Historical features that condition development in the region

The economic, social and environmental debts faced by Latin America and the Caribbean, as evidenced in the previous brief diagnosis, indicate the scope of the challenge to be faced. Addressing it requires an analysis that takes into account the specificities of the regional context and makes it possible to identify the structural factors that condition the possibilities for development.

Three phenomena stand out because they cut across the multiple dimensions of development and because they are also characteristic of the region: high informality, infrastructure gaps and crime. The first is both a cause and a consequence of low productivity, and increases inequalities. The second makes households and businesses in the region remote from each other, which hinders production and access to services. And the third affects the social and economic fabric, representing a critical obstacle to growth, well-being and social cohesion.

Despite these challenges, the region shows strengths that should not go unnoticed and that are instrumental to the policies required for the region’s development. Macroeconomic and financial institutions have made significant progress, providing a base of relative stability in a context of global volatility. In addition, and especially, the rich endowment of natural resources, increasingly valued on the global stage, offers opportunities to boost development.

Productive informality 

Productive informality is a measure of the degree of compliance with the regulations imposed by the State for a business or person to carry out an economic activity. These regulations are of different nature and may vary between sectors or according to the characteristics of the company, especially its size. In practice, even when regulations do not have a design bias by size, compliance tends to be less frequent in smaller companies, so that many regulations end up being, in fact, size-dependent.

Informality is a very prominent phenomenon in the region. An example of this is labor informality¹. On average, around 57 % of employed people do not pay social security contributions, which is the most common measure of this type of informality. This average hides important differences between countries. The rates range between 27 and 32 % in Chile and Uruguay, and up to 80 % in Bolivia, Guatemala, Honduras and Nicaragua. This scenario is also evident in the Caribbean: Bahamas, 18 %; Dominican Republic, 56 %; Jamaica, 55 %; Trinidad and Tobago, 70 %; Barbados, 62 % (ILO, 2024, except own calculations for T&T 2014).

The labor informality rate tends to fall with the country’s per capita income. However, in the countries of the region, it is even higher than in countries with similar incomes. Hence, we can speak of an excess of informality (see figure 1.6).

The high proportion of self-employed, which in the region reaches 40 % of the employed, explains to a large extent labor informality. But this also manifests itself under the condition of salaried workers, especially in micro-enterprises. Indeed, in Latin America, 1 out of every 4 informal wage earners is in companies with 10 workers or more, while 8 out of every 100 are in companies with at least 100 workers (Álvarez et al., 2018). It also tends to be more intense in sectors such as agriculture, where it reaches 80 % of wage earners, but even in sectors such as manufacturing, 35 % of wage earners are informal.

The level of informality also varies according to the characteristics of the workers, being particularly high among young people, those with less education and those with low incomes. Wage earners with incomplete secondary education account for 59 % on average in the region, and in almost half of the countries analyzed (7 out of 16) it exceeds 75 %. Informality, in the lowest income quintile, reaches 86 % of salaried employment.

It is clear that informality is a drag on productivity, since it implies a poor distribution of the labor force that reduces the aggregate productivity of the economy. In fact, there are significant differences between the average wages of workers in formal and informal jobs (between 15 % and 30 %), regardless of their education, age or gender. These differences are indicative, in part, of productivity gaps between formal and informal jobs. The movement of these workers to formal and more efficient firms would bring significant productivity gains.

The wage gap between formal and informal workers, combined with the socioeconomic gradient of informal employment, makes informality in the region a structural cause of wage inequality. A recent study finds that 34 % of the inequality gap in the lower part of the region’s distribution with respect to the U.S. is explained by a higher concentration of workers in the categories with the worst relative income and productivity: self-employment and employment in micro-establishments (Eslava et al., 2021).

Latin America combines low levels of per capita income with very high inequality [….]. These two problems are not unconnected; they are manifestations of the same basic characteristics of Latin America. […] we have a very large mass of the population that is unable to engage in the most productive activities, that is, in activities where they could generate the most income for themselves and their families and, at the same time, where they could contribute the most to the economy.

Based on an interview with Marcela Eslava

Informality is also detrimental to skill formation. On the one hand, because the low returns to education under the condition of informality discourage investment in education and, on the other, because once in the labor market, people accumulate more skills in a formal job than in an informal one. Indeed, wage earners more frequently report that self-employed people show an increase in their job skills during their employment, both emotional and technical (Berniell et al., 2016). Also, formal wage earners have higher participation in training activities in their employment.

Labor informality is also the main barrier to increasing the coverage and financial sustainability of contributory social protection systems. Based on administrative data on social security in the region, it is found that, on average, a worker makes social security contributions for 35 % of his or her working life in Argentina, 51 % in Brazil, 47 % in Ecuador and 50 % in Uruguay (Álvarez et al., 2020). Because the laws require a minimum number of contributions to access a pension, a significant part of the labor force will not have access to it at retirement. On the other hand, high informality reduces the funds to finance contributory schemes. In fact, if informality were reduced by half, the revenues of contributory pension systems would increase by between 14 % (Uruguay) and 57 % (Ecuador), with an average value of almost 40 % among the countries analyzed ². In general, moreover, informality reduces collection capacities and, therefore, undermines the financing of public spending.

The use of non-contributory instruments is extremely important because the informality means that many of the benefits that are part of the social security system do not reach the poor population.

Based on an interview with Nora Lustig

Finally, informality also introduces challenges for environmental policies. See Box 1.2.

Infrastructure gaps

The economic infrastructure gap is one of the major determinants of productive activity in the region. Transportation networks in all their modes, energy infrastructure and communications networks are central components of production, since they allow access to inputs and markets. The region shows a significant lag in these three components as a result of a low level of investment over time and low investment efficiency.

Infrastructure for greater connectivity and integration among our countries is the priority and the great challenge for the next fifty years. If we do not do this, Latin America will never really be able to overcome its development problems.

Based on an interview with Mauricio Cárdenas

In land transportation, this lag is manifested by the lower availability of road infrastructure. For example, on average, for 11 Latin American countries, road coverage measured in km paved per 100,000 inhabitants is 200, while this indicator for OECD countries reaches 1,400. This low availability, together with the poor quality of existing infrastructure, results in congestion, road accidents and high and uncertain travel times. Air and maritime connectivity indices, which respond to the availability, frequency and importance of the terminals with which countries are connected in each mode, also show significant lags with respect to developed economies (Sanguinetti et al., 2021; AC&A et al., 2020).

Gaps in transportation and energy infrastructure are also evident in the day-to-day operations of companies. In this regard, survey data reveal a high incidence of companies that identify transportation and electricity as a major or very severe constraint to their operations (WBES, 2024). In transportation, for the average of Latin American countries, the incidence of this barrier reaches 23 %, much higher than the OECD average value (14 %, excluding Latin American countries). Electricity is also identified as a barrier in a much higher order than that observed in OECD, both for Latin America and the Caribbean (34 % and 36 %, respectively).

One way to approximate the lag in telecommunications infrastructure is by the speed of internet services that can be accessed in each economy. Graph 1.8 shows information on maximum internet access speed for regions within the countries of the region, from open connection test data. For each country, the graph shows the maximum download speed recorded in the provinces or states (the first administrative division level which is fastest, the median and, finally, the maximum speed recorded in the state or province with the slowest access)³.

These data reveal important connectivity infrastructure gaps. The median download speed in high-income countries exceeds 90 MBPS, above the maximum speed that can be accessed even in the states with the best connectivity for the vast majority of countries in the region. Some countries, such as Cuba, Haiti and Suriname, show notable gaps: the maximum speed that can be accessed in the states with the best connectivity in these countries is only one-sixth of that of the best performer, Brazil (129 MBPS). In addition, all countries show significant internal gaps. For example, in 21 of the 24 countries shown, the best available connection in the slowest states is similar to or lower than the best speed recorded in Haiti (26 MBPS).

The infrastructure gaps in the region are also particularly acute when analyzing safe water and sanitation infrastructure, as shown in figure 1.9. South and Central America have made significant progress in the last two decades, achieving, for example, almost universal coverage of access to safe water in urban areas and over 90 % in rural households. The Caribbean lags behind. For example, nearly half of urban households do not have adequate sanitation infrastructure.

In terms of household access to electricity, there has also been significant progress and challenges. In the last 20 years, the fraction of connected households grew by 10 percentage points; however, in at least six countries in the region, still more than 10 % of rural households are not connected to the electricity system (Allub et al., 2024).

Economic infrastructure supports the flow of physical goods, energy and information, i.e., virtually all economic exchanges, and is therefore key to economic growth.

Transportation infrastructure affects the ease with which companies can access markets, both to obtain inputs and to position their products vis-à-vis competitors and end consumers. In this regard, the region has quantity and quality gaps, particularly in land infrastructure, which may be limiting the deepening of regional value chains. Being deficient, it increases local and international distribution costs, eroding their competitiveness. In turn, it limits the growth and productivity processes associated with productive specialization and trade integration.

Energy is a critical input in production and is transversal to all economic sectors. A deficient energy infrastructure, particularly electricity, results in supply instability, which can cause damage to production equipment and loss of goods. This, in turn, subjects companies to costly investments and expenditures to mitigate risks, for example, in their own power generation capacity and fuel storage. The importance of the electricity sector is growing in view of the decarbonization objectives of economies due to the expected increase in consumption. In addition, the integration of generation capacity from non-conventional sources, which are characterized by being more atomized, dispersed and intermittent, will require substantial investments in transmission networks (Allub et al., 2024).

The telecommunications infrastructure determines the ease with which companies interact with their customers, suppliers and, increasingly, their employees. The digital services supported by this infrastructure represent a growing portion of the value of the goods and services traded. Closing connectivity gaps will therefore be essential for the region’s productive integration.

Finally, water and sanitation infrastructure is a key determinant of household well-being. Promoting access to safe water and adequate effluent treatment reduces the incidence of disease, with lasting impacts on human capital accumulation (chapter 3). Lack of clean energy also harms household health.

The infrastructure deficit we have […] is going to require a lot of private investment and many investment structures in which not only the private sector but also multilateral entities will have to participate.

Based on an interview with Augusto de la Torre

Crime 

Crime is a scourge with very significant economic and social costs. Despite the lack of reliable data, which is usually very present in the measurement of this phenomenon, the available information indicates the magnitude of the problem in the region. With significant differences between countries, the region has high levels of intentional homicides, violent acts, corruption and bribery.

Among the best quality statistics is the rate of intentional homicides. For the year 2000, according to data from the United Nations Office on Drugs and Crime (UNODC), the rate of intentional homicides in Latin America and the Caribbean was 21.66 per 100,000 inhabitants. By 2022, the rate had fallen by just 2 homicides approximately, reaching a figure of 19.58 homicides per 100,000 inhabitants. This figure is significantly higher than that of European countries, which is around 2 homicides per 100,000 inhabitants, but it is also above the world average of 5.61 homicides per 100,000 inhabitants.habitants.

Of course, there are important differences between countries. In Honduras, Jamaica, Trinidad and Tobago and the Bahamas the rate is notoriously high, with more than 30 victims per 100,000 inhabitants. On the other hand, in Bolivia, Uruguay, Chile and Argentina this indicator is below 10.

In the Caribbean we are seeing increases in crime, especially in juvenile transgression. […] Statistics show that […] we are seeing younger fathers, fractured homes, absentee father syndrome, young people feeling disillusioned and joining gangs in search of a sense of belonging. And we need to address the root causes of this.

Based on an interview with Karen-Mae Hill

Crime and violence impose high costs on society. There are direct costs, including public and private spending associated with crime prevention and control, the expense of the criminal justice system and prisons, and the value of assets and property destroyed by crime, as well as costs associated with loss of life and other consequences on the physical and mental health of victims and their families. However, the effect of crime goes beyond these costs. Certainly, crime affects trust among citizens and between citizens and the State. It also changes the behavior of individuals and businesses. In particular, it reduces the incentives of businesses and families to invest in physical capital and education. These indirect costs are significant, although more difficult to estimate (ver Sanguinetti et al., 2014 for more conceptual details of the costs of crime).

There is a direct relationship between crime and economic performance. Because if people don’t feel safe to invest, they don’t do it. People are not going to feel safe to come visit and spend their money. And so, the economy grinds to a halt. Nobody feels safe, nobody feels protected, nobody feels empowered to participate in a crime infested society.

Based on an interview with Karen-Mae Hill

One of the most comprehensive and recent estimates of direct costs is Jaitman et al. (2017). The authors find a direct cost for 17 countries in the region of 3.5 % of GDP, an estimate that doubles the figure with respect to the developed world. Estimates vary across countries. Honduras, El Salvador and Bahamas are above 4 % of GDP, and Argentina, Peru, Chile, Barbados, Uruguay and Mexico, below 2 %⁴. 

Crime and corruption are complex and multidimensional phenomena that demand a comprehensive action strategy. The RED 2019 (Sanguinetti et al., 2014) presents a set of key actions to reduce crime with an important focus on prevention. These actions include policies aimed at the family, schools and the urban environment, but also at criminal justice systems and the State’s own capacities. For its part, RED 2019 (Fajardo et al., 2019) focuses on corruption and highlights policies linked to internal and external control mechanisms, selection schemes for bureaucrats (elected and non-elected) and other institutions to regulate the interaction between the State and the private sector, such as anti-bribery laws and contract award mechanisms.

Macroeconomic institutions

Robust financial markets and macroeconomic stability are two key enabling conditions for economic growth and inclusion. Financial markets play a fundamental role in the wellbeing of families since, through savings and credit operations, they can better adjust their consumption over time. In addition, financial markets make it possible to intermediate funds to productive projects, favoring economic growth. Macroeconomic stability, on the other hand, is essential for the viability of companies’ productive projects and the stability of household income.

The region has made significant progress in the depth of financial markets. In 1980, the credit-to-GDP ratio in the countries of the region averaged 25.6 %; today it stands at 44.7 %. However, the gap in market depth with respect to developed countries has widened: the 2023 credit-to-GDP ratio in the region is significantly lower than in the United Kingdom (121 %) and the United States (195 %).

Figure 1.11. shows a broader set of indicators of the financial system in the countries of the region (Financial Development Index), in the dimensions of access, depth and efficiency in credit markets (identified as financial institutions) and capital markets (identified as financial markets). The graph makes it clear that the countries of the region have shown generalized improvements with respect to the 1980s. Such improvements are especially widespread in the financial institutions sector in the dimensions of access and depth. However, there have been generalized setbacks in the efficiency dimension. As for the capital market, improvements are observed in a group of countries, among which Mexico, Brazil, Chile and Colombia stand out. When comparing current performance with the simple average of the United States and Canada (right panel), significant and generalized lags are observed, which are more pressing for the capital market.

In terms of macroeconomic stability, the region has made significant progress in achieving price stability in recent decades. The 1970s and 1980s were decades of recurrent crises, characterized by accelerated price escalations and a virtual breakdown of the price system. During the 1970s, for example, Argentina reached an inflationary peak of close to 400 % in 1976, and Chile reached 600 % in 1974, followed by peaks of 3,000 % in Argentina in 1989, 7,500 % in Peru in 1990, and 2,500 % in Brazil in 1993.

In general, episodes of inflationary escalation responded to a mechanics of fiscal dominance (Kehoe and Nicolini, 2022; see box 1.3). The achievements in price stability in the region respond, in part, to the introduction of legal reforms that narrowed the mandate of central banks in price stability and strengthened their autonomy. Thirteen countries in the region introduced reforms in this regard between 1990 and 1996. With some exceptions, these reforms were successful and resilient in the face of crisis episodes. Two recent unprecedented episodes—the 2008 global financial crisis and the shock associated with the Covid-19 pandemic in 2020—show that central banks in the region were able to implement countercyclical monetary policy to mitigate the impacts of the crises and were largely successful in reversing previous monetary expansions to contain inflationary pressures (Jácome and Pienknagura, 2022).

When the U.S. inflation rate reached 9 % and the Federal Reserve began raising interest rates quickly and sharply, the region withstood the interest rate increases admirably, which is a very different situation than in the late 1970s and early 1980s, when sharply rising international interest rates led to a general financial crisis. So that points to resilience.

Based on an interview with Carmen Reinhart

Compromised fiscal spaces

Fiscal imbalances represent a major threat to macroeconomic stability. And the region has high and growing levels of indebtedness. Indeed, 13 of the 32 countries shown in Figure 1.13 have public debt levels above 70 % of GDP. The terms of access to financing are costly and uneven across countries: the implicit rate on debt service averages 3.6 %, 4 % and 5.3 % in the Caribbean, South and Central America and Mexico, respectively, while it exceeds 5 % in eight countries in the region as a whole. Consequently, the debt burden represents high levels for both output and fiscal revenues. On the fiscal revenue side, a group of countries—Guatemala, Brazil, Barbados, Belize, Guyana, Haiti and St. Kitts and Nevis—have revenues above 30 % of GDP, similar to the OECD average) (IMF, 2024c), contrasting with their lagging levels of development, suggesting little room for relaxing fiscal restraint on the revenue side.

The analysis of the region’s macroeconomic context shows that, although significant progress has been made, structural challenges persist and must be addressed comprehensively. The fiscal deterioration observed in several countries, partly as a result of Covid-19 response policies, represents a real threat to the institutional framework that has made it possible to achieve a certain degree of stability.

Fiscal issues have become much more acute since Covid-19 because the collapse of production that we saw globally, the displacement of labor markets, meant the collapse of revenues and more government spending to support the economy.

Based on an interview with Carmen Reinhart

The current context demands that the countries of the region undertake fiscal consolidation processes to face new public policy challenges. The growing pressure to address social, environmental and economic development issues can only be handled with well-managed fiscal resources. This implies reducing deficits and controlling public debt, raising fiscal revenues in countries where there are gaps compared to developed economies, and improving efficiency in public spending so that governments can respond to emerging needs without jeopardizing overall economic stability.

Finally, progress in deepening financial markets may offer a complementary path to stimulate growth and economic resilience. As gaps in financial development close under sound regulatory environments, the region could better channel internal and external resources to productive activities. An efficient and inclusive financial system, which facilitates access to credit and capital markets, can boost growth and enable broader and more equitable sharing of its benefits.

Natural resource wealth

Latin America and the Caribbean is an exuberant region. With only 8 % of the global population, it has 16 % of the territory, 15 % of the agricultural land, 23 % of the forest cover, 34 % of the primary forest cover, 31 % of the fishing areas and 32 % of the drinking water sources. In terms of energy, it has 19 % of oil reserves and almost 12 % of the global energy supply from renewable sources, with a very important potential in solar and wind generation. It is also rich in minerals, including those critical for the green transition. For example, 47 % of lithium reserves; 36 % of copper reserves and 34.5 % of silver reserves, to name a few. It is also a highly biodiverse region, with 6 of the 17 countries defined as megadiverse (Venezuela, Brazil, Colombia, Ecuador, Mexico and Peru)⁵.

This natural capital has been and will continue to be a significant source of wealth. Therefore, the importance of economic production and extraction activities linked to natural resources is not surprising. The extractive sectors, agriculture and the provision of electricity, water and gas, represent more than 10 % of the regional GDP, well above the value for the countries of the European Union and the United States. Interestingly, in developed countries such as Australia, Canada and Norway, the contribution of these sectors to the economy is outstanding, as it is in the region. This shows that an economic structure with a high participation of sectors based on natural capital is not incompatible with high economic and social development. The region can, therefore, leverage its development on the significant stock of natural capital it possesses.

The great point of contact between the economic development agenda, social inequality and environmental protection today is precisely to find ways to make better use of natural resources, internalizing that we need to take into account the costs of our decisions as a society.

Based on an interview with Juliano Assunção

The impact of natural resources is also evident in other variables: for example, in fiscal revenues. In the case of hydrocarbon extraction, it exceeds 4 % of GDP in countries such as Ecuador, Guyana, Trinidad and Tobago, and Bolivia. Fiscal revenues associated with minerals represent 3 % and 1.5 % of GDP in Chile and Peru, respectively. Fossil resources also represent an important source of foreign exchange. In Colombia, Bolivia, Trinidad and Tobago, and Ecuador, these exports exceed 20 % of total foreign sales of goods and services.