Growth diagnostics The Case of El Salvador

Growth diagnostics: The Case of El Salvador & Peru

Example: El Salvador • Political violence and economic collapse in 1980 s • A peace agreement, Democracy • Fiscal discipline, Tax reform, Trade liberalization, Privatization, Social security reform, Financial regulation • Education reform: EDUCO • Dollarization • Capital inflows, investment grade • Growth spurt in first half of 1990 s • Since then, lackluster growth

After an initial recovery, the economy stagnated Source: World Penn Tables

Why did growth slow down?

The decision tree Problem: Low levels of private investment and entrepreneurship ? Low return to economic activity Low social returns High cost of finance Low domestic savings + bad international finance Low appropriability government failures bad local finance market failures Low competition bad infrastructure low human capital micro risks: property rights, corruption, taxes information externalities: “selfmacro risks: discovery” financial, monetary, fiscal instability coordination externalities High risk High cost

Investment/savings are low Source: World Penn Tables

Real lending interest rates are low El Salvador 6. 2 Chile 7. 0 Colombia 7. 1 Guatemala 8. 4 Panamá Real lending interest rate, October 2001 10. 0 Paraguay 13. 1 Costa Rica 13. 5 Honduras 13. 8 Bolivia 14. 8 16. 7 R. Dominicana Nicaragua 17. 1 Venezuela 19. 0 Average 19. 0 22. 8 Perú Argentina 34. 6 44. 7 Uruguay 55. 8 Brasil Fuente: FELABAN 0 10 20 30 40 Fuente: Asociación de Bancos de América Latina 50 60

What happens when you relax a non binding constraint? Growth 1996 -2000 3. 0 percent Dollarization Fuente: BCR Growth 2000 -2004 1. 8 percent

After an initial recovery, the economy stagnated Source: World Penn Tables

Explaining growth slowdown • Lack of factor accumulation – Savings – Education • Lack of appropriability – – High taxes High macro risks Contract enforcement and the rule of law Crime • Overvalued exchange rate • Lack of productivity

The decision tree Problem: Low levels of private investment and entrepreneurship ? Low return to economic activity Low social returns High cost of finance Low domestic savings + bad international finance Low appropriability government failures bad local finance market failures Low competition bad infrastructure low human capital micro risks: property rights, corruption, taxes information externalities: “selfmacro risks: discovery” financial, monetary, fiscal instability coordination externalities High risk High cost

Education is low Escolaridad a los 12 años en 1998 URY ARG ECU PAN VEN CHL CRI PRY COL HON NIC SLV BRA GUA 2. 0 2. 5 3. 0 3. 5 4. 0 4. 5 5. 0 5. 5 6. 0

Testable implications • If the economy is dragged down by lack of education. . • . . one should observe high returns education • …and co-movement of education and growth

…and so are returns to education GUA Returns to education . 136268 ECU BRA PRY COL PAN CHL USA NIC SLV CRI HON ARG VEN . 084308 4. 95732 URY Education at age 25 13. 0638

Education enrollment has expanded 100. 00 90. 00 80. 00 70. 00 2002 60. 00 50. 00 40. 00 1992 30. 00 20. 00 10. 00 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 Edad Fuente: Procesado con base en EHPM, 1992 y 2002

…and returns have been falling (men who were 25 -30 years of age in 1992) 500 450 400 350 Completed HS 300 Incomplete HS 250 200 Complete primary 150 Incomplete primary No education 100 50 0 1992 2002

Lack of appropriability • • • Tax rates are low Inflation has come down to 1 percent The country is “investment grade” Crime? Rule of law?

Is it bad institutions? Maybe not

Is it a bad business environment? Maybe not

Low export sophistication

… and lousy open forest

Changing export composition, but to a difficult sector 600 Coffee Maquila 500 Garments 400 300 Coffee 200 100 0 1994 1995 1996 1997 1998 1999 2000 2001

Tentative interpretation • The problem is structural transformation • …made more urgent by the collapse in coffee • …and made more difficult by lousy alternative exports • Industrial policy becomes strategic

Peru

A booming country PIB per capita (Var. %)

Peru: a growth miracle?

Depends on your perspective 0. 6%

Peru’s long-run growth

Log Exports per capita Anatomy of Peru’s growth collapse Log GDP per capita

Is it a pure terms of trade story?

Decomposing the export collapse

Decomposing the export recovery

If the terms of trade deteriorated, why did the monkeys not jump to greener pastures?

Lousy export basket

…and not very well placed in the product space

Or is it a property rights cycle? Pesca Nationalization of fisheries Fishing Exports collapse Colapso Pesca (natural 72) 1960 Pesca 1970 Agrarian reform Mining concessions revoked Petroleum nationalization 1980 1990 Sugar and Cotton collapse Mining exports collapse Oil exports collapse 2000

Is domestic finance a problem? • Assumes something about international finance – Make or buy – Is finance a non-tradable? Why? • Assumes something about ownership vs. entrepreneurship – If banks are bad, why don’t the rich do the investing? • Is financial intermediation low? – Yes, but is it supply or demand? • What could in principle go wrong?

Is financial intermediation low? Log of credit to private sector / GDP vs. Log of GDPpc PPP

Is it supply or demand? Real Interest Rate vs. Log of domestic credit to private sector/GDP

Problems with bank lending • High costs? – Inefficient operations? – Low scale? • High risk? – Macro risks: GDP, BOP, inflation, XR – Micro risks: “real”, contract enforcement • Low competition & monopoly power? – Limits entrepreneurship rents

Is it high cost? Look at operating expenses/assets

…or operating expenses/revenue

Is it risks? • There are many types of risk • Aggregate risks – Not diversifiable through domestic assets – GDP, XR, interest rates • Portfolio composition – Sector bets • Liquidity • Operating risks • Contract enforcement risks

Banking risk indicators • The EIU calculates many banking risk indicators • Overall score • Political risk • Economic policy risk • Liquidity Risk • Political stability risk • Exchange rate risk

One example: overall risk

Monopoly power: high margins • • Are banks super-profitable? Look at net interest margins But is this because of high costs? How about non-interest income? Look at profits But is this due to high risk? What would Price/Earnings ratio indicate?

Risk vs. return Bank profits= Net interest income + non-interest income -operating expenses

Is there credit rationing? • • Why would there be? Time inconsistency and contract enforcement Solutions? Collateral Reputation (credit bureaus) Judicial enforcement Adverse selection: Stiglitz – Weiss How is it affected by the level of the interest rate?

Using Investment Climate Assessment Surveys

ICAs: designed to do a lot n Standard tool (questionnaire, sampling, quality control, methodology) n “Tell us your problems” questions +… n …“Dollars and days” questions +… n …Hard financial data n Many countries and multi-year program

About 60 ICA surveys conducted so far Bolivia Brazil Chile Ecuador El Salvador Guatemala Honduras Nicaragua Peru Venezuela Kyrgyz Republic Lithuania Moldova Poland Algeria Cambodia Serbia-Montenegro Egypt China (update) Morocco(update) Tajikistan Indonesia Turkey (update) Oman Malaysia Uzbekistan Saudi Arabia Mongolia Syria Philippines Tunisia Eritrea Thailand Yemen Ethiopia Kenya Bangladesh Mali Bhutan Mozambique India (update) Nigeria Nepal Senegal Pakistan South Africa Sri Lanka Tanzania Uganda Zambia 20 ICAs a year, 3 -5 year cycle.

Complaining about cost of finance

Confronting complaints with facts and numbers (I)

Complaining about access to finance

Confronting complaints with facts and numbers (II)

Real collateral issues instead.

“Out”: 53% Rejected “In” 46. 6% “Out” 53. 4% Asked for loan 41% Accepted 17% 83% 83% Collateral issues 69% 69% 31% Never asked for loan 59% Don’t need 61% 61% Can’t 39% 39% Profitability