The Age of Productivity: Transforming Economies from the Bottom Up

By Chris Cote
July 15, 2010

An audio recording of the event is available here and Dr. Levy's powerpoint presentation here. 

“Three men work at an orange juice stand in the corner of Mexico City.  One man mixes the oranges, one man serves the juice to customers, and the third cleans the glasses in the back.  They take their electricity from a wire over head.”  These workers in the service sector still receive healthcare from their government while operating in the informal sector.  This gap in social security, among other factors, encourages the proliferation of small firms in Latin America, whose productivity is very low in comparison with larger firms or comparably sized US firms.  Lower productivity levels, specifically in non-tradable goods such as services, are trapping Latin America’s economies in lower growth rates, said a senior Inter-American Development Bank (IDB) economist at a July 15 breakfast discussion at the Dialogue.

Productivity growth is low in Latin America—labor, physical capital, and human capital are inefficient.  “If I could choose higher investment or higher productivity,” said Santiago Levy, vice president of sectors and knowledge at the IDB, “I would choose productivity.”  The region needs to implement policies that promote better ways of using existing resources. 

The ratio of income per capita between Latin America and the US has fallen sharply in the last half century.  If Latin American productivity were close to its full potential, the gap would be closed and millions in the region would be out of poverty. 

The biggest productivity lag is in non-tradables, especially the service sector. “Just as Bill Clinton’s first campaign slogan was ‘It’s the economy, stupid,’ Latin America’s slogan should be “It’s the non-tradables,” Levy said.  And the service sector, the bulk of non-tradable goods, has grown to comprise almost two-thirds of formal employment. 

As Levy noted in his orange juice stand example, many of the small, unproductive firms are also in the informal sector of the economy.  By simplifying tax and credit regimes and allowing social security gaps that let people obtain healthcare and benefits without paying taxes, governments are subsidizing these small firms and holding back productivity growth. 

Governments often give little importance to collecting taxes from the smallest firms, as they collect very little per firm.  And simplified tax regimes reinforce this. However, in Mexico, Levy noted, there are 2 million firms of 5 workers or less, while there are 35,000 firms of 50 people or more.  Levy underscored the issue of convincing policymakers to avoid simplification and retain comprehensive tax regimes. 

Other than taxes and tax evasion, obstacles to productivity growth include: high transportation costs, low access to credit, low innovation, and coordination failures.  

“It is not enough to focus on foreign trade agreements or increasing the competitiveness of the export sector,” Levy explained.  The best way to boost Latin America’s growth is through increasing the productivity of the service sector.