Competition is a good thing not only because of lower prices and larger variety. Higher competition in the domestic market also shifts necessary labour and capital resources from less productive domestic-oriented firms to export-oriented productivity champions. Such firms will make better use of production factors and generate larger output. Thus, simply increasing the level of competition in the domestic market can boost the aggregate productivity of a country.
The aggregate productivity of a country can be boosted even without changing the productivity of individual enterprises. This can be achieved by improving the allocation of resources – the redistribution of labour and capital towards more productive firms. These firms will make better use of production factors and generate larger output. But how can one affect the allocation of resources? Economic theory says that allocation depends on the productivity of individual firms: more productive enterprises attract more labour and capital. However, there exists another factor behind allocation: distortions.
Distortions affect the allocation of resources
A model developed by Hsieh and Klenow (2009) – one of the most popular frameworks to study the allocation of resources – has a very important and realistic feature: it acknowledges that firms are not treated equally. Some firms may face lower supply of banking loans ending with higher capital costs. Other firms could confront with trade unions and higher wages. Tax rates may also differ across firms. These are all examples of distortions. Firms facing larger distortions are forced to underuse respective production factor, while firms that enjoy more favourable conditions tend to overuse capital and labour, generating more output.
While it is virtually impossible to imagine an economy without any distortions (the one where all firms face the same taxes, costs of labour, capital etc.), not all distortions damage the allocation of resources. Only distortions to productive firms create misallocation of resources by shifting labour and capital towards unproductive firms. Thus, removal of such distortions can improve the efficiency of allocation and raise the aggregate output of the country.
According to Hsieh and Klenow (2009) the distortions faced by every individual firm can be quantified from the balance sheets and profit/loss data. For example, observing lower-than-usual ratio of capital to intermediate inputs (comparing with other enterprises in a narrowly defined industry) indicates a capital distortion, possibly related with limited access to banking loans. Similarly, lower-than-usual share of wages in total production costs implies high labour distortions. Finally, the size of the distortion can be detected as a case of abnormally low share of intermediate inputs in total output, and signals about the restrictions to total output (e.g. due to higher taxes for large enterprises).
Misallocation of resources is small in Latvia
In my recent research (see Benkovskis, 2015), I use anonymised firm-level dataset for 2007–2013 and apply the Hsieh and Klenow (2009) model to study the allocation of resources in Latvia – a unique example of a small and open economy facing extreme structural shifts during the financial crisis. According to my estimates, the negative contribution of misallocation to aggregate productivity was close to 27% in 2013 (see Figure 1). In other words, it suggests that actual aggregate productivity could be boosted by 27% if all distortions were removed!
This may seem large but in fact 27% is a comparatively low figure. Hsieh and Klenow (2009) argue that full liberalisation would boost aggregate manufacturing productivity by 86–115% in China, 100–128% in India, and 30–43% in the US. Dias et al. (2015) show that removing distortions would lead to a 30% gain in output of Portugal in 2011. Thus, misallocation of resources is relatively small in Latvia. Even more important: the misallocation of resources decreased after the crisis in Latvia (contrary to the case of Portugal), adding more than 10 percentage points to aggregate productivity growth between 2010 and 2013.
Figure 1. Contribution from misallocation of resources to aggregate total factor productivity, %
Source: Benkovskis (2015). Note: shows the contribution of misallocation comparing with the counterfactual case of no distortions.
The finding that allocation of resources improved after the crisis is interesting per se, but uncovering the reasons behind the improvement is even more important. Figure 1 provides a decomposition, which shows that labour distortions are minor in Latvia due to high flexibility of labour market (in line with recent findings by Braukša and Fadejeva, 2016). The capital distortions, while being minor in 2007–2008, increased afterwards, pointing to some credit supply constraints faced by the highly productive enterprises after the financial crisis. However, by far largest contribution comes from the misallocation of intermediate inputs – the turnover of the most productive firms face some constraints. And it was the ease of constraints to turnover for the most productive firms that determined the improvements in aggregate productivity since 2010.
The level of competition matters for misallocation
My research stresses the importance of the competition level on the market, since higher competition serves as a natural constraint for the firm to increase its turnover. What if the most productive Latvia’s firms systematically come up against higher competition? I found that indeed this is the case. First, recent results by Fadejeva and Krasnopjorovs (2015) show that Latvia’s domestic market has lower competition level comparing with external markets. Second, it is widely acknowledged that exporters tend to be more productive comparing with domestically oriented firms (see e.g. Bertou et al., 2015, who report positive export premiums for EU countries, while Benkovskis and Tkačevs, 2015, find higher productivity of exporters in Latvia). Thus, Latvia’s productive export-oriented firms are subject to higher competition and cannot enlarge their turnover as easy as other entities. This shifts labour and capital towards small and less productive firms working solely on domestic market, creating the misallocation of resources.
The domestic competition factor can also explain the improving allocation of resources after 2010. The study by Fadejeva and Krasnopojorovs (2015) reveals that the competition gap between domestic and foreign markets narrowed after the financial crisis (see Table 1). Namely, life was too easy on the local Latvia’s market during the boom time, allowing unproductive firms to survive and drain away resources from more productive firms. But conditions became tougher after the crisis (although the competition level still remained lower than abroad). We can view this as a “cleansing effect of the crisis”: some of the least productive domestic oriented firms went bankrupt (or decreased their turnover), freeing the necessary capital and labour resources for productive exporters.
Table 1: Change in the competitive pressure on main product in domestic and foreign markets compared to the situation before 2008, %
|Domestic market||Foreign market|
|Does not apply||2.8||2.8||9.4||13.1|
Source: Fadejeva and Krasnopjorovs (2015), Table A.102. Notes: based on the sample of 557 Latvia’s firms; results are weighted to represent firm population.
This research has an important policy conclusions applicable to any country that seeks to increase aggregate productivity. The competition level in the domestic market is important not only for consumers, who enjoy lower prices and higher variety. Higher competition in the domestic market also shifts necessary resources from less productive domestic-oriented firms to export-oriented productivity champions.
- Benkovskis, Konstantins; 2015. “Misallocation of resources in Latvia: did anything change during the crisis?”, Latvijas Banka Working Paper No.5/2015.
- Benkovskis, Konstantins; and Olegs Tkacevs, 2015. “Everything you always wanted to know about Latvia’s service exporters (but were afraid to ask)”, Latvijas Banka Working Paper No.6/2015.
- Berthou, Antoine; Emmanuel Dhyne; Matteo Bugamelli; Ana-Maria Cazacu; Calin-Vlad Demian; Peter Harasztosi; Tibor Lalinsky; Jaanika Meriküll ; Filippo Oropallo; and Ana Cristina Soares, 2015. “Assessing European Firms’ Exports and Productivity Distributions: The CompNet Trade Module”, ECB Working Paper, No. 1788.
- Braukša, Ieva; and Ludmila Fadejeva, 2016. “Internal labour market mobility in 2005–2014 in Latvia: the micro data approach”, Baltic Journal of Economics, 16(2), 152–174.
- Dias, Daniel A.; Carlos Robalo Marques; and Christine Richmond, 2015. “Misallocation and Productivity in the Lead Up to the Eurozone Crisis“, International Finance Discussion Papers 1146.
- Fadejeva, Ludmila; and Olegs Krasnopjorovs, 2015. “Labour Market Adjustment during 2008–2013 in Latvia: Firm Level Evidence”, Latvijas Banka Working Paper, No. 2/2015.
- Hsieh, Chang-Tai; and Peter J. Klenow, 2009. “Misallocation and manufacturing TFP in China and India“, The Quarterly Journal of Economics, 124(4), 1403–1448.
At the very center of Schumpeter’s (1934, 1942) notion of creative destruction is firms’ access to bank capital, which helps to fund the innovation in competitive product markets that drives out less productive firms in favor of those with more profitable ideas. However, competition is a two-edged sword and may result in firms being unable to fund all of their otherwise economically profitable investments. Using unique survey data from 58 countries, Bergbrant, Hunter, and Kelly (2016) find that product market competition increases capital constraints and has a greater effect than banking sector competition. Further, we show that quantity-of-capital constraints negatively impact firm growth.
Capital and creative destruction
At the very center of Schumpeter’s (1934, 1942) notion of creative destruction is firms’ access to bank capital, which helps to fund the innovation in competitive product markets that drives out less productive firms in favor of those with more profitable ideas. While product market competition may be the fundamental driver of the innovation envisioned by Schumpeter, it may also impede access to the very source of capital that is supposed to fund that innovation. More intense product market competition can affect firms’ ability to finance their projects either by increasing the price of financing or by inducing capital constraints, whereby firms are unable to obtain the quantity of capital needed to fund all their positive net present value projects.
Recent research has focused on the price side of financing, showing that product market competition increases the cost of equity (Hou and Robinson, 2006) and the cost of debt (Valta, 2012). In this brief we examine the quantity side of financing; that is, whether product market competition increases capital constraints.
Isn’t it obvious that competition causes capital constraints?
Actually, no. There is a familiar argument that firms are reluctant to disclose commercially valuable information when competitors are more likely to exploit this information. Theory predicts that it is not optimal for creditors to respond to the resulting asymmetric information by raising interest rates; instead, restricting capital is more appropriate (Stiglitz and Weiss, 1981). However, competition may have the very opposite effect because a competitive environment lowers owners’ cost of monitoring and measuring managerial performance. Theory and recent empirical tests indicate that lower cost of monitoring managers induces greater disclosure by owners.
Whether or not product market competition makes banks restrict the supply of loans is arguably more important than whether it influences the cost of debt. Greenwald, Stiglitz, and Weiss (1984) show that firms’ investment behavior is not particularly sensitive to the interest rates they pay, consistent with the notion that increases in the cost of debt may reduce investment, but only at the margin; i.e., projects change from generating economic profits to generating economic losses (net present value changes from positive to negative). By contrast, increased capital constraints can lead to underinvestment by forcing firms to abandon projects which generate economic profits (net present values are positive), thus hindering investment and preventing firm innovation and growth (see Harford and Uysal, 2014).
What does the research tell us?
Recent research by Bergbrant, Hunter, and Kelly (2016) uses survey data obtained from the World Bank’s World Business Environment Survey, conducted among non-financial firms from around the world. Capital constraints are the response to a question about the extent of the obstacle to operations and growth posed by capital constraints that managers and owners rank from 1 (No Obstacle) to 4 (Major Obstacle). Competition is represented by an index constructed from eight individual forms of competition reported by firms.
The empirical evidence indicates that the intensity of product market competition significantly increases capital constraints. Table 1 shows the marginal effects of a change in the intensity of competition on capital constraints. For instance, the first row shows that a small (instantaneous rate of) increase in product market competition leads to an increase in the likelihood that capital constraints are a “major obstacle” (4 on a four- point scale) at a rate of 18.9%. Similar results hold when competition is assessed at a one-standard-deviation (3rd row) increase or when competition changes from 0 to 1 on a version of our competition index which ranges from 0 to 1 (5th row).
Table 1: Effect of competition on capital constraints
|For a change of:
|0 to 1||-0.145||-0.059||0.008||0.196|
Note: The table reports the marginal effects “for a change of” product market competition of varying amounts on firms responding that capital constraints pose one of the four levels of “obstacle” for their operations.
The above results are qualitatively similar when the competition index is replaced by any one of its eight individual components. In addition, competition increases not only a measure of general capital constraints, as employed in the above analysis, but also specific forms of capital constraints. These include the credit constraints that firms experience when, as a precondition for lending, banks require that borrowers have special connections in the banking sector, pledge collateral, satisfy banks’ bureaucratic need for business documents, and pay bribes to corrupt bank officials. Further, the evidence is not unique to domestic bank capital as more intense product market competition also impedes firms’ access to nonbank equity, foreign bank capital, special export financing, and lease financing.
To further validate our main result we account for two well-established strands of research that contend that banking sector competitiveness is among the most important determinants of access to credit and that banking sector structure can also affect the competiveness of non-financial firms’ industries. The evidence reported in Table 2 shows that while (one of three measures of) banking sector competition and the degree of bank freedom affect capital constraints, in general the regulatory structure of the banking sector does not. More important, our main finding is unchanged when controlling for banking sector structure. Finally, it is important to note that in all our models we control for any cost-of-debt (higher-interest-rate) effects.
Table 2: Accounting for banking sector structure
|Competition (10 separate models)||+ve signif.|
|Lerner bank competition index||+ve, signif.|
|Bank concentration ratio||insignif.|
|Boone indicator of banking sector||insignif.|
|private credit as a fraction of GDP||insignif.|
|restrictions on nonbank activities||insignif.|
|fraction of bank applications denied||insignif.|
|bank freedom from gov’t interference||-ve, signif.|
|existence of a credit registry||insignif.|
|foreign bank share of banking system||insignif.|
|government share of banking system||insignif.|
Note: We augment our main model with the above banking sector variables, one at a time, to determine their impact on the significance (signif. or insignif.) of product market competition.
Capital constraints hurt firms’ growth and so we expect our measure of capital constraints to be negatively associated with growth. We confirm this in the data, after controlling for the direct impact of competition on growth. We also find that the quantity-of-capital effect has a greater impact on expected firm growth than the cost-of-capital effect.
Our research indicates that the intensity of product market competition increases capital constraints even in the presence of controls for banking sector competition. Our work suggests several policy recommendations. First, the implementation of a product-market competition policy, for instance by several Central and Eastern European countries in the 1990s (Fingleton et al., 1996; Dutz and Vagliasindi, 2000), should contemplate the possibility that such action is likely to have negative externalities for firms’ access to capital. Second, banking sector reforms aimed at creating a more competitive banking system in order to improve access to capital should not be pursued in isolation and should take into consideration the existing competitiveness of the product market. Third, given that the quantity-of-capital effect has a greater impact on firm growth than the cost-of-capital effect, policymakers should exert at least as much effort in easing quantity constraints as they do to reduce the cost of capital.
- Bergbrant, M.; D. Hunter; and P. Kelly, 2016. “Product Market Competition, Capital Constraints and Firm Growth”. Available at SSRN: https://ssrn.com/abstract=2594218.
- Dutz, M. A.; and M. Vagliasindi, 2000. “Competition policy implementation in transition economies: An empirical assessment”. European Economic Review 44, 762-772. Fingleton, J.; E. Fox; D. Neven; and P. Seabright, 1996. “Competition policy and the transformation of central and eastern Europe”. Working paper. CEPR, London.
- Greenwald, B.; J.E. Stiglitz; and A. Weiss, 1984. “Informational imperfections in the capital market and macroeconomic fluctuations”. American Economic Review 74(2), 194-199.
- Harford, J.; and V. B. Uysal, 2014. “Bond market access and investment”. Journal of Financial Economics 112, 147-163.
- Hou, K.; and D. Robinson, 2006. “Industry concentration and average stock returns”. Journal of Finance 61, 1927-1956.
- Schumpeter, J.A., 1934. “The Theory of Economic Development”. Harvard University Press, Cambridge, MA.
- Schumpeter, J. A., 1942. “Capitalism, Socialism and Democracy”. Harper and Brothers, New York, NY.
- Stiglitz, J.; and A. Weiss, 1981. “Credit rationing in markets with imperfect information”. Amer. Econ. Review 71, 393-410.Valta, P., 2012. “Competition and the cost of debt”. Journal of Financial Economics, 105(3), 661-682.
During the last decade Belarus was one of the leaders of growth in the CEE region. Kruk and Bornukova (2013) have analyzed the sources of growth and found that capital accumulation was the main contributor to growth. The contribution of total factor productivity (TFP) to growth was, on the contrary, quite modest. On the sectoral level, capital accumulation was not always accompanied by the increases in TFP. Hence, the new growth policy, modernization, with the bottom line “more capital” may not be the best option for enhancing productivity-based growth. The competitive advantages of Belarus lie in the resource-based and non-tradable sectors, while the majority of the manufacturing sectors are lagging behind in productivity. Belarus has symptoms of a Dutch disease without the trade surplus, and the devaluation of 2011 did not cure it.
During 2003-2012, Belarus had an average growth rate of 7.1%, and during the ‘fat years’, i.e. 2003-2008, it was even higher – 9.5%. Intuitively, this prominent growth is questionable, as it was achieved in the context of dominating state ownership, centralized allocation of resources, government’s control at the factor and goods markets, as well as poor infrastructural reforms (for instance, according to the indices of the EBRD). The Belarusian case challenges the mainstream paradigm of growth in transitional countries, which assumes that the progress in market reforms is the key factor for high and sustainable growth.
The simplest and most widespread explanation of the Belarusian phenomena is based on ‘non-standard’ gains in productivity. This approach assumes that productivity is the engine of growth (World Bank (2012); Demidenko and Kuznetsov (2012)). To a large extent, these gains in productivity are seen as “artificial”, resulting from Russian injections into the Belarusian economy: cheap gas, specific schemes of oil trade, and preferences in access to the Russian markets (Kruk (2010)). However, under this approach, decomposing the growth in productivity by ‘natural’ and ‘artificial’ parts is hardly possible, as the impact of these factors is already hidden in the available data.
The IMF (2010) gave a substantially different explanation of Belarusian growth. They claimed that the average growth of 8.3% over the period of 2001-2008 was mainly capital-based with a contribution of 4.8 percentage points, while the contribution of productivity growth was only 3.0 percentage points (the rest of growth was explained by labor and cyclical factors).
The main reason behind the substantial difference in the explanation of growth factors is the statistical data on capital used during the growth accounting exercise. Belarusian official statistics reports the data on capital stock based on a direct survey of capital assets according to both gross and net (wealth) capital concept. However, the growth rates of capital are reported only for the gross stock of capital. These growth rates are questionable as they demonstrate ‘unnatural stability’ – they fluctuate around 2% for the last 20 years, despite the fact that investments during this period has displayed huge and volatile growth. Statistical offices in other CIS countries have reported similar dynamics of the capital stock. Voskoboynikov (2012), and Bessonov and Voskoboynikov (2008) show that this trend is a consequence of the statistical methodology used in Russia (which the Belarusian methodology is very similar to). In particular, the trend is driven by biased capital investments deflators (which are overestimated) from the periods of high inflation (1990-s and early 2000-s).
If official data is used as the capital input for the growth accounting exercise, the contribution of TFP to growth will be overestimated. Hence, in the studies of the World Bank (2012) and Demidenko and Kuznetsov (2012), the leading role of TFP may be due to the use of the official data on the capital stock.
Motivated by this concern, we use two different methods to evaluate the value of capital inputs (see Kruk and Bornukova (2013) for more details). The first alternative to using the data from direct capital survey is to exploit a perpetual inventory method (PIM): the historical assessment of initial capital stock is further adjusted by the flow of investments and depreciation. However, if there is a bias in deflators within the sample, the series will also be distorted. This problem may be eliminated if the initial stock will be selected at the moment when there is no bias in investment deflator, in the period of moderate inflation. We call this approach PIM-backward.
The second approach to constructing capital series exploits the concept of productive capital and the data on the flow of capital. It assumes that the productive capacity of a capital good depends on its age. The productive stock of a capital good (i.e. the gross stock adjusted by the age-efficiency profile) generates a flow – capital services. The latter is the productive stock adjusted by the user cost of the individual capital good. For the total output of an industry (or economy) one should aggregate the inputs by different capital goods, which in contrast to the net (wealth) concept depends not only on the value of capital goods, but also on their user costs. This approach has solid theoretical foundations, which is the reason it is prioritized in productivity studies.
From the view of available data in the case of Belarus, this approach has a number of powerful advantages. First, we use individual deflators for individual capital goods, which are expected to be less biased than total deflators for the industry. Second, we use heterogeneous depreciation rates for each capital good in each industry based on actual data of ‘accounting depreciation’, while we would have to use homogenous assumptions for each industry in the case of net (wealth) concept. Third, we can exclude residential housing from our measure of capital input.
There are, however, also disadvantages. First, data of newly employed capital goods (in direct surveys of capital assets) and data on capital investments differ rather substantially. Traditionally, the data on capital investments is treated as more reliable, but based on the direct surveys of capital assets we have to use the series of newly employed capital goods as a flow variable when running PIM. Second, we use exogenous real interest rate for computing unit user costs, but the results are very sensitive to our assumptions on the real interest rates across industries. Third, the necessity to exclude residential housing from the data (because of ‘mixed historical prices’) may be interpreted as a loss of information. Given the strengths and weaknesses of the approach, we prioritize it on the industrial level, but prefer the PIM-backward approach for an aggregate economy analysis.
Based on the PIM-backward measure for the total economy (see Figure 1), we may argue that the contribution of TFP to growth was more modest during the last decade than what was reported in the majority of previous studies on Belarusian growth. This finding is of fundamental importance for the growth agenda: only productivity-based growth may be treated as sustainable, since capital growth will slow down as the capital approaches its stationary value. We argue that only the policy directed to promotion of productivity is vital for growth prospects.Figure 1. Contribution of Production Factors and TFP to the Growth of Gross Value Added (PIM-Backward Approach)
The dynamics of productivity divided according to industries (see Table 1) display that the leaders in productivity growth are either industries that produce non-tradable goods (communications, finance, construction) or those that have a chance of ‘artificial productivity gains’ (chemical and petrochemical manufacturing, and fuel).Table 1. Initial Level and Growth Rates of Productivity in Major Industries
However, the theory suggests that the leaders in productivity growth should be the industries producing tradable goods. . This contradiction may be interpreted in two ways. First, one may argue that a more competitive environment and larger share of private ownership (which are seen in the financial industry, trade and catering) are the core reasons for high productivity level and growth rates in ‘domestic industries’. Second, an attractive position of ‘domestic industries’ may reflect a high level of domestic prices rather than ‘natural’ productivity. The base year for our computations is 2009, in which both the real effective exchange rate of the national currency and income were relatively high. The devaluation of 2011 fixed the problem only temporarily, since the inflation in 2011-2013 quickly eroded the benefits of the devaluation. Therefore, the indicators, in terms of 2009 prices, may capture the changes in nominal values as the main component of the productivity gains, while from a longer-term perspective it would be seen as mainly price movements without substantial progress in productivity. In our view, the second explanation is the main reason for the non-standard disposition of productivity levels and growth rates among industries.
If that is the case, the bigger picture looks as follows. Industries producing tradable goods suffer from the lack of progress in productivity, i.e. lose their competitive advantage; enhancements in total productivity are mainly due to industries with ‘artificial productivity gains’. The latter allows domestic prices to grow, making a productivity illusion of domestic industries. All together these symptoms are quite similar to the Dutch disease.
One more finding from the productivity analysis at the national level is the lack of productivity gains from reallocation of resources from less productive industries to more productive ones. A scatter-plot between capital accumulation growth rates and TFP growth rates (see Figure 2) demonstrates no clear relationship between them.Figure 2. Growth Rates of Capital Input vs. TFP Growth Rates in Manufacturing Branches, 2006-2010.
Notes: The sizes of the circles correspond to industry shares in value added.
However, if there was a free allocation of resources, more productive industries would accumulate more capital. Moreover, the same indicators under the PIM-backward approach demonstrate clear negative relationship. A ‘soft’ interpretation of this phenomenon assumes that the lack of reallocation of capital restrains the development of total productivity. A ‘tighter’ interpretation assumes that at least in some industries there is a trade-off between capital accumulation and productivity gains. For instance, in Kruk and Haiduk (2013) it is shown that spurring capital accumulation through the practice of directed lending leads to losses in efficiency through a number of channels. Hence, the simplest way to increase aggregate productivity is to depart from the centralized allocation of capital and unblock capital inflows to more productive industries and vice versa.
Figure 3 documents the mobility of labor markets across the manufacturing industries in Belarus. While one can expect that labor flow into more productive industries, it is not completely true for the Belarusian manufacturing sector.Figure 3: Labor growth and TFP growth in industries of Belarusian manufacturing, (capital services approach).
Notes: The sizes of the circles correspond to industry shares in value added.
Two distinct trends emerge in the labor market. On the one hand, some industries exhibit textbook behavior: increases in TFP are associated with increases in the number of people employed. The best example here is the fuel industry, which experiences TFP increases due to preferential oil prices. However, there are industries that gain TFP and lose labor at the same time. The chemical industry, machinery manufacturing and woodworking are examples of this pattern. These industries have experienced rapid capital accumulation, which, coupled with high gains in TFP, should have contributed to the increases in labor productivity. Surprisingly, though, these industries did not attract more labor. A possible explanation for this counterintuitive pattern is the excessive employment at the beginning of the period in question. In this case, a decrease in the number of people employed may have contributed to the increases of TFP.
Indeed, Figure 4 confirms our hypothesis: labor was flowing from the industries with lower labor productivity to the industries with higher labor productivity in general. Industries in which TFP increased and which were accompanied by a labor decrease, featured low labor productivity in the beginning of the period in consideration, more precisely in 2005. Only the chemical industry exhibited the unexpected behavior: it lost labor despite high initial productivity. By getting rid of excessive employment they were contributing to an increase in TFP.Figure 4: Labor shifts into the sectors with higher labor productivity.
Notes: The sizes of the circles correspond to industry shares in value added.
How is Belarus doing relative to other countries? We have compared Belarusian TFP to the TFP of the leader of transition, the Czech Republic, and to the regional leader, Sweden. The Czech Republic is more developed than Belarus (in 2010 Czech GDP per capita (PPP-corrected) was 1.73 times higher than in Belarus), and, theoretically, it should be much more difficult and costly for it to continue approaching the technological frontier. However, our findings suggest that the Czech Republic is catching up with Sweden in terms of TFP, and doing it faster than Belarus (see Figure 5).Figure 5: TFP of Belarus and the Czech Republic relative to TFP of Sweden, (PIM-backward approach).
Over the last 10 years, Belarus has closed only 5 percentage points of the gap with Sweden. The Czech Republic, where the contribution of TFP to growth was more substantial, has managed to close 8 percentage points of the gap.
In absolute numbers (in ‘international’ dollars of 2010), aggregate TFP in Belarus in 2010 was 2.92 versus 4.66 in the Czech Republic and 9.38 in Sweden (according to the PIM-backwards method). However, the aggregate picture does not reflect the situation in the sectors of the economy and industries of manufacturing.Table 2: Comparative advantage of Belarusian industries: winners and losers (capital services approach)
Table 2 documents the comparative advantages and disadvantages of the Belarusian economy in 2010 according to the capital services approach. Both the capital services approach and the PIM-backwards approach produce the same winners and losers list with the only difference being that the PIM-backwards method has the construction sector among winners. It is not surprising to see resource-based industries among the winners (mining and quarrying mainly reflects the extraction of potash, while the chemical industry benefits both from potash and from preferential process for Russian oil). Food manufacturing is among the winners mostly due to the price scissors in agriculture: food producers buy their inputs at very low prices. The non-tradable sectors are among winners, and the majority of the manufacturing sectors are among the losers. Again, this is similar to the symptoms of the Dutch disease. It is ironic that Belarus has symptoms of a Dutch disease without the trade surplus. Instead, the desire of the government to inflate wages combined with the preferences for Russia led to the development of the same diagnosis.
Belarusian economic growth is less TFP-led than is commonly believed. While the labor market proves to be relatively successful in its reallocation of employees and its contribution to aggregate increases in efficiency, the capital market is distorted by government interventions. Capital accumulation does not necessarily lead to increases in TFP, and the new modernization policy with the bottom line of “more capital” may not be the best option for enhancing growth. Our conclusion is that Belarus should find new sources for TFP-led growth.
- Bessonov, V., Voskoboynikov.I. (2008). “Fixed Capital and Investment Trends in the Russian Economy in Transition.”, Problems of Economic Transition, 51(4), pp. 6-48.
- Demidenko, M., Kuznetsov, A. (2012). “Ekonomicheskiy rost v Respublike Belarus: factory i otsenka ravnovesiya” (Economic Growth in Belarus: Factors and Equilibrium Assessments), National Bank of the Republic of Belarus, Working Paper No.3.
- IMF (2010). “Sources of Recent Growth and Prospects for Future Growth”, IMF, Country Report No.10/16.
- Kruk, D., Bornukova, K. (2013). “Belarusian Economic Growth Decomposition”, unpublished manuscript.
- Kruk, D., Haiduk, K. (2013). “The Outcome of Directed Lending in Belarus: Mitigating Recession or Dampening Long-Run Growth?”, BEROC Working Paper Series, WP No.22
- Kruk, D. (2010). “Vliyanie krizisa na perspectivy dolgosrochnogo ekonomisheskogo rosta v Belarusi” (The Impact of Crisis on the Perspectives of Long-term Growth in Belarus), IPM Research Center Working Paper Seies, WP/10/07.
- World Bank (2012). “Belarus Country Economic Memorandum: Economic Transformation for Growth”, Country Economic Memorandum, Report No. 66614
- Voskoboynikov, I. (2012). “New Measures of Output, Labour and Capital in Industries of the Russian Economy”, Groningen Growth and Development Centre, Research Memorandum GD