metadata: authors: 0: author: Calvo-Gonzalez,Oscar
1: author: Castaneda Aguilar,Raul Andres
2: author: Farfan Bertran,Maria Gabriela
3: author: Reyes,German Jeremias
4: author: Sousa,Liliana Do Couto
count: Latin America
docna: 0: docna: How is the slowdown affecting households in
            Latin America and the Caribbean ?
docty: Policy Research Working Paper
subtopic: Economic Theory & Research,Industrial Economics,Labor Markets,Poverty Impact Evaluation,Poverty Monitoring & Analysis,International Trade and Trade Rules,Economic Growth,Inequality,Poverty Assessment,Poverty Diagnostics,Poverty Lines,Small Area Estimation Poverty Mapping,Rural Labor Markets
teratopic: Industry,Poverty Reduction,Macroeconomics and Economic Growth
abstracts: cdata!: This paper shows evidence that suggests
            the economic slowdown in Latin America and the Caribbean has
            already translated into slowing social gains, including
            decelerating poverty reduction, stagnating growth of the
            middle class, and lower income growth. The countries of
            South America outperformed Mexico, Central America, and the
            Caribbean in poverty reduction during the decade up to 2012.
            But since then, a new story has emerged. In recent years,
            poverty reduction has been disappointing across the entire
            region, which seems to be converging toward low growth with
            slow poverty reduction and stagnant inequality. However,
            this apparent convergence in poverty reduction is driven by
            diverging labor market patterns. In a reversal of the trends
            seen during the commodity boom, real wages have been falling
            in South America and rising in Mexico, Central America, and
            the Caribbean. As lower economic growth is likely, the new
            normal will pose challenges for policy makers, in protecting
            the gains achieved and for societies as they face a mismatch
            between expectations and actual social mobility.
repnme: repnme: How is the slowdown affecting households in
            Latin America and the Caribbean ?
display_title: How is the slowdown affecting
            households in Latin America and the Caribbean
listing_relative_url: /research/2017/01/27111387/slowdown-affecting-households-latin-america-caribbean
topicv3: Economic Growth m1326241 471,Economic and Social Mobility m1326259 1152,Labor Markets m1326488 855,Poverty m1326687 695,Trade m1326924 698
publishtoextweb_dt: 2017-01-19T00:00:00Z
historic_topic: Industry,Poverty Reduction,Macroeconomics and Economic Growth
no_of_pages: 24
author_keys: 0: author_key: 915932
1: author_key: 1145171
2: author_key: 972540
3: author_key: 1381792
4: author_key: 1262783
model_extractions: WPS7948 Policy Research Working Paper 7948 How Is the Slowdown Affecting Households in Latin America and the Caribbean?

_Oscar Calvo-González R. Andrés Castañeda Maria Gabriela Farfán Germán Reyes Liliana D. Sousa_ Poverty and Equity Global Practice Group January 2017
Policy Research Working Paper 7948

# **Abstract**

This paper shows evidence that suggests the economic slowdown in Latin America and the Caribbean has already translated into slowing social gains, including decelerating poverty reduction, stagnating growth of the middle class, and lower income growth. The countries of South America outperformed Mexico, Central America, and the Caribbean in poverty reduction during the decade up to 2012. But since then, a new story has emerged. In recent years, poverty reduction has been disappointing across the entire region, which seems to be converging toward low growth with slow poverty reduction and stagnant inequality. However, this apparent convergence in poverty reduction is driven by diverging labor market patterns. In a reversal of the trends seen during the commodity boom, real wages have been falling in South America and rising in Mexico, Central America, and the Caribbean. As lower economic growth is likely, the new normal will pose challenges for policy makers, in protecting the gains achieved and for societies as they face a mismatch between expectations and actual social mobility.

This paper is a product of the Poverty and Equity Global Practice Group. It is part of a larger effort by the World Bank to provide open access to its research and make a contribution to development policy discussions around the world. Policy Research Working Papers are also posted on the Web at http://econ.worldbank.org. The authors may be contacted at ocalvogonzalez@worldbank.org.

_The Policy Research Working Paper Series disseminates the findings of work in progress to encourage the exchange of ideas about development issues. An objective of the series is to get the findings out quickly, even if the presentations are less than fully polished. The papers carry the names of the authors and should be cited accordingly. The findings, interpretations, and conclusions expressed in this paper are entirely those of the authors. They do not necessarily represent the views of the International Bank for Reconstruction and Development/World Bank and its affiliated organizations, or those of the Executive Directors of the World Bank or the governments they represent._ Produced by the Research Support Team
# How Is the Slowdown Affecting Households in Latin America and the Caribbean?<sup>*</sup>

Oscar Calvo-González<sup>†</sup> , R. Andrés Castañeda<sup>‡</sup> , Maria Gabriela Farfán<sup>§</sup> , Germán Reyes<sup>**</sup> , Liliana D. Sousa<sup>††</sup> JEL Classification: I3, D63, J6, N36 Keywords: Latin America and the Caribbean, Economic slowdown, Poverty, Inequality.

> * The authors would like to thank the members of the Regional Management Team of the Latin America and the Caribbean region of the World Bank as well as participants of the seminar organized by the Poverty and Equity Global Practice, World Bank, for comments and suggestions.

> † Practice Manager, Poverty and Equity Global Practice, World Bank. E-mail: ocalvogonzalez@worldbank.org

> ‡ Research Analyst, Poverty and Equity Global Practice, World Bank. E-mail: acastanedaa@worldbank.org

> § Young Professional, Poverty and Equity Global Practice, World Bank. E-mail: gfarfan@worldbank.org

> ** Research Analyst, Poverty and Equity Global Practice, World Bank. E-mail: greyes2@worldbank.org

> †† Economist, Poverty and Equity Global Practice, World Bank. E-mail: lsousa@worldbank.org
# **1. Introduction**

After a decade of unparalleled social gains, the years since 2011 have been marked by a protracted economic slowdown in Latin America and the Caribbean (LAC). For five consecutive years, growth trended downwards and even culminated in a contraction in regional economic activity in 2015 (de la Torre et al., 2015, 2016). In the decade or so after 2003 that coincided with the commodity boom time, the region had been characterized by sharp reductions in poverty and inequality and moved towards becoming a middle class region as increasingly large proportions of the population moved into the middle class. In the recent context, however, the question is how much of the achievements of the previous decade are being put at risk because of this protracted slowdown?

The aim of this paper is to describe through a set of stylized facts how the slowdown is affecting households in the region. The paper is organized around two central questions: what is happening with poverty and inequality and what is behind these trends? The first section documents how the slowdown is manifesting in key welfare indicators and presents new emerging trends in the region. The second section further describes what is behind recent trends by looking at the main channels through which the impact of the slowdown is manifesting. Lastly, the paper concludes with a discussion of some of the main implications and challenges that the new scenario poses to policy makers in the region. It does so from the perspective that the lower economic growth in the region is likely the reflection of a “new normal,” driven in turn by the bursting of the commodity price boom and lower growth in China. If that is the case, the future pace of social gains in the region is also likely to be affected and this is likely to pose challenges for policy makers to protect the social gains achieved. In addition, to the extent that the rapid pace of social gains seen in previous years may have been internalized by the population at large and created expectations for future gains, the new normal may result in societies facing a mismatch between expectations and actual social gains and mobility.

# **2. How is the slowdown affecting poverty and inequality?**

As economic growth slows in the region, a particular concern is that it may translate into a slowdown—or even a reversal—of the social gains achieved during the recent period of sustained high growth. Indeed, we find evidence that the slowdown has already translated into a slower pace of poverty reduction and a stagnation of the growth of the middle class (Figure 1).<sup>7</sup>

> 7 The numbers presented in this brief are based on comparable household and labor force surveys in the SEDLAC and LABLAC databases. See Annex 1 for more details about the data and the definitions of the different economic groups. All poverty rates are calculated based on international poverty lines, in particular, $4 per day adjusted for 2005 purchasing power parity (PPP).

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<!-- Start of picture text --> 25<br>a5 4 a 23<br>(less than $4)<br>| ee Poverty<br>20 | 21<br>2003 04 05 06 07 08 09 10 ll 12 13. «2014<br><!-- End of picture text -->
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<!-- Start of picture text --> Income distribution in LAC<br>2003-2014<br>2<br>“ 7 7 » 2014<br>zB 2003 rg 4 ' ‘ a<br><!-- End of picture text --> <!-- Start of picture text --> /An<br>N “ \S<br>re ‘Y<br>ovo —<br>co Vulnerable39% Middle35% Class ~~ >=»<br>oO =< ~—s<br>$4 $10 $50<br>Per capita income USS (2005 PPP)<br><!-- End of picture text -->
<!-- Start of picture text --> 60 60 SA Peers<br>*° ————— “<br>20 MCcc 20 South America<br>0 0<br>Tegsssessnuansa ”gsssesegenaaz\ =<br>ol el cr Sel<br><!-- End of picture text --> <!-- Start of picture text --> 0.0<br>-0.5<br>-0.7<br>-1.0 09 0.9<br>-1.5<br>-15<br>2.0<br>Mcc MCC Peers South America SA Peers<br><!-- End of picture text -->
<!-- Start of picture text --> 5<br>®<br>3<br>overtydidi e Changes in<br>1 : e e 3 poverty tates<br>e e e by country country<br>4 & e = ° ¢ (percentage<br>®<br>Poverty 2 r » S points)<br>down 3§;:§;:;:: 4<br>@<br>4<br>599<br>z<br>e<br>2004-06 2006-08 2008-10 2010-12 2012-14<br><!-- End of picture text --> 5 ® 3 overtydidi e Changes in 1 : e e 3 poverty tates e e e by country country 4 & e = ° ¢ (percentage ® Poverty 2 r » S points) down 3§;:§;:;:: $4 @ 4 599 z e 2004-06 2006-08 2008-10 2010-12 2012-14
During the slowdown, in contrast, the marked differences in poverty reduction observed across MCC and SA countries seem to be disappearing. A new story of convergence emerges if we look at the evolution of changes in poverty reduction across the region. Each dot in Figure 6 represents two-year average annual changes in poverty rates—as percentage points—for each country over the 2004-14 period. Dots above the horizontal line reflect an increase in poverty, whereas dots below the line refer to a decrease in poverty. The further away the dot is from the horizontal line, the greater is the poverty change in absolute value. Figure 5, then, presents some interesting findings. First, though most countries in the region continued to reduce poverty over time, the pace of poverty reduction has slowed. Second, this slowing of poverty reduction across the countries of LAC suggests that the region as a whole may be converging to the same place, in contrast to the recent decade of “two regions” within LAC. Third, if this convergence towards low poverty reduction continues, we are likely to find poverty reduction in the region continue to flatten in the near future, or even begin to see an increase in poverty rates.

_Figure 6: The convergence in poverty reduction rates is due to ‘commodity boom countries’ now looking more like the rest of LAC_

- (a) Boom (2003-11 annual average, excl. 09) (b) Slowdown (2012-14 annual average)

<!-- Start of picture text --> 2 2<br>0 0<br>-2 -2<br>-4 -4<br>Commodity boom countries Commodity boom countries<br>-6 -6<br>-1 1 3 5 7 9 -1 1 3 5 7 9<br>GDP growth (%) GDP growth (%)<br>Poverty Change (ppts) Poverty Change (ppts)<br><!-- End of picture text --> Source: LAC Equity Lab tabulations using SEDLAC data (World Bank and CEDLAS). Note: Commodity-boom countries are identified as those whose terms of trade grew by more than two percent in annualized terms between 2003 and 2013 as defined in World Bank (2015). Commodity boom countries are Chile, Bolivia, Colombia, Peru, Ecuador, Brazil, and Argentina; the other countries included are Dominican Republic, Guatemala, Honduras, Mexico, Paraguay, Uruguay, and El Salvador. Since growth rates in 2009 are significant outliers, they are excluded from the first period.

This convergence in poverty reduction is largely explained by the change in growth performance among countries that benefited from the commodity boom. Figure 6 shows the relationship between poverty change and economic growth during the commodity boom period (2003-11) and the slowdown (2012-14). The best performers in each period are those countries in the bottom right of the figure. Commodity-boom countries have jointly moved to the upper left during the slowdown period, reducing the poverty reduction gap with the non-commodity countries.

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This apparent convergence, however, might be transitory. Figure 7 shows the same scatterplot during the slowdown period but with a different classification of countries: “the Reformers”. These are countries for which the Global Competitiveness Index (published by the World Economic Forum) has increased at a faster pace than the worldwide average increase from 2010 to 2015. Under this definition, the reformers have become more competitive by improving a set of institutions, policies, and factors (e.g., infrastructure, health, and education; macroeconomic stability; and well-functioning labor, financial, and human capital) that determine the level of productivity in their economies (WEF 2016). These reformers appear to have achieved larger poverty gains that non-reformers during 2012-14. This classification suggests a new split in the region that is worthy of analysis, and leaves behind the old “commodity”–“non-commodity” classification.

_Figure 7: Is there a new split in the region in terms of poverty performance?_ Slowdown (2012-14 annual average) <!-- Start of picture text --> 2<br>0<br>-2<br>-4<br>"Reformers"<br>-6<br>-1 1 3 5 7 9<br>GDP Growth (%)<br>Poverty change (ppts)<br><!-- End of picture text --> Source: LAC Equity Lab tabulation using SEDLAC data (World Bank and CEDLAS). “Reformers” are defined as countries which saw their Global Competitiveness Index (World Economic Forum 2015) increase at a faster pace than the worldwide average from 2010 to 2015. The countries identified as reformers are Colombia, Dominican Republic, Ecuador, Mexico, Nicaragua, Peru, and Paraguay.

# **3. What is behind recent trends?**

While the previous section focused on exploring what has been happening with poverty and inequality in LAC since the beginning of the slowdown, this section explores some of the drivers behind these trends. How does slowing economic growth impact household welfare? The labor market and fiscal policy are the two key transmission channels between economic growth and household income (Figure 8). The labor market, the most important channel of transmission due to the important role of labor income in household budgets, reflects the interaction between firms and employees through wages (prices) and employment (quantities). These two components are 9
<!-- Start of picture text --> Employment<br>Labor<br>markets<br>Wap§ = Householdwelfare<br>Fiscal polic ae<br>pouey spending<br><!-- End of picture text -->
<!-- Start of picture text --> Boom Slowdown Boom Slowdown<br>2003-2008 2012-2014 2003-2008 2012-2014<br>0 0<br>_ Growth Fabor<br>- income<br>ra<br>=<br>- 7<br>3<br>e<br>2<br>= -2 -2<br>oS<br>5 Distributional changes WNon-labor income<br>3 3<br><!-- End of picture text -->
<!-- Start of picture text --> 2003-2013<br>6%<br>2 4%<br>g<br>€ 2%<br>So<br>oh<br>a 0%<br>5<br>2%<br>i<br>4%<br>Tradabl es Non-tradables low- Non-Tradables Tradables Non-tradables low- Non-Tradables<br>wage high-wage wage high-wage<br>Countries without commodity boom Countries with commodity boom<br>SUnskilled eLow-skilled oe Skilled<br><!-- End of picture text --> <!-- Start of picture text --> 1 | a a<br><!-- End of picture text -->
<!-- Start of picture text --> 64 12<br>62 9 Brazil<br>2<br>5 Rest of<br>< 60 6 South America<br>a —/ ee<br>58 3<br>56 0<br>2006 2009 2012 2015 2006 2009 2012 2015<br><!-- End of picture text -->
<!-- Start of picture text --> 120<br>e a Brazil<br>a 110<br>o- 100 .<br>@ Ecuador<br>ow Mexico<br>a Costa Rica<br>nn @ 90 Peru<br>80<br>2014 2015<br><!-- End of picture text -->
# **4. Some challenges ahead**

A new normal of lower economic growth and slower social gains is bound to create a number of challenges for policy makers and more broadly for societies at large in the region. These challenges are likely to manifest themselves in a variety of areas, including fiscal policy trade-offs, prospects for long-term growth, and societal demands.

In terms of fiscal policy, decision-makers are likely to face a difficult trade-off between efforts of fiscal consolidation and preserving social expenditures. While this trade-off is nothing new, it is likely to be more difficult than before. After a decade or so of successful poverty reduction there still remained a large number of chronic poor. Following Vakis et al. (2016) by chronic poor we simply mean those households that were poor both in 2004 and in 2012. Those that remained poor during the boom are likely to need specific policy efforts. The falling importance of non-labor income in poverty reduction is probably a reflection of the difficulty of lifting the “harder to reach” out of poverty in recent years. Put simply, those that had better chances of escaping poverty already did so—in part thanks to both public and private transfers—making it more difficult to have an impact at the margin. This suggests that, even in the absence of a growth slowdown, prospects for further poverty reduction among the chronically poor would be weaker going forward.

At the same time, the vulnerable, which remain the largest socioeconomic group in the region, will now be more likely to experience downward economic mobility and increased risk of falling into poverty. Combined the poor and vulnerable account for around two-thirds of Latin Americans. But these two groups may benefit most from different types of interventions and expenditures. In this context, fiscal consolidation will benefit from better understanding what public programs can do for the different groups and where there may be efficiency gains.

As shown in this paper, performance across the region in terms of poverty reduction is no longer correlated with the benefits of a commodity boom. Moreover, there is some emerging evidence that countries’ overall policies, as captured by such a broad measure as improvements in the Global Competitiveness Index, may help to explain some of the differential performance in both growth and poverty reduction across the continent. In short, the hypothesis is that as the super cycle of the commodity boom comes to its end, the old country taxonomy based on commodity prices might be replaced with a taxonomy based on the progress made to increase economy-wide productivity and competitiveness as well the efficiency of spending, led by those countries in the region that are taking the necessary reforms. Further analysis of this hypothesis could help identify how reforming countries can “do more with less” in terms of poverty reduction as growth shifts to a new normal.

The growth agenda will be critical for the social agenda. Decompositions show that during the boom more than two-thirds of poverty reduction in the region was due to growth rather than to changes in the distribution of income. Adjusting to changes in global demand with an eye towards increasing economic growth in a changing environment will be key for continuing social gains.

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<!-- Start of picture text --> Employment<br>Labor<br>markets Household<br>=<br><!-- End of picture text --> <!-- Start of picture text --> ys Fiscal policy spendingSocial<br>“Assets, human capital<br>investments<br><!-- End of picture text -->
<!-- Start of picture text --> Share who think country’s<br>future will be better (percent)<br>45<br>41<br>35<br>|| |<br>15<br>Ss j PHO SL SOPs eye<br><!-- End of picture text -->

<!-- Start of picture text --> 41<br><!-- End of picture text --> Share who think their children will be better off than them (percent) <!-- Start of picture text --> 75<br>.<br>*<br>*<br>50 . aes<br>ee rl<br>.<br>| |<br>0<br>0 25 50 75<br>Size of the middle class (percent)<br><!-- End of picture text -->