El Salvador

Towards a Fiscal Policy for Development: Launch of Latin American Economic Outlook 2009


Remarks by Angel Gurría, OECD Secretary General

28 October 2008, San Salvador, El Salvador

President Saca, Secretary-General Enrique Iglesias, Ministers, friends, good afternoon:

It gives me great pleasure to be here in El Salvador — Cuscatlán,  the “Land of beautiful jewels”  as our ancestors called this lovely part of the world. Latin America is increasingly important for the OECD, and that is why we are here at this gathering prior to the Eighteenth Ibero-American Summit.

In these uncertain and turbulent times, it is important for Latin America not to lose sight of its long-term structural goals. The crisis raises urgent challenges; but we cannot allow current difficulties to distract our attention from the key goals of progress and well-being for our societies.

We are here in El Salvador to launch the second edition of the OECD's Latin American Economic Outlook (LEO-2009), which is becoming an increasingly effective vehicle for learning and the exchange of experiences between our organisation and Latin American countries.

Towards a fiscal policy for development

Latin American Economic Outlook 2009, produced by the OECD's Development Centre, homes in on one of the region's  strategic challenges: harnessing fiscal policy as a development tool.

The tax and expenditure system is increasingly important in today's economic climate. Governments are using fiscal policy to ride out the economic-financial storm, in an attempt to revive credit and growth, through incentives for consumption, bank bailout packages, injections of liquidity into the financial system, and increases in public expenditure and investment.

All of these measures are the focus of debate and certainly warrant in-depth study. But the analysis of fiscal policies in Latin America must reach beyond this and ask to what extent governments are making the most of the potential of fiscal policy as a tool to promote long-term development.

Fiscal policy in Latin America: unexploited potential

The report we are launching today recognizes the progress that Latin America has recently made in the fiscal domain. After six straight years of growth rates around 5%, the region today has a global fiscal surplus of 0.3% of GDP (2007), a primary surplus of 2.3% of GDP, and a falling level of public debt, equivalent to 33% of GDP.  This situation provides greater room for manoeuvre to tackle the global crisis.
Nonetheless, despite achieving this important equilibrium and stability, the truth is that Latin America's fiscal systems do little to combat poverty and reduce inequality, which are clearly two of the region's main challenges.

Let me give an example: as you can see in Figure 1 which is now on the screen, whereas in Europe taxes and transfers reduce inequality by 19 Gini points, the effect in Latin America is less than two points. Thus, while fiscal systems in Europe redistribute wealth and reduce inequality, in Latin America they have virtually no impact.
Figure 1. Gini coefficients of income inequality, before and after taxes and transfers.

Source: Latin American Economic Outlook 2009, p. 122

In a region where the wealthiest 10% of the population receive 41% of total income, and the poorest 10% obtain just 1%, the impotence of tax systems to reduce inequalities is particularly dramatic.

In 2007, Latin America was the region of the world in which the wealth of the richest families (i.e. those with over US$1 million of liquid savings) grew most;  but 360 million Latin American people continue to live with purchasing power of under US$300 per month.

The paradox is that in many of the region's countries, social security spending remains highly regressive and is one of the chief obstacles to exploiting the redistributive potential of fiscal policy.

The quality of essential public goods, such as health, security or education, also fails to respond to the region's development needs, and does not make citizens feel a commitment towards the State.

The perception that taxes do not result in better services undermines people's trust in their democratic institutions and processes. A government's fiscal legitimacy, and trust in its fiscal system, reflect the quality of a nation's social contract.

Latin American countries need to retarget their fiscal policy on their main weakness: inequality. But for fiscal policy to yield better results as a development tool, a number of changes will be essential.

1. Decoupling fiscal policy from political cycles

Firstly it is essential to decouple fiscal policy from political cycles.  This is easy to say, but we all know that it is a complex challenge.

According to LEO 2009, one of the key problems is that the markets for Latin American sovereign bonds, which governments use to partly finance the shortfall between their expenditure and their income, are highly sensitive to Latin American political cycles — much more so than in OECD countries.

This high volatility of capital markets during Latin American electoral cycles can be seen as a lack of credibility in economic decision-making by governments and political parties. Such mistrust undermines the fiscal capacity of Latin American States.

Prudent and transparent economic policy management needs to be matched by painstaking communication to explain the scale, complexity and effectiveness of public expenditure. This would help strengthen the credence that  banks, investors and other economic stakeholders place in fiscal policies.

2. Improve tax collection mechanisms

Another essential step to empower fiscal policy as a development tool entails improving revenue generating mechanisms. Despite recent progress, Latin American governments still fail to raise enough tax revenue to provide quality public services. Between 1990 and 2006, the region's total government income averaged just 23% of GDP, compared to 42% in OECD countries.

In this domain, it is crucial to reduce the excessive reliance on nontax income and revenue from indirect taxes, which provide over half of all fiscal revenue in Latin America, as against one third in OECD countries. Personal income taxes, which tend to be more progressive, produce just 4% of total fiscal revenue in Latin America, compared to 27% in the OECD.

Of course, a key challenge for improving tax revenue continues to be the informal economy; one of the most complex problems in any economic analysis of Latin America. Informal workers are not necessarily tax evaders; many of them are poor people who are excluded from formal labour markets and thus deprived of the benefits associated with having a formal job.

Encouraging tax compliance is essential. But it needs to be achieved through simplified regimes that balance the costs and benefits of formality; and by providing social services that treat formal and informal workers the same. This policy mix is  likely to be better able to tackle the complex phenomenon of informality in Latin America; and our report devotes an entire chapter to this key challenge.

3. Improving the quality of public expenditure

Improving the quality of public expenditure is another key task on the agenda. Latin America not only needs to generate more revenue and spend more: it also needs to spend better — not only to enable the poorest to receive a larger proportion of government expenditure, but also to increase the quantity and quality of public goods and services for the benefit of all.

Public expenditure in Latin America averaged of 25% of GDP between 1990 and 2006, compared to 44% in OECD countries. Although several Latin American governments have been increasing their expenditure, the region needs to improve both the quantity and quality of public goods and services to reduce inequalities.
What better example than the education sector?

Public expenditure on education in Latin America has grown steadily over the last four years, and now represents 4% of regional GDP — the same as in OECD countries. Nonetheless, this expenditure growth has not been reflected in better results in the education system as a whole. Expenditure per student in Latin America is only one fifth of the OECD level, and the achievement gap between Latin American students and their OECD peers is equivalent to three years' schooling.

Turning education expenditure into better students is not a simple matter; but it is arguably the most important challenge facing Latin American countries at the present time. Meeting it requires the design and implementation of suitable policies and reforms to focus educational systems on achieving results, and putting the necessary incentives in place.

As Figure 2 shows, other emerging countries, such as Lithuania and Macau-China for example, spend similar amounts per student, but achieve better results than Latin America in terms of both student performance and equality of opportunities.

Figure 2. Public expenditure on education and performance in the PISA

Source: Latin American Economic Outlook 2009, p. 193

The OECD has a lot to share with you in this area; and I'd like to take this opportunity to invite all Latin American countries to participate in our Programme for International Student Assessment (PISA), in which six of the region's countries are already involved.

We also have valuable experiences to share in the design, promotion and implementation of educational reforms. The recently approved Alliance for Education Quality in Mexico, in which we are working with the Mexican government, is an example of the potential benefits of our cooperation in this field.

Ladies and gentlemen:
Latin America has huge potential. There are few continents with so many young, enthusiastic, enterprising, courageous people with the urge to better themselves through honest endeavour. They are well represented here today. We cannot allow ourselves the luxury of continuing to lose them to emigration, organized crime or drug trafficking.

There is no reason why our more advanced students should be three years behind their counterparts in Europe or the United States. We must give them the best tools to make the most of globalization. But we cannot do this without a modern, vigorous and reliable fiscal policy. Limited budgets produce limited citizens. It's time to unleash the potential of fiscal policy as a development tool — today more than ever.

I invite you to read Latin American Economic Outlook 2009 carefully. It contains our ideas and suggestions; and it describes our experiences compared to yours. This is how major changes begin — with a book, with an idea, a dream and enthusiasm. 

The change that has taken place in Latin American countries over the last 20 years has been impressive; hopefully in the next 20 a retargeted fiscal policy will help produce those prosperous, equitable and secure societies that all Latin Americans deserve and yearn. The OECD will always stand ready to help you on the road to achieving this major goal.

Thank you very much.


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