Growth and productivity in Latin America: an aggregate analysis

Latin America and the Caribbean (LAC) has made significant progress in its quality of life over the last three decades. This is reflected in a growth of around 56 % in per capita income since 1990 (figure 2.1) and is mainly explained by the accumulation of physical and human capital during this period, which has allowed for an increase in labor productivity.

Between 1990 and 2023, the stock of physical capital per worker increased by around 80 %, while the skills of the typical worker grew by around 34 % (figure 2.2). In turn, employment, as a proportion of the population, increased by 24 %, mainly due to the significant growth in female labor participation, which rose from 41 % in 1990 to 54 % in 2023, on average, in the region. However, the number of hours worked per worker fell by 9 % over the same period, partially attenuating the increase in employment. As a result, labor productivity per hour worked increased by 32 %.

Despite this increase, the region lags significantly behind the most advanced countries. In 1990, output per worker in LAC was equivalent to 46 % of that of the OECD, while in 2023 it was 37 %. With respect to the United States, the decline is even more marked, from 36 % to 27 % in the same period (figure 2.3).

Even more dramatic has been the evolution of productivity with respect to the group of emerging and developing countries as a whole. While in 1990 labor productivity in LAC was 2.7 times that of this group of countries, in 2023 it was only 1.2 times higher.

This low labor productivity is also observed in most sectors, especially those in which the private sector plays a relevant role. Except for the Government and utilities sectors, where State-owned enterprises and regulations have a significant influence, all other sectors show, on average, lower labor productivity relative to the OECD (figure 2.4).

Important sectors such as commerce, manufacturing and other services, which employ a significant portion of workers (23 %, 10 % and 11 %, respectively), are characterized by low labor productivity, with levels of 33 %, 39 % and 42 % relative to the OECD. Another relevant sector, agriculture, which accounts for 15 % of employment in the region, also shows a significant gap, with a labor productivity of 55 % in relation to the group of advanced economies.

One factor behind the lag in labor productivity is the low productive efficiency of the region’s economies. Total factor productivity (TFP), an indicator that reflects how efficiently an economy uses its inputs (capital and labor) to produce goods and services, is significantly lower in LAC than in more developed countries. TFP, according to the most recent data, is approximately half of that observed in the United States, and 60 % of that observed in the OECD (figure 2.5).

Low TFP not only has a negative impact on production, but also discourages investment. This is reflected in the low capital endowment per worker in the region, which is barely one third of that observed in the United States and the OECD, despite having increased substantially in recent decades.

An analysis of the labor productivity gap between LAC and the United States during the period 2010-2019 revealed that approximately 80 % of the gap is explained by differences in TFP, considering both its direct effect on output and its indirect impact through physical capital accumulation¹. The remaining 20 % is attributed to differences in human capital, i.e., in the skills and educational background of workers. It is estimated that the human capital of the typical worker in LAC is equivalent to 70 % of the human capital of the typical worker in the United States.

Low TFP in the region has been a constant for at least the last 40 years. Although until the end of the 1970s, TFP grew almost on a par with that of developed countries, the sharp fall experienced in the 1980s generated a significant lag. Since 1990, TFP has shown relative stability with cyclical fluctuations.

This poor TFP performance in the region since the 1980s has limited economic growth that has been based on the accumulation of factors of production, especially physical capital. The results of a growth accounting exercise for the region highlight this reality (figure 2.6). Since 1980, the contribution of TFP to growth has been negative in 30 of the 44 years analyzed, with an average of -0.87 percentage points for the entire period. On the other hand, physical capital, human capital and labor have contributed an average of 1.72, 0.48 and 0.91 percentage points, respectively, for an average annual real GDP growth of 2.23 % since 1980.

This situation is reflected in the persistent lag of per capita income in the region with respect to advanced economies. As figure 2.7 shows, since 1990, LAC’s per capita GDP relative to the OECD and the United States has remained around 34 % and 27 %, respectively, even showing a slight negative trend.

Latin America has been lagging behind in growth for 60 years. [Unlike other regions] Latin America missed the opportunity to connect more effectively with the great engines of growth that were consolidated after World War II […] What one sees in the data is that from the 1950s onwards, Latin American development has barely kept pace with world growth and has lagged behind for long periods of time.

Based on an interview with Augusto de la Torre

We have closed many gaps in many areas, but not the per capita income gap.

Based on an interview with Ricardo Hausmann

This regional analysis, however, hides some success stories. We refer to those of Chile, Costa Rica, Panama, Peru, Dominican Republic, Trinidad and Tobago and Uruguay². Between 1990 and 2023, the GDP per capita of these countries multiplied by a factor of approximately 3.15 in the case of Panama and the Dominican Republic, and between 2.18 and 2.65 for the rest. This allowed them to close the income gap with the more developed countries. For example, in 1990, Panama and the Dominican Republic had a per capita income equivalent to 26 % and 16 % of that of the United States, and in 2023 it reached 49 % and 31 %, respectively. Uruguay, the country that grew the least in this group, went from having a per capita income equivalent to 32 % of that of the United States in 1990 to 42 % in 2023.

The high growth in these countries, in contrast to that observed in the region as a whole, is largely explained by the increase in total factor productivity, which on average grew by 25 % between 1990 and 2019, while in the region it remained practically constant. TFP played a particularly important role in Chile and Peru, where it grew by around 31 %³.

Employment growth as a proportion of the total population was also decisive, especially in the Dominican Republic, Panama and Peru, where it increased by 62 %, 59 % and 48 %, respectively, compared to 22 % in the region.

Physical capital accumulation played an important role in Panama, the Dominican Republic and Chile, where capital per worker increased by a factor of 5.9, 3.5 and 3.2, respectively, while in the region it increased by 2.1⁴. Finally, the increase in human capital was particularly high in the Dominican Republic, where it grew by 44 %, in contrast to 30 % in the region.

From micro to macro: a brief conceptual framework

To fully understand what determines an economy’s productivity and growth, one must consider institutional factors and those most directly related to business activity. Institutional factors, such as the protection of property rights and the quality of regulatory frameworks, shape the business environment, which in turn affects the behavior and performance of firms.

This environment determines both the internal efficiency of firms and the distribution of productive resources among them—also called allocative efficiency. These two factors define aggregate productivity. In essence, an economy will be more productive if it has more efficient companies and if these concentrate more resources and tend to be larger.

This is obviously a dynamic phenomenon influenced, on the allocative efficiency side, by the growth of existing firms and by the entry and exit of firms. As for internal efficiency, factors such as innovation, the adoption of new technologies and improvements in organizational and managerial practices are crucial for increasing productivity.

These phenomena, in turn, are interconnected. On the one hand, changes in the internal efficiency of firms are associated with their growth (Eslava et al., 2023). On the other hand, market distortions that limit the growth of firms or the entry of new ones have an adverse effect on innovation levels and, therefore, on productivity.

The 2018 Report on Economic Development entitled Institutions for productivity: towards a better business environment (Álvarez et al., 2018), argues that the region’s productive lag is largely due to institutional deficiencies that transversally affect the productive sector. The role played by economic institutions in shaping an enabling environment for productive development is crucial.

To better understand how institutional deficiencies affect businesses, the report delves into four key areas: labor relations, access to financing, competition and relations among businesses themselves. A deeper analysis of each of these areas reveals challenges and opportunities for fostering productive development in the region’s economies.

One dimension of the problem of low productivity in Latin America, of course, has to do with the fact that different companies have, on average, lower productivity than those in more developed countries. This is true, not only for companies, but also for any productive unit, including self-employed people. But there is also an additional factor that is sometimes more difficult to imagine, and that is the fact that the most productive companies, which are the ones that have the greatest capacity to absorb more people as labor force, pay them better salaries—precisely because they generate more productivity— […] do not grow as much as they should. That is, they do not end up absorbing as many people as they should. Meanwhile, the companies with the lowest productivity, the productive units that have the least capacity to generate good income, become larger than they should ideally be. Sometimes they survive longer than they would ideally survive.

Based on an interview with Marcela Eslava