Fiscal and democratic legitimacy in Latin America

27 October 2007

Javier SantisoEconomista Jefe

Centro de Desarrollo de la OCDE

Agenda de Desarrollo Iberoamericana 2007Barcelona

2

11 Development and democracyDevelopment and democracy

33 The fiscal transitionThe fiscal transition

22 Fiscal policy: Quality and accountabilityFiscal policy: Quality and accountability

3 Never had there been so much democracy in the continent

Source: OECD Development Centre, 2007. Based on Polity IV project. Note: Polity2 score shown, average of available data for Latin America. Poilty2 is the sum of two indicators “democracy” (0 to10) and “autocracy” (0 to -10 ). These indicators focus on institutionalized aspects of the polity, i.e. de jure. “Democracy is conceived as three essential, interdependent elements.One is the presence of institutions and procedures through which citizens can express effective preferences about alternative policies and leaders. Second is the existence of institutionalized constraints on the exercise of power by the executive. Third is the guarantee of civil liberties to all citizens in their daily lives and in acts of political participation. ” The autocracy index focuses on how restricted political participation is; whether chief executives are chosen in a regularized process of selection within the political elite, and once in office they exercise power with few institutional constraints; and whether theyexercise a high degree of defectiveness over social and economic activity.

The 1980s represent a dramatic turn around for the region in terms of polity

Democracy

Autocracy

4

The region has left the 1980s behind and is recuperating grown in GDP per capita terms

Source: OECD Development Centre, 2007. Based on Angus Madison, Historical Statistics. The World Economy, Paris, OECD, 2003; and Polity IV project. Data is average of available data.

2000

1990

1980

1970

1960 1950

1940

1930 1920

1910 1900

1890 1880

1870 1860

1850 1840 1830 1820

0

1000

2000

3000

4000

5000

-6 -4 -2 0 2 4 6 8

Democratic governance (Polity IV)

GD

P p

er

ca

pit

a (

Ma

dd

iso

n)

more autocracy more democracy

The 1980s were lost in terms of GDP per capita but not in terms of political reform

5Democracy is alive and well:

Elections are competitive affairs

Source: OECD Development Centre, 2007. Based on Daniel Zovatto “Balance Electoral de América Latina 2005 /2006”, in Latinobarómetro, Executive Report 2006 , Political Database of the Americas and Wikipedia (when based on official results).Note: Support is the share of votes of the election winner and margin is the difference with the second highest recipient of votes.

Continuity

Change

Support(% votes)

Margin(% victory)

1st round 50 19

2nd round

51 9

Number of countries

Share (%)

Continuity 8 44

Change 10 56

6

Source: OECD Development Centre based on CEPALSTAT y ECLAC’s Panorama Social de América Latina 2006 and official press release of the Presidency of Chile, 23 September 2007.

% GDP annual growth

Growth has resumed … but it is still far from other emerging economies

China

India Latin America

7Latin American economies have been

loosing grown for some time

Source: OECD Development Centre, 2007. Based on Maddison (2003).

GDP per capita absolute terms GDP per capita relative to US

Plebiscite in Chile, 1988

8… while other regions are accelerating their converge processes with richer economies

Source: OECD Development Centre, 2007. Based on Groningen Growth and Development Centre and The Conference Board, Total Economy Database, 2005.

Note: Annual growth (%) calculated as the average annual rate for the last six decades. Deviation (%) at the beginning of each decade.

1950

19601970

1980

1990

1980

1950

1960

1970

2000/06

1990

2000/06

-4.0

-3.0

-2.0

-1.0

0.0

1.0

2.0

3.0

4.0

5.0

6.0

-30 -10 10 30 50 70 90

GDP deviation (%) with respect to world average ($ 1990)

GD

P p

er

ca

pit

a G

row

th

min

us

av

era

ge

wo

rld

GD

P p

er

ca

pit

a (

% y

ea

rly

)

. Mexico Brazil

1950

1960

1970

1980

1990

2000/06

1950

19601970

1980

19802000/06

-4.0

-3.0

-2.0

-1.0

0.0

1.0

2.0

3.0

4.0

5.0

6.0

-85 -75 -65 -55 -45

GDP Deviation (%) with respect to world average ($ 1990)G

DP

pe

r c

ap

ita

Gro

wth

m

inu

s a

ve

rag

e w

orl

d G

DP

pe

r c

ap

ita

(%

ye

arl

y)

.

China India

Convergence process in Brazil and Mexico compared with other emerging economies

9

Source: OECD Development Centre, 2007. Based on IMF , Globalization and Inequality, 2007. OECD* includes: Australia, Austria, Belgium, Canada, Denmark, Finland, France, Germany, Ireland, Israel, Italy, Japan, Korea, Netherlands, Norway, Singapore, Spain, Sweden, UK, US.

The poorest segments of the population have not joined into the prosperity

0

5

10

15

20

25

-101234567

Q1 Q2 Q3 Q4 Q5

Latin America

1993 2003 change

Unlike other regions, growth in Latin America has left out the poor

GD

P p

er c

ap

ita

by

qu

intile

GD

P p

er c

ap

ita

by

qu

intile

GD

P p

er c

ap

ita

by

qu

intile

GD

P p

er c

ap

ita

by

qu

intile

Qu

inti

le a

nn

ua

l g

row

th

in G

DP

pe

r c

ap

ita

Qu

inti

le a

nn

ua

l g

row

th

in G

DP

pe

r c

ap

ita

Qu

inti

le a

nn

ua

l g

row

th

in G

DP

pe

r c

ap

ita

Qu

inti

le a

nn

ua

l g

row

th

in G

DP

pe

r c

ap

ita

10

Source: OECD Development Centre, 2007. Based on CEPALSTAT y ECLAC’s Panorama Social de América Latina 2006.

% population in poverty

Poverty is falling but it still affects a large portion of the population

Millions of people in poverty

11

Source: OECD Development Centre, 2007. Based on CEPALSTAT y ECLAC’s Panorama Social de América Latina 2006.

Improvements in inequality are modest or absent

deteriorations

improvements

Changes in inequality during the last decade

12

Source: CEPALSTAT y ECLAC’s Panorama Social de América Latina 2006 and official press release of the Presidency of Chile, 23 September 2007.

“There is no mature and constructive democracy when equity and social justice are not tackled …our

democracies have not been efficient … they have not managed to rapidly improve the living condition of the

people, especially of those in most need, and the political consequences are visible today.”

President Michelle Bachelet at the European Union - Latin America

Forum on Social Cohesion

13

11 Development and democracyDevelopment and democracy

33 The fiscal transitionThe fiscal transition

22 Fiscal policy: Quality and accountabilityFiscal policy: Quality and accountability

14

Source: OECD Development Centre, 2007. Based on data by Goñi, López, and Servén (2006)

Fiscal policy plays a very limited redistributive role, especially taxation

Gin

i co

effi

cien

t

Inequality before and after taxes and transfers

Po

ints

of

Gin

i c

ha

ng

e

(% c

ha

ng

e i

n i

ne

qu

ali

ty)

The effects of taxes and transfers

15

Source: OECD Development Centre, 2007. Based on data by Goñi, López, and Servén (2006).

Gin

i co

effi

cien

t

There is no Latin curse:Quality fiscal policy is not a matter of DNA

Inequality before and after taxes and transfers

16

Overall Balance 1990-2006p

Latin America average Country forecast 2006

Source: OECD Development Centre, 2007. Based on ECLAC, Economic Survey of Latin America and the Caribbean, 2006-2007, June 2007.

Fiscal reform has achieved fiscal discipline

17

Source: OECD Development Centre, 2007. Based on Filc and Scartascini (2007), “Budgetary Institutions” in Lora, The State of State Reform in Latin America, IADB and Stanford University PressNote: To construct the figure, the reforms were weighted in accordance with their relevance and direction and were normalized between 0 and 1. So, each curve shows the transition of the institutions from their initial situation in 1990 to their situation in 2005. The slope measures the number of reforms and their relative importance.

The path of reform for fiscal institutions

Reform has succeeded in strengthening fiscal institutions

18

Source: OECD Development Centre, 2007. Based on ECLAC’s ILPES Database and OECD Revenue Statistics Database.

But reform has failed to raise significantly more revenue

Tax revenue (Central Government, % GDP, 2006p)

19

Source: OECD Development Centre, 2007. Based on data by Goñi, López, and Servén (2006) for tax productivity, Lora (2007) for tax exemptions (original source: Gómez-Sabaini) and Schneider and Enste (2005) for shadow economy.

Tax productivity has increased, but remains low for income taxes due to widespread

loopholes and informality

Tax productivity (rate/revenue)

Shadow economy (%GDP)

Tax exemptions (% GDP)

20

Source: OECD Development Centre, 2007. Based on Jiménez, J. P. V. Tromben. “Fiscal policy and the commodities boom: the impact of higher prices for non-renewables in Latin America and the Caribbean”. Cepal Review 90. December 2006.

Revenues from non-renewable as a share of total fiscal revenue

(1990-2005)

Coefficient of Variation in fiscal revenues

(1990-2005)

Revenue systems lean on commodities and produces unpredictability

21

% of citizens who trusttax revenue is well spent

(2003-05)

Source: OECD Development Centre, 2007. Based on Latinobarómetro (2003, 2005) and World Bank Institute, Governance Indicators Database. Based on World Economic Forum, Global Competitiveness Report, 2003-2006.

The result is very limited political capital to work with… fiscal legitimacy is low

Firms’ assessment of the neutrality/composition of government

decisions/spending (2003-2006)

Fairer/Wiser

Unfair/ Wasteful

22

11 DevelopmentDevelopment andand democracydemocracy

33 The fiscal transitionThe fiscal transition

22 Fiscal policy: Quality and accountabilityFiscal policy: Quality and accountability

23

Source: OECD Development Centre, 2007. Based on Latinobarómetro (2003).

Argentina

Bolivia Brazil

Chile

Colombia

Costa Rica

Ecuador

El Salvador

Guatemala

Honduras

Mexico

Nicaragua

Panama

ParaguayPeru

Uruguay

Venezuela

0

5

10

15

20

25

30

35

40

45

50

0 5 10 15 20 25 30

Fiscal legitimacy (% who trust taxes are well spent)

Dem

oc

rati

c p

erfo

rman

ce

(% s

atis

fied

with

dem

ocra

cy)

Fiscal legitimacy enhances democratic governance

24

Source: OECD Development Centre, 2007. Based on Latinobarómetro (2003, 2005).

Fiscal legitimacy enhances democratic governance

Fiscal legitimacy (% who trust taxes are well spent)

Dem

oc

rati

c p

erfo

rman

ce

(% s

atis

fied

with

dem

ocra

cy)

25

Source: OECD Development Centre, 2007. Based on Latinobarómetro (2003, 2005) and ECLAC’s Panorama Social

Social cohesion and fiscal legitimacy go hand in hand

Inequality (Gini coefficient 2000s)

Fis

ca

l le

git

ima

cy

(%

trus

t tax

es w

ell s

pent

)

26

Education Expenditures and Performance

Mexico

NorwayPolandSlovak Republic

Spain United States

Brazil

Indonesia

Thailand

Tunisia

Uruguay

300

350

400

450

500

550

600

- 5,000 10,000 15,000 20,000 25,000 30,000

Annual expenditure on educational institutions per student (2001) in equivalent US dollars converted using PPPs, by level of education, based on full-time equivalents

Mat

hem

atic

s S

core

(P

ISA

200

3)

Source: OECD Development Centre, 2007. Based on PISA (2003) and OECD Education at a Glance (2005)

It is not (only) a question of quantity but of quality (efficiency)

27

Source: OECD Development Centre, 2007. Based on Latinobarómetro (2003) and ECLAC’s Panorama Social.

URG

PER

PAR

NIC

MEXGTM

ECU

CRI

COL

CHL

BRA

BOL

ARG

URG

PER

NIC

MEX

HDN

GTM

SLV

CRI

COL

CHL

BRA

BOL

ARG

URG

MEXGTM

ECU

CRI

COL

BRA

BOL

ARG

5

25

-0.3 -0.2 -0.1 0 0.1 0.2 0.3 0.4 0.5 0.6 0.7

Social expenditures are … (quasi-gini)

Fis

cal l

egit

imac

y (%

trus

ts ta

xes

are

wel

l spe

nt)

Education Health Social Security

progressive regressive

But equity matters as well: Regressive fiscal policies damage legitimacy

28

Source: OECD Development Centre, 2007. Based on Latinobarómetro (2003) and ECLAC’s Panorama Social .

Social spending is regressiveSpecially social security

29

Source: OECD Development Centre, 2007. Based on Freedom House (2007) and ECLAC and OECD Revenue Statistics (2007).

KoreaUnited States

SwitzerlandIreland

Slovak Rep.Turkey

Spain

ItalyFrance

Sweden

Haiti

Venezuela Mexico

Ecuador PeruBolivia

Nicaragua ChileCosta RicaColombia

UruguayArgentina

Brazil

0

10

20

30

40

50

0 10 20 30 40 50 60 70 80 90 100

Freedom of the press(Index: 0-30=Not free, 31-60=Partially free, 60-100 Free)

Tax

Rev

enu

e(2

004

% G

DP

)

Policy dialogue and openness is key for financial accountability

30

Source: OECD Development Centre, 2007. Based on Freedom House (2007).

Venezuela

Venezuela

Chile

Chile

LatAm avge

LatAm avge

Not free

Partially free

Free

1988 Chile’s plebiscite

The democratic transition has not resulted in an overall transition in the media

31

Source: OECD Development Centre, 2007. Based on ECLAC’s ILPES and Latinobarómetro (2003, 2005).

Relaying more on taxes to finance public spending enhances fiscal legitimacy

Relative price of government services(share of taxes on total spending)

Fis

ca

l le

git

ima

cy

(%

trus

t tax

es w

ell s

pent

)

32

Source: OECD Development Centre, 2007. Based on ECLAC ILPES database and Payne et al. (2007) Democracies in Development - Politics and Reform in Latin America International IDEA.

Fiscal policy is a powerful tool to promote democratic participation

Relative price of government services(share of taxes on total spending)

Vo

ter

turn

ou

t(2

000-

05 p

resi

dent

ial e

lect

ions

)

33

Conclusions

Democracy puts fiscal policy at the heart of the relationship between the state and its citizens

Building broad consensus is paramount to success in the implementation of fiscal reforms

Local Think-Tanks can play a crucial role in fostering constructive dialogue over policy options, if they can count with financial independence

It not a technical but rather a political issue

34

Follow ups

Latin American Economic Outlook 2009

Policy Dialogue event

OECD-Club de Madrid sponsored policy dialogues

Current and past Ministers of Finance

Best practices, mutual learning

Fiscal and democratic legitimacy in Latin America

27 October 2007

Javier SantisoEconomista Jefe

Centro de Desarrollo de la OCDE

Agenda de Desarrollo Iberoamericana 2007Barcelona