Download Sources of Growth in Latin America

NS4540
Winter Term 2017
Sources of Growth
in Latin America
Overview
• Central problem in Latin America – slow rate of GDP
growth throughout the region
• For much of the post-war era, economic growth has been
positive
• However growth of economies in Latin America has been slow
relative to some other regions at a similar stage of economic
development
• Modern growth theory stems from the 1950s and work of
Robert Solow at MIT
• Growth is seen in terms of changes in the labor force the stock of
capital and productivity of resources
• More recent “new” growth theory focuses more on human capital
and technology
• Empirically want to develop growth accounting or
contribution of labor, capital and productivity to growth
2
Growth Preconditions I
• In many areas of economics an implicit assumption
concerning some preconditions that need to be in place
• If these preconditions not met, the usual theories we use
in economics may not work as well.
• While there are a number of factors that can interfere with
workings of the market – two that are absolutely critical:
• Property rights, and
• Rule of law
• Many very poor countries and failed states are the result
of the complete lack of either of these preconditions
• Extreme lack of either precondition is not the case in
modern Latin America (usually Haiti is left out of these
discussions).
3
Growth Preconditions II
• Property rights
• Essential – for markets to work must be clear who owns
what
• Lack of enforcement of property rights makes market
participants reluctant to engage in many economic
transitions
• Any reduction in the enforcement of property rights
increases the risk of engaging in transactions
• Effectively increases the cost of normal economic activity
• Fewer transactions most often translate into a lower level of
overall economic activity and GDP
4
Growth Preconditions III
• Currently, Latin America something of a middle ground
with respect to property rights
• Region did not start out well in this regard particularly in colonial
period
• Protection of property often difficult in post-colonial times due to
political instability
• In more recent times
• Prevention of outright theft of property made difficult due to
ineffective enforcement of laws protecting property, or
• The the settlement of property disputes may be slow due to legal
system and courts
• Corruption also makes the rule of law less effective.
5
Property Rights in Latin America
• Scale 0 none to 7 complete
South America
Argentina
Bolivia
Brazil
Chile
Colombia
Ecuador
Mexico
Paraguay
Peru
Uruguay
Venezuela
Average
•
3.2
3.0
4.1
5.1
4.1
3.6
4.1
3.8
4.0
5.2
1.6
3.8
North America
Costa Rica
Dominican Republic
El Salvador
Guatemala
Honduras
Jamaica
Nicaragua
Panama
Average
4.6
4.0
3.8
4.3
4.0
4.7
3.2
4.9
4.2
Source World Economic Forum 2016 Derived from surveys of business
executives
6
Growth Preconditions IV
• Scores for Uruguay, Chile and Panama in the range of
Portugal and Spain
• Latin America scores than scores for Canada (5.9) and
U.S. (5.6)
• Still there is sufficient enforcement of property rights to
be able to use conventional models of economic growth
with some degree of confidence.
• The protection of Intellectual Property Rights
• Covers areas such as copyrights and patents
• In general intellectual property is more protected in developed
countries than developing countries
• Latin America clearly falls into this pattern
• Best scores are Uruguay and Panama
• Worst scores Venezuela and Bolivia
7
Intellectual Property Protection in Latin America
• Scale 0 none to 7 complete
South America
Argentina
Bolivia
Brazil
Chile
Colombia
Ecuador
Mexico
Paraguay
Peru
Uruguay
Venezuela
Average
•
3.6
2.7
4.1
4.3
4.2
3.7
4.2
3.4
3.6
4.8
2.0
3.7
North America
Costa Rica
Dominican Republic
El Salvador
Guatemala
Honduras
Jamaica
Nicaragua
Panama
Average
4.5
4.0
3.4
3.9
4.1
4.4
3.0
4.8
4.0
Source World Economic Forum 2016 Derived from surveys of business
executives
8
Growth Preconditions V
• Rule of Law
• Normal economic transactions involve legally binding
contracts
• If there is no effective referee to enforce business
contracts, far fewer business contracts will occur.
• Rule of law difficult to define in an extremely precise way
• World Bank components in Rule of Law Index
• Enforcement of Contracts
• Judicial independence
• Favoritism in decisions of government officials
• Efficiency of legal framework
9
Rule of Law Ranking
10
Rule of Law: Latin America Large Countries
60
Rule of Law (Percentile)
55
50
45
40
35
30
25
20
15
1996
2000
2003
2005
2007
2009
2011
2013
2015
Legend
ARG
BRA
MEX
11
Rule of Law: South America East
80
Rule of Law (Percentile)
70
60
50
40
30
20
10
0
1996
2000
2003
2005
2007
2009
2011
2013
Legend
ARGENTINA
BRAZIL
Uruguay
VENEZUELA
12
Judicial Independence
13
Growth Preconditions VI
• Summing up
• Latin America has a sufficient level of property rights and
rule of law to foster positive economic growth.
• Improving for most countries in Latin America, although
some back-sliding occurring
14
Neo-Classical Growth Model I
• Stresses increases in Labor, capital and technology
• Technology anything that causes resources to be used in
a more efficient way
• Total factor productivity and technology often used
interchangeably – output beyond what would be
expected from increases in labor or capital stock alone
• Holding capital stock (K) and technology (TFP) constant
and increasing labor will produce increased output at a
declining rate
15
Neo-Classical Growth Model II
• Changes in the capital stock and technology
• If the economy accumulates more capital, the production
function will shift upwards
• L1 workers can now produce Y2 rather than Y1
16
Neo-Classical Growth Model III
• With capital formation the capital-to-labor ratio (K/L) can
increase
• A worker with more capital can produce more goods and
services than one with less
• As the average capital-to-labor ratio rises, real GDP rises
• Because increases in the K/L ratio increase labor productivity it
also is associated with increased wages
• A similar situation occurs when the level of technology or
total factor productivity increases
• An improvement in technology should allow the economy to
produce more goods and services with the same level of capital
and labor
• Graphically the same as the increase in capital
17
Neo-Classical Growth Model IV
• This basic model explains a substantial part of the
progress of economic growth for virtually any country.
• A good place to start to understand economic growth in
Latin America
• As a developing region of the world, the population and
labor force are growing faster than most developed
countries
• To see this growth potential, need to examine the Latin
American labor market and scope for capital
accumulation
18
Latin American Labor Markets I
• The labor market in any country is usually far from
perfectly competitive
• Labor markets are special in two ways
• First, labor markets work, but they work slowly
• Equilibrate much slower than commodity markets
• Second, and more importantly, labor markets are among
the most regulated markets in any county
• This is especially true in the case of Latin America
• Result of these factors – cannot simply infer the supply
of labor from data on the population and the available
labor force
• Imperfections in labor markets influence the quantity of
labor supplied and where it is employed.
19
Latin American Labor Markets II
• The Latin American labor force
• In 2008 around 250 million workers
• Nearly half the population is in the workforce
• Brazil and Mexico alone account for almost 150 million workers
• Argentina, Colombia, Peru and Venezuela have labor forces
between 10 and 20 million.
• Often statistics fail to capture the millions in the informal
sector
• Also missing from the labor force are individuals working
in North America or Europe.
20
Labor Force (millions)
21
Latin American Labor Markets III
• Increases in the labor force mean movement along the
production function
• Can potentially lead to faster economic growth
• If labor force growing rapidly the economy needs to grow at a
fast pace to absorb the large numbers of workers entering labor
force
• If GDP is slow, then problems of unemployment and
underemployment become common
• If employment a problem in face of a rapidly expanding
labor force then production function not shifting upwards
at a fast enough pace
• Could be consequence of either slow rate of growth of capital or
slow productivity increases
• In many countries slow rates of capital formation.
22
Latin American Labor Markets IV
• Labor Market Distortions
• In every country a variety of rules and regulations
designed to protect workers from effects of labor markets
• Large variation throughout the region
• Job security regulations
• Attempt to enhance job stability by employing labor
codes that make it more difficult for firms to adjust the
level of their workforces – Measures
• Minimum advanced notice dismissal
• Mandated severance payments
• Limitations on temporary labor contracts
• Consultations with the government prior to large-scale layoffs.
23
Latin American Labor Markets V
• While such regulations enhance security of existing
workforce they may hinder creation of jobs in formal
sector.
• Latin America has the most comprehensive set of job
security provisions in the world
• Even if a worker can be dismissed, employer must pay such
workers
• In Latin America this “firing tax” is often equal to 64 weeks of
salary
• Practices hinder development of more jobs in the formal sector
• Despite more than two decades of economic reforms,
these regulations have proven to be very difficult to alter.
24
Latin American Labor Markets VI
• Conditions of Employment
• Cover various limitations on what employers may ask
workers to do in terms of number of hours worked and
other conditions of employment
• Relative to the rest of the world Latin America has some
of the more restrictive conditions of employment
• The cost of these restrictions seen in the existence of a
large informal labor market.
• Minimum wage
• Nearly every country has a minimum wage
• One of the most contentious issues in economics
25
Latin American Labor Markets VII
• Important considerations – minimum wage in Latin
America
• First, minimum wage has to be effective.
• In an inflationary environment has to be indexed or regularly
adjusted or it is irrelevant – often this does not happen
• Second, need to consider the existence of the informal
labor market
• Recent estimates indicate 30 to 70 % of Latin American workers
in informal market and 1 to 45% earn less than minimum wage
• Effects of minimum wage have to consider the effects on
the informal as well as formal labor markets
26
Latin American Labor Markets VIII
• Generally minimum wage has two conflicting effects
• Can raise wages of whose who are covered
• However if minimum wage if above the wage equilibrium can
depress the level of employment
• Empirical literature scant in Latin America, but much as
one would expect.
• Increase in minimum wage tends to decrease employment for
low-skilled workers in formal sector
• It does increase the income of those that maintain employment
• As a result, effects on the overall incomes of the poor are
uncertain.
27
Latin American Labor Markets IX
• For the informal sector – workers that lose their jobs in
the formal sector may not become unemployed, but
rather find employment in the informal market
• However this may increase the supply of workers in this
market and depress wages
• The result is that income losses to low-skilled workers
may not be as drastic as in developed countries where
there are fewer employment opportunities outside formal
sector
• It is possible therefore that an increase in the minimum
wage may have positive impacts on the distribution of
income in Latin America
28
Latin American Labor Markets X
• Unions
• Conventional wisdom is that labor unions constitute a
significant labor market distortion in Latin America
• Not wrong, but needs to be qualified
• Labor unions are a much smaller percentage of the labor force in
the area than was once the case
• In every county of Latin America the percentage of unionized
has declined over the last several decades
• Only Brazil and Mexico have over 30% unionized and
• Argentina and Nicaragua with 20%
• For Latin America as a whole only 14% of the labor force is
unionized
• No longer the case where labor unions dominate the
labor markets
29
Latin American Labor Markets XI
• Summing up, labor markets in Latin America are large,
diverse and subject to substantial distortions
• World Bank has developed an index to capture different
labor market conditions. It is composed of:
• The difficulty of hiring workers
• The rigidity of hours worked
• The difficulty of firing workers
• The rigidity of employment and
• The cost of firing workers
• Result allows countries to be ranked based on the
relative flexibility of their labor markets
• Latin America has relatively inflexible markets with
respect to the rest of the world
30
Labor Market Flexibility Index
31
Latin American Labor Markets XII
• Index provides a partial explanation of the relatively poor
economic growth performance of the region.
• Hard to explain how a region full of hard-working
relatively well educated workers can produce relatively
low economic growth.
• Explanations:
• First, mere possession of a quality labor force not
enough
• If significant barriers to the effective utilization of these workers
then potential productivity is diminished
• Second, the size of the informal labor market becomes
more understandable
• If employment in formal labor market involves a large amount of
inflexible rules tendency for employers to evade rules in the
underground economy
32
Capital Formation I
• Capital in Latin America
• As capital stock increases, the production function increases and
GDP rises
• Raid economic growth normally requires rapid increases in the
stock of capital
• As the K/L ratio rises the productivity of the labor force
increases
• Important because in the long run increases in
productivity lead to increases in real wages.
• K/L ratio for Latin America in 2013 was nearly $3,000
• Varies from $5,638 in Chile to a low of $560 in Bolivia
33
K/L and Per Capita Income
34
Capital Formation II
• Growth Patterns
• From 1990 to 2013 the K/L ratio in Latin America increased by
nearly 60%
• For the middle income countries the ratio tripled
• For Latin America GDP per capita increased from $4,130 to
$6,092 or 48%
• For middle income countries GDP per capita increased by 133%
• How can Latin America increase the capital stock?
• Increased savings by business and government could be
funneled through the banking system to produce higher rates of
investment
35
Capital Formation III
• Problems with the savings – banking system –
investment model
• Savings itself may be a function of economic growth and growth
has been slow
• Further exacerbated by the regions somewhat inefficient capital
markets – results in savings not flowing to best areas
• Data show the sum of FDI and savings for the region in
1990 was less than 20%
• Under most circumstances his percentage is unlikely to
lead to a large increase in the production function or
rapid economic growth
• Saving ratio in 2013 was 2% higher, so some reason for
optimism
36
Savings in Latin America
37
New Growth Theory I
• Neo-Classical theory of economic growth described
before is correct as far as it goes
• However an incomplete explanation of the process of
economic growth
• Problem is the theory not explain technology (or TFP)
which is assumed to be determined by factors outside he
model or exogenous
• Empirically meant that TFP was being computed as a
residual.
• Once one had accounted for the amount of economic
growth caused by changes and labor and the stock of
capital, TFP assumed to be the residual or “unexplained
growth”.
38
New Growth Theory II
• In the new growth theory models technology is
endogenous – explicitly included in the model with other
variables determining the level of technology
• Key assumption is that the level of technology and thus
economic growth can be enhanced by the accumulation
of knowledge.
• More knowledge can increase the level of technology and
become a driver of economic growth
• Knowledge has another important characteristic. It can be
accumulated without the constraint of diminishing returns.
• Furthermore, it is usually subject to increasing returns.
39
New Growth Theory III
• What determines or enhances the accumulation of
knowledge? Two factors thought to be important
• First, level of education in a society matters – the
accumulation of human capital matters
• Human capital is the education, training, and job skills embodied
in labor that increases its productivity
• Second, along with human capital investments in
research and development (R&D) can also enhance the
level of knowledge
• In Latin America human capital more critical than R&D. Most of
the world’s R&D occurs in the developed countries where
conditions are favorable for this activity
• Gives Latin America the opportunity to acquire knowledge
inexpensively through trade or FDI
40
New Growth Theory IV
• Patterns of education in Latin America
• One of success stories in Latin America is the low level
of illiteracy
• Literacy rates in the region now approaching those in the highincome countries
• Past primary education the data for the region is less
promising
• There has been some improvement in the number of students
finishing secondary education and moving to tertiary education.
• However even for those students who remain in school the
average quality or actual educational attainment is low by
international standards
• Problem not money spent on education, but its utilization
41
Educational Attainment in Latin America
42
New Growth Theory V
• For a middle-income country, R&D is a less important
factor in economic growth
• With so many pressing investment needs in Latin Amrica,
in both the pubic andprivate sector, not surprising that
the level of R&D low.
• Only Mexico and Brazil have R&D spending approaching
1% of GDP
• For the poorer countries of the region this percentage is
far less
• For Latin America FDI inflows are biggest source of R&D
• Still some key areas such as Embraer jet made in Brazil
embody indigenous R&D
43
New Growth Theory VI
• Summing up
• Neo-Classical theory of growth posits growth a function
of increase in labor force, capital and technology (TFP)
• New theory of economic growth adds two factors:
• Increases in the amount of human capital and
• Investment in R&D.
• Empirical testing critical and this leads to growth
accounting.
44
Growth Accounting I
• Growth models we have discussed ultimately can be
estimated with the relative importance of various inputs
identified – called growth accounting.
• Each factor has part to play in explaining why the growth of a
country has been what it was in the past.
• By explaining past periods of economic growth it is possible to
see what went right or wrong over time
• Using growth accounting possible to narrow the scope of
the problem of growth in Latin America
• Bad news is that there is no magic bullet that will suddenly
transform Latin America into East Asia
• Good news is that these exercises indicate where the bulk of the
problems are, and that in theory these problems can be
remedied over time
45
Growth Accounting II
•
•
•
•
•
•
•
•
•
Basic equation:
Y = f(K,L, H,A) where
Y = real GDP
K = the stock of capital
L = the labor force
H = human capital
A = TFP
Collect historical data on all variables except TFP
Use regression equation to determine the strength of
independent variables affecting real GDP
• One study found:
46
Growth Accounting III
• Growth accounting in Latin America, 1960-99
• Growth at 1.25 positive but low by international
standards. Labor force accounted for 0.43% of total
growth, with capital 0.55% and human capital 0.52%
• Productivity was negative during this period
47
Growth Accounting IV
• Most studies find low productivity growth for the region.
• Not the whole story of the relatively low growth of the
region, but it is a substantial part of it.
• Looking at the differences between Latin America and the
rest of the world are also instructive
48
Growth Accounting V
• Shows that growth in Latin America has not kept up with
the rest of the world
• Much stems from the very low productivity in Latin
America – the last column
• Normally TFP is positive, contributing to growth, not the
case in Latin America
49
TFP Growth in Latin America I
• Researchers have asked question – What would happen
to growth in Latin America if TFP were the same as in the
U.S. Answer – it would double.
• Given empirical evidence on the importance of TFP for
increasing growth in Latin America one might assume it
would be easy to design policies to increase it.
• Problem is TFP can be influenced by a multitude of
general factors that are hard to quantify
• However literature on TFP in Latin America can be used
to produce a list of general factors that could be
negatively influencing TFP in the regions. These include:
• Informal sector,
• Infrastructure,
• Structural reforms and
• Institutional quality
50
TFP Growth in Latin America II
• Informal sector extremely large in Latin America
• International Labor Organization (ILO) estimates that
nearly 50% of workers in low income countries are in the
informal sector
• For middle income countries not Latin America, informal
employment is about 35%
• Latin America is unusual in that the figure is 55%
• Another measure is the % of GDP in the informal sector
• Regional average is nearly 43% with Mexico the lowest at
28%
51
TFP Growth in Latin America III
• Informality has been shown to be an important
determinant of low TFP in Latin America
• One link is the micro data
• The general pattern is that
• firm size is correlated with informality, and
• smaller firms in the informal sector are less productive than
larger firms in the formal sector
• one study found firms with more than 250 workers more than
150% more productive than firms with fewer than 20 workers.
• In general formal firms 84% more productive than informal firms.
• Policy implication: reducing the amount of informality
would have a positive impact on TFP and GDP per capita
52
TFP Growth in Latin America IV
• Little research on the causes of informality in general or
for Latin America in particular
• Main work done by Hernando de Soto who found
• Root cause of informality firms attempting to escape burden of
taxation and/or regulation
• Process seems to be an entrepreneur starts a small business
and never registers it with the government
• World Bank data show the cost of becoming formal in
terms of procedures and taxes – a rough correlation with
the degree of informality in Latin America
• Most small firms in Latin America do not have the
resources to devote to the time or resources to comply
with the tax laws
53
Starting a Business in Latin America
54
Business Taxes in Latin America
55
TFP Growth in Latin America V
• Summing up
• Causes of low TFP and hence economic growth can be
traced in part to informality
• Causes of informality are complex, but part of the
problem can be traced to the difficulty of starting a
business in the region
• This is compounded by
• tax rates that are higher than the global average and
• A cost of complying with the tax regulations that is considerably
higher than the global average
• The social cost of reducing these impediments is low
• However reducing labor market inflexibility is more
difficult – many genuinely designed to protect workers
56
TFP Growth in Latin America VI
• Old truism that much of the problems in Latin America
can be boiled down to two things: education and
infrastructure
• Poor infrastructure makes it difficult for businesses to
operate efficiently – thus reduces TFP
• Term infrastructure does not have a precise definition,
but some of its more important dimensions are easy to
define.
• World Economic Forum published surveys of business
perception of infrastructure
• Countries are rated on a scale of 1 (low) to 7 (high)
• Latin America overall rated 3.7 versus a global mean of 4.2. In
every category the story is the same.
• Best category is electricity and by far the worst is railroads
57
Infrastructure Quality in Latin America
58
TFP Growth in Latin America VII
• Great scope for increasing infrastructure
• One study found infrastructure investment in region
currently around 2.0-2.5% of GDP
• If infrastructure investment doubled, GDP could increase by as
much as 2%
• If investment at these levels could be maintained for 20 years,
infrastructure in the region would catch up with the more
successful Asian economies
• Problems with expansion in infrastructure
• Money scarce
• Private savings low, and
• Public sector budgets tight with a bias toward current
expenditures
59
TFP Growth in Latin America VIII
• Other factors affecting TFP include institutional quality
• Have already looked at property rights and rule of law as
essential preconditions to economic growth
• Economic historians have emphasized
• the role of institutional factors that tended to encourage
economic growth or
• The absence of institutions as retarding growth
• “New Institutional Economics” argues that economic
growth is critically dependent on the quality of
institutions in a country
• Point: major differences in the level of economic
development among countries that cannot be explained
purely in terms of growth of the labor force, the capital
stock, or human capital
60
TFP Growth in Latin America IX
• It is assumed that institutional quality affects economic
growth through TFP
• Unfortunately the link between the two is difficult to
quantity due to our inability to define precisely what
institutional quality is.
• Best to look at a number of different indexes of
institutional quality then look for a common story.
• Common dimensions of institutional quality include
• Corruption – Latin America fairly average by international
standards
• Ease of Doing Business – Latin America worse than international
standards
• Government Effectiveness – Latin American Governments
relatively ineffective
• Competitiveness – tends to be better than other parts of the
developing world
61
Measures of Institutional Quality in Latin America
62
TFP Growth in Latin America X
• While none of these indexes is definitive, overall picture
is of a region with moderate problems with
• Corruption
• A poor business environment, and
• Relative ineffective governments
• Not surprising that increasing TFP in this kind of
environment would not be easy
• Despite the bleak data on institutional quality –must be
something beyond these numbers
• Figures on competitiveness derived from surveys of
business executives
• Executives usually thinking not just about the present
but also future
• If the data is expressing expectations then future of Latin
63
America looks brighter