Latin America and the Caribbean is grappling with the world's lowest levels of public investment, hampering efforts to break free from persistent development traps that have held back growth for decades, according to a new report from the Santiago-based UN Economic Commission for Latin America and the Caribbean (ECLAC).

The region's general government gross fixed capital formation averaged just 2.1% of GDP in 2022, more than a percentage point below other developing regions and well short of the 3.3% recorded by advanced economies. This investment drought comes as countries face mounting fiscal pressures, with overall deficits averaging 3.1% of GDP in 2024 and public debt levels remaining elevated despite recent improvements.

The fiscal constraints reflect what ECLAC describes as three interlinked development traps: low capacity for sustained growth, high inequality with limited social mobility and weak institutional capacity. These challenges have been exacerbated by rising interest payments on public debt, which consumed an increasing share of government budgets in 2024 as global interest rates remained elevated.

The commission argues that fiscal policy must play a central role in enabling the structural transformations necessary for countries to achieve the Sustainable Development Goals, despite the challenging environment.

Investment efficiency matters

Despite the limits, ECLAC's econometric analysis suggests that well-managed public investment could provide significant economic returns. The commission estimates that each dollar of public investment generates a fiscal multiplier of 0.5 within two years when using high-frequency data, rising to 0.9 by the fourth year with annual data.

However, the effectiveness of such investment depends critically on governance quality. Countries with higher levels of investment efficiency achieve multipliers of 0.7 after two years, compared with just 0.3 for less efficient counterparts – a difference that renders the latter statistically insignificant.

The analysis reveals that public investment effects unfold in phases. Initially spending boosts construction activity and employment, with private consumption rising alongside imports of capital goods. Subsequently the newly created infrastructure begins to attract private investment, leading to productivity gains through capital deepening.

Green incentives proliferate

Across the region, governments are increasingly deploying tax incentives to promote environmental sustainability, though with mixed results. ECLAC identified measures in 10 countries supporting sectors including renewable energy, electric mobility, the circular economy and sustainable forestry.

Tax expenditures related to environmental sustainability range from 0.015% of GDP in Costa Rica to 0.185% in Colombia, with most countries concentrating benefits on energy transition initiatives. However, the report notes that many incentives lack performance criteria, potentially undermining their effectiveness.

The commission stresses the need for stronger governance frameworks, including systematic evaluation of tax expenditures and better coordination between different policy instruments. Some countries continue to provide preferential treatment for fossil fuels, creating contradictions with sustainability objectives.

Subnational challenges

The fiscal picture is complicated by the heavy dependence of subnational governments on central transfers, which account for 57% of total subnational revenue across the region. While this dependency has provided some stability, it limits local fiscal autonomy and can create vulnerabilities during economic downturns.

Argentina's provinces face particular exposure to external shocks, with 76% of provincial debt derived from bonds, the vast majority placed in international markets. This leaves them vulnerable to exchange rate fluctuations and changing investor sentiment.

Path forward

ECLAC argues that breaking free from the region's development traps requires strengthening what it terms "technical, operational, political and prospective" (TOPP) capabilities across government institutions. For public investment, this means improving project evaluation systems, establishing clear prioritisation criteria, and enhancing coordination between different levels of government.

The commission also calls for more systematic approaches to tax policy, including regular evaluation of incentive schemes and better alignment between tax and spending policies. With fiscal space remaining constrained, maximising the efficiency of available resources becomes paramount.

The findings come ahead of the Fourth International Conference on Financing for Development, scheduled for Seville in June 2025, which will focus on mobilising resources for sustainable development. For Latin America, the challenge will be demonstrating that increased investment can generate the productivity gains and institutional improvements needed to justify higher public expenditure in an era of fiscal constraint.