Estudios Gerenciales ISSN: 0123-5923 [email protected] Universidad ICESI

Sandilands, Roger J. How to motivate faster growth in Colombia: the leading sector strategy revisited Estudios Gerenciales, núm. 85, octubre - diciembre, 2002 Universidad ICESI Cali, Colombia

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How to cite Complete issue Scientific Information System More information about this article Network of Scientific Journals from Latin America, the Caribbean, Spain and Portugal Journal's homepage in redalyc.org Non-profit academic project, developed under the open access initiative HOW TO MOTIVATE FASTER GROWTH IN COLOMBIA: THE LEADING SECTOR STRATEGY REVISITED ROGER J. SANDILANDS • Roger Sandilands is a Reader in Economics. A graduate of Strathclyde and Simon Fraser Universities, he has held university posts in the , Canada, , Sweden and Peru, and has worked as an economic consultant to the , the Colombian Agricultural Research Institute, and the Colombian National Planning Office. His books include Monetary Correction and Housing Finance in Latin America (Gower, 1980): The Life and Political Economy of Lauchlin Currie: New Dealer, Presidential Adviser, and Development Economist (Duke University Press, 1990); and Money and Growth: Selected Paper of (Routledge, 1999). • His published papers deal with international trade, housing finance, land value taxation, , growth theory, agricultural modernization, industrialization, and the economic history of the Great Depression. He has also been Managing Editor of the Journal of Economic Studies.

Fecha de recepción: 21-10-2002 Fecha de aceptación: 16-12-2002

ABSTRAC allocation of resources, and why it This paper reproduces two public lec- especially harms long-term housing tures given at an Incolda conference finance and exports. It explains the in Bogota, October 1, 2002 on «La logic of Lauchlin Currie’s leading sec- Realidad de la Economía Colombi- tor theory of growth and shows why ana». It reviews the great structural and how housing and exports can be changes in output and employment given special protection to accelerate over recent decades and how macro- development. economic policies can strengthen or weaken the natural forces underly- KEY WORDS ing these changes. It distinguishes Colombia, growth, structural chang- between potentially inflationary pol- es, inflationary policies, leading sec- icies designed to increase demand in tor theory of growth, housing sector, a monetary sense, and those that fo- exports sector, development. cus on institutional changes that en- hance competition and mobility. It explains how inflation distorts the Clasification: B

How to motivate faster growth in Colombia: ESTUDIOS The leading sector strategy revisited GERENCIALES 67 ESTUDIOS 68 GERENCIALES No. 85 • Oct. - Dic. de 2002 It has been a few years since I worked rural areas; by the late 1960s this pro- serioly on the details of the Colombi- portion had fallen to less than 40 per- an economy, so I am a little divorced cent. Today it is around 25 percent. from the contemporary reality, which There was always an imbalance be- I do understand is extremely complex tween the proportion of the work force and fragile at the moment. But I hope engaged in agriculture and the pro- that the work that I have done in and portion of the GDP generated by that on Colombia since I first came here sector —around a third in 1950, a in 1968 gives me a long-term perspec- quarter in the late 1960s and around tive that will justify my addressing 13 percent today. A simple arithmetic this distinguished audience today. calculation shows you that this puts When I first arrived here in the late average rural output and incomes per 1960s the structure of the Colombian worker significantly below the in- economy was very different from what comes of workers in the urban sectors. it is today. The population was «only» Urban workers —in manufacturing, 17 millions. This was up from 10 mil- commerce, construction and servic- lions in 1950 when the first World es— are much more productive than Bank Mission arrived, and even then their rural counterparts in terms of the mission report complained of an the value of what they can produce. excessively high birth rate. This was This is the most powerful reason for the mission headed by Lauchlin Cur- the continuing mass migration from rie, and the health expert on the team, village to town and from town to city Dr Joseph Mountin of the US Public in Colombia over the past 50 years. Health Service, later initiated work in This process has been powerfully re- the National Health Service in Wash- inforced by the continuing process of ington that led eventually to the pill.1 Currie remained in Colombia after technification of agriculture that dis- delivering his famous Informe Currie places rural labour in the face of low —the Report of 1950— elasticity of demand for the products and he played a very important —and, of this sector. This process of techni- naturally, very controversial— part in fication still has a long way to go be- guiding Colombia’s economic develop- fore productivity levels approach ment in the following four decades. I those in and Europe was a student of Lauchlin Currie’s in where barely 2 percent of the active graduate school in Canada and what population now work in agriculture. I have to say today owes much to his Of course, rural violence is another influence and to the work I have done factor but this is nothing new in Co- here in Colombia in association with lombia, though there has recently him at Planeación Nacional and oth- been a tragic increase in this expul- er places. sion factor. When the first World Bank Mission Rural -urban migration is just one arrived here in 1950, about 70 percent manifestation of underlying natural of the Colombian population lived in market forces at work-forces that

1. However, it takes much more than the availability of the pill to bring the birth rate down - see below

How to motivate faster growth in Colombia: ESTUDIOS The leading sector strategy revisited GERENCIALES 69 persuade or compel resources from ing standards today are about 8 sectors where the return is low to times higher than in the 1960s and activities where the return is much per capita income higher than in higher. When labour and capital most of Europe. move from the textile sector in Bogo- The problem for Colombia is of course ta toward the electronics sector (or to compounded by the fact that the birth pharmaceutics or conmmerce or con- rate continues to be much higher struction) because of higher returns than in Europe and North America in the latter over time, this is a pro- in the 19th century, while mortality cess that is encouraged. But when rates have come tumbling down. labour and capital move from Boya- Thus Colombia’s population today is ca to Bogota this is often seen as a more than double what it was when cause for regret; as a Bad Thing. I first came to Colombia, and more This regret is understandable. The than 4 times what it was when the social, psychological and infrastruc- first World Bank Mission launched tural burdens associated whith the Colombia on its first serious develop- economic mobility mechanism in the ment programme. That is an extra 33 process of rural-urban migration are millions, whith nearly a million more much greater than in the case of ur- each year or so. ban-urban mobility. And much great- Fortunately, population growth is er than anything experienced in Eu- slower now than in the 1960s. This rope or North America at comparable is largely due not so much to the pill stages of their development. Never- as to the incentive to reduce the birth theless, the more that these burdens rate. This is due to the impact on in- are assumed and tackled the greater centives of higher rates or urbaniza- the efficiency of the economic machine, tion, higher incomes, greater job op- and the greater the potential increase portunities for women outside of the in overall GDP and in average real home, and higher levels of education, incomes and living standards for ru- ral and urban workers alike. Indeed, particularly for girls. the rewards —in terms of potentially Does Colombia need all these extra much higher growth rates than in 19th people to fuel its economic develop- century Europe and Nort America— ment? Of course most of them will are also much greater if policy mak- eventually be members of the work ers put oil rather than sand into the force. But the productivity of the work mobility mechanism. force depends on how disciplined and It is no accident that compound educated they are. And, above all, on how much physical capital and tech- growth rates in the Asian tigers nology they each will have to work have been as high as 8-10 percent with. It is the productivity of the work per year the last few decades. At force, not their number, that makes these rates there is a doubling of per for a high per capita level of income, capita incomes every 10 years. Thus a high standard of living, and a more in Singapore, for example, a coun- equal distribution. try that I also first visited in the 1960s and where I have recently My own thinking of these issues is, as spent 6 years of my working life, liv- mentioned, considerably influenced by

ESTUDIOS 70 GERENCIALES No. 85 • Oct. - Dic. de 2002 Lauchlin Currie, who in turn was Competition, mobility, and unre- greatly influenced by his Harvard stricted access to the cheapest and mentor, the great American economist best goods and services available at Allyn Young whose most famous writ- home and abroad were the key con- ing was delivered as the presidential ditions. Competition, mobility and address to the British Association in openness increase both the ability to 1928, on «Increasing Returns and Eco- produce more via specialization, and nomic Progress» while Young was a to enjoy greater purchasing power, or visiting professor at the London increased real incomes. And it was in- School of Economics. (Young had the creasing real incomes (arising from unique distinction of being president the ability to use one’s income to buy of the AEA, the ASA and the BA.) Let the cheapest and best available goods me try to explain the relevance of his and services) that represented the in- theories to an audience of Colombian creased real demand or size of the entrepreneurs. market. Young’s theme took as its point of From these insights it is possible to departure Adam Smith’s famous ac- construct a theory of cumulative cau- count, in the opening chapters of The sation or self sustaining growth. De- Wealth of Nations, of the economies pending on the degree of competition of scale available in a simple pin fac- and mobility, falling costs of produc- tory. This was written in 1776 —a tion will be passed on to consumers time when Britain was a developing in the form of lower prices or higher country like Colombia today, so real wages. This is what increases the Smith’s writings are still relevant. size of the market. This in turn in- The key point was that the opportu- creases the incentive and the finance nities to exploit the amazing possi- needed to expand output and produc- bilities of enhanced productivity via tive capacity throughout the econo- specialization depended on the size my, and to adopt productivity-en- of the market. Hence Smith’s famous hancing technologies and organiza- aphorism that «the division of labour tions in existing and new industries. depends on the size of the market.» Increased market size makes for Young developed this basic insight. He changes that are both quantitative explained that the form in which spe- and qualitative. The qualitative changes —new technologies, new cialization —and hence productivity ways of organizing firms and indus- growth— occurs in the modern econo- tries, new skills, new products, new my was via specialization by firm as jobs— engender macroeconomic in- well as within firms. And accompany- creasing returns that are largely au- ing this specialization was a greater tomatic, or the natural result of mar- degree of «roundaboutness» or capital- ket forces. intensity. Hence the growing economy is a more and more complex economy This has come to be known as the in which industrial diversification and Young-Currie multiplier. It means sub-division is just as important, or that the growth rate has an endoge- more important than industrial con- nous tendency to continue at the same centration and monopoly. rate year after year. For growth means

How to motivate faster growth in Colombia: ESTUDIOS The leading sector strategy revisited GERENCIALES 71 that the real market size is bigger each tion needs to be given to the factors year. Thus growth increases the divi- that hold back an increase in real de- sion of labour. But increased division mand for the goods and services that of labour, or specialization, increases Colombia is capable of producing if productivity and growth. Thus, in only the incentive is given. It is not Young’s words: «the division of labour just, or mainly, a matter of increasing is limited by the division of labour»; the supply of capital, or foreign ex- or growth is limited by growth. This change, or workers. It is a matter of implies that automatic market forces how to make it appear worthwhile to may perpetuate a slow as well as a fast entrepreneurs. Who will use their own growth rate. The existing growth rate, or other people’s money to invest in whatever it is, has a tendency to con- new capacity and technology if the tinue at the same rate. potential increase in supply looks as The key problem for policy makers is if it will outstrip the potential increase how to convert a slow growth trend in demand? In those circumstances into a fast growth trend. Or in other and increase in supply at the level of words, how can policy makers expand the individual firm or individual sec- the size of market demand in order tor may result in a fall in price that is more fully to capture the benefits of faster than the potential cost savings. specialization and achieve greater The potential result is bankruptcy. So increasing returns? the individual entrepreneur holds back and increases output only in line The answer does not lie in an increase with the historic trend. And in Colom- in the or in continuous bia this secular trend has been rather fiscal deficits. That way there may miserable. indeed be an increase in monetary demand. And in Colombia there has Thus it is incumbent upon policy- never been any difficulty in achiev- makers to get the macroeconomic con- ing that. If that were the solution ditions right. Colombia would have had one of the In my opinion there have been two fastest growth rates in the world in major, related failings here: the past 40 years. Instead it has one of the slowest —and much slower (i) The first is the belief that the major than that of the Asian tigers and constraint on non-residential business much below Colombia’s potential. expansion is a lack of credit and/or in- This is a country immensely rich in terest rates are too high. entrepreneurial and natural resourc- (ii) The second is the belief that de- es, but these resources have been valuation causes inflation and that largely underutilized. therefore the best way to control in- The solution lies in measures that flation is to control the exchange rate. increase real demand. Both of these issues are intimately But real demand depends on real sup- related to the recent problem of re- ply, and vice versa. How break into cession worldwide, and in particular this circle, to ensure that the circle ex- to Colombia’s recent economic mis- pands year after as fast as possible? ery.2 After the break I shall go into The answer is that much more atten- these two issues a little more deeply.

ESTUDIOS 72 GERENCIALES No. 85 • Oct. - Dic. de 2002 But what if the main cause of infla- expensive. This means that when try- tion is actually an excessive expan- ing to sell their goods and services, sion of the money supply? What if this Colombian producers have had to rely is partly brought on by a central bank too much on the limited domestic upon which strong political pressures market and not enough on the poten- are brought to bear to keep interest tially vast world market. rates low? What if the Banco de la Republica acts not solely as a central Import controls and export subsidies bank whose prime role is to control have been employed to try to help the supply of money in line with the Colombian producers, but these have real growth of the economy but also created an excessively large bureau- as a development bank that provides cracy. This is extremely frustrating development finance and cheap credit to business, wastes productive re- to favoured farmers and industrial- sources, and is partial and discrimi- ists? In these circumstances there is natory. It does little to enable Colom- a real conflict of objectives; and in the bia to increase its world market pen- past the cheap money lobby or the etration. When the demand is limit- influence of the spending ministers ed, supply has to follow the distorted has prevailed too often. and limited pattern of demand. Spe- cialization, diversification, and the The result has been an inflation rate adoption of new technologies are frus- much higher than the world average. trated. Increasing returns and fast This has had at least two extremely damaging effects on investment and growth are sacrificed. the efficiency of the economy (as well In parenthesis, I may mention a re- as noxious effects on the distribution lated problem that Colombian indus- of income). The first concerns the ef- trialists face when the exchange rate fect on trading opportunities with the is overvalued and the country expe- rest of the world. The second con- riences chronic balance-of-payments cerns the market for housing finance, difficulties. In trying to deal with the and hence investment in building and allocation of foreign exchange bu- related industries. reaucratically rather than through the market mechanism civil servants • FOREIGN TRADE at Incomex tell industrialists what Let me first discuss the issue of for- they can and cannot buy from abroad. eign trade opportunities. With a chronic unemployment prob- In Colombia the tendency has fre- lem and low wages, you are told by quently been to control the exchange civil servants to spend your money rate instead of the money supply in (not theirs) on labour-intensive meth- the face of inflation. This has pro- ods rather than the methods that you duced a chronic tendency toward an regard as most economic and suited overvalued exchange rate. This has to your particular needs. The import made Colombia’s imports artificially of capital-intensive technologies are cheap and her exports artificially discouraged and even prohibited.

2. Show Sergio Clavijo´s “Index of economy misery”, 1967-2001

How to motivate faster growth in Colombia: ESTUDIOS The leading sector strategy revisited GERENCIALES 73 Let me give you an example, though I Thus there is an intimate connection am sure many of you will have similar between the health of the sectors sup- or better examples than mine. I know plying foreign markets and those sup- an energetic Colombian industrialist plying the home market. They do not who was denied an import licence for expand at each others’expense. Their an advanced German machine that fortunes, and that of the whole econo- would produce drip irrigation tubes my, are mutually reinforcing —either rapidly and cheaply. Instead he was in the upward or in the downward di- forced to use antiquated second-hand rection. If, for example, the housing machinery bought locally. The machi- sector is sick, it will be harder not eas- ne broke down frequently and was slow. ier for exporters to keep their costs low The up-front capital cost of this machi- and to exploit economies of scale. ne was much less than the foreign one; but what of the overall costs of produc- • THE HOUSING MARKET tion for the tubes? Overall costs inclu- This brings me to the second debili- ded the costs of slowness and breakdo- tating effect of inflation (or an exces- wn, and the labour costs were also hig- sive expansion of monetary demand), her. Nevertheless, the increased la- namely, its debilitating effect on real bour-intensity of the antiquated, low- demand in the housing market. Once productivity methods is often been re- again the problem relates to the view garded as an advantage rather than a that credit ought to be offered on the disadvantage in the eyes of the econo- cheapest possible terms to borrowers. mically illiterate. With higher unit And just as industrialists constantly costs and smaller output, the irrigation lobby the government and central equipment is sold at a higher price to bank to keep interest rates low and farmers and flower growers. Ultima- credit cheap, so in the market for tely domestic consumers of food and the housing finance the voice of the bo- foreign purchasers of flowers face hig- rrower has greater political weight her prices. Domestic and foreign sales than the voice of the saver. are thus lower than would be possible The result? Big potential demand for if the manufacturer had been free to housing finance, but small supply. use his own best technical and econo- And the market always clears at the mic judgments when investing his own short end. A short supply means that money. large potential demand becomes short effective demand. The key pro- The lesson is a universal one. If costs blem for policy-makers is how to con- are artificially raised through protec- vert potential into actual demand. tionism, the home and foreign mar- kets available to Colombian producers The housing finance market is not like generally is lower. Protection for one most other credit markets, because it group is disprotection for the rest of typically finances an asset whose va- the economy. Whith smaller markets, lue is usually very large relative to the the incentive for all Colombian pro- borrower’s income, and so needs to be ducers to invest and innovate is lower. on much longer terms than most. Low demand, low incentives, low When inflation is high nominal inter- growth: A vicious cycle is perpetuated. est rates are also high, even when they

ESTUDIOS 74 GERENCIALES No. 85 • Oct. - Dic. de 2002 are negative in real terms. At high the potential to employ hundreds of nominal rates of interest, say 20 per- thousands of workers in relatively cent, there is a major «front-end- well-paying jobs, even when efficient loading» or cash squeeze problem for capital-intensive building methods borrowers. To buy an apartment with are employed. a mortgage of $100.000 requires that A dynamic housing sector is vital also the borrower pay $20.000 in interest to the better functioning of the labour payments alone in the first year. This mobility mechanism. Workers mov- may nearly exceed his entire annual ing from village to town, from town income even though in theory that to city, and from city slums into bet- apartment should be easily affordable ter accommodation in the same city in the long term to someone with his need housing if they are to make the income. Furthermore, even if he could move easily. Thus housing is a vital overcome the frontend loading pro- part of a job creation programme. It blem, why would savers bothers to put employs labour directly in the build- their money into the system if infla- ing of houses and related infrastruc- tion is, say, 22 percent or more? That ture. And it plays a crucial indirect is, if interest rates in the corporacio- role in making labour available to nes de vivienda (CAVs) are negative other employers in industry, com- in real terms. And they would be do- merce and services. An increased sup- ubly reluctant if the banks speciali- ply of housing at lower cost reduces zing in short-term loans to other ty- the cost of an important wage good, pes of borrower are able to offer bet- and so enables employers to cut their ter rates to lenders and extract hig- own wage costs without reducing the her rates from borrowers. standard of living of the workers. (Incidentally, now that Colombia’s Furthermore, by playing this vital CAVs have been fused into the banks, role in oiling the labour-mobility the banks may have less incentive mechanism, a dynamic construction than when the CAVs were indepen- sector enables more and more work- dent specialist institutions, to use ers to move from low-to higher-pay- their funds to finance housing rather ing jobs. Ultimately real wages all than automobiles and consumer cred- round should increase, thanks to the it. I well recall Dr Gabriel Rosas pre- overall productivity-enhancing ef- senting a paper on behalf of Lauchlin fects of better mobility and the way Currie at a convention in Cartagena in which this in turn increases over- in 1991 that warned of the benefits of all size of the market, or GDP. This financial specialization and the dan- is what encourages investment and gers of multi-banking. A pity his words innovation that would not otherwise have not been heeded.) have been worthwhile. The main pint is that inflation intro- Note too that those idnustrialists who duces a major distortion into capital are producing goods and services that markets by discriminating heavily enter into the building of houses (the against housing. Yet this is the very construction sector itself is basically sector where potential demand is very an assembly industry) see no point great. It is also a sector with a rela- in expanding their operations great- tively low import content. And it has ly, or establishing new specialist

How to motivate faster growth in Colombia: ESTUDIOS The leading sector strategy revisited GERENCIALES 75 plants that yield big economies of rowers to pay a reasonable real in- scale, unless they are happy with the terest rate to savers without encoun- prospective increase in demand for tering the crippling cash flow prob- their products: bricks, cement, glass, lem that had artificially restrained pipes, sanitary fixtures, furnishings, demand for many years. paint, etc. They need an incentive; and the incentive comes from an ex- In the early years of the valor con- pansion in demand, not in terms of stante system it operated fairly close- money only, but in real terms. ly to a theoretical and practical ide- al. Savings flowed into the system at It is in this sense that for many years a rate that astonished the skeptics; Professor Currie pushed hard for the but demand increased even more rap- adoption of a leading sector strategy idly. Construction boomed without in Colombia, with construction and recourse to massive subsidies or bur- exports as the two most important den on the taxpayer or the central candidates for this role. bank. Colombia’s growth rate was Exports were to be encouraged higher in this period than before or through the preservation of a more since. But sadly, over the years, once permanently competitive exchange the borrowers had got their mortgag- rate. This would be achieved through es they formed a powerful pressure policies that ensured that the exter- group to persuade the government to nal value of the peso kept in line with weaken the system by loosening the its internal value. If domestic inflation index link with inflation. This was to is depreciating the internal value of the detriment of savers and jeopar- the peso then its external value should dized the competitiveness of the hous- be allowed to reflect this. Otherwise a ing finance system vis-a-vis the rest major distortion is introduced into the of the capital markets. As saving de- market signaling process. clined the government has had to rely Housing was to be encouraged more and more on «social» housing, through the valor constante system at great fiscal cost and with far less that guaranteed savers a fair return housing constructed than in the past, on their savings while at the same and with a socially and economically time making it much easier for bor- costly pattern of urban development.

Table 1. Inflation, Unemployment and Growth in Colombia

Index of Inflation Unemployment Growth Macroeconomic (Cpi-Average) (Main Cities) (Real-GDP Var) Suffering Periods (1) (2) (3) (4)=(1)+(2)+(3) 1967-74 12.1 9.9 6.2 15.8 1975-81 24.7 9.5 4.5 29.6 1982-89 22.6 11.7 3.5 30.9 1990-97 24.0 10.1 4.0 30.0 1998-01 11.7 18.3 0.2 29.8 Sergio Clavijo, «Monetary and Exchange Rate Policies in Colombia: Progress and Challenges (1991-2002),» mimeo, Bank of the Republic, Bogota, May 2002.

ESTUDIOS 76 GERENCIALES No. 85 • Oct. - Dic. de 2002 Thus, although housing has a great in Colombia from the time of his ar- potential as a leading sector in the rival here in 1949 right up to his potential acceleration of the rate of death in 1993, Colombian policy- economic growth in Colombia, it also makers may make amends and en- has the potential to lead the econo- sure that his leading sectors strate- my down as well as up. I hope that as gy is resurrected. It would be a fit- a tribute to the unparalleled efforts ting way to mark the centenary of his of Lauchlin Currie on behalf of fast- birth a week from today. er economic growth and social justice

How to motivate faster growth in Colombia: ESTUDIOS The leading sector strategy revisited GERENCIALES 77 ESTUDIOS 78 GERENCIALES No. 85 • Oct. - Dic. de 2002 ESTUDIANTE INVITADO

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