It has been a very good decade for Andean nations, in particular for Colombia and Peru. Boosted by very positive terms of trade—underpinned by rapid urbanisation and rising consumer purchasing power in Asia—the two countries have experienced an export-led bonanza. Colombian and Peruvian authorities have also succeeded in the last ten years in putting in place sound fiscal and monetary policies to guarantee low inflation and improving debt indicators, along with rapid GDP growth. This virtuous cycle has not gone unnoticed by foreign investors, who have piled into both countries to take advantage of their vast natural resources (including oil, gas, minerals and agricultural products), growing middle class and expanding links with other high-growth emerging economies, particularly along the Pacific Rim in both Latin America and Asia.
However, as the commodity super-cycle fades and income levels in both countries start to converge with the median of Latin America, questions about future growth trends are mounting. A major question is whether policymakers will be able to put in place the necessary measures to increase productivity, which would sustain real income growth over the long term and allow both countries to break the middle-income trap and become advanced economies. Until now, Colombia and Peru have been able to benefit from relatively easy productivity gains prompted by rising urbanisation and a rapid increase of the labour force. But these trends are slowly running their course, highlighting the need to address structural challenges that have proven difficult to tackle in the past.
The task is complex and is made harder by the lack of perceived urgency, as the short-term economic picture remains fairly positive. In Colombia there is still scope for productivity improvements via a reduction in formal unemployment (helped by recent measures that reduce labour costs for businesses), while Peru will be able to enjoy a few more years of strong private investment growth from huge mining projects that are already in the pipeline. These trends, however, are unlikely to last for more than five years, meaning that policymakers should ideally already start tackling long-standing issues such as poor infrastructure, highly dysfunctional education and healthcare systems and high levels of underemployment, among others.
Although the authorities in Colombia and Peru are well aware of the challenges, there is a serious risk of complacency and/or policy paralysis, in particular given the politically sensitive character of the reforms needed. Indeed, efforts to improve education or strengthen local institutions, such as the judiciary, have proven to be particularly problematic in both countries, and this is likely to remain the case over the medium term. Added to this, there is a long-standing problem with policy implementation—particularly at the local level, where there is a lack of, or limited, state presence—which complicates the execution of projects.
In this context, the outlook for businesses is mixed. Colombia and Peru have made huge strides in setting up well-functioning macroeconomic frameworks and attractive foreign investment schemes that will not be rolled back. Moreover, a recent push to address infrastructure deficiencies will also help to improve competitiveness in certain segments. But unless they make a concerted effort—and achieve political consensus—to invest in their human capital (by improving their education sectors and dealing with talent shortages) and strengthen their institutions (particularly the judiciary), there will be a lingering risk that the boom years come to a permanent end, with both countries failing to break the middle-income trap.
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