## DISSECTING ECONOMIC GROWTH IN URUGUAY

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### Introduction and headline findings
- Uruguay experienced a major economic boom during 2004–14; annual growth in real GDP per capita averaged 4.9 percent over 2004–14, compared with 2.3 percent for Latin America and the Caribbean (LAC).
- Growth slowed after 2014: real GDP growth averaged 1.6 percent from 2015 to 2018.
- Prior to the boom, Uruguay’s GDP per capita had been growing at an average annual rate of under 1 percent for 50 years and had been declining relative to the US until the trend reversed in 2004.
- Goal of the analysis: distinguish short-term vs. sustainable drivers of the 2004–14 boom and identify structural impediments to raise sustainable growth (labor market, education outcomes, private sector dynamism, macro stability).

### Causes of the 2004–14 boom
- Multiple demand- and supply-side factors contributed: recovery from crisis, commodity price boom, increased demand from Argentina, emergence of new export sectors, and exchange rate appreciation.
- Recovery from the crisis:
  - Uruguay suffered a severe downturn in the early 2000s; GDP growth averaged -1.7 percent over 1998–2003.
  - Augmented Dickey-Fuller test on annual GDP growth strongly rejects the unit-root null at 1 percent level, implying mean reversion.
- Terms-of-trade and external demand:
  - Around 50 percent of Uruguayan exports are agricultural commodities and their derivatives.
  - Soybean production and exports rose from nearly negligible in the early 2000s to account for 15 percent of total exports in 2014.
  - China became the most important export destination by the end of the boom period, with soybeans accounting for over half of total exports to China.
- Argentine inflows and tourism:
  - Nonresident deposits declined from about 40 percent of total deposits in 2001 to less than 10 percent in 2018.
  - Goods exports to Argentina declined from close to 15 percent of total goods exports in 2001 to less than 5 percent in 2018; service exports, notably travel and tourism, remain substantial and constitute over 15 percent of total exports.
  - Tourism exports grew at an annual rate of 16 percent during the boom.
  - From 2002 to 2012, annual foreign direct investment (FDI) from Argentina increased by 26 times.
- Exchange rate appreciation:
  - Nominal exchange rate vs. USD appreciated over 20 percent from 2004 to 2014.
  - Real GDP in PPP terms almost doubled over the boom period, compared to 68 percent increase without PPP adjustment.
  - Short-term income effects from appreciation supported domestic demand through cheaper imports.
- Sectoral structural change and policy support:
  - ICT exports grew from 2 percent of total exports at the beginning of the boom years to over 10 percent.
  - Montevideo became a leading software development/outsource center, exporting primarily (over 50 percent) to the U.S.
  - Cellulose pulp (forestry) emerged after large investment by UPM; sectoral incentives included 100 percent income tax exemption for software exports (Decree 150/2007) and various incentives for UPM operations.
- Productivity:
  - Measured total factor productivity (TFP) increased over the boom period (Penn World Tables), but TFP correlates highly with output growth and reversed after 2014.

### Quantitative decomposition — relative importance of factors (numerical exercise)
- Method: supply-side contributions measured by real increase in sector exports (2004–14) divided by total real GDP increase; exchange-rate effects based on Selected Issues Paper (2016); rebound effect estimated from regression of 5-year growth on its lag.
- Estimated contributions to the aggregate growth during 2004–14:
  - Rebound from the crisis: about 13 percent of the boom years’ growth.
  - Rise of various commodity exports (e.g., soybean, livestock): over 15 percent of aggregate growth (captures both price and quantity effects).
  - Nominal exchange rate appreciation: around 6 percent of growth.
  - Export growth from new industries (ICT outsourcing and paper pulp): about 10 percent of growth.
- Caveats and biases:
  - Difficult to separate impacts across factors (e.g., soybean and tourism growth contributed to appreciation).
  - Appreciation’s contribution may be overstated; supply-side contributions may be understated.
  - Simultaneity and indirect effects (e.g., external investment inflows contributing to appreciation) complicate attribution.

### Sustainability assessment of growth drivers
- General observation: Some boom drivers are transitory; others may be more sustainable. With external factors waning, focus is on strengthening sustainable drivers and leveraging transitory opportunities to build long-term potential.
- Agricultural commodities:
  - Real agricultural commodity prices display a long-run declining trend, partly due to rising productivity.
  - Commodity prices are expected to remain subdued (World Economic Outlook, October 2019).
  - Increased Chinese demand explained over 60 percent of world demand increase in soybeans in the prior decade and a half; with China’s slowing growth, soybean price declined since 2013.
  - Uruguay’s soybean exports have been on the decline after 2013; neighboring countries (Paraguay and Brazil) show stronger cost and productivity competitiveness.
  - Soybean productivity in Uruguay is at par with the U.S. technological frontier; U.S. soybean sector productivity has historically grown at an average rate of 1 percent per year, implying limited scope for convergence-driven productivity gains in soybeans alone.
- Forestry and paper pulp:
  - Forestry/pulp enjoys relatively stable export prices and steadily increasing world demand; second pulp mill from UPM positions the industry to become Uruguay’s largest exporting industry.
  - Long-run growth contribution depends on spillovers to local auxiliary industries and broader structural constraints in Uruguay.
- Overall implication:
  - Without strong external-demand-driven investment, productivity gains in commodity sectors alone are unlikely to sustain convergence with advanced economies.
  - Emerging industries (ICT, forestry/pulp) present opportunities but face challenges tied to structural constraints.

### Conclusions and policy-relevant implications (from analysis)
- Short-term cyclical and external factors explained a sizable share of the 2004–14 boom; durable convergence requires strengthening sustainable supply-side drivers.
- Key areas to enhance for sustainable growth: labor market flexibility and equity, education outcomes, higher private sector dynamism, and continued macro stability.
- Policy actions should aim to:
  - Leverage growth in ICT and forestry/pulp to generate domestic value chains and auxiliary industries.
  - Address structural constraints that limit spillovers from new export industries to the broader economy.
  - Recognize limitations of relying on commodity-driven growth given long-run price trends and competition.

### The growth prospect of high value-added service exports — labor supply and ICT sector
- Growth prospects depend on the cost, quality, and quantity of labor supply.
- During the boom years, the ICT industry grew to be one of the fastest growing export sectors.
- Uruguay’s comparative advantage in ICT stems from relatively good telecom infrastructure and a well-educated workforce, in particular compared to other countries in the region.
- However, compared to other top ICT exporting countries in the world, Uruguay lags in measures of education quality:
  - lower secondary school completion rate,
  - lower PISA scores in science and math.
- The quality and quantity of labor supply going forward may pose a challenge to the sector’s long-term competitiveness.
- Efficiency of labor markets (allocation of workers to high productivity sectors) will also influence the sector’s international competitiveness.

### The role of the exchange rate
- Nominal appreciation supported short-term growth during the boom.
- Historical pattern:
  - high growth episodes typically led by positive external demand shocks,
  - a surge in growth is almost always followed by immediate exchange rate appreciation.
- During the commodity boom period (2004 to 2014):
  - Uruguayan peso appreciated in real effective terms by 47 percent,
  - and in real terms against the U.S. dollar by about 100 percent.
- After the commodity super cycle ended, nominal depreciation did not translate into equivalent real depreciation in effective terms because of sharp depreciations of the currencies of its neighbors, and an inflation rate higher than its most trading partners.
- An elevated exchange rate might weaken competitiveness of the noncommodity tradable sector and reduce firms’ profit level, reducing investment.
- Comparative empirical points:
  - Uruguay seems to experience larger real exchange rate appreciation in response to GDP shocks (short-term response at t+1 appears among the highest in the region).
  - Inflation in Uruguay seems to be affected more strongly by terms of trade shocks.
  - SVAR estimation indicates a stronger contemporaneous positive impact from terms of trade shocks to inflation compared to other countries in the region.
  - The positive linkage between terms of trade shocks and inflation is asymmetrical: present when shocks are positive, not when negative.
- Regional linkages:
  - Close linkage with the Mercosur market, Argentina in particular, amplifies the impact on Uruguay’s nontradable prices and inflation when regional economies face the same external shocks.

### Structural considerations — overview
- To improve sustainability of supply-side growth drivers, structural reforms that increase the dynamism of the domestic private sector are needed.
- Cross-country comparisons used to identify reform focus:
  - High-growth peers selected by countries that were once at a similar development stage (GDP per capita relative to the U.S. in a 10 percent band around Uruguay 2018) and then had the fastest speed of economic convergence (relative GDP per capita growth higher than 70 percent of the whole sample) in the subsequent 10 years.
  - Trade competitors defined by cosine similarity of revealed comparative advantage for SITC 4-digit goods.
- Comparisons categorized into factors affecting capital input, labor input, human capital, and total factor productivity.

### Investment and capital accumulation
- Investment rate declined after the boom:
  - peak of 25 percent of GDP in 2012,
  - around 16 percent in 2017.
- Even the peak investment rate during the boom years was lower than the average of high-growth peer countries.
- Credit to the private sector is low:
  - private sector credit to GDP ratio is perennially lower than in most peer countries.
  - Financial development score is lower than both comparison groups.
- Possible causes include both demand-side (financing model of private businesses, lower demand for real investment) and supply-side factors (limited banking sector competition, high lending rates, insufficient nonbank market financing options).

### Labor market
- Uruguay fares relatively well on labor welfare indicators, inequality, poverty, and informality.
- Challenges:
  - maintaining social protection while preserving economic efficiency and growth,
  - ensuring labor market flexibility to enable sectoral reallocation and maintain employment.
- Survey data (World Economic Forum) indicate perceived lower labor market flexibility than both high-growth peers and trade rivals in:
  - wage flexibility,
  - hiring and firing regulations,
  - cooperation in labor-employer relations (perceived cooperation less favorable).
- Population dynamics:
  - Population growth is low compared to high-growth countries at a similar development stage.
  - Uruguay has slower population growth and an older population relative to the high-growth peer group.

### Human capital
- Quantity of education is at par with high-growth peers (e.g., average years of schooling).
- Quality of human capital lags:
  - perceived quality of the education system is lower than in both high-growth peers and trade rivals (private sector survey data),
  - Uruguay scored 12–15 percent lower in math and science scales of the PISA assessments compared to the high-growth peer group.

### Productivity
- TFP growth:
  - increased during the boom (reflecting the terms-of-trade shock),
  - over the past 10 years, average TFP growth was a little over 1 percent per year,
  - currently estimated at around 0–0.5 percent.
- TFP growth rate is lower than the average of the high-growth peers at a similar development level, though higher than the average of trade rivals.

### Institutional quality
- Uruguay compares favorably in public governance:
  - scores better than both comparison groups in measures of judicial independence and corruption within the political system.
- Room for improvement in law enforcement, possibly reflecting a rising crime rate.

### Infrastructure
- Quality of transport infrastructure trails high-growth peers and has declined over the years.
- Infrastructure spending:
  - dropped significantly since the mid-1980s,
  - stayed at an average level of around 4 percent of GDP per year,
  - in the last few years fluctuated at around 2 percent of GDP.
- The stock of infrastructure has not improved, or has slightly declined over the past 30 years depending on assumed depreciation rate.

### Business environment
- Uruguay is broadly at par with comparison groups on some business environment aspects (transaction costs for regulatory compliance for tradable sector, tax burden, licensing and permitting).
- Many measures improved over the boom years (overall tax and contribution burden, quality of business regulations, export costs).
- Remaining gaps:
  - compliance costs of international trade (relative to high-growth peers),
  - time and cost of registering property.
- Private sector dynamism:
  - new business activities, measured by new firm registrations per 1,000 adult population, is 70 percent lower than both peer groups,
  - new business activities have been on a trend decline over the past 10 years.

### Macroeconomic environment
- Uruguay preserved macroeconomic stability despite severe regional shocks.
- Over the 10-year span (boom), annual growth in real GDP per capita averaged 4.9 percent, compared with 2.3 percent for Latin America and the Caribbean (LAC).
- Spillovers from Argentina limited largely to real sector and exchange rate channels due to a robust financial sector with reduced exposure to Argentina.
- Remaining macro vulnerabilities relative to comparison groups:
  - higher public debt level (nonfinancial public sector),
  - higher real exchange rate volatility,
  - higher dollarization.
- Inflation:
  - Uruguay has much higher inflation than its trade rival group (excluding Argentina) and the high-growth peer group in recent years.
  - Keeping inflation low and stable would help reduce dollarization and indexation, deepen financial markets, and increase effectiveness of monetary policy.

### External demand shocks and regional transmission
- The external demand shocks came from both within and outside the region.
- Although the commodity price boom was primarily driven by the demand from outside Mercosur, demand from within the region increased as well.
- Uruguay’s main trading partners in the region, Argentina and Brazil, are also prime beneficiaries of the commodity price boom.
- The boom manifested as increased capital inflow and demand on tourism, particularly from Argentina.
- External conditions no longer supportive:
  - The commodity super-cycle ended in 2014 and the commodity prices are expected to remain subdued going forward.
  - Potential growth of the global economy and key trading partners of Uruguay (including China) is much lower than a decade ago.
  - Risks to global growth are on the downside (2019 October, World Economic Outlook).
  - Uruguay continues to be subject to large exchange rate shocks stemming from the region.
  - Prices of some of the key export sectors (such as agriculture) may also be affected by a global trend decline, including due to productivity increases.

### Emerging export industries and structural constraints
- New export sectors gaining importance: ICT and related business services, forestry and paper pulp.
- Continued growth of new sectors requires leveraging strengths and eliminating structural bottlenecks for private sector development.
- Institutional strengths supporting sustainable growth:
  - Strong public governance.
  - A stable regulatory environment for trade and foreign investment.
- Ongoing infrastructure projects (upgrading road networks and introducing a central railway) will help close infrastructure gaps and set the ground for higher growth.

### Structural policy reforms (key constraints and recommendations)
- Structural reforms on key constraints to the private sector will help realize the potential of new export industries and set the stage for inclusive growth:
  - a. Strong, flexible, and equitable labor market is key to support inclusive growth in the face of low population growth and declining labor force participation. Further improvements in the efficiency and flexibility of labor market would help facilitate labor allocation to high productivity sectors, accommodate large negative shocks and incentivize employment.
  - b. Quality and quantity of education should match the needs of skill-intensive new sectors.
  - c. Further improving the business environment, such reducing time and cost of registering property, and financial market development will support the business dynamism.
  - d. Low population growth and aging pressures could be alleviated by further raising female participation or facilitating integration of immigrants into labor market.
  - e. While crime is still low relative to the regional peers, the recent deterioration in crime rates should be addressed before they become macro critical or affects perception on law enforcement.

### Macro policy framework
- A strong and credible macro policy framework is essential for growth sustainability.
- Efforts to reduce debt, inflation, and dollarization and keep them at low levels will lay the foundations for structural reforms to flourish.

### Impact of planned infrastructure investment — overview and financing
- Uruguay’s infrastructure stock is among the highest in the region, but it has barely grown for over the last three decades.
- Public investment has dropped to around 4 percent of GDP per year for the past three decades—fluctuating at around 2–2.5 percent of GDP in recent years.
- A higher base level of infrastructure stock means more resources are needed for simply maintaining the existing stock; quantity and quality of infrastructure have not improved, or have even declined.
- Compared to both high-growth peer countries and main trade rivals, Uruguay lags behind in the quality of transport infrastructure.
- Planned PPPs and projects include the US$800 million central railway project accompanying a new paper pulp plant by UPM, several road transportation projects, and projects to improve education infrastructure.
- Total infrastructure investments over 2019–23 are projected to be around US$2.3 billion (around 4 percent of 2018 GDP).

Projected Infrastructure Investment Amount (2019‑2023, in USD mn)
- Year 2019: Amount 304
- Year 2020: Amount 800.7
- Year 2021: Amount 724.7
- Year 2022: Amount 420.7
- Year 2023: Amount 19

### Methodologies used to assess GDP impact
- Three methods used to estimate direct and indirect impact on GDP:
  - Direct value-added approach.
  - Fiscal multiplier approach.
  - General equilibrium approach (GIMF calibration for Uruguay).

### Direct value-added approach — findings
- Direct impact calculated by adding projected investment amounts to aggregate investments and adding imported components to aggregate imports.
- Under alternative assumptions of 30 percent and 70 percent imported components, for 2020 (the year of highest infrastructure investment) the impact on GDP ranges from 0.4 to close to 1 percent of GDP.
- This approach does not assume indirect, lagged, or knock-on effects; the projected impact returns to zero after projects complete in 2023.

### Fiscal multiplier approach — literature and estimates
- Public investment multipliers vary greatly across country and spending category and depend on country-specific conditions.
- Econometric estimates for Uruguay are less reliable due to little variation in public investment historically.
- Selected multiplier ranges and patterns:
  - Short term multipliers range between 0.1–0.5 percent.
  - Long term multipliers range between 0.4–1.5 percent.
- Multiplier evidence used from three sources to create scenarios:
  - 1) IMF’s World Economic Outlook (2014) — scenario 1.
  - 2) IMF’s Regional Economic Outlook for Latin America (2018) — scenario 2.
  - 3) Furceri & Li (2017) — scenario 3.
- Results:
  - Two of three scenarios imply GDP growth with infrastructure investment higher than baseline throughout the projection period.
  - By the end of 2024, the real GDP level under scenarios with infrastructure investment is 1 to 1.8 percent higher than the baseline.
  - Note: For scenario 2, growth would be higher than baseline from 2019 to 2022, and then drop lower than baseline for the subsequent two years due to higher base GDP.

### General equilibrium approach (GIMF) — setup, assumptions, and results
- GIMF calibrated for Uruguay; simulation assumptions include:
  - Share of liquidity constrained households simulated for both 50 percent (close to estimated share for Uruguay) and 25 percent (average share for advanced economies).
  - Infrastructure investment assumed to be debt-financed and paid back over time through small fiscal adjustment (either raising VAT or cutting transfers).
  - Investment increases public capital stock; maintaining high stock requires maintenance costs.
  - If maintenance costs are minimal (0.08 percent of GDP) public capital depreciates through time—consistent with Uruguay’s past experience.
- GIMF properties:
  - Multi-country DSGE model with optimizing households and firms, sticky prices and wages, liquidity-constrained households, and financial accelerator mechanisms.
  - Version used comprises 6 regions: The United States, the euro area, Uruguay, Latin America excluding Uruguay, emerging Asia (including China), and the remaining countries as a single entity.
- Simulation caveats:
  - Results should be interpreted as an upper bound because:
    - i) simulations assume all investments (roads, rail roads and education projects) are equally productivity enhancing;
    - ii) there are no efficiency losses;
    - iii) the model has strong financial accelerator properties amplifying short-term demand effects, which are not present in Uruguayan economy;
    - iv) if part of investment is done by foreign companies, wealth effects will be smaller than implied by the model.
  - Key short-term amplifying factor: share of liquidity constrained households.
- Simulation outcomes:
  - Simulations suggest a significant impact of planned infrastructure investments on Uruguay GDP, with amplification coming from non-Ricardian effects and liquidity-constrained households.

### Scenarios simulated (four scenarios and core assumptions)
- Four scenarios are simulated:
  - Scenario 1: availability payments to private sector partners financed by raising consumption taxes (which could be in the form of reducing exemptions).
  - Scenario 2: availability payments financed through reducing public transfers.
  - Scenario 3: share of liquidity-constrained households is around 25 percent, while availability payments are financed through raising consumption tax.
  - Scenario 4: maintenance spending after implementation of investment projects is 2/3 lower than the level required to keep the public capital stock constant.
- Common assumptions across scenarios 1 and 2: around 50 percent of the households in the country are liquidity-constrained.
- In all scenarios except scenario 4, maintenance spending is assumed to cover capital depreciation entirely.

### Short-term and long-term GDP implications from scenarios
- Short-term GDP implications:
  - By 2024, the GDP level is projected to be roughly 1½–1¾ percent higher than the baseline (i.e. the scenario without the planned public investments).
  - Short-term implications on GDP level are similar across scenarios and mainly affected by the path of planned investment and its indirect demand effects.
  - The short-term effects are highly dependent on the size and presence of indirect demand channels.
- Long-term GDP effects and role of maintenance and financing:
  - If the public capital stock is maintained, in the long-term real GDP could be 2 percent higher than in the baseline.
  - If public capital stock declines over time due to insufficient maintenance investment, the impact on real GDP is around 1 percent.
  - Using consumption tax for fiscal adjustment is more distortionary compared to using transfers; therefore the impact on real GDP is marginally lower when consumption taxes finance availability payments.
  - The real GDP level is permanently higher versus baseline reflecting productivity effects, though the magnitude depends on whether public investments are maintained.
- Aggregate estimated ranges from methods used:
  - By the end of the five-year projection period, assuming some degree of indirect impact (multiplier and general equilibrium approaches), the increase in GDP level compared to the baseline ranges from 1 percent to 1¾ percent.
  - The longer-term effects, conditional on maintenance of investments, can range between 1 percent to 2 percent.

### Conclusions on infrastructure investment in Uruguay
- The level of infrastructure investment in Uruguay is projected to increase in the next few years.
- Although public investment spending level is not low compared to regional peers, the public capital stock in Uruguay has barely increased over past decades because maintaining the large initial stock would have required higher maintenance investment.
- The planned infrastructure projects are expected to close infrastructure gaps in both quality and quantity, helping to:
  - increase productivity,
  - reduce export costs,
  - boost economic catchup of poorer regions in the country,
  - and raise the level of real GDP.
- Infrastructure investments are expected to have a positive impact on real GDP level, though magnitude depends on many factors (maintenance, financing, indirect demand channels); GDP growth rates will be higher during investment but the growth impact declines with project completion while the level effect is permanent.

*Source: DISSECTING ECONOMIC GROWTH IN URUGUAY (INTERNATIONAL MONETARY FUND), January 28, 2020.*

### References _____________________________________________________________________________ 22

### DISSECTING ECONOMIC GROWTH IN URUGUAY

### Introduction and headline findings
- Uruguay experienced a major economic boom during 2004–14; annual growth in real GDP per capita averaged 4.9 percent over 2004–14, compared with 2.3 percent for Latin America and the Caribbean (LAC).
- Growth slowed after 2014: real GDP growth averaged 1.6 percent from 2015 to 2018.
- Prior to the boom, Uruguay’s GDP per capita had been growing at an average annual rate of under 1 percent for 50 years and had been declining relative to the US until the trend reversed in 2004.
- Goal of the analysis: distinguish short-term vs. sustainable drivers of the 2004–14 boom and identify structural impediments to raise sustainable growth (labor market, education outcomes, private sector dynamism, macro stability).

### Causes of the 2004–14 boom
- Multiple demand- and supply-side factors contributed: recovery from crisis, commodity price boom, increased demand from Argentina, emergence of new export sectors, and exchange rate appreciation.
- Recovery from the crisis:
  - Uruguay suffered a severe downturn in the early 2000s; GDP growth averaged -1.7 percent over 1998–2003.
  - Historical growth evidence indicates mean reversion: an augmented Dickey-Fuller test on annual GDP growth strongly rejects the unit-root null at 1 percent level, implying low growth episodes tend to be followed by rebounds.
- Terms-of-trade and external demand:
  - Around 50 percent of Uruguayan exports are agricultural commodities and their derivatives.
  - Soybean production and exports rose from nearly negligible in the early 2000s to account for 15 percent of total exports in 2014.
  - China became the most important export destination by the end of the boom period, with soybeans accounting for over half of total exports to China.
- Argentine inflows and tourism:
  - Nonresident deposits declined from about 40 percent of total deposits in 2001 to less than 10 percent in 2018.
  - Goods exports to Argentina declined from close to 15 percent of total goods exports in 2001 to less than 5 percent in 2018; service exports, notably travel and tourism, remain substantial and constitute over 15 percent of total exports.
  - Tourism exports grew at an annual rate of 16 percent during the boom.
  - From 2002 to 2012, annual foreign direct investment (FDI) from Argentina increased by 26 times.
- Exchange rate appreciation:
  - Nominal exchange rate vs. USD appreciated over 20 percent from 2004 to 2014.
  - Real GDP in PPP terms almost doubled over the boom period, compared to 68 percent increase without PPP adjustment.
  - Short-term income effects from appreciation supported domestic demand through cheaper imports.
- Sectoral structural change and policy support:
  - ICT exports grew from 2 percent of total exports at the beginning of the boom years to over 10 percent.
  - Montevideo became a leading software development/outsource center, exporting primarily (over 50 percent) to the U.S.
  - Cellulose pulp (forestry) emerged after large investment by UPM; sectoral incentives included 100 percent income tax exemption for software exports (Decree 150/2007) and various incentives for UPM operations.
- Productivity:
  - Measured total factor productivity (TFP) increased over the boom period (Penn World Tables), but TFP correlates highly with output growth and reversed after 2014.

### Quantitative decomposition — relative importance of factors (numerical exercise)
- Method: supply-side contributions measured by real increase in sector exports (2004–14) divided by total real GDP increase; exchange-rate effects based on Selected Issues Paper (2016); rebound effect estimated from regression of 5-year growth on its lag.
- Estimated contributions to the aggregate growth during 2004–14:
  - Rebound from the crisis: about 13 percent of the boom years’ growth.
  - Rise of various commodity exports (e.g., soybean, livestock): over 15 percent of aggregate growth (captures both price and quantity effects).
  - Nominal exchange rate appreciation: around 6 percent of growth.
  - Export growth from new industries (ICT outsourcing and paper pulp): about 10 percent of growth.
- Caveats and biases:
  - Difficult to separate impacts across factors (e.g., soybean and tourism growth contributed to appreciation).
  - Appreciation’s contribution may be overstated; supply-side contributions may be understated.
  - Simultaneity and indirect effects (e.g., external investment inflows contributing to appreciation) complicate attribution.

### Sustainability assessment of growth drivers
- General observation: Some boom drivers are transitory; others may be more sustainable. With external factors waning, focus is on strengthening sustainable drivers and leveraging transitory opportunities to build long-term potential.
- Agricultural commodities:
  - Real agricultural commodity prices display a long-run declining trend, partly due to rising productivity.
  - Commodity prices are expected to remain subdued (World Economic Outlook, October 2019).
  - Increased Chinese demand explained over 60 percent of world demand increase in soybeans in the prior decade and a half; with China’s slowing growth, soybean price declined since 2013.
  - Uruguay’s soybean exports have been on the decline after 2013; neighboring countries (Paraguay and Brazil) show stronger cost and productivity competitiveness.
  - Soybean productivity in Uruguay is at par with the U.S. technological frontier; U.S. soybean sector productivity has historically grown at an average rate of 1 percent per year, implying limited scope for convergence-driven productivity gains in soybeans alone.
- Forestry and paper pulp:
  - Forestry/pulp enjoys relatively stable export prices and steadily increasing world demand; second pulp mill from UPM positions the industry to become Uruguay’s largest exporting industry.
  - Long-run growth contribution depends on spillovers to local auxiliary industries and broader structural constraints in Uruguay.
- Overall implication:
  - Without strong external-demand-driven investment, productivity gains in commodity sectors alone are unlikely to sustain convergence with advanced economies.
  - Emerging industries (ICT, forestry/pulp) present opportunities but face challenges tied to structural constraints.

### Conclusions and policy-relevant implications (from analysis)
- Short-term cyclical and external factors explained a sizable share of the 2004–14 boom; durable convergence requires strengthening sustainable supply-side drivers.
- Key areas to enhance for sustainable growth: labor market flexibility and equity, education outcomes, higher private sector dynamism, and continued macro stability.
- Policy actions should aim to:
  - Leverage growth in ICT and forestry/pulp to generate domestic value chains and auxiliary industries.
  - Address structural constraints that limit spillovers from new export industries to the broader economy.
  - Recognize limitations of relying on commodity-driven growth given long-run price trends and competition.

*Source: DISSECTING ECONOMIC GROWTH IN URUGUAY (INTERNATIONAL MONETARY FUND), January 28, 2020.*

### 23.      The growth prospect of high value-

### 23.      The growth prospect of high value-added service exports

### Labor supply and ICT sector
- Growth prospects depend on the cost, quality, and quantity of labor supply.
- During the boom years, the ICT industry grew to be one of the fastest growing export sectors.
- Uruguay’s comparative advantage in ICT stems from:
  - relatively good telecom infrastructure, and
  - a well-educated workforce, in particular compared to other countries in the region.
- However, compared to other top ICT exporting countries in the world, Uruguay lags in measures of education quality:
  - lower secondary school completion rate,
  - lower PISA scores in science and math.
- The quality and quantity of labor supply going forward may pose a challenge to the sector’s long-term competitiveness.
- Efficiency of labor markets (allocation of workers to high productivity sectors) will also influence the sector’s international competitiveness.

### The role of the exchange rate
- Nominal appreciation supported short-term growth during the boom.
- Historical pattern:
  - high growth episodes typically led by positive external demand shocks,
  - a surge in growth is almost always followed by immediate exchange rate appreciation.
- Nominal appreciation helped distribute external demand windfalls across the population via de facto increases in income and lifted domestic demand.
- During the commodity boom period (2004 to 2014):
  - Uruguayan peso appreciated in real effective terms by 47 percent,
  - and in real terms against the U.S. dollar by about 100 percent.
- After the commodity super cycle ended, nominal depreciation did not translate into equivalent real depreciation in effective terms because of:
  - sharp depreciations of the currencies of its neighbors, and
  - an inflation rate higher than its most trading partners.
- An elevated exchange rate might weaken competitiveness of the noncommodity tradable sector and reduce firms’ profit level, reducing investment.
- Compared to regional peers:
  - Uruguay seems to experience larger real exchange rate appreciation in response to GDP shocks (short-term response at t+1 appears among the highest in the region).
  - Inflation in Uruguay seems to be affected more strongly by terms of trade shocks.
  - SVAR estimation indicates a stronger contemporaneous positive impact from terms of trade shocks to inflation compared to other countries in the region.
  - The positive linkage between terms of trade shocks and inflation is asymmetrical: present when shocks are positive, not when negative.
- Regional linkages:
  - Close linkage with the Mercosur market, Argentina in particular, amplifies the impact on Uruguay’s nontradable prices and inflation when regional economies face the same external shocks.

### Structural considerations — overview
- To improve sustainability of supply-side growth drivers, structural reforms that increase the dynamism of the domestic private sector are needed.
- Cross-country comparisons are used to identify reform focus:
  - High-growth peers selected by countries that were once at a similar development stage (GDP per capita relative to the U.S. in a 10 percent band around Uruguay 2018) and then had the fastest speed of economic convergence (relative GDP per capita growth higher than 70 percent of the whole sample) in the subsequent 10 years.
  - Trade competitors defined by cosine similarity of revealed comparative advantage for SITC 4-digit goods.
- Comparisons are categorized into factors affecting capital input, labor input, human capital, and total factor productivity.

### Investment and capital accumulation
- Investment rate declined after the boom:
  - peak of 25 percent of GDP in 2012,
  - around 16 percent in 2017.
- Even the peak investment rate during the boom years was lower than the average of high-growth peer countries.
- Credit to the private sector is low:
  - private sector credit to GDP ratio is perennially lower than in most peer countries.
  - Financial development score is lower than both comparison groups.
- Possible causes include both demand-side (financing model of private businesses, lower demand for real investment) and supply-side factors (limited banking sector competition, high lending rates, insufficient nonbank market financing options).

### Labor market
- Uruguay fares relatively well on labor welfare indicators, inequality, poverty, and informality.
- Uruguay faces the challenge of maintaining social protection while preserving economic efficiency and growth, and ensuring labor market flexibility to enable sectoral reallocation and maintain employment.
- Survey data (World Economic Forum) indicate perceived lower labor market flexibility than both high-growth peers and trade rivals in:
  - wage flexibility,
  - hiring and firing regulations,
  - cooperation in labor-employer relations (perceived cooperation less favorable).
- Population dynamics:
  - Population growth is low compared to high-growth countries at a similar development stage.
  - Uruguay has slower population growth and an older population relative to the high-growth peer group.

### Human capital
- Quantity of education is at par with high-growth peers (e.g., average years of schooling).
- Quality of human capital lags:
  - perceived quality of the education system is lower than in both high-growth peers and trade rivals (private sector survey data),
  - Uruguay scored 12–15 percent lower in math and science scales of the PISA assessments compared to the high-growth peer group.

### Productivity
- TFP growth:
  - increased during the boom (reflecting the terms-of-trade shock),
  - over the past 10 years, average TFP growth was a little over 1 percent per year,
  - currently estimated at around 0–0.5 percent.
- TFP growth rate is lower than the average of the high-growth peers at a similar development level, though higher than the average of trade rivals.

### Institutional quality
- Uruguay compares favorably in public governance:
  - scores better than both comparison groups in measures of judicial independence and corruption within the political system.
- Room for improvement in law enforcement, possibly reflecting a rising crime rate.

### Infrastructure
- Quality of transport infrastructure trails high-growth peers and has declined over the years.
- Infrastructure spending:
  - dropped significantly since the mid-1980s,
  - stayed at an average level of around 4 percent of GDP per year,
  - in the last few years fluctuated at around 2 percent of GDP.
- The stock of infrastructure has not improved, or has slightly declined over the past 30 years depending on assumed depreciation rate.

### Business environment
- Uruguay is broadly at par with comparison groups on some business environment aspects (transaction costs for regulatory compliance for tradable sector, tax burden, licensing and permitting).
- Many measures improved over the boom years (overall tax and contribution burden, quality of business regulations, export costs).
- Remaining gaps:
  - compliance costs of international trade (relative to high-growth peers),
  - time and cost of registering property.
- Private sector dynamism:
  - new business activities, measured by new firm registrations per 1,000 adult population, is 70 percent lower than both peer groups,
  - new business activities have been on a trend decline over the past 10 years.

### Macroeconomic environment
- Uruguay preserved macroeconomic stability despite severe regional shocks.
- Over the 10-year span (boom), annual growth in real GDP per capita averaged 4.9 percent, compared with 2.3 percent for Latin America and the Caribbean (LAC).
- Spillovers from Argentina limited largely to real sector and exchange rate channels due to a robust financial sector with reduced exposure to Argentina.
- Remaining macro vulnerabilities relative to comparison groups:
  - higher public debt level (nonfinancial public sector),
  - higher real exchange rate volatility,
  - higher dollarization.
- Inflation:
  - Uruguay has much higher inflation than its trade rival group (excluding Argentina) and the high-growth peer group in recent years.
  - Keeping inflation low and stable would help reduce dollarization and indexation, deepen financial markets, and increase effectiveness of monetary policy.

### Conclusion
- The economic boom in Uruguay over 2004–14 was driven by a combination of positive external demand shocks, rebound from the crisis, and emergence of new sectors.
- The 10-year growth acceleration starting in the mid-2000s was the biggest economic boom in Uruguay’s history over the past half century, propelled by overlapping factors including:
  - bounce back from the early-2000s crisis,
  - growth in external demand of commodities that boosted agricultural export prices,
  - emergence of new export sectors.

*Source: 1uryea2020002 - 23.      The growth prospect of high value-*

### 47. The external demand shocks were particularly strong because they came from both

### The external demand shocks were particularly strong because they came from both

### External demand shocks and regional transmission
- The external demand shocks came from both within and outside the region.
- Although the commodity price boom was primarily driven by the demand from outside Mercosur, demand from within the region increased as well.
- Uruguay’s main trading partners in the region, Argentina and Brazil, are also prime beneficiaries of the commodity price boom.
- The boom manifested as increased capital inflow and demand on tourism, particularly from Argentina.

### External conditions no longer supportive
- The commodity super-cycle ended in 2014 and the commodity prices are expected to remain subdued going forward.
- Potential growth of the global economy and key trading partners of Uruguay (including China) is much lower than a decade ago.
- Risks to global growth are on the downside (2019 October, World Economic Outlook).
- Uruguay continues to be subject to large exchange rate shocks stemming from the region.
- Prices of some of the key export sectors (such as agriculture) may also be affected by a global trend decline, including due to productivity increases.

### Emerging export industries and structural constraints
- New export sectors gaining importance: ICT and related business services, forestry and paper pulp.
- Continued growth of new sectors requires leveraging strengths and eliminating structural bottlenecks for private sector development.

### Institutional strengths supporting sustainable growth
- Uruguay’s institutional strengths include:
  - Strong public governance.
  - A stable regulatory environment for trade and foreign investment.
- Ongoing infrastructure projects (upgrading road networks and introducing a central railway) will help close infrastructure gaps and set the ground for higher growth.

### Structural policy reforms (key constraints and recommendations)
- Structural reforms on key constraints to the private sector will help realize the potential of new export industries and set the stage for inclusive growth:
  - a. Strong, flexible, and equitable labor market is key to support inclusive growth in the face of low population growth and declining labor force participation. Further improvements in the efficiency and flexibility of labor market would help facilitate labor allocation to high productivity sectors, accommodate large negative shocks and incentivize employment.
  - b. Quality and quantity of education should match the needs of skill-intensive new sectors.
  - c. Further improving the business environment, such reducing time and cost of registering property, and financial market development will support the business dynamism.
  - d. Low population growth and aging pressures could be alleviated by further raising female participation or facilitating integration of immigrants into labor market.
  - e. While crime is still low relative to the regional peers, the recent deterioration in crime rates should be addressed before they become macro critical or affects perception on law enforcement.

### Macro policy framework
- A strong and credible macro policy framework is essential for growth sustainability.
- Efforts to reduce debt, inflation, and dollarization and keep them at low levels will lay the foundations for structural reforms to flourish.

### Impact of planned infrastructure investment — overview
- Uruguay’s infrastructure stock is among the highest in the region, but it has barely grown for over the last three decades.
- Public investment has dropped to around 4 percent of GDP per year for the past three decades—fluctuating at around 2–2.5 percent of GDP in recent years.
- A higher base level of infrastructure stock means more resources are needed for simply maintaining the existing stock; quantity and quality of infrastructure have not improved, or have even declined.
- Compared to both high-growth peer countries and main trade rivals, Uruguay lags behind in the quality of transport infrastructure.

### Planned infrastructure projects and financing
- Planned PPPs and projects include the US$800 million central railway project accompanying a new paper pulp plant by UPM, several road transportation projects, and projects to improve education infrastructure.
- Total infrastructure investments over 2019–23 are projected to be around US$2.3 billion (around 4 percent of 2018 GDP).
- Projected Infrastructure Investment Amount (2019‑2023, in USD mn):
  - Year 2019: Amount 304
  - Year 2020: Amount 800.7
  - Year 2021: Amount 724.7
  - Year 2022: Amount 420.7
  - Year 2023: Amount 19

### Methodologies used to assess GDP impact
- Three methods used to estimate direct and indirect impact on GDP:
  - Direct value-added approach.
  - Fiscal multiplier approach.
  - General equilibrium approach (GIMF calibration for Uruguay).

### Direct value-added approach — findings
- Direct impact calculated by adding projected investment amounts to aggregate investments and adding imported components to aggregate imports.
- Under alternative assumptions of 30 percent and 70 percent imported components, for 2020 (the year of highest infrastructure investment) the impact on GDP ranges from 0.4 to close to 1 percent of GDP.
- This approach does not assume indirect, lagged, or knock-on effects; the projected impact returns to zero after projects complete in 2023.

### Fiscal multiplier approach — literature and estimates
- Public investment multipliers vary greatly across country and spending category and depend on country-specific conditions.
- Econometric estimates for Uruguay are less reliable due to little variation in public investment historically.
- Selected multiplier ranges and patterns:
  - Short term multipliers range between 0.1–0.5 percent.
  - Long term multipliers range between 0.4–1.5 percent.
- Factors affecting multiplier size: advanced vs emerging economy status, recessionary conditions, public investment efficiency, debt levels, trade openness.
- Multiplier evidence used from three sources to create scenarios:
  - 1) IMF’s World Economic Outlook (2014) — scenario 1.
  - 2) IMF’s Regional Economic Outlook for Latin America (2018) — scenario 2.
  - 3) Furceri & Li (2017) — scenario 3.
- Results:
  - Two of three scenarios imply GDP growth with infrastructure investment higher than baseline throughout the projection period.
  - By the end of 2024, the real GDP level under scenarios with infrastructure investment is 1 to 1.8 percent higher than the baseline.
  - Note: For scenario 2, growth would be higher than baseline from 2019 to 2022, and then drop lower than baseline for the subsequent two years due to higher base GDP.

### General equilibrium approach (GIMF) — setup and assumptions
- GIMF calibrated for Uruguay; simulation assumptions include:
  - Share of liquidity constrained households simulated for both 50 percent (close to estimated share for Uruguay) and 25 percent (average share for advanced economies).
  - Infrastructure investment assumed to be debt-financed and paid back over time through small fiscal adjustment (either raising VAT or cutting transfers).
  - Investment increases public capital stock; maintaining high stock requires maintenance costs.
  - If maintenance costs are minimal (0.08 percent of GDP) public capital depreciates through time—consistent with Uruguay’s past experience.

### GIMF properties (summary)
- GIMF is a multi-country DSGE model with optimizing households and firms, sticky prices and wages, liquidity-constrained households, and financial accelerator mechanisms.
- Model captures non-Ricardian effects making fiscal measures non-neutral in short run and long run.
- Version used comprises 6 regions: The United States, the euro area, Uruguay, Latin America excluding Uruguay, emerging Asia (including China), and the remaining countries as a single entity.

### GIMF simulation results and caveats
- Simulations suggest a significant impact of planned infrastructure investments on Uruguay GDP.
- Results should be interpreted as an upper bound because:
  - i) simulations assume all investments (roads, rail roads and education projects) are equally productivity enhancing;
  - ii) there are no efficiency losses;
  - iii) the model has strong financial accelerator properties amplifying short-term demand effects, which are not present in Uruguayan economy;
  - iv) if part of investment is done by foreign companies, wealth effects will be smaller than implied by the model.
- Key short-term amplifying factor: share of liquidity constrained households.
- Simulations assume investment is debt-financed and repaid via small fiscal adjustments (VAT increase or transfers cut).

*Source: Excerpt from IMF country chapter on Uruguay (1uryea2020002) contained in the provided content unit.*

### 11.      Specifically, four scenarios are simulated. In scenario 1, it is assumed that the government will

### 1uryea2020002 - 11. Specifically, four scenarios are simulated. In scenario 1, it is assumed that the government will

### Scenarios simulated (summary of assumptions)
- Four scenarios are simulated:
  - Scenario 1: availability payments to private sector partners financed by raising consumption taxes (which could be in the form of reducing exemptions).
  - Scenario 2: availability payments financed through reducing public transfers.
  - Scenario 3: share of liquidity-constrained households is around 25 percent, while availability payments are financed through raising consumption tax.
  - Scenario 4: maintenance spending after implementation of investment projects is 2/3 lower than the level required to keep the public capital stock constant.
- Common assumptions across scenarios 1 and 2: around 50 percent of the households in the country are liquidity-constrained.
- In all scenarios except scenario 4, maintenance spending is assumed to cover capital depreciation entirely.

### Short-term GDP implications
- By 2024, the GDP level is projected to be roughly 1½–1¾ percent higher than the baseline (i.e. the scenario without the planned public investments).
- Short-term implications on GDP level are similar across scenarios and mainly affected by the path of planned investment and its indirect demand effects.
- The short-term effects are highly dependent on the size and presence of indirect demand channels.

### Long-term GDP effects and role of maintenance and financing
- If the public capital stock is maintained, in the long-term real GDP could be 2 percent higher than in the baseline.
- If public capital stock declines over time due to insufficient maintenance investment, the impact on real GDP is around 1 percent.
- Using consumption tax for fiscal adjustment is more distortionary compared to using transfers; therefore the impact on real GDP is marginally lower when consumption taxes finance availability payments.
- The real GDP level is permanently higher versus baseline reflecting productivity effects, though the magnitude depends on whether public investments are maintained.

### Aggregate estimated ranges from methods used
- By the end of the five-year projection period, assuming some degree of indirect impact (multiplier and general equilibrium approaches), the increase in GDP level compared to the baseline ranges from 1 percent to 1¾ percent.
- The longer-term effects, conditional on maintenance of investments, can range between 1 percent to 2 percent.

### Conclusions on infrastructure investment in Uruguay
- The level of infrastructure investment in Uruguay is projected to increase in the next few years.
- Although public investment spending level is not low compared to regional peers, the public capital stock in Uruguay has barely increased over past decades because maintaining the large initial stock would have required higher maintenance investment.
- The planned infrastructure projects are expected to close infrastructure gaps in both quality and quantity, helping to:
  - increase productivity,
  - reduce export costs,
  - boost economic catchup of poorer regions in the country,
  - and raise the level of real GDP.
- Infrastructure investments are expected to have a positive impact on real GDP level, though magnitude depends on many factors (maintenance, financing, indirect demand channels); GDP growth rates will be higher during investment but the growth impact declines with project completion while the level effect is permanent.

### Methods used to assess effects
- Three approaches were used to assess direct and indirect GDP level effects:
  - i) direct value-added approach,
  - ii) multipliers,
  - iii) simulation of a general equilibrium model.
- All three approaches suggest a positive effect on growth; estimated magnitudes vary widely.

*Sources: BCU and IMF staff calculations.*

### References

### References

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- Mazzuchi, G. (2009). Labor Relations in Uruguay 2005-2008. Geneva: International Labor Office.

*Source: References section of the supplied content unit.*

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_Source: https://www.imf.org/-/media/files/publications/cr/2020/english/1uryea2020002.pdf_