Latin America in the rearview mirror

TL;DR: This paper found that Latin American countries are the only Western countries that are poor and that are not gaining ground on the U.S. due to TFP differences, and that this failure is not plausibly accounted for by human capital differences, but rather reflects inefficient production.

About: This article is published in Journal of Monetary Economics.The article was published on 2005-01-01 and is currently open access. It has received 179 citations till now. The article focuses on the topics: Latin Americans & Total factor productivity.

Summary

1. Introduction

• Various short-run crises-exchange rate crises, debt crises, inflation crises, balanceof-payment crises, financial crises-have dominated recent macroeconomic research about Latin America.
• This comparison shows that all Western countries-including those with initial income levels reasonably similar to those in Latin America in 1950-have made substantial progress in catching up to the United States.
• In sharp contrast, no Latin American country has made any significant progress in catching up to the United States.
• First, the authors find that stagnant relative total factor productivity (TFP) is the key determinant of Latin America's relative income and labor productivity stagnation.
• In particular, big increases in barriers to competition are followed by large productivity decreases, and big decreases in these barriers are followed by large productivity increases.

2. A Neoclassical Framework

• The authors use the neoclassical growth model to guide their analysis.
• For their empirical analysis, the authors will assume that U.S. TFP is a reasonable proxy for the world technology frontier, which implies that η US = 1.
• This simple model generates long-run income differences between countries through two channels: (1) through the relative efficiency term η and (2) through differences in the relative supplies of capital and labor, which in their model are governed by country-specific preference differences.
• Note that any factor that affects income in the long-run-such as tax distortions-will manifest itself as a change in either one or both of these two channels.
• The authors will first use this model to gauge how important these two channels are for understanding Latin American macroeconomic development.

3. Latin America's Persistent Economic Stagnation

• This section examines Latin America's long-run macroeconomic performance, which the authors measure as per capita income relative to that of the world frontier (U.S. per capita income).
• Interpreting the income gap between Latin America and the United States requires a benchmark that lets us assess how large of a gap should be expected today, and how much this gap should have changed over the last 50 years.
• Commonality leads us to assume that Latin America and the other Western countries should have the same innate ability to learn and adopt successful Western technologies, and that with similar cultures, they should have similar preferences for market goods.
• If TFP is the dominant factor, then the authors should be formulating explanations for why production efficiency is so much lower in Latin America than in the United States.
• This latter impact is observed in the Euler equation that governs capital accumulation.

5. Human Capital Is Not a Major Factor

• The authors analysis has measured labor services as employment, without any adjustment for differences in human capital between regions.
• Moreover, a human capital-based explanation makes two other empirical predictions: (1) Latin America should have a very low ratio of human capital to output compared to the United States, and (2) Latin American TFP levels should be similar to those in the United States after adjusting TFP for human capital differences between the two regions.
• The authors will show that neither of these predictions is consistent with the data.
• A third reason that human capital is not the central factor accounting for Latin America's TFP gap is because a large gap between the United States and Latin America remains after adjusting for human capital differences.
• Klenow and Rodriguez-Clare, using 1985 data and some different procedures, find that these countries have an average of 67 percent of U.S. TFP.

6. Latin American Stagnation and Competitive Barriers

• A very old view, extending back to at least Adam Smith, argues that barriers to competition will discourage innovation.
• According to this view, countries that have more competitive barriers will be poorer.
• A major rationalizing element in these models is that a subset of society would be harmed by the adoption of superior technologies, and this subset has sufficient resources to successfully block their adoption.
• In all of these papers, lowering competition reduces productivity through the channel of "X-inefficiency," in which an organization fails to produce at its minimum cost.
• In the next section the authors establish that Latin America erects significantly more competitive barriers than the successful countries in Europe and Asia.

7. Latin America Puts Up Significant Competitive Barriers

• The authors now focus on government policies that restrict competition.
• The authors will examine a number of different types of barriers that they categorize as either international competitive barriers, including tariffs, quotas, multiple exchange rate systems, and regulatory barriers to foreign producers, and domestic competitive barriers, including entry barriers, inefficient financial systems, and large, subsidized state-owned enterprises.
• The authors will present evidence that shows that Latin America has constructed many international and domestic barriers that have closed off Latin America from both internal and external competition.
• Loayza and Palacios (1997) show that average tariff rates in Latin America were about 38 percent between 1984 and 1987, compared to 16 percent for East Asia.
• In the language of their model, this means openness can affect the level of η in a country, and this permanent change in η would be associated with temporarily higher growth associated with transitional capital accumulation dynamics.

B. Latin America's Domestic Competitive Barriers: High Entry Barriers

• Latin America has systematically higher domestic competitive barriers than the European and Asian successes, including (i) high entry costs, (ii) poorly functioning capital markets, and (iii) high costs of adjusting the workforce or building up an experienced workforce.
• Entry costs can be an important competitive barrier because they reduce the incentive for firms to enter an industry.
• These data suggest that entry costs are indeed much higher in Latin America, and constitute a potentially important competitive barrier.
• These data are from La Porta, Lopez-de-Silanes, and Shleifer (2002).
• In summarizing the results of a collection of studies on Latin American and Caribbean (LAC) labor markets, Heckman and Pages (2003) conclude that while the overall costs of labor market regulation are quite similar in LAC and OECD countries, the LAC countries impose these costs much more in the form of job security measures than in social security provisions.

8. Microeconomic Evidence on the Impact of Competition

• The authors now present microeconomic evidence from Latin America that shows how productivity and output change when there is a change in competition.
• They conduct industry-level analyses in which there is a large, exogenous change in competition, and in which productivity is easy to measure both before and after the competitive change.
• The authors follow this approach here by presenting industry cases in which there are large and exogenous government policy changes that significantly affect the level of competition.
• The authors then present five cases that show the adoption of policies that foster competition are associated with large productivity and output gains.
• The authors call the first type of barrier entry impediments, which keep high productivity firms out of an industry.

A. Eliminating Competition in the Venezuelan Oil Industry

• The authors now provide an important case where nationalization eliminated foreign competition and reduced productivity substantially in a major sector.
• The authors discussion draws on recent work by Restuccia and Schmitz (2004) .
• Output and productivity continued to fall after the nationalization.
• By 1995, which is the ending year for their data, output had returned only to its 1963 level, and productivity had returned only to its 1960 level.
• The authors conclude that nationalization of the Venezuelan oil industry, which eliminated the efficient international management of the industry, led to large productivity and output losses.

B. Eliminating Competition in the Venezuelan Iron Industry

• Restuccia and Schmitz (2004) also show that Venezuela followed a similar nationalization policy with its iron ore industry, with similar results.
• The output and productivity patterns mirror those from the oil industry.
• Both output and productivity rose significantly until just before nationalization, with output growing at 6.1 percent per year and productivity growing at 11.5 percent per year from 1953 to 1974.
• By 1983, output was 62 percent below its 1974 peak level and productivity was 58 percent below its peak level.
• The authors now turn their attention to the impact of policy changes that increase competition.

C. Allowing Entry in Chile's Copper Industry

• The authors first show that bringing foreign competition to Chile's copper industry is associated with a large and permanent increase in productivity and output.
• Figures 13 and 14 show how output, productivity, and Codelco's industry share changed with the introduction of foreign competition.
• Garcia, Knights, and Tilton (2001) show that about 30 percent of the productivity gain was from higher efficiency at individual mines, while 70 percent of the gain was from shifting location, that is, from the production of new entrants.
• Figure 15 shows that Chile's rapid post-reform productivity growth significantly reduced the labor productivity gap between Chile and the United States.

D. Reversing Quotas in Brazil's Computer Industry

• The authors now show how eliminating a zero quota policy in Brazil's computer industry is associated with a large increase in output and productivity.
• The policy thus insulated Brazilian computer producers from foreign competition, and the policy also featured entry barriers to new firms through a maze of bureaucratic requirements.
• Moreover, prices fell substantially immediately after Collor's election.
• Since productivity growth in the U.S. computer industry has been estimated to be around 30 percent per year, 16 this means that Brazil had only about 20 percent of the U.S. productivity level in 1989 prior to the reforms.
• 17 Imports rose 150 percent with the new policy, but despite this increase in foreign competition, many of the Brazilian firms were able to successfully compete.

E. Privatizing State-Owned Enterprises: Brazilian Iron Ore

• The authors next analyze the privatization of the Brazilian iron ore industry.
• Plans to sell CVRD also began in the early 1990s, and this led CVRD to change its organization structure in preparation for privatization.
• Prior to privatization, work rules placed significant limitations on the number of tasks a worker could perform.
• Productivity grew about 140 percent between 1990 and 1997, and output grew about 30 percent during this period.
• As in the case of the Chilean copper industry, the Brazilian iron ore industry produced more output with significantly fewer workers following the policy reform.

F. The Large-Scale Privatization of Mexican SOEs

• The authors now explore larger-scale Latin American privatizations.
• The authors discussion draws on work by La Porta and Lopez-de-Silanes (1999).
• Prior to the early 1980s, state-owned enterprises (SOEs) played a significant role in the Mexican economy.
• They accounted for about 14 percent of GDP and about 38 percent 18 Data are available only beginning in 1986.
• For a significant fraction of the economy by removing entry impediments.

G. The Large-Scale Privatization of Argentinian SOEs

• Argentina also privatized many of its SOEs in the 1990s.
• When the government sold the enterprises, it often kept the monopoly structure in the industry to make the firm attractive to prospective buyers.
• Hence, the productivity consequences of privatization might not have been as large under this strategy.
• They also find unit costs declined 10 percent and production rose 25 percent.
• In particular, these cases suggest that Latin America indeed can achieve Western productivity levels when competitive barriers are removed.

9. Conclusion

• This is because it is the only group of Western countries that are not already rich, or that have not gained significant ground on U.S. income levels in the last 50 years.
• The authors have argued that competitive barriers are a promising route for understanding Latin America's large and persistent productivity gap.
• The authors findings also have implications for these other factors.
• The fraction of the population that speaks a Western European language, also known as **Language.
• The share of the population whose native tongue is Spanish (age 5 or higher), 1993 Census, Instituto Nacional de Estadistica e Informatica (INEI), also known as Peru.

Figures

Table 6. Investment-to-Output Ratios by Region (Regional Averages for Selected Countries)

Table 4. Employment Rates by Region (Regional Averages for Selected Countries)

Table 7. Bils-Klenow Relative Human Capital Levels (Regional Averages for Selected Countries, U.S. = 100)

Table 5. Capital-to-Ouput Ratios by Decade Average Relative to the U.S.*

Table 10. Government Ownership Share of the Top 10 Banks

Table 11. Mandated Severance Pay

Table 8. Nominal Rates of Protection in 1960 Latin America and the EEC

Table 9. Business Start-up Costs

Table 1. Percentage of Latin American Population of Western Descent, Language and Religion