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Example 25: In Brazil, about half the labor force is employed in the informal economy.
The informal economy consists of unregulated and untaxed business activities, such as street
vendors, at-home manufacturing, self-employed service providers, etc. Since the informal
economy generally avoids taxation, the formal economy must be taxed heavily to support the
large government.
The heavy taxation of the formal economy takes away much of the productivity advantage that
formal companies have over informal companies and makes it difficult for the more productive
formal companies to drive the less productive informal companies out of business. To increase
productivity, the more productive companies need to expand and the less productive companies
need to shrink or disappear.
Free and Competitive Product Markets
Free and competitive product markets are vitally important for achieving high productivity. In a
competitive product market, a firm can increase its profits by increasing its productivity. This
increase in productivity may arise from developing a more valuable product or a more efficient
method of production. The more productive firm gains market share from less productive firms.
The less productive firms must either increase their productivity or go out of business.
Example 26: In 1987, Wal-Mart had 9% of the general merchandise market in the U.S. and had a
44% productivity advantage over the rest of this market. Wal-Mart’s productivity advantage
allowed it to gain market share. By 1995, Wal-Mart had 27% of the general merchandise market
and a slightly larger productivity advantage than in 1987. By 1999, Wal-Mart had 30% of the
general merchandise market and had increased its productivity by 5.1% per year from 1995 to
1999. However, its chief competitors had increased productivity even faster, by 6.4% per year,
and were catching up with Wal-Mart in productivity.
Focus on Consumer Interests
A focus on consumer interests rather than on producer interests is necessary to achieve free and
competitive product markets. Governments often restrict competition in product markets to benefit
special-interest groups.
Example 27: Small shopkeepers are a powerful special-interest group in Japan. For many years,
Japan restricted the size of retail stores. This protected traditional small shops from competition
against larger (and more productive) stores. As a result, traditional small shops make up a large
percentage of retail stores in Japan. The traditional small shops are much less productive than
larger modern stores. Moreover, the large number of traditional small shops hinders productivity
in the wholesale sector. (It is much more efficient to deliver goods to one Wal-Mart than to deliver
goods to 100 mom-and-pop stores.)
Example 28: In India, the tariff on imported cars is 44%. Also in India, the Small-scale
Reservation law limits production of over 800 products to small-scale firms.
Increasing Labor Productivity
To increase labor productivity, countries need to increase competition in product markets. This
can be accomplished by:
1. Reducing trade restrictions on imports. This will force domestic producers to compete with the
most productive firms from around the world.
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2. Permitting foreign direct investment in the domestic economy. LDCs do not have to “discover”
the best methods of production. Foreign companies allowed to make direct investments will
bring the best methods of production to the LDCs.
15 - 11 Less Developed Countries