Abstract
Selected Issues
Potential Growth in Colombia1
A. Introduction
1. Colombia experienced an extended period of high growth up until 2014, against a background of rising commodity prices. Growth averaged 4.3 percent in 2000–14, while oil prices increased 241 percent. A liberalization of the oil sector allowed Colombia to double oil production. A large increase in labor participation and formalization supported growth. Favorable global conditions also played a role. IMF (2017, April WEO) identifies 2004–13 as a period of growth acceleration in Colombia, driven to a large extent by benign external conditions.
2. The sharp and largely permanent decline in oil prices since 2014 took a toll on growth. GDP grew 3.1 and 2.0 percent in 2015 and 2016, as exports decelerated and domestic demand started adjusting to a lower level of national income. As noted in IMF (2015), oil exporters were expected to grow less than 2 percent below trend growth in 2015–17 and, more importantly, were projected to experience lower rates of potential GDP growth going forward.
3. What are Colombia’s growth prospects in a world of lower oil prices? Part of the recent economic slowdown is a temporary phenomenon associated to the transition to weaker terms of trade. It is however unlikely that Colombia will permanently return to the high growth rates of the early 2000s. The central thesis in this paper is that past employment gains and the large accumulation of capital that accompanied high oil prices are unlikely to be repeated in the near term. Nevertheless, the implementation of the peace deal together with macroeconomic stability and structural reforms, such as infrastructure and the tax reform, could set the stage for new growth drivers to emerge. This paper assesses the prospects for medium-term growth in Colombia in a world of low oil prices building on the insights from a production function. The technical details of the analysis can be found in Lanau and others (2017).
B. Insights from a Production Function
4. Production function methods use information on capital and labor inputs, and productivity to estimate potential growth. This paper estimates and projects potential output in Colombia for the period 1990–2022, taking into account the impact of permanently lower commodity prices and planned policies on investment, labor markets, and productivity. The production function takes the following form
where Y is potential output, A is total factor productivity, K is the net capital stock in the economy, L is the potential labor input, and 1 – α is the labor share in national income. An application of the production function to actual GDP growth shows that in recent years factor accumulation made a larger contribution to growth than productivity. The following subsections delve into the dynamics of each component of the production function. Data sources are listed in the annex.
Capital Input
5. The composition of the capital stock in Colombia changed remarkably in the last three decades as a result of high commodity prices (Figure 1). Machinery and equipment grew from 3 percent to 9 percent of the total capital stock as a result of high growth in the oil and mining sectors. The capital expenditures of Ecopetrol—the largest domestic firm in the oil sector—and FDI to the sector provide evidence of how much mining investment grew. These two components of investment increased from 2½ percent of GDP in 2005 to 4½ percent of GDP in 2009–13.
Actual Growth Decomposition
(Percent)
Citation: IMF Staff Country Reports 2017, 139; 10.5089/9781484302187.002.A003
Sources: DANE, Penn World Tables, and Fund staff calculations.Actual Growth Decomposition
(Percent)
Citation: IMF Staff Country Reports 2017, 139; 10.5089/9781484302187.002.A003
Sources: DANE, Penn World Tables, and Fund staff calculations.Actual Growth Decomposition
(Percent)
Citation: IMF Staff Country Reports 2017, 139; 10.5089/9781484302187.002.A003
Sources: DANE, Penn World Tables, and Fund staff calculations.
The Impact of Commodity Prices on Investment and the Capital Stock
Citation: IMF Staff Country Reports 2017, 139; 10.5089/9781484302187.002.A003
Sources: DANE, IMF WEO, Banrep, Ecopetrol, and staff calculations.The Impact of Commodity Prices on Investment and the Capital Stock
Citation: IMF Staff Country Reports 2017, 139; 10.5089/9781484302187.002.A003
Sources: DANE, IMF WEO, Banrep, Ecopetrol, and staff calculations.The Impact of Commodity Prices on Investment and the Capital Stock
Citation: IMF Staff Country Reports 2017, 139; 10.5089/9781484302187.002.A003
Sources: DANE, IMF WEO, Banrep, Ecopetrol, and staff calculations.6. The capital stock is projected to continue to increase, mainly as a result of 4G infrastructure projects and the tax reform. Oil and mining are unlikely to be a significant source of capital accumulation going forward but the outlook for investment in nevertheless positive. In a trend scenario without 4G infrastructure projects or tax reform, staff estimate that the net capital stock would increase at an average of 4.3 percent in 2017–22, given projected oil prices and budgeted public investment (Lanau and others 2017). The construction phase of 4G infrastructure projects is projected to add up to 0.1 percentage points to the average growth rate of the capital stock in the next five years.
7. The structural tax reform will boost private investment, adding up to 0.1 percentage points to the average growth rate of the capital stock. As noted in chapter 3, investment is projected to grow by 3 percent as a result of the structural tax reform. Moreover, the mortgage subsidies and new schools in the Colombia Repunta stimulus plan are likely to support construction and investment in structures in the near term.
8. Infrastructure and the real exchange rate depreciation will increase corporate investment, adding a further 0.1 percentage points to the average growth rate of the capital stock (Box 1, and Lanau 2017a, 2017b). In addition to the aggregate demand and productivity effects of infrastructure, a further contribution to corporate investment is expected from the large real depreciation that accompanied the drop in oil prices. Staff analysis shows exporters invest more in response to depreciations.
9. Taking into account the factors discussed above, the capital stock is projected to increase at an annual average of 4.3 to 4.7 percent in 2017–22 (Figure 2). The lower bound corresponds to a trend scenario with no impact from 4G infrastructure projects or the tax reform, while the upper bound incorporates the full impact of both policies on investment. The capital/output ratio would climb up to 2.6, from 2.4 in 2016.
Projected Investment and Capital Stock Growth Rates
Citation: IMF Staff Country Reports 2017, 139; 10.5089/9781484302187.002.A003
Sources: DANE and staff calculations.Projected Investment and Capital Stock Growth Rates
Citation: IMF Staff Country Reports 2017, 139; 10.5089/9781484302187.002.A003
Sources: DANE and staff calculations.Projected Investment and Capital Stock Growth Rates
Citation: IMF Staff Country Reports 2017, 139; 10.5089/9781484302187.002.A003
Sources: DANE and staff calculations.Labor Input
10. The labor input to the production function grew strongly since the mid-2000s but its contribution to growth is expected to moderate in the next five years. Potential labor is projected to grow slightly above 2 percent per year in 2017–22, sharply down from an average of 3.8 percent in the last five years. The labor input can be broken down into working age population, potential labor force participation rate (LFPR), natural unemployment, and human capital. Each component is discussed in turn and summarized in Figure 3.2
Labor Market Developments
Citation: IMF Staff Country Reports 2017, 139; 10.5089/9781484302187.002.A003
Sources: DANE, UN, OECD, Penn World Tables, and staff calculations.Labor Market Developments
Citation: IMF Staff Country Reports 2017, 139; 10.5089/9781484302187.002.A003
Sources: DANE, UN, OECD, Penn World Tables, and staff calculations.Labor Market Developments
Citation: IMF Staff Country Reports 2017, 139; 10.5089/9781484302187.002.A003
Sources: DANE, UN, OECD, Penn World Tables, and staff calculations.The Impact of Infrastructure on Growth and Investment
Colombia scores weakly in the quality of infrastructure dimension of the Global Competitiveness Report (GCR) by the World Economic Forum. The 4G projects are an opportunity to improve infrastructure and lift investment and potential growth.
Lanau (2017a) explores the impact of infrastructure improvements on growth and corporate investment in Colombia and Latin America exploiting the variation in the dependence of sectors in the economy on infrastructure and the variation in the quality of infrastructure across countries.
WEF Quality of Infrastructure
Citation: IMF Staff Country Reports 2017, 139; 10.5089/9781484302187.002.A003
Source: World Economic Forum.WEF Quality of Infrastructure
Citation: IMF Staff Country Reports 2017, 139; 10.5089/9781484302187.002.A003
Source: World Economic Forum.WEF Quality of Infrastructure
Citation: IMF Staff Country Reports 2017, 139; 10.5089/9781484302187.002.A003
Source: World Economic Forum.The analysis shows that improving the quality and/or quantity of infrastructure increases growth in Colombia. More specifically, sectors that depend relatively more on infrastructure grow relatively faster when infrastructure improves. For example, if the quality of roads in Colombia according to the GCR improved to the sample median (the level in the Czech Republic), a sector with median dependence on transportation (hotels and restaurants) would growth 0.15 percentage points faster. At the aggregate level, GDP growth would increase 0.12 percentage points. A 10 percent increase in the size of the road network would increase growth by 0.14 percentage points. 4G infrastructure projects are expected to deliver an additional 7,000 kilometers of new primary roads.
Impact of Improving Road Quality on GDP Growth
(Percentage points)
Citation: IMF Staff Country Reports 2017, 139; 10.5089/9781484302187.002.A003
Source: Lanau (2017a)Impact of Improving Road Quality on GDP Growth
(Percentage points)
Citation: IMF Staff Country Reports 2017, 139; 10.5089/9781484302187.002.A003
Source: Lanau (2017a)Impact of Improving Road Quality on GDP Growth
(Percentage points)
Citation: IMF Staff Country Reports 2017, 139; 10.5089/9781484302187.002.A003
Source: Lanau (2017a)
Impact on Median Investment Rate from Improving Roads
(Percentage points)
Citation: IMF Staff Country Reports 2017, 139; 10.5089/9781484302187.002.A003
Source: Lanau (2017a)Impact on Median Investment Rate from Improving Roads
(Percentage points)
Citation: IMF Staff Country Reports 2017, 139; 10.5089/9781484302187.002.A003
Source: Lanau (2017a)Impact on Median Investment Rate from Improving Roads
(Percentage points)
Citation: IMF Staff Country Reports 2017, 139; 10.5089/9781484302187.002.A003
Source: Lanau (2017a)The corporate investment analysis shows that firms that depend relatively more on infrastructure increase investment when the quality of infrastructure improves. The investment rate of the median firm in Colombia would increase by about 0.1 percentage points if the quality of roads improved to the sample median. The nontraditional sectors that stand to benefit the most from the large real exchange rate depreciation in terms of investment are transport equipment, computers and electronics, and wholesale trade.
Nontraditional sectors for which the i mpact of a 10 perce nt real depreciation on corporate investment rates is the l argest
Citation: IMF Staff Country Reports 2017, 139; 10.5089/9781484302187.002.A003
Source: Lanau (2017a)Nontraditional sectors for which the i mpact of a 10 perce nt real depreciation on corporate investment rates is the l argest
Citation: IMF Staff Country Reports 2017, 139; 10.5089/9781484302187.002.A003
Source: Lanau (2017a)Nontraditional sectors for which the i mpact of a 10 perce nt real depreciation on corporate investment rates is the l argest
Citation: IMF Staff Country Reports 2017, 139; 10.5089/9781484302187.002.A003
Source: Lanau (2017a)Decelerating population growth. Similarly to other emerging markets, DANE and UN projections point to slowing demographic trends in Colombia. Working age population is projected to grow at an annual average of 1.1 percent in 2017–22, down from 1.7 percent in 2000–16.
Plateauing LFPR. The LFPR climbed to an all-time high of 64–65 percent in 2015–6, making a substantial contribution to the high growth rate of labor inputs. The LFPR is projected to remain at around current levels for the projection period since it is already high in international perspective. The gender gap is relatively large but Colombia’s female LFPR is above the OECD average, limiting somewhat the scope for further gains.
Falling natural unemployment rate. Unemployment has been on a declining trend since its peak shortly after the 1999 crisis. A modest cyclical uptick is expected in 2017 but as growth picks up, unemployment is projected to fall back to 9 percent.
Steady increase in the human capital stock. The human capital stock increased steadily since 1990 but remains below that of a number of emerging markets. It is assumed that the human capital stock continues to increase at an unchanged rate in the next five years (around one percent). In the long-term, the human capital stock may increase faster since the end of the conflict with the FARC will help raise school enrollment rates in the affected areas. Improvements in the quality of education (Colombia’s PISA scores were weak in 2015), could also boost human capital accumulation in the long run.
11. Falling labor market informality helped improve the quality of labor inputs. It is well known that informal labor is less productive than formal one (Perry and others 2007, Dabla-Norris and others 2005). Informality fell 7 percentage points since 2001, indicating that the average quality of the Colombian labor force improved. Some provisions in the structural tax reform might extend this trend.
Labor market informality
(percent)
Citation: IMF Staff Country Reports 2017, 139; 10.5089/9781484302187.002.A003
Source: DANE.Labor market informality
(percent)
Citation: IMF Staff Country Reports 2017, 139; 10.5089/9781484302187.002.A003
Source: DANE.Labor market informality
(percent)
Citation: IMF Staff Country Reports 2017, 139; 10.5089/9781484302187.002.A003
Source: DANE.Productivity
12. Total factor productivity grew significantly in the 2000s but was weaker in recent years (Figure 4).3
A number of factors help explain the significant productivity improvements starting at the turn of the century: a sharp reduction in crime,4 progress in financial deepening and financial inclusion (Karpowicz 2014), and a better business environment (e.g., cutting almost by half the days it takes to get a construction permit). Favorable terms of trade dynamics may have also been reflected in TFP (IMF 2017).
The recent decline in trend TFP is influenced by the sharp drop in measured TFP at the time of the financial crisis, which may largely reflect factors such as labor hoarding rather than fundamental productivity changes. But, as Sosa and others (2013) hypothesize, part of the recent decline in TFP could be related to the expansion of mining into areas of lower marginal productivity where production became profitable due to the commodity price boom. Moreover, the decline in TFP growth is a global phenomenon (Jones 2015, Haldane 2017).
It is important to bear in mind the limitations of TFP as a measure of productivity. Since TFP is a residual, it can be contaminated by measurement errors in the labor and capital inputs (e.g., changes in the quality of the capital stock or fluctuations in hours worked). Labor productivity in the non-primary sector is an alternative productivity measure that avoids some of the pitfalls of TFP. As shown in Figure 5, Colombia’s labor productivity grew at a healthy clip in 2003–08 according to this metric (although part of the improvement is due to capital accumulation, not pure productivity). In international perspective, though, Colombia’s productivity is relatively low compared to other EMs.
Aggregate TFP figures mask large productivity differentials across firms and regions (Figure 5). As Brown and others (2013) document, the dispersion in firm productivity is larger than in OECD countries. IMF (2017) finds evidence of resource misallocation in the manufacturing sector in Colombia. The degree of misallocation is moderate in international perspective but correcting it could increase growth by 0.3 percentage points.
Low spending in R&D may also be hindering productivity growth. CONPES (P.40) notes this issue, as well as the little coordination between centers producing knowledge and the private sector, and points out a number of policy measures to address it.
Productivity Indicators
Citation: IMF Staff Country Reports 2017, 139; 10.5089/9781484302187.002.A003
Source: DANE, OECD, and staff calculations.Productivity Indicators
Citation: IMF Staff Country Reports 2017, 139; 10.5089/9781484302187.002.A003
Source: DANE, OECD, and staff calculations.Productivity Indicators
Citation: IMF Staff Country Reports 2017, 139; 10.5089/9781484302187.002.A003
Source: DANE, OECD, and staff calculations.
Measures of Productivity Dispersion
Citation: IMF Staff Country Reports 2017, 139; 10.5089/9781484302187.002.A003
Sources: DANE, IMF (2017).Note: Estimates of resource allocation efficiency follows Hsieh and Klenow (2009). Estimates correspond to the latest available data for the manufacturing sector.Measures of Productivity Dispersion
Citation: IMF Staff Country Reports 2017, 139; 10.5089/9781484302187.002.A003
Sources: DANE, IMF (2017).Note: Estimates of resource allocation efficiency follows Hsieh and Klenow (2009). Estimates correspond to the latest available data for the manufacturing sector.Measures of Productivity Dispersion
Citation: IMF Staff Country Reports 2017, 139; 10.5089/9781484302187.002.A003
Sources: DANE, IMF (2017).Note: Estimates of resource allocation efficiency follows Hsieh and Klenow (2009). Estimates correspond to the latest available data for the manufacturing sector.13. Going forward, productivity growth could reach one percent in a scenario with very strong reform implementation but could be much weaker in the absence of reforms. TFP growth would gradually increase to 1.1 percent in 2022 if the positive effects of the following factors materialize in full:
Productivity gains from better infrastructure (0.25 percentage points). Improvements in infrastructure as a result of the 4G projects will make the existing stock of capital and labor more productive, especially in rural areas where the infrastructure gap is the largest.
The peace dividend (0.5 percentage points). Further improvements in security as a result of the peace agreement with the FARC will improve business confidence and productivity in the areas most affected by the conflict. Together with peace-related public spending, this will help close the large productivity gaps across firms and regions. In the long-run, the peace dividend could grow further, reaching up to 0.7 percentage points in terms of productivity growth.
Productivity gains from the tax reform (0.1 percentage points). The simplification of the tax system will make firms more productive as the cost of filing taxes falls.
Ongoing efforts to improve the business environment and reduce barriers to trade (0.1 percentage points). Recent progress at the planning department (DNP) to streamline regulations and reduce subsidies in line with best OECD practices has the potential to improve productivity. The recently approved customs code and a planned simplification of import tariffs should make firms, especially exporters, more productive. Removing nontariff barriers (Garcia and others 2016) as well as efforts to promote new export markets and products will also contribute to productivity growth.
Putting it all Together: Potential Growth
14. Factor accumulation, especially labor, drove potential growth up to an average of 4 percent in the last 15 years. High population growth, a large drop in the unemployment rate, and improving schooling rates increased labor inputs significantly. Together with increasing capital accumulation and some TFP gains, these developments lifted potential growth to above 4 percent on the eve of the global financial crisis.
15. Medium term potential growth would be in the 2.8 to 4.1 percent range depending on the strength of policies (Figure 6). The lower bound is an unlikely scenario where incomplete reform implementation results in no TFP growth, and the effects of 4G infrastructure projects and the tax reform on investment do not materialize. The upper bound corresponds to one percent TFP growth by 2022 due to very strong structural reforms and full impact of policies on capital accumulation. A central scenario with medium term potential growth of 3.5 percent is shown in Figure 6. While less optimistic than the upper bound, the central scenario still involves a significant turnaround in productivity that requires strong reform implementation.
Potential Growth Projections
Citation: IMF Staff Country Reports 2017, 139; 10.5089/9781484302187.002.A003
Sources: DANE, UN, OECD, Penn World Tables, and staff calculations.Potential Growth Projections
Citation: IMF Staff Country Reports 2017, 139; 10.5089/9781484302187.002.A003
Sources: DANE, UN, OECD, Penn World Tables, and staff calculations.Potential Growth Projections
Citation: IMF Staff Country Reports 2017, 139; 10.5089/9781484302187.002.A003
Sources: DANE, UN, OECD, Penn World Tables, and staff calculations.16. Further reductions in the natural unemployment rate and informality could increase potential growth but may be offset by other developments. It is conceivable that unemployment and informality fall below the assumptions in the production function exercise. However, growing skill mismatches and concerns about the quality of education may offset the gains.
Potential Growth
(Percent)
Citation: IMF Staff Country Reports 2017, 139; 10.5089/9781484302187.002.A003
Source: April 2017 WEO.Potential Growth
(Percent)
Citation: IMF Staff Country Reports 2017, 139; 10.5089/9781484302187.002.A003
Source: April 2017 WEO.Potential Growth
(Percent)
Citation: IMF Staff Country Reports 2017, 139; 10.5089/9781484302187.002.A003
Source: April 2017 WEO.17. Declining potential growth is a common theme among commodity exporters and highlights the importance of structural reforms to grow in a world of low oil prices. Potential growth is expected to soften in most commodity exporters. In many cases, the decline is projected to be significantly larger than Colombia’s.
C. Conclusion
18. Potential growth is likely to moderate to a range of 2.8 to 4.1 percent in a world of lower oil prices. The results from a production function indicate that potential growth rose to 4–5 percent in the era of high oil prices. Potential growth estimates fell considerably with the sharp drop in oil prices but the outlook is positive under successful implementation of structural reforms:
The 4G infrastructure projects and the tax reform will increase investment, offsetting the sharp decline in capital accumulation in the oil sector. Capital accumulation is projected to contribute 1.4 to 1.6 percentage points to average annual potential growth in 2017–22, highlighting the importance of executing 4G projects without delays.
Improvements in productivity are essential to lift potential growth. The large increases in the labor force observed in the last 15 years are unlikely to continue, making productivity-enhancing reforms central for growth. Better infrastructure, the peace agreement with the FARC, and ongoing efforts to improve the business environment and reduce trade barriers are welcome steps to boost productivity and growth.
Annex I. Data Sources
Data Sources
| Variable | Source |
|---|---|
| GDP | DANE and staff projections |
| Employment, unemployment, working age population | DANE |
| Working age population projections | DANE and UN |
| Human capital index | Penn World Tables |
| Capital stock | DNP and Banrep |
| Depreciation rate | Staff calculations |
| Oil price | WEO |
| Variable | Source |
|---|---|
| GDP | DANE and staff projections |
| Employment, unemployment, working age population | DANE |
| Working age population projections | DANE and UN |
| Human capital index | Penn World Tables |
| Capital stock | DNP and Banrep |
| Depreciation rate | Staff calculations |
| Oil price | WEO |
References
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Lanau, S., J.D. Rodriguez, and J. Roldos, 2017, “Potential Growth in Colombia” IMF Working Paper, forthcoming.
Perry, G. E., W.F. Maloney, O.S. Arias, R. Fajnzylber, A.D. Mason, and J. Saavedra-Chanduvi, 2007, “Informality: Exit and Exclusion,” (Washington: World Bank).
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Prepared by Sergi Lanau, Daniel Rodriguez-Delgado, and Jorge Roldós.
The LFPR and unemployment are filtered to obtain the potential LFPR and natural unemployment rate.
TFP is obtained as a residual from the log version of equation (1), using actual GDP, the capital stock adjusted by utilization, and actual employment adjusted by human capital. Potential TFP is the result of applying an HP filter (λ=6.25) to the TFP residual.
See Cardenas and Rozo (2002) on the link between crime and productivity in Colombia.
