Chapter 2: Reallocation and Productivity

Outline IPES

I. Setting the stage– Chapter 1: Productivity level and trends– Chapter 2: Productivity and

Reallocation– Chapter 3: Within firm productivity growth

Outline of IPES

II. Policy levers for higher productivity– Social policies (taxes on social security) – Taxes & uneven enforcement – Trade, FDI and transportation costs – Small firm policies– Barriers to the entry and exit of firms– Access to credit & capital– Innovation policies– Industrial and cluster-based policies

Outline of IPES

III- Going forward– Understanding the political economy of

productivity policies– Unlocking productivity in LAC

Outline

• Hypothesis• Main questions• Reallocation across sectors• Reallocation across firms• Reallocation across formal and informal

firms

Hypothesis

• Lack of dynamism in, and barriers to the reallocation of resources in the economy across sectors and firms is a key factor explaining the low productivity levels and growth in the region.

Main questions

• How much room there is to improve productivity by reallocating existing factors?– Across sectors– Across firms– Across formal and informal firms

• How much entry/exit of firms contribute to productivity growth?

• What drives low reallocation?

Heterogeneity

• Productivity in the aggregate is the weighted productivity across activities.

• High heterogeneity; Productivity in manufacturing and even business sector accounts for fraction of TPF

• Gains through reallocation are possible if heterogeneity in marginal products

There is seemingly a big share of employment in very low productivity activities

We plan to do this for more countries (Brazil, Chile?)Ideally, we would like to estimate marginal product across activities

Reallocation across sectors

Relative labor productivity, Manufacturing=100

38

59

54

110

70

0 50 100 150 200 250 300

Agriculture, hunting, forestry,

fishing

Mining and Utilities

Construction

Wholesale, retail trade,

restaurants and hotels

Transport, storage and

communication

Other Services

824

Average for ARG, BRA, CHL, COL, MEX, PER, VENOutput from UN, Employment from LAC Statistical offices

• Across history, large gains in TFP from getting people out of agriculture and into manufacturing

• Latin America has still a relative large share of agriculture. It also has a relative low share of manufacturing compared to other economies.

Sector distribution of output across countries

Agriculture

0 20 40 60 80

Trini. and Toba.

Panama

Nicaragua

Jamaica

Honduras

Guatemala

El Salvador

Dominican Rep.

Cuba

Costa Rica

Barbados

Uruguay

Paraguay

Ecuador

Bolivia

Venezuela

Peru

Mexico

Colombia

Chile

Brazil

Argentina

Mining and Utilities

0 20 40 60 80

Manufacturing

0 20 40 60 80

Services

0 20 40 60 80

Trini. and Toba.

Panama

Nicaragua

Jamaica

Honduras

Guatemala

El Salvador

Dominican Rep.

Cuba

Costa Rica

Barbados

Uruguay

Paraguay

Ecuador

Bolivia

Venezuela

Peru

Mexico

Colombia

Chile

Brazil

Argentina

Big Countries

South Am. -Small-

Average OECD 24Central Am.

and the Caribbean

Source: UN

Whereas many other developing countries have larger shares of manufacturing

Agriculture

0 20 40 60 80

Thailand

Singapore

Malaysia

Korea

China

Turkey

South Africa

Morocco

Mauritius

Malta

Egypt

Cyprus

Bahrain

Mining and Utilities

0 20 40 60 80

Manufacturing

0 20 40 60 80

Services

0 20 40 60 80

Thailand

Singapore

Malaysia

Korea

China

Turkey

South Africa

Morocco

Mauritius

Malta

Egypt

Cyprus

Bahrain

East Asia

Average OECD 24

Source: UN

I. Reallocation across sectors

0 0.05 0.1 0.15 0.2 0.25 0.3 0.35 0.4

OECD: English Speaking

OECD: Continental Europe

Africa - Middle Income

East Asia

LAC: Central America and theCaribbean

LAC: Small-South America

LAC: Big Countries

Employment GDP

Reallocation of employment and output Lilien Index. Early 1990s – Early 2000

Note: GDP series by economic activity at one digit level of disaggregation at constant 1990 prices in US Dollars from the United Nations Statistics

Division. Lilien Index measures the dispersion in the growth rate across industries and is defined as follows: 2/1

2)lnln(

stst

t

stt Xx

X

x

0 0.1 0.2 0.3 0.4 0.5 0.6

Trinidad and Tobago

Panama

Nicaragua

Jamaica

El Salvador

Dominican Republic

Costa Rica

Barbados

Uruguay

Bolivia

Venezuela

Peru

Mexico

Colombia

Chile

Brazil

Argentina

Employment GDP

Big Countries

Central Am. and the

Caribbean

Lilien index of reallocation. LAC

Sources: GDP: United Nations Statistics Division; EMP

Measuring gains from reallocation

s

ststkts

kitstits

ksttpPppP )(

• Issue: Marginal versus average products;

Total Growth

-0.03

-0.02

-0.01

0

0.01

0.02

0.03

0.04

0.05

Venezuela Nicaragua Peru Paraguay Brazil Mexico El Salv ador Colombia Panama Costa Rica Argentina

Dominican

Republic Chile

Between Term

-0.03

-0.02

-0.01

0

0.01

0.02

0.03

0.04

0.05

Cross Term

-0.03

-0.02

-0.01

0

0.01

0.02

0.03

0.04

0.05

Venezuela Nicaragua Peru Paraguay Brazil Mexico El Salv ador Colombia Panama Costa Rica Argentina Dominican

Republic

Chile

Within Term

-0.03

-0.02

-0.01

0

0.01

0.02

0.03

0.04

0.05

Total Growth

Counterfactual exercises

• How much productivity growth would we have seen in LAC had we observed the same sector reallocation than in East Asia? – If LAC had same sector allocation than EAST ASIA.

• Compare sector reallocation in LAC with other resource intensive nations (New Zealand, Australia, Finland).

(using GGDC total economy 10-sector database 1950-2005)

Contribution of each sector to productivity• Which sectors are in relative terms more

productive in each country?• Which sectors have contributed more to

growth in LAC?• Which sectors have contributed more to

productivity growth in EAST ASIA and how do they compare to LAC?

• How does the sector productivity evolution in LAC compare to other resource-rich economies?

Reallocation and reforms

• Data presented in Timmer and de Vries (2008) suggest that contribution of “between” term in post reform period negative, in all countries but Mexico.

• We would like to relate between and within growth to reforms

• Did the destruction of jobs in manufacturing and shift towards low productivity services contribute to this phenomenon?

cjtj

obetween

ct formsP Re1

cjtj

obetween

ringtcmanufactu formsP Re1

II. Reallocation across firms

• Decompositions of productivity growth

)()(

)(

ktkitExits

kitktitEntries

it

Continuersititkt

Continuerskititit

Continuerskit

t

PpPp

pPppP

Issues:•Marginal versus average products•Revenue versus quantity productivity

Firm Entry and Exit

• An important margin of how reallocation of resources affects productivity growth is through the entry/exit of firms and establishments

• Policies that prevent exit of unproductive firms (i.e. low competition, high transportation costs) or prevent entry of productive firms (high barriers of entry)

Labor Productivity Growth Decomposition – ManufacturingFive years differencing, real gross output -1990s

-.5

0.5

11

.5

ArgentinaChile

ColombiaUSA

Within BetweenCross EntryExit Firm Turnover

Labor Productivity Growth Decomposition – ManufacturingFive years differencing, real gross output -1990s

-.5

0.5

11

.5

ArgentinaChile

ColombiaUSA

Within BetweenCross EntryExit Firm Turnover

Very little importance of entry/exit in Argentina

Decompositions for LAC countries

• Will do with TFP decomposition• With a few exceptions only in manufacturing• But interpretation problems with this

methodology.– It says how much of the productivity growth

occurred because of the different dimensions.– It does not say how much room for

productivity gains of reallocation.

Other methodological issues

• What does it mean to transfer resources to more productive firms?

• What determines allocation of resources across firms in a world where firms are heterogeneous?

Hsieh-Klenow (2008) approach

• It quantifies the extent of resource misallocation across firms within sectors.

• Static model with heterogenous firms (Ai) and imperfect competition

• In equilibrium, pi is inversely related to Ai and piAi is constant for all firms. Firms hire L and K to the point where MPL =MRL. High Ai firms are larger.

Hsieh-Klenow (2008) approach (II)

• It allows for departures of optimal: firm specific taxes and subsidies imply that MPL≠MRL.

• Taxes are more distorting the more correlated they are with productivity: they make more productive firms smaller than otherwise.

• Reallocation gains occur when resources flow from low to high marginal product firms.

• Hsieh-Klenow 2008 find that if resources were reallocated as in US benchmark, productivity in manufacturing will increase:– INDIA: 40-60%– CHINA: 30-50% – LAC: ?

• Computations assume distribution of productivities across firms as given. Gains occur by reallocating L and K across these firms.

HK (2008) Methodology in LAC

• Through Research Network Project (& other sources) will obtain results for:– Argentina– Bolivia– Brazil– Chile– Colombia– Ecuador– Mexico– Uruguay– Venezuela

– El Salvador? – Peru?

Some preliminary results (1)

TFP Gains in Manufacturing

Years Relative to the US Full LiberalizationIndia 100-128%China 86-115%Argentina 1998-2002 35-45%Bolivia 1988-2001 31-94%Brazil 2000-2005 58‐ 65%Colombia 1982-1998 25-46% (1997) 79-109%Ecuador 1996-2005 252-585%Mexico 1994, 1999, 2004 140%Uruguay 1998-2005 52-63%China 30-50%India 40-60%

The data does not show gains in allocative efficiency

Colombia-TFP gains from Equalizing TFPR relative to 1997 U.S. Gains

0

5

10

15

20

25

30

35

40

45

50

82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98

The data does not show gains in allocative efficiency

Colombia-TFP gains from Equalizing TFPR relative to 1997 U.S. Gains

0

5

10

15

20

25

30

35

40

45

50

82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98

Ecuador: 1995-2005

Uruguay: 1998-2005

URUGUAY. TFP gains from equalizing TFPR within industries

Manufacturing Commerce Hotel &Restaurants

Transport &Communications

Real estate &renting

Education Health Others

1998 58,9% 215,4% 76,4% 288,1% 48,1% 14,3% 16,3% 42,1%1999 52,5% 204,9% 105,4% 199,6% 47,7% 17,9% 12,6% 33,5%2000 49,2% 204,5% 94,6% 162,8% 67,1% 13,6% 7,8% 9,5%2001 60,3% 233,9% 36,8% 207,6% 73,0% 19,3% 11,4% 41,2%2002 53,0% 321,5% 41,2% 222,8% 73,1% 20,3% 8,9% 34,7%2003 59,8% 243,2% 36,5% 114,4% 87,1% 28,0% 10,6% 62,3%2004 47,6% 258,1% 59,4% 123,6% 83,5% 19,4% 9,8% 55,5%2005 63,4% 266,4% 164,0% 167,0% 101,4% 20,7% 12,9% 12,1%Total 55,6% 243,5% 76,8% 185,7% 72,6% 19,2% 11,3% 36,4%

TFPR (Distortions) and SizeBrazil

Smaller firms have subsidies (they arelarger than they should be)

Smaller firms are constrained

In Ecuador..

Large firms shouldexpand moreActual versus Efficient size

More firms should expand

In Colombia

Many small should shrink

In Bolivia, many large firms are too large and many small are too small.

12% of largest Plans should shrink

10% of smallest plansShould grow by more

Than 200%

Correlation between distortions and productivityBrazil 2000-2005

More productive firms tend to be more distorted (they should be larger than they are)

Very preliminary results suggest that:

• There is a large correlation between size and distortions in Brazil, Ecuador, and Colombia (as in India). Many large firms are too small; many small firms are favored and therefore are too large given they inherent productivity;

• Things look quite different in Bolivia where many small firms look too small and distortions make large firms too large.

Some remarks

• Picking winners through industrial policy requires important “within” gains in productivity to make it worthwhile, particularly if picking firms of low productivity to begin with. – Low relative to sector average?– Low relative to world average?

• Can those “break even” gains in “within” productivity be computed?– Cost-benefit analysis should account for

‘between’ distortion as well.

III. Reallocation across formal and informal firms: the importance of high taxes and imperfect enforcement

• Are there too many small, informal, and unproductive firms in Latin America?

• How much of the distortions in productivity are explained by taxes+imperfect enforcement?

• Hsieh and Klenow application to Mexican Census Data in 1994, 1999, and 2004

• Gain from equalizing TFPR = 140%

Still more work to do:

• How much due to IMSS non‐compliance?• How much in other sectors?• How has this changed over time?• Why so many firms with low TFPQ?

Mexico

Informality and productivity

• Will compare productivity distributions of formal versus informal firms (Brazil, Chile?).

• Case studies and focus groups: Do formal and informal firms compete?-Supermarkets in Argentina-Lingerie industry in Colombia

Rest of the report: examine in detail reallocation (and within firm) productivity effects of:

• Social policies (taxes on social security) • Taxes & and uneven enforcement • Trade, fdi and transportation costs • Access to credit & capital• Small firm policies• Barriers to entry and exit of firms• Innovation policies• Industrial policies