Fiscal Policy and Latin America’s Development Washington - 24 March 2009 Latin American Economic...

Fiscal Policy and Latin America’s Development

Washington - 24 March 2009

Latin American Economic Outlook 2009:

Javier Santiso

Director and Chief Economist

OECD Development Centre

Organization of American States


Non-OECD members

2009 - 11 members

OECD members

2009 - 23 members

Chile

South Africa

India

Thailand

Egypt

Israel

Brazil

Romania

Vietnam

Colombia

The Development Centre: Bridging OECD and Emerging Economies

Indonesia

Future Members

2009 - 4 members

Morocco

Costa Rica

Peru

Mauritius


• 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

The Development Centre: Renewed Impact


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

The OECD and Latin America


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


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)

-7%

-6%

-5%

-4%

-3%

-2%

-1%

0%

1%

2%

1974-75 1980 1982 1991 2001 AllRecessionsSource: IMF , 2007

United States

Latin America

Export Exposure to the US (change in average output gap during recessions)

-3

-2,5

-2

-1,5

-1

-0,5

0

Least exposed Most exposed Least exposed Most exposed

Industrial Countries Emerging Markets

Source: Lane and Milesi-Ferreti, 2006


Initial impact has been limited...

Source: OECD Development Centre, based on IMF (WEO October 2008)

-5

-4

-3

-2

-1

0

1

2

3

4

5

1990 1992 1994 1996 1998 2000 2002 2004 2006 2008

Advanced countries Emerging countries

Latin America

-2

-1

0

1

2

3

4

5

6

7

2000 2001 2002 2003 2004 2005 2006 2007 2008

Advanced countries Latin America

Output gap (%) GDP (% annual growth)

Source: OECD Development Centre, based on IMF (WEO October 2008)

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



Things could be different today: current accounts are largely positive

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

Current Account Balance (% GDP)


Current account : Trade and remittances on the spot

-5

0

5

10

15

20

25

2004 2005 2006 2007 2008

El Salvador Guatemala

Mexico Latin America

Remittances (%, annual growth)

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

Latin American Exports (by destination)

Source: OECD Development Centre based on WITS data, 2008

65%


0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

C hina E U US A R est of the World

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

C hina E U US A R est of the World

Source: OECD Development Centre based on WITS 2008.


Source: OECD Development Centre, based on ECLAC ILPES database

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

Primary Fiscal Balance (% GDP)

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


Source: OECD Development Centre calculations based on Datastream database

EMBI Global L atA m vs . V IX (1998-2004)

EMBI Global LatAm = 27.6VIX + 117.1Correlation coefficient = 0.78 0

200

400

600

800

1 000

1 200

1 400

1 600

9 19 29 39VIX index

average

EMBI Global L atA m vs . V IX (2005-2008)

EMBI Global LatAm = 2.3VIX + 232.4Correlation coefficient = 0.14

0

200

400

600

800

1 000

1 200

1 400

1 600

9 19 29 39VIX index

average

Sovereign-bond Spreads vs. Global Risk Aversion

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

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


The impact is worsening...

Inflation (% y-o-y) Industrial production (% annual growth; moving average)

Source: OECD Development Centre, based on Thomson Datastream, 2009Source: OECD Development Centre, based on Thomson Datastream, 2009

-15

-10

-5

0

5

10

Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09

Brazil Chile United States Mexico

1

2

3

4

5

6

7

8

9

10

Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09

Brazil Chile Mexico

Room for monetary stimulus in some Latin American countries?


GDP growth forecasts are on the downside

Slowdown is not necessarily recession

GDP forecasts for 2009 and 2010 (% annual growth)

Source: OECD Development Centre, based on Consensus Forecasts, 2009

Source: OECD Development Centre, based on Consensus Forecasts, 2009

GDP forecasts for 2009 in Latam (% annual growth)

-2

-1

0

1

2

3

4

5

LatinAmerica

NorthAmerica

WesternEurope

Asia/Pacific EasternEurope

2009 2010

na

-1

0

1

2

3

4

5

Argentina Mexico Venezuela Chile Colombia Brazil Latam

September 08 October 08 November 08 January 09


… 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)

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


Gini coefficients of income inequality, before and 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

Fiscal policy does little to reduce inequality in Latin America

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


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

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

Political context: democratic consolidation…

Democratic performance is improving – by fits and starts – throughout the

region, according to political scientists and Latin

American citizens alike.


Improved Public Debt Management

5

10

15

20

25

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

30

40

50

60

70

80

External P ublic Bonds over GNP External P ublic Bonds over Exports (right axis)

Source: OECD Development Centre calculations based on World Bank, Global Development Finance database (2008).

0,0

0,2

0,4

0,6

0,8

1,0

2002 2003 2004 2005 2006 2007 - J une2008

Brazil Colombia Peru Uruguay

“Original Sin Index”External Public Bonds in Latin America

Source: OECD Development Centre calculations based on World Bank, Global Development Finance database (2008).

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


Source: Nieto Parra and Santiso (2008), based on Datastream.

The paradox of democracy and debt

Real Exchange Rates around Elections

99,0

99,5

100,0

100,5

101,0

101,5

102,0

102,5

103,0

-9 -8 -7 -6 -5 -4 -3 -2 -1 0 1 2 3 4 5 6 7 8 90 = e le c tion m onth

Inde

x

-1,0

-0,8

-0,6

-0,4

-0,2

0,0

0,2

0,4

0,6

0,8

1,0

Correlation Between Exchange Rate and Sovereign-bond Spreads During Elections

Capital Markets, Democracy and the Cost of Debt


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

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)

Are Capital-market Jitters around Elections Justified?

P rimary balanc e

-0,8

-0,7

-0,6

-0,5

-0,4

-0,3

-0,2

-0,1

0,0

0,1

OECD Latin America

P rimary ex penditure

-0,1

0,0

0,1

0,2

0,3

0,4

0,5

0,6

0,7

0,8

OECD Latin America

Impact of Elections on Fiscal Policy, 1990-2006 (% of GDP)




Bank recommendations are downgraded prior to elections, but tend to move positively again once the uncertainty has passed

Source: Nieto Parra and Santiso (2008), based on Datastream database.

The paradox of democracy and debt: are conditions improving?

Investment-Bank recommendations around elections

Brazil 2002 and 2006: From Lula Preta to Lula de Mel

-0,4

-0,3

-0,2

-0,1

0,0

0,1

0,2

0,3

0,4

-9 -8 -7 -6 -5 -4 -3 -2 -1 0 1 2 3 4 5 6 7 8 90 = e le c tion m onth

-1,0

-0,5

0,0

0,5

1,0

200 200 200 200 200 200

P residential election date


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.

Taxes and expenditures in Latin America


Tax (and non-tax) revenues in Latin America and OECD countries

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-Latin American tax gap: lower levels, different sources

Source: OECD Development Centre 2008, based on the ECLAC ILPES Public Finance database, OECD Development Centre Latin American Revenue Statistics Database, the OECD Revenue Statistics database and OECD General Government Accounts data

(% o

f GD

P, 2

005)


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?

Informality and the fiscal system


Labour informality in Latin America

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.

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

Informality and the fiscal system


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.

Quantity – and quality – of public spending


Public spending on education and performance in PISA

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.

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

Quantity – and quality – of public spending

Fiscal Policy and Latin America’s Development

Washington - 24 March 2009

Latin American Economic Outlook 2009:

Javier Santiso

Director and Chief Economist


Organization of American States

Fiscal Policy and Latin America’s Development Washington - 24 March 2009 Latin American Economic...

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