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Social policy and the financial crisis in Latin America: is there any fiscal space left?

Date
Time (GMT +00) 17:30 19:00
Hero image description: Mayan woman walking with basket Image credit:Robert Crum Image license:Creative Commons

Speakers:

Dr. Jeff Dayton-Johnson - Senior Economist & Head of the Latin America and Caribbean Desk, OECD Development Centre

Dr. Hernandez Licona - Executive Secretary of the National Council of Social Policy Development (CONEVAL)

Discussant:

Geoff Handley - Research Officer, ODI

Chair:

Enrique Mendizabal – Research Fellow and Programme Leader, ODI

Speaker 1) Dr. Jeff Dayton Jones

The basic message this year is that fiscal policy should be an arm of social policy and a tool for development.

Starting with the effects of the financial crisis;

Latin America (LA) is undoubtedly being affected, particularly due to slowing exports and incoming remittances. Many of the Latin American countries rely on commodities for the export earnings and have witnessed a considerable shift from their pre-crisis improving terms of trade. But even those not overtly affected are exposed in other ways. For example Mexico is exposed to the toxic asset channel due to large foreign ownership of banks.

However, besides the current account/toxic ownership issues, much of LA is better poised to manage this crisis relative to the crises in the past (i.e.1994/1991/1982). This is largely because before this downturn there was rapid growth in many of the emerging economies and as such some are going into the crisis with a fiscal surplus. Undoubtedly these surpluses have much to do with improved fiscal policy which reflects, in part, institutional changes and better financial discipline.

Now more than ever it is important that we remember that fiscal policy is not just a stabilisation tool; it can also be a tool for lasting development. Traditionally fiscal policy in LA has focused on tightening belts/reducing spending etc. but now we need to look at the longer term objectives which can be served by fiscal policy, such as tackling poverty.

The guiding metaphor of this OECD report is therefore the importance of a strong social contract. i.e. the state providing public goods and services (with fiscal transparency and legitimacy) in exchange for progressive and transparent taxes.

Moving on to Latin American fiscal performance;

There have been recent improvements in capacity to mobilize resources, but there is still a huge difference between LA and the OECD. Expenditure is around 42% of GDP in OECD and only 22% in LA. There is also considerable volatility of fiscal assets in LA which has negative macroeconomic effects.

There has also been little improvement in reducing the need for development i.e. by reducing inequality (JDJ presented some interesting slides on inequality and the gini coefficient here). The much higher inequality we see in LA is in large part due to the inefficient fiscal systems that fail to address the unbalanced distribution of income. What we need for a redistributive fiscal system is democratic consolidation.

The paradox of democracy and debt: are conditions improving?

Public debt has declined as a share of GDP across LA and in the ‘Original Sin Index’ i.e. there is a better quality of public debt. But investment bank recommendations around elections are particularly negative about public debt; which makes life very difficult for the governments to manage debt. Here JDJ presented some useful findings on fluctuations around Brazil’s Lula Preta elections (2002 & 2006). See the OECD Economic Outlook for these graphs.

Tax revenues in LA and OECD

There is a quantity problem and a quality problem. In LA there is large non-public tax revenue i.e. export commodities, which are very volatile. Direct taxes are also much lower in LA (18%) vs OECD (32%). Regressive taxes are also used a lot more with a greater burden on the poor.

But one of the reasons why direct taxes are so low in LA is because of the distribution of income and of course the low average of income.

Spending

JDJ took the example of public spending on education (drawing on findings from the PISA study which uses standardized exam data to contrast average performance against public resources devoted per student). Again we see this quantity and quality problem.

The quality dimension is evident when you look at a country like Finland where the same amount is spent as other countries but the results are considerably higher. JDJ also briefly pointed out some of the issues relating to equity i.e. the share of the variants in performance of students that can be explained by variance in the socio-economic status. See OECD Report for these case studies.

Speaker 2) Dr. Hernandez Licona

In general when we talk about development policies we take fiscal policy as granted but if we want to look at long term, we need to take both parts into account. The results of the tax system of a country provides a snapshot of the social contract that binds the government and its citizens.

General problems in Latin America:

-          High % of tax revenue comes from oil taxes, whilst consumption taxes are low relative to labour taxes

-          The composition of taxes affects job creation: the funds for social security come from those who have formal employment.

-          There is large-scale tax evasion

-          Social spending in general is not progressive (bar a few policies like Opportunidades in Mexico)

-          A transparent framework for public expenditure has not been completely established yet.

Challenges for 2009 (taking Mexico as a case study):

-          Social rights are not explicitly mentioned in various social plans and programmes

-          There is a lack of coordination between social programmes

-          Formal social security affects the fulfilment of universal social rights and generates few formal jobs

-          Low healthcare coverage

-          Low coverage of social security etc…

Specific proposal: Foster a comprehensive advancement in the fulfilment of social rights through;

-          Universal healthcare

-          Reducing the cost of social security

-          Institutional changes in social security so that it can cover all Mexicans, regardless of employment

-          The scheme should be financed through general taxes

Most of all we need to encourage a stronger link between economic and social policy focused on universal social security. Then we can change the source of tax/increase the tax base and so forth. This will create jobs and lower informality, improving productivity. It will also stop small company social security tax evasion because it will be universal.

At the centre of these reforms you will have lower public deficit with lower inequality and a lower social contract.

Above all we need to think about all of these interwoven strands together, instead of changing only one.

Discussant) Geoff Handley

It might be a misnomer to call this report an economic outlook; it’s a political economy outlook and it is very welcome. Fiscal and social policy often happen in parallel so placing politics at the centre of economic forecasts and focusing on political questions is a refreshing approach.

Some comments:

-          In this OCED report there has not been a lot of focus on the organisation of the budget. There has been high quality research on this (commissioned by the DFID Latin American office before its closure and by IADB) so perhaps it is worth drawing on some of these findings.

-          The rich data analysis in this report should be complemented with work on the underlying stories of change. For example, the OECD is well placed to develop research based on historical examples from developed OED countries; there is a lot to learn from rich country history. Simon Szreter recently did a presentation at ODI (at the Growth and Equity Conference) that was very strong on learning from the past and offered some valuable insights.

-          Turning to social protection and comparisons with other regions; we need to look at the demand driven side of social protection. In Africa social protection is funded by aid projects, but is this sustainable or does it risk creating a contingent liability? In Latin America there are examples of social protection programmes that are financed from domestic tax revenues, like Opportunidades. I think this report would benefit from making more of this. How have these been adopted and campaigned for? We need a much better understanding of previous efforts to change the composition of public spending and build social protection programmes (particularly of the political processes) to better inform current efforts to develop and finance social policies within governments.

Financial crisis:

In the context of the crisis many public commentators are calling for percentages of government bailout funds to be handed down to developing countries. It is laudable to want to send these funds to the South, particularly through social protection measures. But it is important to remember that aid is not tax revenues. These systems would not necessarily be ‘owned’ by aid recipient governments and within country there is often insufficient capacity to implement them. So my message is that we need to guard against risks of wasteful spending. There are a lot of reasons why chucking money at poor low capacity countries won’t work. These arguments should not be forgotten in the context of the current crisis.

Comments from the chair) Enrique Mendizabal:

-     The emphasis on the social contract is extremely interesting and sound

-          Particularly when we consider dependence on aid or oil taxes etc.

-          What is the obligation of the government to provide services for people if it is not dependent on them for revenue?

-          How do we break this cycle and improve the social contract?

-          Lets look at history as has been suggested

Questions:

1)      I am considered that the primary focus in LA has been on conditional cash transfers? There is evidently more to this than just giving money to the poor (as OECD graphs show) so should we move away from this? And focus on better health policies etc. all the intrinsics of a welfare state.

JDJ- It’s not so much that taxes are regressive, but spending is not progressive and by and large the biggest explanatory factor there is pensions. I am a big fan of CCTs but I agree it’s a stop gap measure and it doesn’t address underlying asset-holding inequality.

We need to examine further how public spending on education/health compares on income distribution.

HL- CCTs are limited. It is very difficult to think that the social policy of a country should rest of such an expensive and singular policy. What we need to do is to build a more complex system. There is nothing linking pensions and CCTs- the only two comprehensive systems at present. We need to link our systems and make them progressive. If we think improving CCTs is the route out of poverty we are wrong. This needs a comprehensive transformation.

2)      Universal social rights….  I wonder if you think that the perception of inequality has changed in recent history, in Mexico?

3)      Do you think that the improvement in fiscal policy is the result of the increase of bilateral investment in the area?

JDJ: Do you mean tax competition? There is competition to attract investment by having low and simple taxes i.e. Brazil is frequently not touched because of complexity of the tax system.

4)      Suggestions of universal taxation are inappropriate if there is as much informality as you previously pointed out.

HL: You are quite right; we can not tax full employment so lets fund it through general taxes (consumption taxes) so all have the right to social security and so you don’t distort creation of formal job creation.

5)      How do we persuade governments for such comprehensive reform? Can we use the economic downturn as a platform?

JDJ: Now we can tell them that their revenues aren’t very high and their plunging into deficits (not structural), so they can buy this idea that we have to spend in a structural more long term way.

GH: fiscal space is contracting at the moment for sure but crisis can create change.

HL: Now the price of oil is falling, this is a good opportunity to plan an alternative for 2010; for many countries the insurance for oil price drops will soon expire so crunch time for alternative revenues sources. The point is we have to think about alternatives

6)      What is the position of OECD about increasing consumption taxes?

There is no OECD position. There is a lot of disagreement. Many in the economic offices would probably claim that consumption taxes are good, but consumption taxes may be anti development so we need to balance this; as our report shows.

Consumption taxes as % in OECD and LA is actually very similar, so perhaps this is one of the things that we should not tamper with? But this is a hot topic and complex problem i.e. trying to increase growth now, but also trying to increase growth and development for the future.

7)      Comments from Chris Scott (LSE)

This report present data is a very specific way i.e. the graph 6.11 using the PISA data. There is a production function here; the premise is that quality depends on spending. But we all know educational efficiency is very dependent on what happens at home i.e the amount of homework/parents influence.

So I would urge caution with regards to a) the data’s presentation and b) other variables.

JDJ: things that seem to matter in the PISA study is the length of the school day and the curriculum. So, I concur, we should note that money doesn’t necessarily buy you happiness.

Description

The OECD Latin American Economic Outlook 2009 argues that Latin America could do a lot more to use fiscal policy to promote development. It explains how governments in the region can go beyond using fiscal policy uniquely for macroeconomic stabilisation and begin to maximise the potential of debt management, tax systems and public spending to combat poverty, prevent social exclusion and provide more equal opportunities. This event will see Dr. Jeff Dayton-Johnson introducing the OECD Development Centre’s Latin America Economic Outlook 2009 (http://www.oecd.org/dev/publications/leo) focusing on the effect that the current financial crisis might have on already weak fiscal systems. Taking account of this economic outlook Dr. Hernandez Licona will reflect upon what this means for social policy in the region and what the state’s role in re-enforcing social policy is. Geoff Handley will then discuss fiscal space for social protection policy in the context of a looming financial crisis and comparisons from other regions.

This event offered an opportunity to draw lessons from Latin America on the potential impact of the financial crisis on social protection policies across the development world. It also provided a space to launch the Latin American Economic Outlook 2009.

D302, Clement House, Aldwych