Latin America Needs Greater Investment and Productivity. This Is Why

Greater investment and productivity could spark growth in Latin America and the Caribbean

As the global economy gains strength and Latin America and the Caribbean recovers from recession, the region is actually falling further behind, continuing to lose its share in global GDP and putting in jeopardy the aspirations of its growing middle class

The reasons behind this are complex. But low investment and productivity are fundamental factors. They require significant reforms if the region is to shake off its plodding progress and begin to catch up to the faster-growing developing economies and even the advanced ones.

To be sure, the problems are far from new. Between 1960-2017, the average per capita growth rate in real GDP for the region stood at 2.4%. That was considerably below the rate for Emerging Asian countries (4.9%) and below the average for countries outside the region (2.6%).

Investment was low. Investment rates in region were on average 7 percentage points of GDP below those in Emerging Asia. Today among world regions only Sub-Saharan Africa  invests less as a percentage of GDP. As we argued in our 2016 flagship report, insufficient domestic savings rates, small and inefficient financial systems, and a poor channeling of resources all played a role. They contributed to that underinvestment that was critical to holding the region back.

In some countries, low investment rates seem to be related more to lack of profitable opportunities rather than to low savings.  Problems for investors to appropriate returns due to poor corporate governance, a lack of creditor rights or the inability to produce more sophisticated or valuable products may all play a role in lowering returns for investors.

Greater productivity could make a big difference

Low productivity was another significant element of the story. During the nearly six decades, the region benefitted from a demographic bonus of young workers that was increasingly becoming more educated, with nearly universal access to primary education and vastly expanded access to both secondary school and tertiary education. But after accounting properly for improved skills, other determinants of productivity lagged. Total factor productivity (TFP), a measure of how efficiently an economy uses labor and capital, has been very low. Indeed, the contribution of changes in TFP to growth was essentially zero  over the last 50 years, a significant reason behind the region’s relatively low growth compared to other parts of the world.

Behind this phenomenon are many factors in which the region must improve if it is to turn its fortunes around: low levels of innovation, informality in labor markets, and distortions in taxes that keep firms small and inefficient.

Investment productivity Latin America Caribbean Economy

But for the moment, consider just the issue of taxes. Some countries may or may not have very high corporate tax rates, but with limited resources, they tend to focus enforcement efforts on large firms. This may have the perverse effect of encouraging companies to remain small — and hence less productive — so they can fly under the radar of tax authorities. Efforts to help small firms, by implementing lower statutory tax regimes that make it easier for them to operate in the formal market, often compound the problem. Since firms can only qualify for the lower rates if they remain below a certain level of sales, employees or physical space, they have incentives to remain small. That is especially true if their after-tax profits fall as they grow in size. The impact of thus favoring less productive small firms is a hit to the productivity of the economy as a whole.

Low productivity in turn influences the efficiency of investments. For every peso invested, there is a very limited amount of incremental output in Latin America and the Caribbean.  Indeed, investment efficiency in Latin America and the Caribbean is lower than Emerging Asia and the rest of the world. While a percentage point of incremental investment as a share of GDP yields about 0.28 percentage points of higher GDP growth per year in Emerging Asia, it yields only about 0.20 percentage points in Latin America. These differences accumulate over time to produce significant growth gaps between the regions.

Higher, more efficient investment is key

Looking at levels of investment and investment efficiency together gives us a rather stark view of what the region is missing out on. If the region had had the average level of efficiency as Emerging Asian economies from 1960-2017, its GDP would be twice as large as its actual GDP. Its GDP would also have been double if its investment rates had equaled those of Emerging Asia. But if both investment rates and efficiency together matched those of Emerging Asia, real GDP by 2017 could have been an impressive 6 times higher.

Latin America is quickly losing its demographic advantages. Its population is aging, and by the latter part of the century, it will surpass Europe to become the region with the highest share of elderly to working inhabitants.

But the region can turn things around. While the prospects of a new international commodity boom seem remote, there is still much room to improve education and skills at home. And by investing more, improving productivity and in the process making investment more efficient, it could leap ahead, achieving significantly higher, sustainable growth. While some of the issues are common across countries, policies are necessarily country-specific. The recently released Latin American and Caribbean Macroeconomic Report discusses how countries may wish to think about appropriate policy initiatives depending on current conditions.  Moreover, a set of background Country Development Briefs discuss individual country challenges and policy responses.

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The Author

Eduardo Cavallo

Eduardo Cavallo

Eduardo Cavallo is currently a Lead Economist at the Research Department of the Inter-American Development Bank (IDB) in Washington DC. Prior to re-joining the IDB, Eduardo was a Vice-President and Senior Latin American Economist for Goldman Sachs in New York. Eduardo had already worked at the IDB as a Research Economist between 2006 and 2010. Before that he served as a research fellow at the Center for International Development (CID), a visiting scholar at the Federal Reserve Bank of Atlanta, and a member of the faculty at the Kennedy School of Government's Summer Program. In Argentina he co-founded Fundación Grupo Innova. Eduardo’s research interests are in the fields of international finance and macroeconomics with a focus on Latin America. He has published in several academic journals, and is the co-editor of the IDB book Dealing with an International Credit Crunch: Policy Responses to Sudden Stops in Latin America. He holds a Ph.D. in Public Policy and an MPP from Harvard University, and a B.A. in Economics from Universidad de San Andres (UdeSA) in Buenos Aires, Argentina.

The Author

Andrew Powell

Andrew Powell

Andrew Powell is the Principal Advisor in the Research Department (RES). He holds a Ba, MPhil. and DPhil. (PhD) from the University of Oxford. Through 1994 he dedicated himself to academia in the United Kingdom as Prize Research Fellow at Nuffield College, Oxford and Associate Professor (Lecturer) at London University and the University of Warwick. In 1995, he joined the Central Bank of Argentina and was named Chief Economist in 1996. He represented Argentina as a G20/G22 deputy and as member of three G22 working groups (on crisis resolution, financial system strengthening and transparency) in the late 1990’s. In 2001, he returned to academia, joining the Universidad Torcuato Di Tella in Buenos Aires as Professor and Director of Graduate Programs in Finance. He has been a Visiting Scholar at the World Bank, IMF and Harvard University. He joined the IDB’s Research Department in 2005 as Lead Research Economist and in 2008 served as Regional Economic Advisor for the Caribbean Region until returning to the Research Department as the Principal Advisor. He has published numerous academic papers in leading economic journals in areas including commodity markets, risk management, the role of multilaterals, regulation, banking and international finance.

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