REV. DE ECONOMÍA POLÍTICA DE BS. AS.| Año 4 | Vols. 7 y 8 | 2010 | 49-102 | ISSN 1850-6933 UNDERSTANDING PRODUCTIVITY LEVELS, GROWTH AND DISPERSION IN THE TEXTILES SECTOR IN ARGEN- TINA: AN O-RING STORY OF LOW-PRODUCTIVITY TRAP* Gabriel Sánchez Banco Inter-Americano de Desarrollo Inés Butler Instituto de Estudios sobre la Realidad Argentina y Latinoamericana ABSTRACT We use case study techniques to analyze the determinants of the marked pro- ductivity decline experienced by the textiles sector in Argentina since 1996. We find that, given the observed complementarity in the qualities chosen by di- fferent firms in this sector, low productivity results from a failure to coordina- te in the investment in quality upgrading technologies by all firms. The sector was pushed to a poor productivity equilibrium by adverse financial shocks that combined with capital wedges to prompt some firms to invest in lower quality or to exit the market, propagating to the other firms through the quality com- plementarity. RESUMEN Este trabajo analiza los determinantes del colapso en productividad del sector textil en Argentina desde 1996, empleando técnicas de estudio de caso. Dada la complementariedad encontrada en la elección de calidad por distintas empre- sas, la baja productividad resulta de una falla de coordinación para invertir en tecnologías que mejoren la calidad. El sector fue empujado hacia un equilibrio de baja productividad por una combinación de shocks financieros adversos junto con imperfecciones crediticias que llevaron a algunas empresas a invertir en calidad inferior o a dejar el mercado, propagándose a las demás empresas a través de la complementariedad en calidades. * We are very grateful for the useful comments and suggestions of Carmen Pages and for the superb research assistance of Guadalupe Gonzalez. All errors are ours. 50 | Revista de Economía Política de Buenos Aires I. Introduction The object of this paper is to shed light on the wedges that may affect resource allocation and the productivity levels in the textile sector in Ar- gentina. Special interest is placed on analyzing whether there exist govern- ment and market failures that hinder reallocation of resources towards the most efficient firms, and that impede equating revenue productivity across firms. We are also concerned about how these failures affect the distribution of productivity itself. More specifically, we care about the differential impact of financial constraints; taxation; non-compliance with taxes and labor regulations; macroeconomic volatility; and trade restrictions. We are also concerned about the roles played by coordination failures that may hinder the pro- vision of public goods that are required for the acquisition of bigger scales and better technologies. We additionally care about possible coor- dination failures to develop different stages of the value chain that may also hamper the distribution of productivities and resource allocation. The textile value chain includes the following stages. First comes the processing of cotton fibre. The spinning stage, which generates the yarn, follows next. Then ensues the weaving and knitting stages, which gen- erate the cloth. The fabrics then have to undergo different treatments, like bleaching and dyeing, to obtain the final product. Finally comes the apparel stage, which includes the production of clothing, linen, towels, upholstery, draperies, etc. In this study we are concerned specifically about the weaving and knitting stages, which are stages with apparent potential for competi- tiveness and which have been subject to distinct shocks that appear to have distorted resource allocation and the distribution of productivity. The analysis includes the production of both woven and knitted fabrics. We include in our analysis the spinning stage, as many producers of fabrics are vertically integrated backwards. The textile and spinning sector in Argentina experienced an important SÁncheZ / Butler | 51 restructuring between 1991 and 1997, which led to substantial produc- tivity growth (above the economy wide productivity growth), although sectoral production did not grow during that period. The combination of the large devaluation in Brazil in 1999, the large domestic recession between 1999 and 2002 and the growing financial constraints associated to capital outflows during that period shocked negatively this sector, both in terms of productivity and production. During this period and even during the recovery since 2003 sever- al policy and economic shocks have distorted resource allocation and choices of scale and technologies. As a result labour productivity in the sector fell 45% between 1997 and 2002, and recovered only partially since then (the 2007 productivity was still 25% below 1997), while la- bour productivity and TFP for the economy as a whole respectively fell 30 and 18% between 1997 and 2002 and by 2007 had surpassed the initial levels. The bulk of the productivity decline was borne by the decline in sectoral output, which fell 65% between 1997 and 2002 and, while par- tially recovering since then, in 2007 was still 38% below the 2007 level. Hence, the sector appears to have been subject to major shocks that both led to lower output and also to operate with less productive technolo- gies and/or production techniques. Alternatively, it could also be the case that new wedges were introduced preventing the expansion of po- tentially productive firms and establishments. These are the hypotheses that we explore in our research. The main suspects are financial distor- tions, coordination failures within the sector and trade policy failures. One important feature appears to be the coexistence of firms that seek to base their competitiveness on product differentiation and quality, and firms that want to be cost-competitive, which is not possible due to global competition from cheaper foreign competitors. We conduct this research both by analyzing the available data on the pattern of allocation of resources and sales within this sector and on the distribution of labor productivity in this sector and, more importantly, 52 | Revista de Economía Política de Buenos Aires by undertaking a case study analysis based on interviews to relevant actors. We have interviewed most of the largest textile producers, both national and foreign owned, and of smaller firms with varying produc- tivity levels. We conduct structured interviews in the manner of Javor- cik, Keller and Tybout (2006). The results obtained regarding the nature of the capital wedges and coordination failures that hinder productivity in the sector can be ad- equately interpreted using the O-Ring model of economic development proposed by Kremer (1993). Section 2 provides a macroeconomic and policy background and the stylized facts for the sector. Section 3 presents the industrial organiza- tion of the textiles sector in Argentina, and the patterns of allocation and the distribution of productivity. Section 4 analyzes the different govern- ment and market failures that affect resource allocation and productiv- ity in this sector in Argentina. Section 5 sketches an O-Ring model of productivity decline for the textiles sector. Section 6 concludes. Appen- dix 1 describes the design and implementation of the methodology and questionnaire employed in the case study analysis. II. Macroeconomic and policy background and stylized facts for the sector In this section we provide a sketchy macroeconomic and policy back- ground. During the 1990s there was macroeconomic stabilization and openness to trade and capital flows, together with a favourable envi- ronment for FDI. In comparison to the previous decade, during this pe- riod a more predictable policy and regulatory environment prevailed over discretion. This was a period of fast growth and price stability until 1998. This period witnessed trade liberalization, which started in the late 1980s and deepened with Mercosur. There was some incipient real ex- change rate appreciation, which was exacerbated after 1998. Based on CEPAL (2004), we learn that during 1993-1998 trade lib- eralization and real exchange rate appreciation caused the textil sector SÁncheZ / Butler | 53 to experience a decline in production and a bigger decline in employ- ment and hours, which raised labour productivity (see Figures 1a and 1b). Real wages and other labor costs also fell significantly. This labor saving was the main mechanism used to raise competitiveness vis-à- vis foreign competitors, rather than bigger investment and incorpora- tion of technology. This period also showed increasing informality and firm exits. The existence of important fixed costs, especially in the yarn and woven fabrics sectors, made productivity contingent on produc- tion levels. Figure 1a: Textiles productivity 1997=100 160 140 120 100 80 60 Labor productivity 40 Hourly productivity 20 Labor productivity total industry Hourly productivity total industry 0 1 3 5 7 9 1 3 5 7 199 199 199 199 199 200 200 200 200 Source: IERAL-Fundación Mediterránea, based on Industrial Survey On the other hand, during this period the price stabilization facili- tated access to bigger banking and, especially, commercial financing by suppliers. The first years of the 1990s actually witnessed stable produc- tion levels until 1996; the actual decline started after 1997. 54 | Revista de Economía Política de Buenos Aires Figure 1b: Textiles production 1997=100 140 120 100 80 60 40 Textiles 20 GDP Manufactures 0 1 3 5 7 9 1 3 5 7 199 199 199 199 199 200 200 200 200 Source: