Nearshore Americas

The Real Problem in Latin America: Enabling Worker Productivity

CANCÚN, Mexico – Low productivity growth is the main reason most countries in Latin America and the Caribbean have lagged growth rates of both advanced countries and peer countries in East Asia, according to a study by the Inter-American Development Bank (IDB).

The study, which analyzed how efficiently nations are utilizing their productive resources, looked into productivity gains and losses, relative to the United States, for a sample of 76 countries, including 17 from Latin America and the Caribbean. Chile was the only country in the region to increase its productivity against the United States since 1960.

Half of the 20 worst performing countries in terms of productivity in the sample are from Latin America and the Caribbean (see graph and table below).

Breaking against the commonly held notion that the region’s growth suffers from insufficient investment, the study shows that Latin America and the Caribbean could greatly accelerate their economic growth and narrow the income per capita gap against industrialized nations with policies that promote a better use of existing resources in the economy.

A typical Latin American country could have increased income per capita by 54 percent since 1960 if its productivity had grown like the rest of the world during the period. Income per capita in this typical country would almost double if its productivity was close to its full potential.

“More than additional investments, countries in the region need to make better use of the existing stock of physical and human capital,” said IDB economist Carmen Pagés-Serra, who coordinated a team of researchers for the upcoming IDB book: The Age of Productivity: Transforming Economies from the Bottom Up.

“There is a huge, untapped opportunity for policymakers in the region to invest in reforms and sensible policies that can allow the region to quickly catch up with  other regions of the world,” said Santiago Levy, Vice President of Sectors and Knowledge of the IDB.

Economic growth and income per capita in the region could dramatically improve, for example, with increased credit, simpler and better distributed tax regimes, better transportation, and  a better tailored social policy to reduce labor informality. Productivity would also greatly benefit from targeted policies to provide for key public goods, such as better infra-structure and regulatory environment, to increase the efficiency of the productive sector as well as measures to foster technological innovation in the private sector.

The book, part of the series Development in the Americas, the IDB’s annual flagship publication, offers a comprehensive analysis of productivity in the region, its impact on economic growth and recommendations for policymakers on how to address the causes of low productivity.

The IDB unveiled the results of the book during an event preceding its Annual meeting in Cancun, Mexico. The Age of Productivity: Transforming Economies from the Bottom Up will be available at selected bookstores next month.

Winners and Losers

Since 1970, productivity in Latin America and the Caribbean has consistently lagged the rest of the world, a trend that has exacerbated after the debt crisis of the 1980s. The failure to catch up with developed economies has been widespread in the region.

Even though Chile was the only country in the region to increase its productivity against the United States since 1960, its gains were smaller than other developing nations such as India, Thailand and China (see graph below).

Source: Author’s calculations.

Nicaragua, Honduras, Venezuela and El Salvador were the countries whose productivity decreased the most relative to the United States since 1960 and whose performance was below much poorer countries in Africa including Algeria, Uganda and Kenya (see tables at the end).

On the other hand, Panama, Brazil, the Dominican Republic and Ecuador were the countries where productivity decreased the least when compared with the United States.

The problem is in the service sector

The study analyzed productivity in several sectors of the economy in the region.  Agriculture is the fastest growing sector, yet its growth is still below the world average. But the bad news really lie is in the dismal performance of the service sector, which employs about 70 percent of the region’s workforce and is increasingly dragging down aggregate productivity in the region.

Latin America’s productivity growth in both industry and, particularly in services has underperformed compared to East Asian and industrial countries (see table below). This has been true both during the 1980s, when productivity in industry and services in Latin America actually decreased, and from 1990 onwards when productivity increased but at a slower pace than in the other two regions.

The case of the service sectors is the most dramatic. In this large part of the economy, productivity fell sharply during the 1980s and has remained stagnant for the last 15 years. The gap is large relative to East Asia, where productivity in services has grown by about 2.5 percent a year in the last 15 years, and also relative to high-income countries, where productivity in services has increased by about 1.4 percent a year.

In most categories of services, productivity has been poor. Between 1990 and 2005, productivity of community, personal and government services grew only 0.7 percent compared with a productivity growth of 5 percent for mining and 4 percent for public utilities in the region. Productivity actually declined for financial services and retail and wholesale trade, falling 0.8 percent and 1 percent, respectively, during the same period.

Had productivity in the service sector grown at the pace it did in East Asia, economy wide productivity growth in the typical country of the region would have almost doubled.

New Focus on Policies

It has become commonplace for policymakers in the region to focus on boosting exports and improving the quality of tradable goods as a strategy to improve competitiveness and income levels. However, this study suggests that increasing productivity in the service sector is key for boosting economic growth in Latin America and the Caribbean in coming years.

“Given the size of its tertiary sector, the region urgently needs to implement policies to increase productivity of this industry,” said Pagés.

Chief among the reforms is to tackle the high rates of informality in this sector, which gives small firms—the vast majority of which are very inefficient— an unfair advantage in the market place against formal companies. By being informal, these small companies are shielded from the competition of better and more productive business models. These firms survive because they evade taxes, utilizing productive resources that would otherwise go to more efficient sectors of the economy.

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Simplified tax regimes coupled with measures to reduce evasion and lower corporate taxes could reduce the level of informality in the economy. The study also recommends governments expand credit for companies, a move that would not only pave the way for more innovation but also help reduce the level of informality in the economy.

More tailored social policies that do not rely on the taxation of formal labor could increase incentives for companies to register their workers and contribute toward a reduction in informality. The region could boost the productivity of its manufacturing industry by promoting greater competition and better regulations in ports and airports and by making transportation more efficient and cheaper.

“A decade after conquering economic stability, Latin America and the Caribbean face the challenge of achieving faster economic growth,’’ said Pagés. “Higher productivity growth will be vital to unleash this process in years to come. Only by utilizing its resources more efficiently, will the region be able to achieve the kind of growth rates that will pave the way to lift millions out of poverty.”

Also available in: Español

Kirk Laughlin

Kirk Laughlin is an award-winning editor and subject expert in information technology and offshore BPO/ contact center strategies.

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