# **1. The supply side perspective**

At the aggregate level, studies of LA growth based on a Solow-type approach decompose growth into factors accumulation and total factor productivity (TFP)—where the latter is obtained as a residual, i.e., as the excess of output over what can be attributed to factor accumulation—and generally conclude that productivity explains a large, if not dominant, share of growth gaps and growth fluctuations.<sup>2</sup> The literature then seeks to identify the drivers behind LA’s growth gaps (relative to advanced economies) using panel or cross-country growth regressions that include a wide range of possible explanatory factors. It typically concludes that while the adverse growth impact of macro stabilization policies has lessened over the past decades, supply side variables (structural or institutional) have increasingly become the binding constraints on growth.<sup>3</sup> Applying the Solow-inspired approach at the firm level has led to a similar emphasis on supply-based productivity. Following in particular the work of Hsieh and Klenow (2009), this literature finds unusually wide (by advanced economy standards) productivity differences between firms, which are broadly interpreted as “resource misallocations”. The high positive correlation between per-capita income and misallocation intensity is then viewed as evidence that correcting the misallocations (i.e., shifting resources from low productivity to high productivity firms) should, in and by itself, have a significant expansionary economic impact. And the high negative correlation between the extent of resource misallocation and the quality of the enabling environment is seen as an indication that the best way to correct the misallocations is through addressing their structural and institutional roots.<sup>4</sup> Thus, at either the aggregate or micro levels, the supply side approach suggests that LA’s disappointing growth performance stems mainly from large productivity gaps resulting from the poor quality of factors of production (particularly human capital) and an inefficient allocation and use of such factors. The policy agenda that flows from this diagnosis emphasizes, therefore, the need for “horizontal” (sector-neutral) reforms aimed at improving the enabling environment (contract rights, information, taxation, regulation, etc.) for all economic initiatives, and places a premium on the goal of boosting the allocative function of markets, particularly labor markets.

The supply side narrative is, however, too narrow and can become misleading in its diagnosis and policy emphasis because it downplays the role of demand, domestic as well as external, aggregate as well as idiosyncratic.<sup>5</sup> At the aggregate level, because of the high

> 2 Good examples of LA growth studies along these lines include Blyde and Fernandez-Arias (2004), Loayza, Fajnzylber and Calderon (2005), and Alfaro and Kanczuk (2020).

> 3 See Loayza, Fajnzylber and Calderon (2005), Araujo et al (2014) and David, Komatsuzaki and Pienknagura (2020).

> 4 Contributions along these lines include Pages et al (2010); Busso, Madrigal, and Pages (2013); Leal (2014); and Saborowski and Misch (2019).

> 5 See in this connection a recent literature review on the determinants of productivity by Syverson (2010), which highlights the need to better incorporate demand as a top priority in forthcoming research on growth.

7