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Financial Times

Latin America's digital spring: work in progress

As well as boosting productivity, automation and other technologies can help small and midsize companies expand their consumer base and go global, write Jaana Remes and Andres Cadena in Financial Times.

Earlier this year Japan’s SoftBank announced a new $5bn technology growth fund aimed at Latin America and quickly followed up with a $1bn investment in Rappi, a Colombian online delivery firm that now operates in countries from Argentina to Uruguay.

SoftBank thus joins a fast-growing list of international investors to Latin America that are bringing new hope to the region.

Could this digital spring revive Latin America’s growth momentum after almost two decades of lacklustre performance? The answer will depend on the extent to which digital tools can help tackle the “missing middles” that have held back the region — a dearth of vibrant midsize firms that grow, compete and create better-paying jobs, and the lack of middle-class spending power that is needed to fuel domestic demand and investment.

Digital technologies on their own won’t suffice to revitalise inclusive growth, that will take more fundamental change, but they could play a role in accelerating such change.

Even before the SoftBank announcement, venture capital investment in Latin American start-ups quadrupled between 2016 and 2018 to $2bn.

Among the largest start-ups are Mercado Libre, a digital marketplace based in Argentina with a valuation of more than $30bn, dubbed the “Amazon” of Latin America, that has more than 200m users, and São Paulo-based Nubank, which heads a cohort of financial technology companies in the region.

Most countries in Latin America are seeing annual growth rates of nearly 50 per cent in the number of financial start-ups. Nubank has a valuation of about $10bn* and has attracted investment from China’s Tencent, among others.

Regional accelerators such as StartUp Chile, IncuBAte (in Buenos Aires), and Ruta N in Medellín have helped foster some of these companies, and the digital ecosystem that has sprung up around the region is an indication of new-found economic dynamism that is sorely needed.

Beyond these digital green shoots, we will need to see more, and much broader applications, to shift the region’s macroeconomic trajectory.

The economic story out of Latin America since the beginning of this century has been one of weak growth and unequal distribution of the gains of that growth. Despite benefiting from the cyclical upturn in global commodity prices, major Latin American economies have been sluggish; gross domestic product growth in the region averaged just 2.8 per cent annually between 2000 and 2016, compared with a 4.8 per cent annual rate in 56 other emerging economies, not including China.

Moreover, in sharp contrast with peers in other regions, Latin America’s GDP growth has largely been fuelled by an expanding labour force rather than rising productivity. With the demographic picture changing as a result of declining birth rates, productivity gains will become increasingly important for the region if it is to maintain even its current trajectory.

Latin America has some very dynamic large firms, of course, but they tend to be fewer in number and less diversified beyond energy, materials, and utilities than in other regions, especially Asia. At the same time, Latin America has a long tail of small and often informal companies that collectively provide large-scale employment, but whose low productivity and stagnant growth hold back the economy.

In terms of their digital readiness, Latin American firms still lag behind their peers in North America — but the gap is not insurmountable. Surveys we have conducted suggest that Latin firms are roughly three to five years behind North American companies in relation to the digital frontier; about 17 per cent of sales are through digital channels, compared with 23 per cent in North America, while 16 per cent of the labour force is allocated to digital initiatives (vs 26 per cent) and 7 per cent of market share goes to digital natives (vs 10 per cent).

Digital can help fill in the missing middles on several fronts. Three priorities in particular are needed: policymakers will need to create competitive and open markets by cutting red tape, including less onerous business regulation and a lighter tax burden, improving access to finance and expanding market reach.

More participatory labour and consumer markets will need to spread productivity gains to the vulnerable and middle classes, so that consumer spending can create new demand. Finally, government itself will need to develop new capabilities for delivery.

On all three fronts, digital technologies can help. As well as boosting productivity, automation and other technologies can help small and midsize companies expand their consumer base and go global. Digital can also ease the integration of smaller suppliers into the supply chains of larger customers, reduce costs, increase revenues and lower risk by improving demand forecasting and better matching of offerings to consumer needs.

The region is already seeing a pay-off from the digital ecosystem in the form of new, well-paid jobs. In Argentina, for example, the knowledge-based services sector has become the third-largest employer in the economy, with average wages significantly above the median. And digitising government services can be a powerful tool for improved public sector efficiency, as countries such as Estonia have shown.

Latin America’s growing band of unicorns, and investors such as SoftBank, have already identified the prize: a highly urbanised and growing middle class with an appetite for online shopping and banking — and strong aspirations for a better life that have not yet been met. Policymakers still must step up to ensure that the digital spring turns into a long and fruitful summer.

This article first appeared in Financial Times.