Adriana Arreaza
Directora de Estudios Macroeconómicos de CAF
For decades, Latin America and the Caribbean have not managed to converge to the per capita income levels of developed countries. On average, the region's per capita income has remained below 30% of the equivalent in the United States.
This non-convergence can be explained by the fact that growth in the region has been slow and, therefore, not enough to bridge the gap with more advanced economies.
In the words of Nobel Prize-winning economist Paul Krugman, productivity isn't everything, but in the long run, it's almost everything. Apart from the low growth levels, the region faces a low productivity problem. Productivity is simply the way we combine the factors of production—physical and natural capital, and labor—to produce goods and services.
The countries that have achieved solid, sustained growth over time have done so precisely through productivity gains. Southeast Asian economies represent a well-known and widely cited example in the literature.
This is not the case for Latin America. The region's growth has been driven by the accumulation of production factors, mainly investment and labor, rather than productivity gains.
But what makes us less productive? Well, evidence suggests that there are productivity gaps across all industries. In other words, it depends less on what we produce and more on how we produce it.
Thus, when we zoom in on the sectors, sub-sectors, and even on individual businesses, we find is that the average company in the region is less productive than the average company in the same industry in advanced economies.
The industries with a larger presence of informal companies and workers tend to have the widest productivity gaps. This is because informal businesses have sub-optimal scales, have less access to credit, and engage in little innovation.
But the problem is not just that many workers are active in informal businesses. In addition, formal companies in Latin America and the Caribbean are also less productive than their counterparts in the same industries in more advanced economies.
And what makes companies less productive in the region? Our formal companies hire fewer people in the region. In other words, they do not grow. Consequently, there are fewer salaried employees and a greater number of self-employed people in the region. Among these freelancers, self-employment is often not a choice, as they would rather be employed.
The decisions to be an entrepreneur, self-employed, employee, formal or informal worker, are based on a combination of individuals' abilities and the environment at work or when starting a business.
These skills largely depend on education. Judging by the poor results in a number of tests that measure mathematical and language skills of young people in the region, for example, there is still work to be done to bridge the education gaps and the relevance of education in LAC. These deficiencies also apply to socio-emotional skills, which, when combined with cognitive skills, are essential for more productive, better-paying jobs.
Skills may be strengthened through public policies that improve opportunities and incentives for lifelong learning for individuals, starting from the family environment and early childhood, elementary, technical and advanced education, and training in the workplace, among others.
In addition to individual skills, the economic environment determines the decisions of entrepreneurs and workers. If I invest, will I have the returns that make my investment profitable? Is the macro environment stable enough to make my returns more predictable? Do I have legal certainty about the appropriability of those returns? Is it easy to start a business or are there barriers that hinder entry and competitiveness of new, more innovative? Is it easy to hire formal staff, or is it so expensive that I prefer to hire people informally? ¿Can I find workers with the skills I need? Is there an infrastructure and the services needed to access the raw material I need to produce and then trade my products?
In our region, these questions usually do not have positive answers. The reasons behind it are of an institutional nature, and the solutions are technically and politically complex. It is about the arrangements that determine the relationships between people and the decisions of workers and entrepreneurs.
But if no work is done on the fundamentals to build individual capacities and improve the institutions that shape the productive environment, and that ultimately determine productivity, it is difficult to have the major global trends (nearshoring, artificial intelligence, lithium exploitation, electrification) lead a transformative leap for the region in terms of growth and development.
In order to truly leverage these opportunities and take that productive leap, it is essential to advance an agenda of cross-cutting and sectoral public policies to bridge the structural gaps that limit investment and, of course, productivity.
