Inter-American Development Bank Research Department Competitiveness: The Business of Growth 2001 Report Economic and Social Progress in Latin America

Much evidence indicates that Latin America lacks competitiveness

Growth has been disappointing

…while income gaps with more developed countries are widening

Factor productivity is not increasing

-5%-4%-3%-2%-1%0%1%2%3% Haiti Jamaica Honduras Venezuela Nicaragua Colombia Mexico El Salvador Paraguay Ecuador Panama Trinidad y Tobago Guatemala Brazil Bolivia Costa Rica Barbados Peru Dominican Republic Uruguay Argentina Chile East Asia LATIN AMERICA Developed Annual growth of Total Factor Productivity (average 90's) Source: RES-IDB Calculations Productivity growth in the 90s …but falling, especially in the poorest countries

Source: World Bank Number of people living on less than $2 a day (%) South Asia Sub-Saharan Africa East Asia and Pacific Excluding China Latin American & Caribbean Middle East & North Africa Europe and Central Asia As a result, poverty is not declining

Latin America ranks low in the international rankings of competitiviness

…although a few countries rank high Chile Costa Rica T&T Mexico Brazil Uruguay Argentina Dominican Rep. Jamaica Panama Peru El Salvador Venezuela Colombia Guatemala Bolivia Ecuador Honduras Paraguay Nicaragua Ranking Growth Competitiveness Index Source: World Economic Forum 2001.

…most rank low for their income levels Ranking Growth Competitiveness Index Source: World Economic Forum 2001.

Also the case for the largest economies Growth Competitiveness Index Source: World Economic Forum % 4% 17% 10% 2% Chile Mexico Brazil Argentina Peru Venezuela Colombia Ranking 12% Expected for income level Gap

…implying that their growth potential is low Competitiveness gaps (given income level) and growth in the 1990s Paraguay Venezuela Colombia Argentina Honduras Uruguay Jamaica Costa Rica Chile China Relative competitiveness Growth of GDP per capita, Source: IDB calculations based on World Bank (1999) and World Economic Forum (2001). See Appendix 1.3. Note: Each dot represents a country. Ukraine Russia Trinidad and Tobago Dominican Rep. Ireland Singapore

The largest firms are too small 18,018 28,288 30,753 36,748 46,597 53, , , ,729 1,326,523 1,683,048 4,603,380 6,280,798 1,174,702 3,982,546 14,000,000 10,000100,0001,000,00010,000,000100,000,000 Guatemala Honduras Nicaragua Panama Costa Rica El Salvador Peru Colombia Venezuela Argentina Chile Mexico Brazil Latin America East Asia Developed countries Average value of assets for the 25 largest firms (Thousand US dollars) Regional Comparison of the Size of Large Firms Source: Calculations RES-IDB based on WorldScope and América Economía

…even for the size of the economies 13% 98% 164% 211% 100,0001,000,000 10,000,000 Brazil Mexico Chile Argentina Venezuela Colombia Peru The size of “large” firms vis-a-vis the size of the economies Average assets of 25 largest firms (US$ Thsd) Source: IDB calculations based on WorldScope and America Economia. Expected for economy’s size Gap

However, export competitiveness has improved substantially

…and Latin America has become a magnet for foreign direct investment Total Inflows of FDI by Region, (Percent of GDP) Middle East and North Africa Rest of Africa Rest of Asia East Europe East Asia Latin-America Developed Countries Source: IMF (2000). Average of country ratios Average by region

Is the lack of competitiveness due to deficiencies in the markets of the main productive factors? Credit Human resources Infrastructure Technology

Is it lack of credit?

Lack of financing is obstacle #1 to Latin American business development Major Obstacles to Business Development in Latin America Judiciary system Organized crime Corruption Practices against competition Infrastructure Street crime Exchange rate Inflation Policy instability Taxes and regulations Financing Source: World Business Environment Survey (WBES) and IDB calculations. (Percentage that thinks it is the principal obstacle)

Financial liberalization has taken big strides Banks privatized Most interest rates liberalized Reserve requirements reduced Capital adequacy ratios adopted in all countries Supervision strengthened.

…and it has paid off

But it has not been enough: Credit is still scarce in Latin America

Credit markets are underdeveloped Credit to private sector (as % of GDP) 93% 14% 35% 153% 316% 172% 188% 10%20%30%40%50%60%70%80%90% Chile Brazil Colombia Mexico Argentina Peru Venezuela Expected for income level Gap

The main remaning problem is weak creditor protection Governments often interfere in financial contracts: –Maximum interest rates (11 countries) –Mandatory investments (7 countries) –Credits targeted to some sectors (5 countries) Collateral pledge/recovery is burdensome Creditors poorly protected in the event of bankruptcy Law is unstable/unclear or not enforced.

Effective protection of creditor rights is low in many countries

…discouraging credit

…and increasing credit volatility

Strengthening creditor rights is essential to expand credit and improve competitiveness

Is it lack of human capital?

In Latin America, education is not growing fast enough

Workers are still concentrated in low-wage sectors, where cost competition is tough

This makes some costs troublesome Contribution to Social Security by Employers and Employees 1999 (Percent of Gross Wages) Source: Social Security Administration (1999) Jamaica Haiti Trinidad & Tobago Bahamas Honduras Barbados Panama Guyana Dominican Republic Venezuela Guatemala Nicaragua Ecuador Chile El Salvador Paraguay Peru Mexico Bolivia Costa Rica Brazil Colombia Uruguay Argentina Latin America Average United States Japan Germany Average OECD

This makes some costs troublesome Cost of Mandatory Job Security Provisions in Latin America and the Caribbean, 1999 (In monthly wages) Source: Ministries of Labor in Latin America and OECD(1999).

What can be done? Reduce payroll taxes and contributions Strengthen the link between contributions and benefits Instead of penalizing firms for firing …make them support employees’ saving plans Remove barriers to labor productivity

Removing barriers to labor productivity: Education The main problems: late enrolment and early drop outs Main strategies: –demand incentives –education systems more responsive to the users

Removing barriers to labor productivity: Training The main problem: centralized training systems are too costly and ineffective Main strategies: –Education policy to ease transition between school and work –Tax policies to encourage private training –Separate training regulation and provision –Condition public funds to the programs that improve trainees’ hiring possibilities.

Is it lack of infrastructure?

Latin America is leader in infrastructure privatizations Africa Middle East S. Asia Europe and Central Asia East Asia and the Pacific LATIN AMERICA Private Capital Participation in Infrastructure, Source: PPI, Proyect Database, World Bank. US $ Mll Privatizations New investment Operation Management with major private capital expenditure

…in all main infrastructure sectors Source: Private Participation in Infrastructure data base web page, World Bank (2001).

…but infrastructure is still below international standards Infrastructure Index: electricity, water, roads, telephones * Includes electricity generation, acces to improved water source, paved roads and telephone mainlines. 12% 5% 39% 7% 17% 12% Chile Mexico Argentina Brazil Colombia Peru Expected for income level Gap

Privatization has brought benefits: THE CASE OF TELECOMMUNICATIONS Privatization has (with respect to previous trends): Increased the number of lines by 7% Reduced waiting lists 60% Reduced faults per line 30% Accommodated increased traffic: international traffic grows 15% yearly.

Some countries have caught up with the international standard 36% 18% 1% 8% 45% 22% Argentina Chile Venezuela Colombia Brasil México Perú Telephone Mainlines and Mobile Source: IDB calculations based on ITU (2000) Expected for income level Gap

But problems remain: THE CASE OF TELECOMMUNICATIONS The cost of local calls has increased 14% Huge telephone penetration gaps remain –There are 5 times more telephones per capita in the developed world than in Latin America –Penetration in the richest quintile is 7-10 times higher than in the lowest quintile Monopolies in the sector are obtaining returns of up to 45%!

Privatization in electricity has been uneven Ecuador Mexico Venezuela Honduras Nicaragua Guatemala Costa Rica Bolivia Peru Jamaica Dominican Republic El Salvador Trinidad & Tobago Colombia Panama Brazil Argentina Chile Divestiture Greenfield Projects Operation Management with major private capital expenditure Private investment in the electricity sector, US Dollar per capita Source: PPI database, World Bank (2000).

…and much remains to be done 33% 61% 59% 36% 24% 73% Chile Argentina Brazil México Colombia Perú Electricity generation Source: IDB calculations based on World Bank WDI (2001) Expected for income level Gap

Privatization is not enough Introduce competition as soon as possible Grant independence to regulatory authority Regulate according with institutional capabilities

Is it lack of capacity to assimilate new technologies?

Latin America is not a laggard in the technological race Internet Hosts and Personal Computers by Region, 1999 Africa Middle East East Europe East Asia Latin America Developed Countries Log scale Internet Hosts (per 10,000 people) PCs (per 1,000 people) Source: ITU (2000)

Internet adoption is going fast 1% México Argentina Chile Brazil Colombia Venezuela Peru Internet Hosts/populatiom Source: IDB calculations based on ITU (2000) Expected for income level

The initial stages of information technology adoption have been fast Because: Enough market freedom No lack of education among entrepreneurs Up-to-date telecommunication systems in the large countries.

…but further progress may be more difficult Education is concentrated in a few Training systems lack dynamism Credit is scarce for small firms Weak intellectual property rights Obstacles to business creation

Latin American governments hinder the creation of new firms

Strategies to accelerate the adoption of the new technologies Focus on the big determinants: education and training, credit, property rights, obstacles to business creation But also: –Improve environment to innovate (R&D, innovation clusters) –Modernize industrial and investment policies.

Synthesis: What is missing: Deeper credit markets –Strengthen creditors protection Better use of existing human capital: –Reduce payroll taxes and ease hiring and firing More education and training: –More performance incentives, less centralization More and better infrastructure: –Make regulation more independent and effective