The Political Economy of Productivity

Competition and productivity
Politics and Economy

Since productivity consists of producing more with the same resources, it should be a desirable goal for any society. In practice, however, political systems and governments do many things that work against this goal.

As an IDB study concludes, Latin American countries are falling behind with respect to the levels of per capita income in developed countries. The main reason is the poor use of their productive resources—not lack of investment. Policies that reward inefficiency, discourage competition and innovation, or divert resources to rent-seeking or unproductive activities are, unfortunately, all too common.

Powerful obstacles of political economic nature stand in the way of changing this state of affairs. Overcoming these hurdles depends on five key actions: understanding, coordinating, blocking, executing, and persisting.

Understanding the impact of policies on productivity is the first task. Broadening access to credit, improving transport infrastructure or raising the quality of education are productivity-friendly policies. But it is more difficult to understand –and accept- that many well-intentioned policies work against productivity. Two examples: subsidizing companies that generate a lot of jobs but are inefficient, or taxing the most productive firms to fund programs which support informal or small enterprises which do not pay taxes.

Coordinating politicians, government and private sector is the second challenge. For example, developing an integrated and efficient freight transport system requires conceiving a coherent and workable plan, adapting regulations, mobilizing tax revenue, raising domestic and external financing, and forming partnerships between the public and private sectors to develop and operate infrastructure. This is difficult when there is too much fragmentation and short-termism in the political decision-making system or in the business strategies of the private sector, or when there is not even a minimum of trust among the parties involved.

Blocking rent seeking is no minor challenge. Corruption and parasitism thrive better in monolithic or very fragmented political systems where checks and balances between the executive, legislative and judicial branches cannot function. They also tend to thrive in countries with abundant natural resources which have failed to diversify their economies. But rent seekers abound in all countries, rich and poor, and not only in government  but also in private firms and groups. Blocking rent seekers requires not only good institutions but also good leadership.

Executing policy decisions well is the fourth link in the chain for achieving productivity. There are no good policies without good state bureaucracies committed to the public good. But good policy execution also depends on the presence of academic institutions, non-governmental organizations and international organizations that, by virtue of their independence and credibility, help overcome difficulties and oversee compliance with the commitments involved in any public policy decision.

Finally, policymakers and investors should persist until results are visible. The most effective ways to raise productivity are not usually the ones that have an immediate impact but those that take a long time to develop and consolidate. This means restraining impatience—a normal aspect of  democracies, through more structured political parties, intense public debates and institutional rotation of power. For entrepreneurs to persist in their efforts, stable macroeconomic policies are crucial. These require an independent central bank and rules of fiscal behavior that enforce saving in good times to get through the bad times.

Brazil, Colombia, Chile and Peru are among the Latin American countries best positioned to capitalize on the growing world demand for commodities. Not only do they have adequate resources, but also dynamic private sectors, well-established democracies and strong economic institutions. Even so, they will have to overcome many obstacles on the political economy front if they are to turn this opportunity into higher levels of productivity and income.

Disclaimer: The author is associated with the IDB but the opinions expressed are his own.

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