In this section, we investigate ways to achieve the moderate and ambitious reform TFP paths using the LTGM-TFP extension of Kim and Loayza (2019). Based on an extensive literature review, Kim and Loayza (2019) identify the main determinants of economic productivity as innovation, education, market efficiency, infrastructure, and institutions (Box 2). Based on underlying proxies, that paper constructs indexes representing each of these main categories of productivity determinants and, combining them through principal component analysis, obtains an overall determinant index. TFP growth has a positive and significant relationship with the proposed TFP determinant index, and this relationship is then used to provide a set of simulations on the potential path of TFP growth if certain improvements on TFP determinants are achieved.

The Innovation and Infrastructure determinants of TFP perform worse in Peru than in its peers. Within the five components of TFP growth in Kim and Loayza (2019), Peru underperforms in Innovation and Infrastructure compared to aspirational and structural peers, lagging also behind the LAC, UMIC and HIC Median (Table 3). These are the two areas where the country possesses a wider gap with the rest. The stance regarding Market Efficiency and Institutions is lower than the aspirational peers, although it surpasses some of the structural peers and the regional median. Peru fares relatively well compared to peers on Education.

**Table 3. Main determinants of TFP in Peru and peer countries**

|||Asp|irational P|eers|S|tructural Pe|ers||||
|---|---|---|---|---|---|---|---|---|---|---|
||Peru|Chile|Malaysia|Romania|Ecuador|Colombia|South Africa|LAC Median|UMIC Median|HIC Median|
|Overall determinant index*|43.8|56.4|60.8|55.2|38.8|44.6|50.4|40.4|44.9|78.9|
|Innovation|3.6|11.7|23.7|13.0|7.9|6.5|11.2|4.0|6.6|40.2|
|Education|53.2|62.5|55.5|66.4|52.1|48.8|51.2|41.9|51.1|71.5|
|Market Efficiency|67.0|71.3|82.3|71.7|48.1|68.3|79.3|55.5|63.2|86.9|
|Infrastructure|42.4|52.8|60.4|53.7|43.4|46.6|46.7|45.4|48.3|68.9|
|Institutions|56.8|76.1|67.0|63.7|50.0|55.2|60.0|53.4|53.6|82.0|
|*The composite index of the subc<br>Scale from 1 to 100 (best) as of 2|omponen<br>019 excep|t indexes f<br>t for group|or the five ca<br>medians|tegories of|the determi|nants|||||

Convergence to HI country values in the Innovation and Infrastructure sub-dimensions produces the largest boosts to growth, followed by Education and Institutions, and lastly market efficiency. To assess the sensitivity of TFP growth to each component, we simulate a shock to the five components one at a time, mimicking the trajectory of the 75<sup>th</sup> percentile index among HIC for each component (while the rest are held constant). We then compare the results to a scenario where all components remain constant. Among the five determinants, raising the Innovation and Infrastructure components to this target will lead to the fastest TFP growth, 0.29 and 0.28 percentage points higher on average annually between 20242050 (Figure 10). Education and Institutions have the second largest impact, at about 0.24 percentage points. Market Efficiency has a slightly lower impact on TFP growth.

Experiences from other countries, such as the fast-growing Asian Tigers and China, show that sustaining high TFP growth for a long period is possible but requires continuous reforms to remove constraints and distortions in the market. Given that Peru’s TFP fundamentals could be further improved, closing the gap with HI countries will be important to sustain high TFP growth. However, it will require substantial efforts to remove market imperfections to improve market competition, infrastructure, and human capital as well as to create an enabling environment for innovation.

15