Economist Dr Peter John Gordon says low productivity within countries of Latin America and the Caribbean (LAC) is caused primarily by a misallocation of resources, market failures and poor economic policies rather than worker inefficiencies.

Gordon, a research fellow at the Sir Arthur Lewis Institute of Social and Economic Studies, made the remarks last week during a presentation at the Jamaica Employers’ Federation head offices on Ruthven Road.

In making reference to a recent Inter-American Development Bank (IADB) study titled ‘The Age of Productivity: Transforming Economies from the Bottom Up’, Gordon said that it is the economic policies that “distort incentives for innovation, prevent efficient companies from expanding and promote the survival and growth of inefficient firms”.

“Attaining aggregate efficiency gains is a complex process which requires the alignment of fair competition and the opportunity for firms with good ideas to thrive,” Gordon said.

He noted that among the most problematic causes of the low productivity of firms in Latin America and the Caribbean (LAC) is the fact that they have little incentive to grow. Gordon noted that larger firms attract higher taxes and are often overlooked by policies that promote nascent industries or firms over existing, productive enterprises. He said smaller firms tend to be less productive than larger ones and therefore by reducing the share of small firms to medium-sized or larger ones, LAC countries can increase its productivity levels.

“There is a strong relationship between productivity and size,” said Gordon. “Larger firms tend to be more productive…Smaller firms on average tend to be less productive than larger ones.”

“Reducing the share of small manufacturing firms and increasing the share of medium sized manufacturing firms so as to match the distribution in the USA, leaving productivity levels of firms unchanged would almost double manufacturing productivity. This boost would be sufficient to eliminate the manufacturing productivity gap with the USA,” Gordon said.

The average per capita income in LAC was one-sixth that of the USA in 2006. The region’s productivity gap with the US is 37 per cent of the income gap, accumulated factors account for the remaining 63 per cent. The LAC region has experienced growth rates below that of the rest of the world.

Gordon argued that policies can distort which firms operate in the market, and either promote the survival of poorly performing firms or the exit of more efficient ones. Among the causes of this distortion, said Gordon, is the intervention in the market by governments, along with credit and tax policies that help low productivity firms gain market share or hinder productive firms from gaining markets.

“These policies usually cover the areas of trade, credit, taxes, social protection, aid to small firms, innovation and industrial promotion,” said Gordon.

He argued that market forces should be left to the invisible hand of the market, not governments or other policymakers who by trying to resolve co-ordination problems and provide inputs for sectors “handpicked for their potential comparative advantage”, inadvertently “pick losers” as well.

“I have great difficulty in endorsing much of this sort of policy,” Gordon said of picking winners. “Bureaucrats do not have any better information than anyone else about future demand conditions. Guessing wrong on future demand will doom an industrial policy even if the supply side responds in the intended way,” he said.

The tax regimes within the region are also to blame for the low productivity and GDP growth according to Gordon. It takes an average of 320 hours per year for LAC firms to file taxes, while firms in high income countries take 177 hours on average per year. Gordon argued that in addition to the use of productive time to file taxes, the tax system itself exacerbates the productivity problem with expansion of lower productive firms taking place at the expense of higher productive firms because of unequal tax rates.

“Tax systems which exempt firms below a certain size from paying taxes encourage firms to stay small and less productive,” said Gordon. “The main problems with these regimes is that they stunt the growth of small firms. These regimes create gaps or so called non-linearity- which mean that firms wanting to grow do not have the correct incentives to do so,” Gordon said.

He noted firms which grow in size may see a significant drop in profits because of the discontinuity in marginal tax rates within LAC countries. Examples from Peru and Argentina indicate that firms who ‘graduate’ from low to high tax regimes have a 53 to 62 per cent drop in profits respectively.

Gordon said that industries should not be protected from international competition, as is the case with many countries in LAC, including Jamaica. Low exposure to international trade, whether by tariffs, non-tariffs or other barriers protect low productivity firms from competition, thereby allowing the less productive firms to survive, Gordon argued. He said opening up the markets to international competition will increase the rate at which low productivity firms exit the market, thereby providing the channel for productivity to increase.

Gordon said Jamaica should aim to move its productivity forward by examining the effects of policies on long-term productivity and placing the national interest at the forefront of policy debate rather than that of sectoral or interest groups.

“Anticompetitive practices particularly from the informal sector rank as the third most important constraint to formal firms’ growth…after corruption and macro instability and ahead of other pressing issues such as inefficient regulations, high tax rates, the economic cost of crime, high cost of electricity or inefficient tax administration,” Gordon said.

“Latin America and the Caribbean productivity is about half its potential,” said Gordon. “Improving productivity must be central in any economic programme.”