1. 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

2. OECD Development Centre 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

3. OECD Development Centre 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

4. OECD Development Centre 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

5. 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

6. OECD Development Centre The financial crisis: Should Latin America be worried? Historically speaking, yes: when the U.S. sneezes, Latin America catches a flu.

7. OECD Development Centre Initial impact has been limited... Source: OECD Development Centre, based on IMF (WEO October 2008) Output gap (%)GDP (% annual growth) Source: OECD Development Centre, based on IMF (WEO October 2008)...thanks to credible economic policies and high internal demand

8. OECD Development Centre The financial crisis: Should Latin America be worried? 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)

9. OECD Development Centre Current account : Trade and remittances on the spot 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% The financial crisis: Should Latin America be worried? Source: OECD Development Centre based on WITS 2008.

10. OECD Development Centre 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?

11. OECD Development Centre Source: OECD Development Centre calculations based on Datastream database 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?

12. OECD Development Centre The impact is worsening... Inflation (% y-o-y)Industrial production (% annual growth; moving average) Source: OECD Development Centre, based on Thomson Datastream, 2009 Room for monetary stimulus in some Latin American countries?

13. OECD Development Centre 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 GDP forecasts for 2009 in Latam (% annual growth)

14. OECD Development Centre … 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…

15. OECD Development Centre 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.

16. OECD Development Centre 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.

17. OECD Development Centre Improved Public Debt Management Source: OECD Development Centre calculations based on World Bank, Global Development Finance database (2008). “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

18. OECD Development Centre Source: Nieto Parra and Santiso (2008), based on Datastream. The paradox of democracy and debt Real Exchange Rates around Elections Correlation Between Exchange Rate and Sovereign-bond Spreads During Elections Capital Markets, Democracy and the Cost of Debt

19. OECD Development Centre 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? Impact of Elections on Fiscal Policy, 1990-2006 (% of GDP) Capital Markets, Democracy and the Cost of Debt

20. OECD Development Centre Capital Markets, Democracy and the Cost of Debt 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

21. OECD Development Centre 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

22. OECD Development Centre 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 (% of GDP, 2005)

23. OECD Development Centre 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

24. OECD Development Centre 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

25. OECD Development Centre 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

26. OECD Development Centre 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

27. 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