From IDB

POLICIES NEEDED TO CLOSE THE GAP IN INVESTMENT AND PRODUCTIVITY OF FASTER-GROWING REGIONS

MENDOZA, Argentina – Latin American and the Caribbean countries require an ambitious growth agenda that focuses on overcoming large gaps in investment and productivity, a report by the Inter-American Development Bank finds.

While the global economy faces potential risks from higher interest rates and a correction to global asset prices, the region’s overall outlook is positive, with a 1.9% growth rate expected this year. This, however, is well below the growth rate expected for the world of 3.9%, and Latin America and the Caribbean will continue to lag unless substantial policy changes are enacted on the economic front.

Past drivers of growth such as positive demographic trends, increasing commodity prices, and available fiscal stimulus space are either reversed or restricted, according to A Mandate to Grow, released at the Annual Meeting of the Boards of Governors of IDB Group.

“For many decades now, Latin America has been accumulating a growth deficit,” said IDB Vice-President for Sectors, Santiago Levy. “Macroeconomic stability is a good starting point to get an economy moving forward. But to grow more vigorously, we need to invest more and more productively, and we need to tackle the bottlenecks that limit growth, which include the design of tax systems, low savings, credit constraints and the lack of competitive markets that reward high productivity.”

Investment: quantity and quality

Latin America and the Caribbean certainly need more investments, particularly in infrastructure. Investment rates for the 1990-2017 period averaged 17% of GDP, well behind the 26% rate for Emerging Asia. Also, the region is 40% less effective than Emerging Asia in generating GDP growth for every additional invested dollar. Latin America’s economy would be three times larger today if it had managed to match Emerging Asia’s investment rates and efficiency since 1990.

Challenges for the region include the low savings rates, with small and inefficient financial systems, pension systems that have low coverage, and on the fiscal front, low revenues and a bias against public investment relative to consumption.

Latin America also underperforms in productivity. Most of the region’s growth since 1960 is accounted for by capital accumulation, improved skills, and the growth of the labor force. After adjusting for the improvement in skills, the additional boost given by productivity growth was nil. In fact, the region became somewhat less productive over the past six decades.

At the heart of the productivity shortfall lie the size and lack of dynamism of the region’s firms, the report finds.

There are many very small and unproductive firms, which survive longer than they should, while productive firms are not growing as fast as their potential. In Mexico and Peru, for example, 95% of firms have fewer than five employees. In the U.S., the figure is 40%. In Mexico, firms appear to stop growing after ten years, and productive firms are just as likely to exit the market as unproductive ones.

Causes highlighted in the report include financial market imperfections, uneven taxation, poorly enforced labor market regulations, high entry costs, and other barriers to competition.

Financial markets need legal systems that provide adequate protection to creditors, and a more effective use of collateral and guarantees, as well as better information about borrowers. These problems prevent productive firms from financing good ideas and attain ideal size. Tax authorities tend to focus on larger firms, so smaller ones have incentives to stay smaller to evade paying taxes. This problem is compounded when tax regimes provide special exemptions to smaller firms. Labor market regulations make firing difficult, and social insurance programs make hiring costly, especially as a firm grows.

“Countries should revise tax and labor policies to ensure competition that provides a leveled playing field, in which more productive firms can thrive,” said Eduardo Cavallo, an IDB lead economist and co-author of the report. “These reforms are difficult, of course, but the region would gain a big growth windfall in return.”

About the IDB

The Inter-American Development Bank is devoted to improving lives. Established in 1959, the IDB is a leading source of long-term financing for economic, social and institutional development in Latin America and the Caribbean. The IDB also conducts cutting-edge research and provides policy advice, technical assistance and training to public and private sector clients throughout the region.

SOURCE: https://www.iadb.org/en/news/idb-proposes-growth-agenda-latin-america-and-caribbean-new-report