CIEN - FIEL 1

Competitiveness and GrowthCompetitiveness and Growthin Guatemalain Guatemala

D. Artana, S. Auguste, M. Cuevas, and J. Diaz

Washington DC, September 2007

CIEN - FIEL 2

Slow Economic GrowthSlow Economic Growth

Per capita real GDPRealGDP

1950-1980 2.2 5.0

1980-1990 -1.5 0.9

1990-2006 1.1 3.2

1950-2006 1.3 3.9Remark: After the lost decade and civil war, other countries in the Remark: After the lost decade and civil war, other countries in the Central America region recovered or exceed pre 80s growth rates. Central America region recovered or exceed pre 80s growth rates. Guatemala did not. Why? What has changed in Guatemala or the Guatemala did not. Why? What has changed in Guatemala or the world?world?

CIEN - FIEL 3

Slow Growth Across the Board…

(0.06)

(0.04)

(0.02)

-

0.02

0.04

0.06

0.08

0.10

0.12

1965

1968

1971

1974

1977

1980

1983

1986

1989

1992

1995

1998

2001

2004

INDUSTRY AGRICULTURE SERVICES

Potential growth of GDP by economic sectorPotential growth of GDP by economic sector

CIEN - FIEL 4

Low Investment in Low Investment in GuatemalaGuatemala

• GFCF/GDP GFCF/GDP – Guatemala: =13%Guatemala: =13%– Latin American Average= 23% Latin American Average= 23% – Fast growing economies in East Asia=22%Fast growing economies in East Asia=22%

• Average private GFCF/GDP 1970-2003Average private GFCF/GDP 1970-2003– Latam=16%Latam=16%– Guatemala= 10%.Guatemala= 10%.

CIEN - FIEL 5

As a Consequence…Low Capital AccumulationAs a Consequence…Low Capital Accumulation

0%

5%

10%

15%

20%

25%

30%

35%

1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003Priv

ate

Gro

ss F

ixed

Cap

ital F

orm

atio

n as

a r

atio

of

GD

P

(con

stan

t pr

ices

)

Guatemala

Costa Rica

El Salvador

Chile

CIEN - FIEL 6

Poor TFP Growth• Standard growth decomposition-Average annual TFP growth close to 0% over five decades

(Loening, CIEN)-Method may be overestimating HK contribution and thus

underestimating true TFP growth

• Harberger´s “real cost reduction”-RCR yields positive annual trend growth (1.7% 1986-

2001)

-HK contribution source of divergence…

• Compare with Costa Rica (over 2%), Chile (over 3%)

CIEN - FIEL 7

Is it Costly International Is it Costly International Finance? (i.e. aggregate Finance? (i.e. aggregate

financial constraint)financial constraint)

* A g g re g a te F in a n c ia lC o n s tra in ts* P o o r D e b tM a n a g e m e n t

C o s tly In te rn a tio n a lF in a n c e

* F in a n c ia l c o n s tra in ts* W e a k R e g u la tio n* B a n k in g sy s te m

a n d re g u la tio n s

C o s tly L o c a lF in a n c e

B a rrie rs to in v e s tm e n t

* E x te rn a litie s* S p illo v e rs

* C o o rd in a tio n fa ilu re* C rim e

* C o rru p tio n* 'F o re x ' R isk s* T a x p re ssu re

* T a x re g u la tio n

L o wA p p ro p ria b ility

L o w C o m p e titiv in e ssL o w S u p p ly o f C o m p l.In p u ts (H K a n d In fr .)

* T o o -little se lfd isc o v e ry

* H ig h C o s t( in fr . c o s ts )

L o wS o c ia l R e tu rn s

L a c k o f O p p o rtu n itie s

L o w I & G ro w th

CIEN - FIEL 8

Not Costly International Financing

• Strong BOP and dynamic international resource flows…

• …but resource inflows mostly consumed (not invested).

• External financing not likely to be a binding constraint from macro perspective.

CIEN - FIEL 9

Is it Costly Local Finance?Is it Costly Local Finance?

* A g g re g a te F in a n c ia lC o n s tra in ts* P o o r D e b tM a n a g e m e n t

C o stly In te rn a tio n a lF in a n c e

* F in a n c ia l c o n s tra in ts* W e a k R e g u la tio n* B a n k in g sy s te m

a n d re g u la tio n s

C o stly L o c a lF in a n c e

B a rrie rs to in v e s tm e n t

* E x te rn a litie s* S p illo v e rs

* C o o rd in a tio n fa ilu re* C rim e

* C o rru p tio n* 'F o re x ' R isk s* T a x p re ssu re

* T a x re g u la tio n

L o wA p p ro p ria b ility

L o w C o m p e titiv in e ssL o w S u p p ly o f C o m p l.In p u ts (H K a n d In fr .)

* T o o -little se lfd isc o v e ry

* H ig h C o s t( in fr . c o s ts )

L o wS o c ia l R e tu rn s

L a c k o f O p p o rtu n itie s

L o w I & G ro w th

CIEN - FIEL 10

Local Financing Better than Comparator Group: Cluster

Analysis

Unweighted Averages

Repressed High Guatemala Low

Cost Cost

Percentage

Spreads 66.6 13.0 10.0 6.3

Real Interest Rate -16.8 13.3 8.5 5.6

Saving/GDP 8.2 10.4 13.8 25.0

Number of countries 2 48 -- 79

Source: Author’s calculations on the basis of WDI data (corresponding to 2004/2005)

CIEN - FIEL 11

Domestic Financing not a Binding Constraint

• From an aggregate perspective, terms and availability of domestic financing are adverse,…

• …but no worse than comparator countries.

• Domestic financing not likely to be a binding constraint at this moment.

CIEN - FIEL 12

Is it Low Social Returns?Is it Low Social Returns?

* A g g re g a te F in a n c ia lC o n s tra in ts* P o o r D e b tM a n a g e m e n t

C o s tly In te rn a tio n a lF in a n c e

* F in a n c ia l c o n s tra in ts* W e a k R e g u la tio n* B a n k in g sy s te m

a n d re g u la tio n s

C o s tly L o c a lF in a n c e

B a rrie rs to in v e s tm e n t

* E x te rn a litie s* S p illo v e rs

* C o o rd in a tio n fa ilu re* C rim e

* C o rru p tio n* 'F o re x ' R isk s* T a x p re ssu re

* T a x re g u la tio n

L o wA p p ro p ria b ility

L o w C o m p e titiv in e ssL o w S u p p ly o f C o m p l.In p u ts (H K a n d In fr .)

* T o o -little se lfd isc o v e ry

* H ig h C o s t( in fr . c o s ts )

L o wS o c ia l R e tu rn s

L a c k o f O p p o rtu n itie s

L o w I & G ro w th

CIEN - FIEL 13

Literacy Rates

Lower-Middle Income LAC

40

50

60

70

80

90

100

110

0 1,000 2,000 3,000 4,000 5,000

GNI per capita

Lite

racy

Rat

e

Guatemala

60

65

70

75

80

85

90

95

100

105

0 1,000 2,000 3,000 4,000 5,000 6,000 7,000 8,000

GNI per capita

Lite

racy

Rat

e

GuaGuatemala

CIEN - FIEL 14

Net Enrollment Ratio Secondary School

Lower-Middle Income LAC

10

20

30

40

50

60

70

80

90

100

0 1,000 2,000 3,000 4,000 5,000

GNI per capita

Net E

nrol

lmen

t Rat

io, S

econ

dary

Sc

hool

(%)

Guatemala

0

10

20

30

40

50

60

70

80

90

100

0 1,000 2,000 3,000 4,000 5,000 6,000 7,000 8,000

GNI per capita

Net E

nrol

lmen

t Rat

io, S

econ

dary

Sc

hool

(%)

Guatemala

CIEN - FIEL 15

Gross Enrollment Ratio Tertiary Education

Lower-Middle Income LAC

0

10

20

30

40

50

60

70

0 1,000 2,000 3,000 4,000 5,000

GNI per capita

Gros

s Enr

ollm

ent R

atio

, Ter

tiary

Ed

ucat

ion

(%)

Guatemala

0

10

20

30

40

50

60

70

0 1,000 2,000 3,000 4,000 5,000 6,000 7,000 8,000

GNI per capitaGr

oss E

nrol

lmen

t Rat

io, T

ertia

ry

Educ

atio

n (%

)

Guatemala

CIEN - FIEL 16

Public Expenditure in Educationas Percentage of GDP (year

2004)

Lower-Middle Income LAC

0

2

4

6

8

10

12

14

16

18

0 1,000 2,000 3,000 4,000 5,000

GNI per capita

Publ

ic Ex

pend

iture

in E

duca

tion

as a

%

of G

DP

Guatemala0

1

2

3

4

5

6

7

0 1,000 2,000 3,000 4,000 5,000 6,000 7,000 8,000

GNI per capita

Publ

ic Ex

pend

iture

in E

duca

tion

as a

%

of G

DP

Guatemala

CIEN - FIEL 17

Conclusions about stock of HK• Low stock of human capital

• Strong gender and racial differences in education

– Illiteracy rate higher among women and indigenous groups

– 60% of illiterate people belong to indigenous groups and 67% of them are women.

• Some Recent Improvement. Part of the lack of human capital is due to older cohorts (inherited)

CIEN - FIEL 18

If a factor is scarce its compensation should be highIf a factor is scarce its compensation should be high

0 0.05 0.1 0.15 0.2 0.25

Taiwan

Dominican Rep.

Uruguay

Venezuela

Argentina

Costa Rica

Honduras

El Salvador

Nicaragua

Bolivia

Latin America Average

Panama

Colombia

United States

Chile

Mexico

Peru

Paraguay

Brazil

Ecuador

Guatemala

Thailand

Guatemala has the Highest Returns to Education in LATAM. Guatemala has the Highest Returns to Education in LATAM. Private returns have not declined during the last 20 years in spite of strong Private returns have not declined during the last 20 years in spite of strong increase in schooling (showing that HK is still scarce)increase in schooling (showing that HK is still scarce)

CIEN - FIEL 19

Poor Quality EducationPoor Quality Education

• Bratsberg and Terrell 2002), Guatemala 64 out of 67 Bratsberg and Terrell 2002), Guatemala 64 out of 67 countries in terms of “quality” (only Haiti, Mexico and countries in terms of “quality” (only Haiti, Mexico and Dominican Republic have lower quality) Dominican Republic have lower quality)

And Inequality in EducationAnd Inequality in EducationIndigenous Groups Non-Indigenous GroupsIndigenous Groups Non-Indigenous Groups

0.5

11.

5D

ensi

ty

6.5 7 7.5 8 8.5Fitted values

0.2

.4.6

.81

Den

sity

6 7 8 9 10Fitted values

CIEN - FIEL 20

InfrastructureInfrastructure

• Some successful reforms (electricity, Some successful reforms (electricity, telecommunications).telecommunications).

• Low penetration of Internet seems more related to Low penetration of Internet seems more related to HK than infrastructure.HK than infrastructure.

– Cross subsidies in electricity pricingCross subsidies in electricity pricing

• There are some problems in ports and There are some problems in ports and transportation, as well as problems with electricity transportation, as well as problems with electricity pricing.pricing.

• Although, it does not seem as critical as HKAlthough, it does not seem as critical as HK

CIEN - FIEL 21

• Klinger and Lederman (2005) Guatemala 5Klinger and Lederman (2005) Guatemala 5thth from 73 from 73 countries in new discoveries. 106 new products exported in countries in new discoveries. 106 new products exported in 1997-2002.1997-2002.

• CONCLUSION: actual export basket does not seem to be a CONCLUSION: actual export basket does not seem to be a binding constraint to growthbinding constraint to growth

• So, why export growth is weak? Same factors affecting So, why export growth is weak? Same factors affecting investment and GDP growth investment and GDP growth

-

500,000

1,000,000

1,500,000

2,000,000

2,500,000

3,000,000

BRA SLV ARG GTM CHL COL GUY NIC PAN ECU JAM(*)

TTO

Open Forest is not so Open Forest is not so badbad

CIEN - FIEL 22

• Striking figure in Guatemala is the high level of informality (around 75% of workers)

• In terms of value added, the informal sector in 2006 was around 34.4% of the total economy

• High informality can affect economic growth, because it affects the production technology, sector composition of the production, capital structure, R&D investment, human capital, etc.)

• Informal activites in Guatemala: Demand less qualified workers, Wages are much lower (showing productivity is smaller) and Capital accumulation is slow and more volatile

InformalityInformality

CIEN - FIEL 23

General Conclusionsand

Policy Recommendations

CIEN - FIEL 24

• Constraints:– Stock and quality of education, health– Weak enforcement of property rights and

laws / dysfunctional justice– Certain types of infrastructure (with high

public-good component)

• Common thread in binding constrains is low supply of public goods to complement private investment.– Financing expansion in the supply of public

goods is difficult without raising tax revenues and improving quality of expenditures.

– Note that public sector has no important sources of revenue, debt financing not recommended.

CIEN - FIEL 25

• Policy reforms to address binding constraints on the economy have been considered…

• …but financing expansion in the supply of public goods is difficult without raising tax revenues and improving quality of expenditures (policy constraint…not economic constraint).

• Therefore:

– Taxation (for example, VAT and Excises to raise tax revenues with progressivity through public outlays)

– Focus on reducing informality and continue with efforts to improve HK (investment in education and health)

– Complete reforms that are “less intensive” in public money (for example, PPPs, regulation of utilities, regulation of the financial system, labor regulation)

– Picking the winners demands stronger public institutions (addressing issue of “state capture” by powerful interest groups)