1. Chapter 2: Reallocation and Productivity

2. Outline IPES I. Setting the stage –Chapter 1: Productivity level and trends –Chapter 2: Productivity and Reallocation –Chapter 3: Within firm productivity growth

3. 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

4. Outline of IPES III- Going forward –Understanding the political economy of productivity policies –Unlocking productivity in LAC

5. Outline Hypothesis Main questions Reallocation across sectors Reallocation across firms Reallocation across formal and informal firms

6. 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.

7. 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?

8. 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

9. 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

10. Reallocation across sectors Average for ARG, BRA, CHL, COL, MEX, PER, VEN Output from UN, Employment from LAC Statistical offices

11. 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.

12. Sector distribution of output across countries Source: UN

13. Whereas many other developing countries have larger shares of manufacturing Source: UN

14. I. Reallocation across sectors 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:

15. Lilien index of reallocation. LAC Sources: GDP: United Nations Statistics Division; EMP

16. Measuring gains from reallocation Issue: Marginal versus average products;

17. Total Growth

18. 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)

19. 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?

20. 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?

21. II. Reallocation across firms Decompositions of productivity growth Issues: Marginal versus average products Revenue versus quantity productivity

22. 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)

23. Labor Productivity Growth Decomposition – Manufacturing Five years differencing, real gross output -1990s

24. Very little importance of entry/exit in Argentina

25. 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.

26. 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?

27. Hsieh-Klenow (2008) approach It quantifies the extent of resource misallocation across firms within sectors. Static model with heterogenous firms (A i ) and imperfect competition In equilibrium, p i is inversely related to A i and p i A i is constant for all firms. Firms hire L and K to the point where MPL =MRL. High A i firms are larger.

28. 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.

29. 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.

30. 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?

31. Some preliminary results (1)

32. The data does not show gains in allocative efficiency

34. Ecuador: 1995-2005

35. Uruguay: 1998-2005

36. TFPR (Distortions) and Size Brazil Smaller firms have subsidies (they are larger than they should be) Smaller firms are constrained

37. In Ecuador.. Large firms should expand more Actual versus Efficient size More firms should expand

38. In Colombia Many small should shrink

39. In Bolivia, many large firms are too large and many small are too small. 12% of largest Plans should shrink 10% of smallest plans Should grow by more Than 200%

40. Correlation between distortions and productivity Brazil 2000-2005 More productive firms tend to be more distorted (they should be larger than they are)

41. 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.

42. 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.

43. 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

44. 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

45. 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

46. 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