taking its eye off the reform ball and losing its way.

“Blissful external conditions will not last forever,” Alejandro Werner, the International Monetary Fund’s chief economist for the region, warned last week. “Peru, losing the Midas touch,” was the title of a recent Bank of America report. “Region increasingly vulnerable” was another by Capital Economics, a London-based consultancy.

Feeding fears are increasing qualms about the sustainability of Latin America’s economic model. Its two motors – record commodity prices spurred by Chinese demand, and strong growth in domestic credit which propelled a consumer boom – are starting to slow.

The windfall from the commodity boom, which began in 2002, has been huge. The IMF estimates it was equivalent to an extra 15 per cent of output a year. But now China’s slowing economy has undercut commodity prices, raising questions about how long the “commodity supercycle” will last.

The average length of these supercycles is 30 years, estimated José Antonio Ocampo, a Columbia University economist, in a recent study. “That puts us about halfway through this one,” he says. Commodities account for half of South American exports, according to JPMorgan, and commodity-linked companies dominate local stock markets.

Signs of strain are already appearing. The value of Brazilian exports fell by 8 per cent in the first quarter, year on year. Current account deficits are widening. In Chile, the world’s largest copper producer, the IMF estimates it will reach 4 per cent of gross domestic product this year.

This need not be a problem while abundant international liquidity and ample foreign investment plug the financing gaps. But should either falter alongside lower commodity prices, strong domestic demand will need to be reined back – perhaps drastically – to stop current account deficits gaping wider.

Boom followed by bust “is an old Latin American movie that has played many times before”, says Walter Molano of BCP Securities, a Connecticut-based investment bank.

Although the IMF forecasts Latin America will grow 3.5 per cent this year, that movie may be reappearing among the region’s least reform-minded countries, which spent more of their windfall on consumption rather than investing it.

The region’s biggest economies are investing at an average 24 per cent of GDP, Asian-style levels and “an encouraging finding”, says Augusto de la Torre, chief Latin America economist for the World Bank.

But this average masks national differences, points out Tony Volpon, strategist at Nomura. “In Argentina, Venezuela and, to a lesser extent, Brazil, lack of investment during boom years . . . has led to increasing inflation with falling growth, the classic hallmark of economies facing supply-side constraints,” says Mr Volpon.

Indeed, “high investing” and reform-minded countries such as Mexico, Colombia, Chile and Peru will grow an average 5 per cent this year, the IMF forecasts, while Brazil, Argentina and Venezuela, will grow an average of 2 per cent.

Another concern is that the commodity boom and abundant capital inflows have caused “financial Dutch disease”, akin to Spain in the colonial years. The fear is appreciating currencies have priced local manufacturers out of international markets, and turned economies instead towards lower value-added services directed at the local market – a potential developmental cul-de-sac.

That is partly why Mexico, less dominated by commodities and exporting more manufactured goods than the rest of Latin America combined, is lately an investor favourite.

Mr de la Torre suggests worries about the rise of services may be overblown. “The broad statement that manufacturing is good and services are bad is silly,” he says. “What you see is more nuanced, complex and interesting.”

A new World Bank study, for example, finds that Latin American services have more skilled workforces than manufacturing – a fifth of employees have university degrees. Outsourcing and modular manufacturing chains also means the line between “service industries” and “manufacturing” is increasingly thin. Furthermore, many services are high-value added exports, such as medical services and tourism.

This shift to services has accompanied a further change in Latin America – falling birth rates and greater educational coverage. “As a result, we have finally ceased to be a region of abundant unskilled labour,” says Mr Ocampo. “It is a fundamental change with important social benefits.”

It also has policy implications. If maintaining these social benefits means South America’s development model must become less like east Asia’s – based on cheap labour and manufactured exports – and more like, say, Canada or Norway – productive and resource-rich economies with high social protection – so be it.

To achieve that means boosting productivity with more reforms. That is an easier task than overcoming the dictatorships and macroeconomic instability of the not-so-distant past. But it is still difficult while the living can seem easy and commodity prices remain relatively high.

“You can’t ever begin to think you are even halfway with reforms,” says Mauricio Cardenas, finance minister of Colombia. “Resisting complacency is essential,” adds Luis Castilla, finance minister of Peru.

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