Between 1960 and 2019, Latin America and the Caribbean grew faster than advanced economies in terms of labor, years of schooling, and physical capital. Yet, the difference in average annual growth between the two groups of countries was striking, with the advanced economies growing 2.6% versus around 1.8% for Latin America and the Caribbean.
The biggest difference between the two groups of countries—and with Emerging Asia which grew at around 4.5% per year—was productivity, a factor which lies at the heart of Latin America and the Caribbean’s growth challenge. Productivity advanced steadily in advanced countries and Emerging Asia economies at around 1.4% and 2.3% respectively during those six decades. But it stagnated in Latin America and the Caribbean at 0.06%, with profoundly negative impacts on standards of living and national wealth.
Were productivity more robust, the region would look very different today. Had its productivity kept pace with that of Emerging Asia, its GDP would have been 3.6 times larger. Moreover, its GDP per capita would have stood at 90% of the U.S. level, rather than the much lower 25% where it stood in 2019.
These shortcomings point to a profound challenge: The region must vastly improve the factors leading to greater productivity, including education and allocation of capital. Only in that way can it unlock its economic potential and significantly close its enormous development gap with more prosperous areas.
Coming Up Short in Education
Improving educational quality is critical. As emphasized in the IDB’s 2024 Latin American and the Caribbean Macroeconomic Report, Latin America and the Caribbean has substantially boosted the average years of education individuals receive, with higher GDP-per-capita countries in the region generally enjoying more years of schooling than their lower performing peers. But quality is a sore point. In the 2022 Program for International Student Assessment (PISA), an exam comparing 15-year-old students’ abilities around the world, students in the region were, on average, behind their OECD peers by the equivalent of five years of schooling in math. They were also worse in reading and science than students from most participating countries.
Inefficient allocations of capital similarly hold the region back. Preferential tax treatment for small firms and restrictions on the size of larger ones lead to lower output at the firm and economy-wide level. Heavy taxation and onerous regulations for firms in the formal sector, including those related to payroll and firing costs, encourage firms to remain informal, smaller and less productive. And protectionist trade measures, such as tariffs and quotas, shield inefficient domestic industries from international competition and prevent the reallocation of capital to more productive sectors.
Credit markets have to become more competitive and provide cheaper credit. At present too many unproductive or established firms have preferential access to credit while firms with innovative ideas and high growth potential scrounge for financing. In Brazil alone, misallocation of credit may have cost the country up to 39% of its GDP, according to a recent paper.
Boosting Productivity to Escape the Middle-Income Trap
In 2016, colleagues from the IDB published a landmark study to determine what sectors in a given country most needed investment to increase productivity and help that country jump to a new level in per capita income. Several countries in the region moved into the high-middle income group between 1990 and 2019, the study showed. But an enormous gap remained between them and high-income countries, with a powerful focus on productivity determinants and effort required for them to burst out of the so-called middle-income trap. Our more recent study adds to that work. It shows that, among many other reforms, countries need to vastly improve the quality of their education, their trade openness, and their tax, regulatory, and credit market regimes. While productivity is essential to prosperity, it can only be achieved with better human capital and pro-competition policies that fight monopolies and market power, leveling the playing field across all enterprises.
