A New Tool to Help Boost Incomes

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Colombian Finance Minister Mauricio Cardenas once posed a question in an international meeting that has resounded as among the most significant for government planners. A finance minister has limited resources and a narrow window of reform. In which sectors will reform pay off most in terms of increasing per capita incomes?

As countries in Latin America and the Caribbean—and the world—try to answer that question, a new tool developed at the IDB has emerged on the scene. Known as Priorities for Productivity and Income (PPI), the instrument focuses on productivity determinants and their impact on the likelihood of a country’s ability to jump to a higher income group. A key contribution is its identification for individual countries of priority sectors where investment will be most efficient in helping to make that leap.

The tool provides an interactive template based on 34 indicators spread across eight sectors, including capital markets, education, health, labor markets, infrastructure, integration, telecommunications and innovation. It also takes into account a country’s current per capita income level, and assigns each country to one of four income-per-capita clusters. Countries, in the case of Latin America and the Caribbean, range from a low income bracket, like Honduras and Nicaragua, to those in a slightly higher bracket, like Bolivia and Ecuador, and those in a middle income bracket, like Argentina and Brazil, with a fourth cluster reserved for wealthy countries outside the region.

First and foremost, priorities are readily identified for each of the income-per-capita groups. Many different issues are taken into account when selecting these priorities. Increasing investment in one specific sector, for example, may have little impact if other particular sectors lag behind, as would be the case of complementarities across sectors. And priorities could change substantially depending on a country’s income level. Moreover, deficiencies or gaps in a particular sector may or may not be relevant to a country’s potential to grow. But the tool helps identify which of those gaps represents the most relevant binding constraint: i.e., which gaps are most important at a particular moment in a country’s development.

It is elegantly simple. A user can go to a map of Latin America and click on a nation he wants to analyze. He can then see that country’s priorities, as well as numerous graphs, showing how each sector compares to the mean of other countries in its income-per-capita group, or cluster, and to the mean in the next highest one. A country template for each country reveals priorities and the indicators that went into the analyses. And still another feature allows one to compare indicators across multiple sectors and multiple years for countries around the world.

Perhaps the most valuable visual aid reveals in motion the impact that increases in productivity determinants will have. For each increase in a priority sector or sectors, a three dimensional graph reveals how that investment would affect a country’s probability of jumping to a higher income per capita group.

Each country’s path will be different. A certain degree of increase in investment in capital markets and infrastructure has a much different effect in a middle income country than in a low income country, where health and education are the priorities. And investing in certain sectors simultaneously provides a much bigger boost than investing in them separately. All these variations can be visualized in detail in the interactive graph provided.  

For years, countries have struggled with the Cardenas question. Policymakers have identified a myriad of weak sectors and tried to simultaneously bolster them as if going through a check list. But in a world of limited resources, this is neither practical nor especially effective. The new tool seeks to provide a different way forward. By allowing policymakers to identify where investment priorities lie according to their country’s income level and according to the sectors offering the greatest returns, it will hopefully provide a roadmap to governments embarking on the path of reform by pointing to the most direct and efficient routes for increasing productivity and raising per capita incomes.

 

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The Author

Alejandro Izquierdo

Alejandro Izquierdo

Alejandro Izquierdo is currently a Principal Economist at the Research Department of the Inter-American Development Bank. Previously he worked at the World Bank in the Department of Economic Policy, and taught courses on macroeconomics and international finance at several Latin American universities. He holds a Ph.D. in Economics from the University of Maryland, an M.S. from Instituto Torcuato Di Tella, Argentina, and a B.A. in Economics from Universidad de Buenos Aires, Argentina. Alejandro has several publications in professional journals and edited volumes. His current research interests include issues in international finance such as the role of external factors on growth, the relevance of balance-sheet effects and financial integration in determining the likelihood of experiencing Sudden Stops in capital flows, as well as how countries recover from output collapses following Sudden Stops. He has also worked on the impact of Sudden Stops in the variance of relative prices, fiscal sustainability under Sudden Stops, and amplification effects of collateral constraints on the real exchange rate and output. Additionally, he has conducted research on the impact of macroeconomic external shocks and public expenditure allocation on poverty reduction for developing countries using computable general equilibrium models.

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