Latin America is held back by small middle class and the lack of middle-sized companies

Jul 23, 2019 | 10 comments

A bar in Buenos Aires that was forced to close during a blackout (Getty).

By June Webber and Frederica Cocca

Once the world’s most prosperous emerging region, Latin America has fallen behind in recent years — due in part to its missing middle: a lack of medium-sized companies, and a shortage of middle-class consumers, according to recent research.

Although emerging economies’ contribution to global growth has risen from 37 per cent in 1980 to 60 per cent this year, Latin America’s share of that performance has shrunk. From generating a third of emerging economies’ growth three decades ago, it now contributes just 12 per cent.

Growth across the region averaged 2.8 per cent a year between 2000 and 2016, compared with the 4.8 per cent average growth rate of 56 other emerging economies, excluding China.

One reason why Latin America is lagging behind is that the region lacks a solid tier of midsized companies able to create productive jobs and a robust middle class of consumers whose spending and saving could propel demand and investment, according to a report by McKinsey Global Institute.

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Addressing these twin gaps could increase annual growth to 3.5 per cent by 2030, McKinsey estimated; that would boost Latin America’s gross domestic product by $1tn, an extra $1,000 a year per capita.

“Smaller companies are not growing fast enough to become big,” said Alberto Chaia, a senior partner at McKinsey in Mexico City and a co-author of the report. And he warned that “demographics are changing. You cannot rely on demographics for growth any more”.

When measured relative to their GDP, Argentina, Brazil, Chile and Mexico only have about half as many firms with revenues above $50m as 10 other leading emerging economies that McKinsey used as comparators — China, India, Indonesia, Malaysia, Philippines, Poland, Russia, South Africa, Thailand and Turkey.

The region boasts titans such as Anheuser-Busch InBev, América Móvil, Bimbo, Cemex, Embraer, Femsa, Techint and Arcor, but, at the other end of the scale, informality is rife.

And Latin America’s population is sharply economically divided between uber rich and very poor, holding back the level of savings and thus the investment rate, which is running at half the level in East Asian emerging economies.

Since 2000 poverty in the region has halved to under 15 per cent of the population, but a quarter of Latin Americans remain vulnerable to crashing out of the middle class because of high prices, a lack of higher wage jobs and little access to credit, McKinsey said.

The two factors are interlinked, said Andres Abadia, senior international economist at Pantheon Macroeconomics: “Middle class consumers represent about 40 per cent of the total [Latin American] population — it is crucial that they do well for small and midsized businesses to grow.”

And productivity is a “a massive issue”, Mr Abadia said. “Governments should invest into research and development, as well as education and infrastructure, to boost these numbers.”

According to Marco Oviedo, chief Mexico economist at Barclays, “the challenge for firms and unions too is to come up with some sort of rule to link wage growth to productivity in order to avoid higher inflation or higher costs to firms”.

The region’s businesses also need to break away from government subsidies that create economic distortions, he said.

Some contributing factors are idiosyncratic to particular countries, according to Gersan Zurita, a senior vice-president at Moody’s. In Mexico “the economy is bipolar, dominated by oligopolies and monopolies — for example, a single large public utility company owned by government or a large oil company also owned by the government”, he said. “And then a whole slew of small companies; not much in between.”

The Mexican tax system is holding back companies by effectively incentivising them to remain small, he added: “As soon as they have more than 200-250 employees, their income tax skyrockets so they hold back on hiring.” Meanwhile in Brazil, Mr Zurita blamed archaic regulations, tax systems and bureaucracy.

“In this new economy companies need to move very quickly to catch up with global firms and expand — they can’t do this in a system that it 80 years old,” he said, noting that the government is trying to digitise and simplify these systems. It is a matter that is increasingly occupying the minds of the region’s governing politicians.

In Mexico, leftist nationalist President Andrés Manuel López Obrador has promised to break the country out of a three-decade rut in which growth has averaged about 2 per cent a year, but the economy contracted in the first quarter.

Brazil’s far-right President Jair Bolsonaro has vowed to open Brazil’s relatively closed economy but faced a long battle over pension reform — and that has economic consequences, according to Cassiana Fernandez, Brazil chief economist at JPMorgan. “The political tensions of the beginning of the year led to an important decline in business confidence, with consequences for this year’s growth,” she said.

There are signs of progress: increasing numbers of fintech firms such as Nubank, Rappi, Mercado Libre and Cornershop are leading innovation in what McKinsey’s Mr Chaia called “the first signs of a digital spring”. But turning the region’s economy around requires its fragile midsized companies to become more dynamic, he said.

“Unless you promote formalisation, digitalisation of the economy and an increase in productivity, it’ll be very difficult to grow at all.”
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Credit: Financial Times, www.ft.com

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