Micro lessons for Argentina: In Latin America, macroeconomic reform isn't enough: sustained growth can be achieved only by removing microeconomic barriers to productivity as well.(Statistical Data Included)

Latin America appeared to make substantial progress in handling its macro economy in the 1990s. Following the emerging-market textbook for economic development, the region's major countries brought down inflation and public deficits, at least initially. Yet these efforts turned Out to be superficial; sustained economic growth remained elusive. Mexico, Brazil, and now Argentina have lurched from one financial crisis to another.

There is little doubt that Argentina's collapse into economic chaos at the end of 2001 was caused in part by mismanagement of public finances. Less debated is the role of microeconomic factors, yet microlevel barriers were responsible for a failure to improve productivity and thus contributed to the country's eventual inability to sustain the peso peg against the dollar.

Good macroeconomic management is critical if an economy is to achieve a sustained increase in productivity-the key determinant of growth and wealth. Fiscal and monetary stability eases interest rates, makes investors more confident, and thereby helps companies raise their productivity. But stability isn't enough. Our microlevel analysis of several Latin American countries shows that sectors and companies within them perform very differently even under the same macroeconomic conditions.

Productivity problems are rife in Latin America. In Brazil, for example, the dairy industry's productivity stands at a mere 10 percent of the US level but the poultry industry at 80 percent, while individual institutions in the commercial-banking industry are 20 to 120 percent as productive as the industry's US counterpart. In Argentina, the residential-construction sector achieves only 26 percent of the US sector's productivity, though some individual companies boast as much as 52 percent. In meat processing, the average is 39 percent, with some producers at 69 percent.

Such differences in productivity among industries in the same country, and even the same industry, strongly suggest that nonmacroeconomic factors prevent inefficient companies from raising their productivity and productive companies from gobbling up inefficient ones.

Argentina is a good example of the inadequacy of pure macroeconomics. Besides pegging the peso to the US dollar at parity in 1991, the country lifted price controls and regulations on the movement of capital and embarked on a sweeping program of privatization, including mining, oil, telecommunications, transport, and utilities. In the beginning, these bold moves virtually eradicated inflation and pushed down interest rates; the fiscal deficit was brought under control, and interest payments on foreign debt became manageable. From 1990 to 1995, the country's GDP grew by 5.9 percent a year and labor productivity by 4.5 percent. The International Monetary Fund (IMF) hailed Argentina as the role model for reform in emerging markets.

Then things started to go wrong. In the second half of the decade, the growth of labor productivity slowed to 0.4 percent, contributing to the slide into recession in 1998. Tax revenues slumped while public spending continued to boom, debt obligations became increasingly hard to meet, and the currency peg came under pressure. By January 2002, Argentina had abandoned it and defaulted on government debt.

Barriers to productivity growth

What happened to Argentina's nascent productivity miracle--if there ever was one? A detailed look shows that the productivity gains of the early 1990s were confined to newly privatized sectors. These gains, moreover, were …