Latin American Economic Outlook 2009:

Fiscal Policy and Latin America’s Development

Organization of American States

Javier Santiso Director and Chief Economist OECD Development Centre Washington - 24 March 2009

OECD members 2009 - 23 members

The Development Centre: Bridging OECD and Emerging Economies

Non-OECD members 2009 - 11 members Chile Israel South Africa Brazil India Thailand Egypt Indonesia Romania Vietnam Colombia OECD Development Centre Future Members 2009 - 4 members Morocco Costa Rica Peru Mauritius

The Development Centre: Renewed Impact

• Stronger links with the private sector cemented by an Emerging Markets Network (EmNet) • Deepened relations with international organisations, think tanks and academia • Institutionalisation of contacts with officials and decision makers

OECD Development Centre

The OECD and Latin America

An emerging commitment

• • • •

Increasing importance of Latin American market democracies for the OECD

The Latin American dimension at the OECD: - Mexico: Member since 1994; Chile: candidate since May 2007; Brazil: enhanced engagement, May 2007

The Development Centre: A bridge between OECD countries and emerging economies

The Latin American dimension at the OECD Development Centre: - Four Latin American members of the Centre’s Governing Board: Brazil, Chile, Colombia and Mexico - Consolidation of Latin America and Caribbean Desk

OECD Development Centre

Fiscal Policy for Development

Latin American Economic Outlook 2009

Using the potential of fiscal policy as a development tool...

...to boost economic growth, combat poverty and inequality, and set a cornerstone for democratic consolidation

Latin American Economic Outlook 2009: Fiscal Policy and Latin America’s Development

OECD Development Centre

The financial crisis: Should Latin America be worried?

Historically speaking, yes: when the U.S. sneezes, Latin America catches a flu.

Effect of US Recessions on Latin American growth

(Median for Region) 2% 1% 0% -1% -2% -3% -4% -5% -6% -7% 1974-75 1980 1982 1991 2001 United States Latin America All Recessions

So urce: IM F , 2007

Export Exposure to the US

(change in average output gap during recessions) 0 -0,5 -1 -1,5 -2 -2,5 -3 Least exposed Most exposed Industrial Countries

So urce: Lane and M ilesi-Ferreti, 2006

Least exposed Most exposed Emerging Markets

OECD Development Centre

Initial impact has been limited...

...thanks to credible economic policies and high internal demand

GDP (% annual growth) 5 4 7 6 1 0 3 2 -1 -2 2000 2001 Advanced countries 2002 2003 Latin America 2004 2005 2006 2007 2008 Source: OECD Development Centre, based on IMF (WEO October 2008) Output gap (%) Advanced countries Latin America -2 -3 -4 -5 2 1 0 -1 5 4 3 1990 1992 1994 1996 1998 Emerging countries 2000 2002 2004 2006 2008 Source: OECD Development Centre, based on IMF (WEO October 2008)

OECD Development Centre

The financial crisis: Should Latin America be worried?

Things could be different today: current accounts are largely positive

Current Account Balance (% GDP)

Source: OECD Development Centre, based on Thompson DataStream and EUI, 2008.

OECD Development Centre

The financial crisis: Should Latin America be worried?

Current account : Trade and remittances on the spot

Latin American Exports (by destination) 65% Remittances (%, annual growth) El Salvador Mexico Guatemala Latin America 25 20 15 10 5 0 -5 2004 2005 2006 2007

Source: OECD Development Centre based on World Bank, November 2008

2008

Source: OECD Development Centre based on WITS 2008.

OECD Development Centre

1. The financial crisis: Should Latin America be worried?

Things could be different today: Credible fiscal policies have reduced fiscal deficits

Primary Fiscal Balance (% GDP)

Source: OECD Development Centre, based on ECLAC ILPES database

OECD Development Centre

1. The financial crisis: Should Latin America be worried?

Things could be different today: Perceptions of sovereign bonds are improving

Sovereign-bond Spreads vs. Global Risk Aversion Source: OECD Development Centre calculations based on Datastream database

OECD Development Centre

The impact is worsening...

Room for monetary stimulus in some Latin American countries?

Industrial production (% annual growth; moving average) Brazil Chile United States Mexico 10 -5 -10 5 0 -15 Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Source: OECD Development Centre, based on Thomson Datastream, 2009 Brazil 10 9 8 5 4 7 6 3 2 1 Jan-06 Jul-06 Inflation (% y-o-y) Chile Mexico Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Source: OECD Development Centre, based on Thomson Datastream, 2009

OECD Development Centre

GDP growth forecasts are on the downside

Slowdown is not necessarily recession

GDP forecasts for 2009 and 2010 (% annual growth) 0 -1 -2 5 4 3 2 1 na Latin America North America 2009 Western Europe Asia/Pacific Eastern Europe 2010 Source: OECD Development Centre, based on Consensus Forecasts, 2009 GDP forecasts for 2009 in Latam (% annual growth) September 08 October 08 November 08 January 09 5 4 3 2 1 0 -1 A rgentina M exico Venezuela Chile Co lo mbia B razil Latam Source: OECD Development Centre, based on Consensus Forecasts, 2009

OECD Development Centre

In this macro context, the next step is to use…

… fiscal policy as a development tool

• Latin America has not neglected fiscal policy • But macroeconomic stabilisation is not the sole objective of fiscal policy: Fiscal systems provide resources to tackle poverty and inequality Publicly-provided goods and services of a reasonable quantity and quality (expenditure side) financed on the basis of transparent and progressive tax systems (revenue side) can repair the social contract (fiscal legitimacy)

OECD Development Centre

20 10 0 60 50 40 30

Fiscal policy does little to reduce inequality in Latin America

Gini coefficients of income inequality, before and after taxes and transfers

Inequality before taxes and transfers Inequality after taxes and transfers

While taxes and transfers reduce the inequality by 19 Gini points in Europe, the difference is less than two Gini points in Latin America

Source: OECD Development Centre (2008), based on Euromod (2008) for OECD countries and Goñi et al. (2008) for Latin America.

OECD Development Centre

Political context: democratic consolidation…

Democratic Consolidation in Latin America: Experts’ and Citizens’ Views

Democratic performance is improving – by fits and starts – throughout the region, according to political scientists and Latin American citizens alike.

Sources: BTI Index (2008) and Latinobarómetro (2007).

OECD Development Centre

Improved Public Debt Management

External debt is falling and countries can increasingly borrow abroad in local currency

25 External Public Bonds in Latin America External Public Bonds over GNP External Public Bonds over Exports (right axis) 80 70 20 15 60 50 10 40 5 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 30 Source: OECD Development Centre calculations based on World Bank, Global Development Finance database (2008).

1,0 0,8 0,6 0,4 0,2 “Original Sin Index” 0,0 2002 2003 2004 2005 2006 2007 - June 2008 Brazil Colombia Peru Uruguay Source: OECD Development Centre calculations based on World Bank, Global Development Finance database (2008).

OECD Development Centre

Capital Markets, Democracy and the Cost of Debt

The paradox of democracy and debt

Real Exchange Rates around Elections Correlation Between Exchange Rate and Sovereign-bond Spreads During Elections Source: Nieto Parra and Santiso (2008), based on Datastream.

OECD Development Centre

Capital Markets, Democracy and the Cost of Debt

Are Capital-market Jitters around Elections Justified?

The market’s fears have some justification: elections are indeed associated with fiscal volatility

Impact of Elections on Fiscal Policy, 1990-2006 (% of GDP) P rim ary balanc e P rim ary ex penditure

-0,3 -0,4 -0,5 -0,6 -0,7 -0,8 0,1 0,0 -0,1 -0,2 0,3 0,2 0,1 0,0 -0,1 0,8 0,7 0,6 0,5 0,4 OECD Latin A merica OECD Latin A merica Note: The impact of elections on fiscal policy is calculated as the difference between the fiscal variable (as percentage of GDP) during the election year and non-election years.

Source: Nieto Parra and Santiso (2008b, forthcoming)

OECD Development Centre

Capital Markets, Democracy and the Cost of Debt

The paradox of democracy and debt: are conditions improving?

Bank recommendations are downgraded prior to elections, but tend to move positively again once the uncertainty has passed Investment-Bank recommendations around elections Brazil 2002 and 2006: From Lula Preta to Lula de Mel Source: Nieto Parra and Santiso (2008), based on Datastream database.

OECD Development Centre

Taxes and expenditures in Latin America Public revenue generation and Inequality in Latin America

• Why do fiscal systems do so little? - Lower levels of fiscal resources - Lower use of personal income taxes (27 % of total tax revenue in OECD, 4% in LA) - Greater dependence upon regressive indirect taxes • This is explained by lower average incomes (small base for income taxation) and unequal income distribution: Only one out of three Latin Americans is subject to income taxation • Eliminating tax evasion completely would do little to close the tax collection gap, it might even create a net fiscal loss.

OECD Development Centre

OECD-Latin American tax gap: lower levels, different sources Tax (and non-tax) revenues in Latin America and OECD countries OECD

% of total revenues 20,6 26,0 14,8 37,0 Nontax revenuec Indirect taxes Direct taxes SSC

Latin America

% of total revenues 40,3 11,3 28,2 17,7 Direct taxes SSC Latin America OECD OECD America-Pacific 4 2 8 6 14 12 10 0 Taxes on goods and services Social security contributions Taxes on payroll and workforce Notes: a) Where possible, coverage corresponds to general government, otherwise the statistics are restricted to central government.

b) The Latin American countries covered are Argentina, Brazil, Chile, Colombia, Costa Rica, El Salvador, Guatemala, Mexico, Peru and Venezuela.

c) OECD America-Pacific comprises Australia, Canada, Japan, Korea, Mexico, New Zealand and United States.

OECD Development Centre

Informality and the fiscal system

Living with duality

• Informality is an important indicator of a weak or broken social contract, and has important consequences for the fiscal system • Opting out versus forced out?

• Europe: informality largely a matter of tax evasion; Latin America: much more complex • Policy response: Special “add-ons” for taxes and social protection for informal sector… …or simplified universal rules for all workers and firms?

OECD Development Centre

Informality and the fiscal system Labour informality in Latin America

Productive definition (% of workers) Legalistic definition ( % of employees) 80 70 60 50 40 30 20 10 0

More than half of Latin American workers are not entitled to pension rights through their jobs

Nota: Informal employment, as defined in Gasparini and Tornarolli (2007) and Perry et al. (2007), includes unskilled self-employed workers, workers in firms of less than five workers and unpaid workers.

Source: Gasparini and Tornarolli (2007), Perry et al. (2007) and CEDLAS, Socio-Economic Database for Latin America and the Caribbean.

OECD Development Centre

Quantity – and quality – of public spending Improving the quality of public spending: The case of education

• Social spending –in particular, health and education – can play an enormous role in equalising opportunities.

• Spending on education as a share of total public expenditure has been growing in Latin America (now stands at around 4%, similar to OECD level), but still there is room for improvement • Latin America’s PISA results give cause for concern: - OECD-Latin America testing gap equivalent to 3 years worth of schooling – twice the gap for other emerging countries • More money is needed, but how that money is spent matters as much or more.

OECD Development Centre

Quantity – and quality – of public spending Public spending on education and performance in PISA

600 Finland Macao-China Korea 500 Lithuania Spain Portugal 400 Uruguay Chile Colombia Argentina

Education spending per pupil is still five times lower in Latin America than in OECD countries... But quality is as big a problem as quantity

300 0 5 000 10 000 15 000 20 000

Public spending per pupil in primary and secondary education in equivalent USD

25 000 Notes: a) Public spending is calculated as average of available data since 2000. b) Countries performance average on the PISA science scale Source: OECD Development Centre 2008 based on PISA 2006 Science Competences for Tomorrow’s World and OECD and UNESCO World Educational Indicators, UNESCO's Institute of Statistics database.

OECD Development Centre

Latin American Economic Outlook 2009:

Fiscal Policy and Latin America’s Development

Organization of American States

Javier Santiso Director and Chief Economist OECD Development Centre Washington - 24 March 2009