The images of vast numbers of people defying confinement rules (and/or significant levels of repressive force) in the emerging world have become routine.
Cultural factors aside, for millions of people who earn their meager income day to day, must shop at open markets because supermarkets are too expensive, or don’t have a fridge, the formal rules are in a distant nation.
The informal economies of Latin America, the Middle East and East Asia are not new, but the coronavirus crisis reminds us of the stark contrast between the part of society regulated by the government and the millions who live outside it in the informal sector.
A book published in Spanish by Rafael de la Cruz, Osmel Manzano, and Mario Loterszpil of the Inter-American Development Bank goes to the crux of the problem (“How to Accelerate Economic Development and Strengthen the Middle Class in Latin America”).
The informal sector represents — in the Andean countries, for instance — between 58 and 78 percent of the economy. In the Middle East and North Africa it represents one-third of the total economy and two-thirds of the labor force.
What this means is not only that a large part of the economy is not as productive as it could be, but also that governments burden legal businesses very heavily. A typical Latin American business pays more than 51 percent of its earnings in taxes.
Taxes on labor alone amount to 40 percent of company earnings in Brazil and more than 30 percent in Colombia. Because this hampers the formal businesses’ ability to become more productive, tax revenue in Latin America and the Middle East is not much higher than 20 percent on average, despite continuous efforts to raise it to the level of OECD countries (about 35 percent).
In times of plenty, usually linked to a boom in commodity prices, the middle class expands, as it did in Latin America the last 20 years, where it now represents more than two-thirds of the population.
But those figures are deceiving because 40 percent of the population now considered middle class is extremely vulnerable, as the coronavirus crisis has reminded the world.
Furthermore, since the economic growth that took place during the commodities boom was linked to incoming investment capital and the expansion of the labor force but not to an increase in productivity, the sustainability of this success is precarious.
Total factor productivity contributed almost nothing to Latin America’s economic growth in these two decades even as some free-market reforms helped these economies grow.
The crowding out of private investment has contributed to the fact that 60 percent of research and development is funded by the government, unlike in South Korea, where private research has contributed to the successful fight against the coronavirus.
To make matters worse, the populist governments of Latin America, more interested in building political clienteles, have not emphasized innovation — R&D represents barely 0.8 of the region’s GDP.
Fiscal expenditures have little to do with investment and are directed at running the government. Unsurprisingly, the region’s infrastructure and logistics are well behind other regions: the network of paved roads (1.5 miles for every 39 square miles of territory) is 20 times smaller than in Southeast Asia.
The book authors think that only an average growth rate of 6 percent for the next 20 years would bring the region’s per capita GDP (in terms of purchasing power parity) to $30,000, on a par with southern Europe.
That will require expanding the tax base by making it easier and less costly to join the formal economy rather than squeezing formal businesses; facilitating rather than impeding research and innovation; shifting part of the government’s finances away from its current priorities; removing disincentives to private enterprise in infrastructure investment; and focusing government action on those areas where private businesses may hesitate to tread.
There is lots of food for thought here.
And this is the right time to have a debate on what needs to change in the developing world in order to overcome the current crisis and lay the foundations for sustained development.
