Miguel Pérez (ECLAC)
Latin America and the Caribbean’s current account deficit is growing fast: From 1.8% of GDP in 2012 to 2.6% in 2013, which the rest of the world is financing chiefly through foreign direct investment. As any liability, FDI needs to be repaid. This is done through FDI income, or the profits made by transnational corporations in the region. Returns on FDI are generally higher than other forms of capital: The average profitability of FDI in the region fluctuates with the economic cycle but rarely goes below 5%. More important, the liability is now huge and keeps growing. Stock of FDI in the region grew from 500 billion ten years ago to almost 2 trillion now.
A large stock and a consistently high rate of return generate a large outflow of FDI income, 112 billion in 2013, which is the largest debit item in the current account. This is hardly compensated by FDI income brought home by trans-Latin corporations from abroad. As a result, the deficit of FDI income has been close to 100 billion for the past three years (see chart below). On the other hand, the single largest positive item in the current account, the trade of goods, was reduced sharply in the past two years.
A large stock and a consistently high rate of return generate a large outflow of FDI income, 112 billion in 2013, which is the largest debit item in the current account. This is hardly compensated by FDI income brought home by trans-Latin corporations from abroad. As a result, the deficit of FDI income has been close to 100 billion for the past three years (see chart below). On the other hand, the single largest positive item in the current account, the trade of goods, was reduced sharply in the past two years.
Different factors beyond these two variables can affect the current account deficit, especially if we consider that this is a regional aggregate which hides very heterogeneous situations across the countries of the region. In some countries, lower prices of metals and other commodities over the past two years have been the most determinant factor in widening the current account deficit. Other items of the current account, like trade in services, remittances and other type of investment income are certainly important in many economies.
But a common trend across most of the region has been the rise in imports caused by economic growth and the advancement of the middle classes. Latin American economies are still unable to produce the goods that their citizens increasingly demand, as well as the capital goods needed for investment. This external restriction is nothing new, although the role of FDI, as the region’s largest external liability, was never so prominent. While FDI has been praised for its stability (it rarely turns negative), it gives rise to persistent effects on the current account. Such effects are not compensated by parallel changes in the production structure that could allow for an export drive in the future. Even in industries where large FDI flows have clearly increased production capacities (like the automobile industry), the shallowness of local value chains turn these industries into net importers as well.
But a common trend across most of the region has been the rise in imports caused by economic growth and the advancement of the middle classes. Latin American economies are still unable to produce the goods that their citizens increasingly demand, as well as the capital goods needed for investment. This external restriction is nothing new, although the role of FDI, as the region’s largest external liability, was never so prominent. While FDI has been praised for its stability (it rarely turns negative), it gives rise to persistent effects on the current account. Such effects are not compensated by parallel changes in the production structure that could allow for an export drive in the future. Even in industries where large FDI flows have clearly increased production capacities (like the automobile industry), the shallowness of local value chains turn these industries into net importers as well.