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Latin America’s commodity dependence

by Augusto De La Torre

WASHINGTON — In 1672, Potosi, Bolivia, was one of the largest and richest cities in the world. Located at the base of Cerro Rico, Potosi was a hotbed of Spanish silver mining. Its operations were so prolific that “potosi” became synonymous for great riches.

Three hundred forty years later, Potosi is poor and rife with conflict. Just last month, miners barricaded all routes out of the city, trapping more than 100 foreign tourists for 20 days. It’s hardly a surprise that the Bolivian press calls mining the burden of Potosi.

Latin American history is littered with tales of commodity booms gone bust like Potosi’s. That the quick riches never seem to produce lasting wealth has led some to conclude that the region, like other resource-rich regions, is under a “natural resource curse.”

But for Latin America, where 93 percent of the population and 97 percent of economic activity is in countries that are net commodity exporters, the hex is far from universal. A team of World Bank economists and political scientists this year has found some important trends that suggest today’s commodity booms will not end like the old.

One reason for this optimism is good governance. National governments and financial institutions are far better than they used to be and much more likely to manage the latest commodity windfalls with an eye on long-term growth over short-term gains.

Chile, the world’s largest copper exporter whose commodities account for more than 75 percent of its exports, is a case in point. Years ago the country’s leaders, on both ends of the political spectrum, agreed to save a significant percentage of earnings from the copper boom and spend the rest wisely.

In the past five years, the country’s investments in innovation have grown 24 percent annually. At the same time, Chile has invested vigorously in education and created a $6 billion scholarship fund that will send some 3,300 professionals abroad to study this year — a 672 percent increase over 2006.

Had Chile ignored the need to improve productivity, invest in human capital and encourage innovation, its commodity dependence could have become a liability and undermined growth. Instead, in the past decade, Chile’s gross domestic product grew more than 2 1/2 times.

The other reason for optimism is that commodity production in the region is changing. In the past, foreign companies profited most — they built the road or the railroad to the mine, extracted the country’s wealth, took it abroad and left poorer nations behind.

Today, it is far more common to see commodity extraction linked to other economic activities directly benefiting the source country. A 2009 study of a Peruvian gold mine, for example, found an extensive network of local businesses tied to the operations of the mine. Each 10 percent increase in the mine’s purchases paralleled a 1.7 percent increase in local incomes.

What’s more, regional commodity producers no longer need to be foreign to be big and skillful. In Brazil, the main force behind its farming revolution is Embrapa, the Brazilian Agricultural Research Corporation. Thirty years ago, soils on the country’s vast savannas, known as the cerrado, were deemed too acidic for any sort of productive farming. “Today the cerrado accounts for 70 percent of Brazil’s farm output and has become the new Midwest,” according to a recent article in The Economist.

Embrapa, a public company founded in 1973, is now considered the world’s leading tropical-research institution. Its major achievement has clearly been to turn Brazil, in less than three decades, from a food importer to one of the top food exporters in the world.

This kind of investment in research and development requires long-term vision plus long-term savings. The region as a whole, unfortunately, does not excel on this front yet. Of the five countries in the region that set aside hydrocarbon or mineral revenues into an investment fund during the 2002 boom, only two had enough savings to contribute to their postcrisis recovery.

History has shown that negative outcomes in resource-abundant countries are mainly confined to those with poor governance. Demands to spend during a boom are politically hard to ignore, particularly for weak regimes with little credibility. Without sufficient savings, any boom is likely to turn into a bust.

The good news is that governance in Latin America has come a long way. And for most countries in the region, commodities now are far more likely to be a blessing than a curse.

Augusto de la Torre, an Ecuadoran national, is the chief economist for Latin America and the Caribbean at the World Bank, and the former head of the Central Bank of Ecuador (1993-97). In November 1996, Euromoney Magazine chose him the year’s “Best Latin Central Banker.” (Adelatorre@worldbank.org)