Looking for the Ark of lost growth

New political cycle, new fiscal policy in the digital age

The decisions taken by Latin America in 2018 will mark the passage of its social and economic history for the years to come. In a short period of time, a group of countries, representing approximately 80% of the regional GDP –Chile, Colombia, Mexico and Brazil are among them- have begun a new political cycle, characterised by deep desires for change in the electorate. The end of the Governments of Bachelet, Santos and Peña Nieto, but also the conclusion of the “Brazilian transition” managed by Temer, carries huge implicit challenges for successors: the main one, probably, is the recovery of trust in the democratic institutions that presided over the economic growth of the so-called “prodigious decade”.

In Chile, the return to the power of President Sebastián Piñera has been oriented from the beginning to resume economic strength, which has been implemented through the so called ”modernisation tax”, with a focus both on the reduction of the tax burden on agents already incised by the tax code as well as the search for new revenue among subjects today not fully incised (most notably, the so-called digital platforms). Nevertheless, the challenges of Chile also extend to the attention of social problems already in evidence in the first Piñera Government; including pension and educational reform; which have been joined recently environmental issues.

The President of Colombia Iván Duque will have three major challenges: on the domestic front, the management of peace agreed upon with the FARC; on the external front, the design of a new international policy, marked by the accession of the country to the OECD and NATO; on the economic front, the search for a model of sustained growth placed in the modernisation of the economy (the so-called “Orange economy”) and the exploitation of non-traditional sources of revenue, such as tourism (this industry has gone in just 7 years from capturing 2 million visitors to practically 7 million).

In Mexico, President Enrique Peña Nieto’s presidency will be over after 6 years, and the new cycle also appears to be marked by important social aspirations: reform of a political system viewed as corrupt and ineffective to overcome the enormous economic inequality; combating crime and insecurity, especially in the North of the country; and the recovery of economic growth, affected by the uncertainty associated with the renegotiation of NAFTA and relations with the United States of America. Andrés Manuel López Obrador’s new Government, with a team already fully formed and ready to jump onto the pitch, must face -with all the political power which it has been invested- huge social demands, at the time in which it is making decisions on the continuity of structural reforms implemented by Peña Nieto under the umbrella of the so-called “Pact for Mexico”.

All this occurs while the elections in Brazil are conducted in an environment of great uncertainty, marked by the disqualification of former President Luis Ignacio Lula da Silva as a candidate, the continuity of the atavistic political fragmentation of the country, which will lead once more (very likely) to a Congress without solid majorities and the acquisition of relevance of new political options on the right of the system, of little relevance until now in the Brazilian panorama.

Although with national nuances, it is perceived over the length and breadth of Latin America -already affected by a growing institutional instability- at least two common aspirations. The main one, as it has been said, is the reform of the political systems, deeply touched by mega-corruption scandals and more and more evident signals of an institutional structural inefficiency. Also, it is noteworthy the recovery of economic growth which those political systems must be able to ensure, and on which the social peace in the region depends.

Latin American economy has been marked in recent years by the aftermath of the “Prodigious Decade” of raw materials: low rates of growth, growing fiscal deficits and problems of competitiveness and productivity. The Latin American GDP grew 48% between 2003 and 2016, based on the rise in the prices of raw materials. Unfortunately, the contribution of productivity to economic growth over the past decade was negative: in the same period, in China and South Korea multifactor productivity contributed more than 3 points to the growth of the Asian economies.

“Observable macroeconomic risks in Latin America (low productivity, fiscal deficits, reduction of international reserves, etc.) represent a strong disincentive for investors that should be considered by Public Administrations in the new political cycle”.

As the case of Argentina has put into evidence, emerging economies may be particularly impacted by radical changes in the exogenous factors (such as the price of raw materials or changes in the monetary or commercial policy of the main powers) unless they have the tools for the implementation of countercyclical policies. In other words: in the same way that will not be possible to recover the confidence of citizens in the political institutions without undertaking institutional reforms that they demand, the region may not be able to overcome the potential scenario of rates of poor growth (or decrease) unless their Governments focus on the stabilization of the tax situation.

The economic reforms that Latin America needs, in short, must ensure fiscal consolidation, combat informality as an unavoidable path for the sustainability of the economy and build tools for the application of countercyclical economic policies; all this, without neglecting the maintenance of incentives for investment and economic growth.

On the threshold of a new political cycle, do these fiscal policies meet the characteristics of Latin American countries?

The World Bank states that countries in this region have traditionally implemented pro-cyclical fiscal policies, which involves the risk that economies have more pronounced growth peaks during expansive periods and deeper effects throughout the recessive part of the economic cycle. It is true that some countries (among them, Colombia, Peru and Chile) have already implemented institutional locks in their fiscal systems – expenditure ceilings, surplus savings obligations – which allow the development of countercyclical policies, but it is no less true that most of the region’s economies continue to execute marked pro-cyclical policies. The main problem of maintaining pro-cyclical fiscal policies is the lack of operation of drastic changes in the terms of exchange, deep recessions or high volatility in economic cycles. The World Bank also highlighted the lack of fiscal consolidation in large parts of the Latin American economies, where 28 of the 32 countries analysed presented public accounts in red numbers with an average [public] deficit of 3.1% of the GDP.

The lack of formalisation of the Latin American economies is also part of the pending agenda in the new cycle. As it concerns the OECD in its Latin American Economic Outlook, 2018, the region is affected by the credibility of its institutions, allowing for that part of society to socially justify adverse behaviours, such as tax evasion[1]. Informality is a colossal offender in the sustainability of tax systems, to the extent that it reduces the taxable base and affects public revenue, but also as it leads to the easy recourse to increase tax burden on the already incised formal agents, discouraging investment and endangering economic growth.

However, the biggest economic challenge for Latin American Governments in this new political cycle is the improvement of productivity as a key element to resuming the path of growth, affected by the degradation of exogenous factors that have traditionally driven our economic expansion. And for productivity to contribute to the development of Latin America it is essential for economic policies to establish the necessary incentives.

“In 21st century economies, digitalisation is a key element in this process: Professor Raúl Katz’s studies indicate that an increase of the digitalization index of 1% results in an increase of 0.32% in the GDP and 0.26% in labour productivity”.

Put another way: those Governments that strongly rely on the digital transformation of their economies can remain competitive and aspire to identify new growth vectors; those that lack strategic vision in digital material or that fail in its execution, will inexorably observe how the distance that separates them from the digital leaders – United States, China, Korea, Israel – will continue expanding.

A recently study published by the Inter-American Association of Telecommunications Companies (ASIET) shows, despite this reality, that the telecommunications industry – responsible for providing the infrastructure necessary to enable the digital economy – bears the highest tax burden in the region. The consequences of this policy are already evident throughout the length and breadth of the territory of Latin America: operators in a situation of failure, prolonged fall of margins, effects on the market value of companies with exposure to the region, reduced availability of cash for making investments in new networks. According to ASIET, the telecommunications industry contributes 29.77% value added -or 12.12% of their revenue- to public coffers of the Latin American States on average, a burden which is a 51% higher than that borne by the other sectors of the economy. If digitalisation has a clear multiplier effect on productivity and growth, maintenance of the status quo is harmful. With even higher global levies that affect tobacco or oil in some countries, fiscal policy which applies to telecommunications will make it difficult to complete the laying of 4G-LTE networks in all countries in the region or to develop a sustainable fibre business to the house, it is going to deepen the technological backlog of rural areas and convert 5G mobile networks – already starting to be built in the United States – into science fiction in our societies.

How to design tax and regulatory policies that favour the digital transformation of Latin America and contribute to releasing the forces of productivity associated with the digitalisation?

Firstly, it is imperative to place the digital policy at the centre of governance. The steps taken in Colombia deserve special attention: this is a country in which for eight years there has been a Ministry of Information and Communication Technologies and in which the President Duque has considered it necessary to appoint a High Commissioner in the digital field. The centralisation of political responsibility is a necessary step but is not sufficient in guiding government action.

Secondly, the tax burden borne by the telecoms sector must be standardized with that facing the rest of the economic activities. The gradual loss of attraction of investment in telecommunications operators is a reality that should especially concern developers of public policies, considering that more than 80% of the investment in telecommunications networks comes from the private sector. To move forward in this line, the multitude of taxes and special levies affecting the sector should be reviewed – and ideally, disposed: special taxes for security (5% of revenues) in El Salvador, applicable royalties depending on the share of the market in Ecuador, special taxes on products and services in Mexico, etc. To the same extent, it is paramount to undertake a thorough review of the universal service policy (which detracts resources from industry that, in many cases, become the treasury funds and has scarcely served social interest in most of countries) and of the political spectrum. In terms of the spectrum, essential input for the development of mobile networks, the region should pay more attention to the early release of the resource and the assurance of coverage rather than revenue, as it has been done in Chile traditionally with good results. The focus on tax policies associated with the spectrum has delayed the availability of frequencies for 4G in most countries, more expensive investment in new networks (less spectrum, more investment) and adversely affected the quality of service.

Finally, it is urgent to review a regulatory policy anchored in the past -whose focus continues to dominate in Brazil for the fixed telephony concessions or in Argentina for restrictions to the provision of convergent services- and to implement enabling frameworks of the digital economy, which encourage innovation and ensure that all stakeholders in the market, national or foreign, assume against customers and governments in the region such obligations in relevant issues such as privacy, security, the collaboration with justice authorities or taxes.

To achieve a future of prosperity and growth, in short, Latin American governments of this new political cycle have the enormous challenge of carrying out reforms to seek balance and fiscal sustainability, but, that at the same time, encourage investment, productivity and, therefore, economic growth. The digital transformation of the economies is an essential piece in the map that will lead them to the Ark of lost growth.

Originally published in Pódium: http://cipyc.org/wp-content/uploads/2018/10/Podium2_web.pdf