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Social welfare 29 Mar 2017

The challenge of lowering productivity barriers

After a years of steep deterioration, Uruguay has managed to partially recover some of the ground lost after a historic fall in productivity.  Despite this, a person working in Uruguay today reaches an average productivity slightly above 40% of the level they would achieve working in an advanced economy.  How is this possible?  What can be done?  This paper sets out a potential explanation and suggests a line of action for further progress.

From a historical perspective, Uruguay underwent a long process of regression with respect to the most productive economies, and went from enjoying a level of productivity on par with the most advanced countries in 1900, to drop to just 25% at the beginning of 2000. Argentina and Uruguay are two extremely rare cases: there are many other countries that, having been highly productive, have had such a marked decline.

Inspired by this reality, a few year back already, in a joint work with Professor Lorenzo Caliendo of Yale University, we made a historical analysis of the policies implemented in Uruguay that had a greater impact on the deterioration of the relative productivity with respect to leading countries.   With a model developed in line with the works by Parente and Prescott, we were able to replicate and explain the observed divergence in productivity. We provided evidence that, throughout history, a succession of self-imposed barriers were pivotal in moving Uruguay away from the levels of productivity in the most advanced countries.

The enormous productivity differentials observed in the world would not necessarily exist

The studies by Parente and Prescott are based on the concept that all people have the same potential, but act in different contexts defined by levels of barriers to productivity.  Thus, in absence of such barriers, given the current ease of access to knowledge, the enormous productivity differentials observed in the world would not necessarily exist. It is precisely the barriers that countries impose on themselves that prevent the productive sector from operating with the most efficient procedures at the global level.

In this framework one could think of several types of barriers:  institutional, operational, regulatory and commercial. Institutional barriers would include a lack of guarantees regarding contract fulfillment and the protection of property rights, perceived corruption and political instability; Operating barriers, the lack of infrastructure and adequate human capital; Regulatory barriers, impositions that distort decision making processes; And trade barriers, tariffs and non-tariff barriers that limit the country’s global insertion.

Although we have made progress in several aspects, the relative improvement in productivity observed in recent years is not strongly correlated to a general reduction of barriers.  This is what international evidence shows. Based on up-to-date and internationally comparable data from the World Bank and the Global Economic Forum, it is possible to compute an approximation of the level of our barriers to productivity. Thus it is possible to define barrier magnitude on a scale of 1 to 100, where 1 is the minimum value of barriers at international level and 100 the maximum.

“The world is moving forward and we are paralyzed

Within institutional barriers, Uruguay maintains a good relative position at global level, which has even improved steadily over the course of the past decade.  This is partly explained because we have passed the crucial test of having governments of all political signs without major institutional alterations. These low institutional barriers translate into low levels of corruption (18 out of 100), adequate levels of legal security and respect for property rights (25 out of 100) and political stability (18 out of 100).

Regarding operating barriers we have relatively low global barriers in technological infrastructure (30 in 100) and physical infrastructure (38 in 100). However, the barriers rise considerably when we look at the potential of the workforce (54 out of 100) and, unfortunately, no improvement is seen when the indicators are updated.

“We have to assume that there is a pending agenda

Regulatory barriers are high.  The weight of the Uruguayan state in the economy leaves us with barriers of 62 in 100. The load that the productive sector bears is too high compared to the quality of the services it receives.  The barrier related to labor regulations is also very high (86 out of 100). We have a new labor regulation – adjusted to a large extent in the last 10 years – but which dates back to the 19th century, and is far from conforming to the changes we are seeing in the labor market.

Finally, trade barriers are also some of the most restrictive. <0} In terms of international insertion, our current level is 71 in 100, and this level tends to increase a bit every year.  Basically because the world is moving forward and we are paralyzed.

The most taxing barriers – education, weight of the state, labor regulation and international insertion – are the ones that should keep us awake every night.  Beyond good intentions, we need to pull out of this standby and send clear signs of commitment to the necessary reforms.  If we want to keep looking up, we have to assume that there is a pending agenda.

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