1. Productivity, Resources Allocations, and Labor Market Reforms Presentation Prepared for: XXXVII MEETING OF THE NETWORK OF CENTRAL BANKS AND FINANCE MINISTRIES April 17, 2013 Session 3. International Currency Wars and Domestic Reforms Luca Flabbi (IDB)

2. ISSUE: LAC’s productivity has declined against the US and Emerging Asian Countries TFP Region/ TFP US

3. POSSIBLE EXPLANATION: Missallocation of resources LAC relative to the US, 1960 - 2007 For the typical LAC country, two thirds of the LAC-US per capita income gap is due to lagging productivity.

4. POLICY IMPLICATIONS: Large gains from improving resources allocation 4 If the median country allocated resources as efficiently as the US, there would be a 20% increase in TFP. Translated into growth, the median country would grow by an additional 1% per annum over ten years as a result of reforms that improve resource allocation.

5. HOW CAN WE IMPROVE ALLOCATION? Misallocation may (must) have many sources Labor Infrastructure Capital Land TFP Efficiency in allocation Complementarities between inputs Input Quality: Education Skills Training Technology Innovation Incentives: tax and social systems and institutions Inputs TENTATIVE RACCOMANDATION: Focus on labor markets reforms

6. WHY LABOR MARKETS? 1) Low level of reform activity 6

7. WHY LABOR MARKETS? 2) Characterized by high level of informality 7 Share of labor force in the informal sector

8. and informality is usually associated with lower productivity 8 1.Smaller firm size associated with: – unexploited economies of scale – less labor training – lower technological innovation – limited access to credit markets 2.Higher workers turnover associated with: – lower accumulation of human capital – both pre-labor market and on-the-job 3.Higher risk to engage in illegal activities: – negative externality on every steps of the production process Table: Cross-country Correlation Productivity and Informality TFP Gap w.r.t. US Informality rate 0.47***0.49** (0.14)(0.21) Controls NoYes Obs. 9968 Countries 1312 R-sq 0.110.32 Note: Unbalanced panel up to 2007. Data source: Daude and Fernandez-Arias (2010); Lora (2012); ILO (2012)

9. WHAT REFORMS? A few tentative principles 9 o Labor markets vary greatly across countries: reforms should be tailored to particular country characteristics. o In countries with high informality rates: reducing informality should be a key reform objective. o Labor market reforms to tackle informality are: necessarily complex; may require the reform of social protection programs. o As a result, a good reform design should include: 1.a diagnosis identifying which institutional features are creating distortions; 2.a design balancing both economic and social objectives; 3.a set of incentives targeted to both workers and firms.