Transcript Security Scenarios And The Global Economy

NS4540
Winter Term 2016
Reyes and Sawyer Ch. 3
Economic Growth in Latin America
Overview I
• Reyes and Sawyer Economic Growth in Latin America,
Ch.3
• General picture of economic growth in LA in post-war era
• Positive, but
• Slow relative to some other regions at a similar stage of
economic development
• Want to use the basic theory of economic growth
developed by Robert Solow and the neoclassicals
• Model essential to understanding economic growth process
• However does not include some important factors in process of
economic development
• Led to “new” growth theory – Romer, focusing on
accumulation of human capital, knowledge and the role
of technology in economic development
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Overview II
• The theories allow us to explain a substantial part of the
growth in Latin America
• Use growth accounting for this purpose
• What cannot still be explained can be discussed in terms
of institutional quality and poor policymaking
• For neoclassical model to be an accurate description of
growth in Latin America, must be a critical mass of
institutional quality to enable markets to function
correctly
• Concludes, probably the case, but still many defects and
inefficiencies in LA economies have suppressed growth.
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Institutions I
• Institutional basics
• Preconditions that need to be in place
• If these preconditions not met – theory used may not work well
• A number of factors can interfere with workings of
markets – two factors absolutely critical
• Property rights and
• Rule of law
• Definition of “failed state” is almost complete lack of
either property rights or rule of law
• In Latin America great variations in these two key
variables
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Institutions II
• Property rights – for market economy to work, need to be
clear who owns what – otherwise transactions may not
occur
• Any reduction in enforcement of property rights
increases risk of engaging in transactions
• Fewer transactions translate into lower level of overall
economic activity and a lower GDP
• World Economic Forum, Global Competitiveness Report
has data on property rights – scale of 1 to 7 where 1 is
the worst and 7 the best
• Best scores Chile and Panama on level of Portugal and Spain
• Venezuela and Argentina very puzzling below much poorer
countries such as Guatemala and Honduras
• Concludes probably enough enforcement of property
rights in LA to be able to use the neoclassical model
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Property Rights in Latin America
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Institutions III
• Problem of Squatting in Latin America
• Occupation of unoccupied space or buildings without the
legal permission to do so.
• Largest property right problem in Latin America
• Any large city in Latin America ringed with squatter
settlements
• Main problems – lack of infrastructure – water, sewage,
electricity, public education – few if any public services
• For Latin America – around 130 million squatters or one
third of the urban population or quarter total populations
• In some countries, Mexico squatters can become de facto
owners of unoccupied land after 5 years occupation
• Public policy problem – formalization of squatter
communities to provide some form property rights and
provision of public services
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• Otherwise no chance of escaping poverty.
Institutions IV
• Intellectual Property Protection
• Copyrights, patents
• In general intellectual property better protected in developed
countries than developing
• Latin America falls into this pattern
• In general less protection of intellectual property than for
property rights in general
• Many cases property of the property of individuals outside the
region
• Less important item on government’s agenda
• Has however, become major issue in trade negotiations
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Intellectual Property Protection
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Institutions V
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Second precondition – Rule of Law
Normal transactions involve legally binding contracts
Often disputes arise
Needs to be a sufficiently developed legal system to
determine appropriate outcome
• If no effective referee to enforce business contracts –
fewer business contracts occur
• Market participants reluctant to engage in normal activies
because unsure of enforcement
• In general enforcement of rule of law in Latin America
adequate to apply modern theories of economic growth
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Institutions VI
• Rule of law difficult to define in a precise way
• Number of factors involved
• Enforcement of contracts – how long, number of
procedures – may be so long that costs of protecting
one’s rights prohibitive
• Judicial independence – how insulated from short
changes in government – many Latin American countries,
insulation is weak or nonexistent
• Favoritism in decisions of government officials – law
needs to be administered impartially
• Efficiency of Legal Framework – ability of system to
handle disputes in a reasonable period of time
• Legal systems in Latin America can be very slow, difficult
for average person to navigate
• In general rule of law is a substantial problem which
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tends to slow growth in Latin America
Rule of Law
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Judicial Independence
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Institutions VII
• Summing up
• Indicators suggest that Latin America has had sufficient
property rights and the rule of law to foster positive
economic growth
• Basic preconditions are being met and both are slowly
improving in the region
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Economic Growth I
• Basic Model of Economic Growth
• Developed by Robert Solow, MIT in the 1950s/60s
• Often called the neo-classical growth model
• Focuses on labor, capital and technology
• Growth in a country can be enhanced through increases in all
• Change in technology is anything that causes resources
to be used in a more efficient way
• Key is inputs and outputs
• More produced with fewer inputs or
• Same amount of inputs produce more
• Management practices, improved rule of law etc. can
contribute to efficiency
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Economic Growth II
• The terms “technology” and “total factor productivity”
(TFP), and “residual” are used interchangeably
• Production Function – relates to inputs and outputs
• Holding capital constant and adding more labor –
diminishing returns
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Economic Growth III
• Changes in the capital stock and technology
• Increases in the capital stock change the production
function
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– shift upwards reflecting increased productivity of labor
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– same would occur with increase in TFP
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Economic Growth IV
• Increase in productivity of labor occurs because the
capital-to-labor ratio (K/L) has increased
• All else equal a worker with more capital becomes more
productive
• Follows the more rapidly an economy can accumulate
capital, the faster it will growth
• Important because changes in real wages are highly
correlated with changes in labor productivity
• Higher the K/L ratio the higher per-capita GDP
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Labor Force I
• Labor Force in Latin America
• In 2013 roughly 300 million workers or half the population
• Mexico and Brazil account for about 150 million
• Often statistics fail to capture those in informal sector
• Between 1990 and 2013 labor force grew by 40%
• Benefits and Costs
• With more labor economies can grow faster
• Economies need to grow faster to absorb increase in labor force
• If growth slow problems of unemployment and underemployment
become problem
• As important as labor is to economic development faster
economic growth cannot be obtained without the
increase of capital
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Labor Force (millions)
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Capital I
• Capital in Latin America
• As K/L ratio increases productivity of workers and their
wages increase
• Employers can only pay a higher wage if it is backed up with
increases in productivity
• K/L ratio for Latin America in 2013 nearly $3,000
• High in Chile $5,638
• Low in Bolivia, 4560
• Generally higher than for middle-income countries but
• Below average for the high income countries
• Close correlation between K/L in Latin America and GDP
per capita
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Capital to Labor Ratio (K/L)
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Capital II
• Problem for Latin America
• From 1990 to 2013 the K/L ratio increased from $1,799 to $2,864
or 60%
• For the middle income countries as a whole the K/L ratio tripled
• Difference shows up in GDP per capita
• For Latin America GDP per capita increased from $4,130 to
46,092 or 48%
• For the middle income countries, GDP per-capita increased by
133%
• Even accounting for different states of development the
growth of the K/L ratio in Latin America has been slow
• Part of the problem of the problem with lagging growth
in Latin America is capital formation has not been high
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Capital III
• What factors cause capital formation?
• Domestic savings
• Relative to their level of income, savings are generally low in
Latin America
• Inefficient capital markets in transferring that savings to efficient
investment
• Foreign investment (FDI)
• Savings has been low by international standards – not increased
since 1990
• FDI pretty good recently relative to other parts of the world
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Savings and FDI
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New Growth Theory I
• Neo Classical School
• Neo-classical theory incomplete explanation of process of
economic growth
• Main problem is neo-classical model assumes that technological
change determined by forces outside the model -- exogenous or
a residual
• New growth theory treats technological progress and
endogenous.
• Now explicitly included in the model with other variables
determining the level of technology
• Key feature of these models is that the level of technology and
thus economic growth can be enhanced by the accumulation of
knowledge
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New Growth Theory II
• Knowledge has an important aspect – it can be
accumulated without the constraint of diminishing
returns
• Knowledge is usually subject to increasing returns rather than
diminishing returns
• What determines knowledge
• Level of education – human capital
• Research and Development (R&D)
• Problem with theory – hard to quantify
• Usual way to look at human capital is the educational attainment
of the population
• Latin America very good at reducing illiteracy
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Education I
• Past primary education not as promising
• There has been some improvement in number of students
finishing secondary education and moving on to tertiary
education
• Situation worse than data indicates
• Even for those students who remain in school, average quality or
actual educational attainment is low by international standards
• Problem not the percentage of GDP being spent on
education relative to other middle-class countries, but
the utilization of these resources
• Making secondary and higher education more effective in
Latin America is one of the more pressing problems
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Education II
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R&D I
• R&D in LA low, but rather typical for countries in this
income range – not a drag on growth
• Problem of R&D in Latin America
• Economies historically closed
• Most R&D undertaken in advanced countries
• New technology then transferred directly or indirectly through
FDI or international trade
• Interfering with these flows or restricting imports –
substantial in history of LA – has probably slowed
growth
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Growth Accounting I
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Growth Accounting in Latin America
Empirically done through regression equations of form
Y = f(K,L,H,A) where
Y = real GDP
K = the stock of capital
L = Labor force
H = Human capital
A = TFP
• TFP measured indirectly = residual after effects of other
factors have been taken into account
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Growth Accounting II
• One study found for 1960-1999 found:
• The negative sign on TFP not an error, rather typical
during this time for LA – one of the main reasons for slow
growth throughout the region
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Growth Accounting III
• Comparing LA with rest of the world
• Each cell is the number for LA minus the analogous
number for another region
• Results show big gaps for LA
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Total Factor Productivity (TFP) I
• TFP Growth in Latin America
• Primary reason for slow growth in Latin America has been the
slow growth of TFP
• Can ask – if labor, capital, and human capital in Latin
America were used as productively as they are in the US,
what would happen to per capita GDP in the region?
• Answer – it would double
• Clearly need to determine what factors affect TFP
• Not easy – can be influenced by many factors that are
hard to quantify usually these include
• Informal sector
• Infrastructure
• Structural reforms, and
• Institutional quality
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Total Factor Productivity (TFP) II
• Informal Sector
• ILO estimates nearly 50% of workers in low income
countries are in informal sector
• For middle income countries not in Latin America is 35%
• In LA – collection of middle income countries informal
sector is 55%
• Smallest estimate of informal sector for region is Mexico
at 28%
• The regional average is nearly 43%
• Has been shown that informality is a significant factor in
reducing TFP in LA
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Total Factor Productivity (TFP) III
• Also micro-links – smaller firms in informal sector are
less productive than larger firms in formal sector.
• Studies have found:
• Productivity in firms with more than 250 workers is more than
150 percent higher than firms with fewer than 20 workers
• Formal firms 84 % more productive than informal firms
• Conclusion
• Reducing the amount of informality should have a
positive impact on TFP and GDP per capita
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Causes of Informality I
• Causes of informality – little research on LA situation.
• One exception – Hernando de Soto
• Found root cause of informality firms attempting to
escape
• Burden of taxation and/or
• Regulation
• In Latin America small and medium sized enterprises
SMEs tend to be informal
• Entrepreneur starts a business and for some reason never
registers it with the government
• World Bank data show the difficulty in starting a
business in Latin America
• Average rank for a country in Latin America is nearly 115.
• Clear that government policy in LA puts a serious burden
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on SMSs that contributes to informality
Starting a Business in Latin America
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Causes of Informality II
• Taxes are also a problem – need to be careful that the tax
burden is reasonable in order to discourage informality
• Regional tax rate is over 53% which is 10% above the global
average
• Another factor is the time taken to comply with the law –
Latin America an outlier
• The world average for compliance is 268 hours. In Latin
America the average is nearly double the world average
• Most SMEs in Latin America don’t have either the time or
resources to comply with the tax laws.
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Business Taxes
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Causes of Informality III
• Final contributor to informality can be the difficulty of
complying with labor laws
• Labor markets in Latin America are large, diverse and
subject to substantial distortions
• One index of labor conditions is constructed from six
variables measuring aspects of the labor markets to get
an idea of labor market flexibility
• Hiring regulations and the minimum wage,
• Hiring and firing regulations
• Centralized collective bargaining
• Hours regulations,
• Mandated cost of worker dismissal, and
• Conscription
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Labor Market Flexibility (rank)
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• Hard to explain how a region full of hard-working and
relatively well-educated workers can produce relatively
low economic growth.
• Labor market inflexibility provides a partial explanation
• If significan tbarriers to the effective utilization of thse
workers, potential productivity of the labor force is
diminished
• Also size of the informal labor market becomes
unstandable
• If employment in the formal labor market involves a large
number of relatively inflexible frules there will be a
tendency for employers to evade thse regulations in the
underground economy
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Infrastructure I
• Poor infrastructure reduces TFP and by extension
economic growth and GDP per capita
• World Economic forum has survey of perceptions of
infrastructure
• Countries ranked 1 to 7 where 1 is low and 7 is high.
• Data are consistent with widespread conception that the quality
of infrastructure in Latin American could be improved.
• Overall quality is 3.7 against a global mean of 4.2
• In every category the regional average is below the world
average.
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Infrastructure Quality (scale 1-7)
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Institutional Quality I
• Already seen how property rights and rule of law can
effect economic growth
• “New Institutional Economics – economic growth
critically dependent on the quality of institutions in a
country.
• Many cases where the level of economic development
among countries or even regions cannot be explained
purely in terms of labor, capital and TFP
• Problem in studying institutional quality has been the
difficulty in precisely defining the concept
• One approach – look at a number of different indexes of
institutional quality and see if thee is a common story
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Measures of Institutional Quality
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Institutional Quality II
• Corruption a problem in the region, but hardly particular
to Latin America
• Latin America pretty average by international standards
• Ease of doing business – composite index of factors in
running a business – employing workers, paying taxes,
enforcing contracts
• Regional average is worse than the global average and
• Many countries where doing business is very difficult
• Government effectiveness – Latin American governments
relatively ineffective
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Institutional Quality III
• While none of these indexes is definitive, overall picture
of a region with
• Moderate problems with corruption
• A poor business environment, and
• Relative ineffective governments
• Increasing TFP in this environment will not be easy
• On other hand the index of competitiveness is far better
than other reported measures
• Derived from surveys of businessmen
• Executives usually thinking not just about the present but also
about the future
• If the data is just expressing expectations – economic
future of Latin America looks brighter.
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