Economic Reform and Progress in Latin America and the Caribbean PDF
Preview Economic Reform and Progress in Latin America and the Caribbean
Policy Research Working Paper 1829 Economic Reform and Thepaperexaminesthe experienceinstructural Progress in Latin America reforminfiveareas— * and the Caribbean governance,internationr:i) trsde.financialmarkets,labor markets,andthegeneration NormanLoayza anduseofpublicresources — LuisaPalacios incountriesofLatin AmericaandtheiJaribbean.It developsquantitative indicatorsforthepolicy*; reformsantifortheir outcomes. TheWorldBank LatinAmericaandtheCaribbeanRegion OfficeoftheChiefEconomist September1997 PolicyResearchWorkingPaper1829 Summaryfindings Inthelate1980s,afterdecadesofpooreconomic arehigh,therearefewornomechanismsforresolving management,manyLatinAmericanandCaribbean labordisputes,andthereistoomuchpublic countriesundertookstructuralreformthatplacedthem employment. onapathtowardsuperioreconomicperformance. Financialdevelopmenthasimproved,especiallythe LoayzaandPalaciosexaminetheexperiencein depthoffinancialintermediation,privatesector structuralreforminfiveareas:governance(reforming participationinbanking,andthesizeandactivityof publicinstitutions),internationaltrade,financial stockmarkets.Asfortheefficientgenerationanduseof markets,labormarkets,andthegenerationanduseof publicresources,muchhasbeendonetomakethevalue- publicresources. addedtaxsystemefficientandtoprivatizepublic Tocharacterizetheexperiencewithstructuralreform enterprises. intheregion,theydevelopquantitativeindicatorsfor Reformgainsingovernancehavebeenmodest.Latin differenttypesofpolicyreformandfortheiroutcomes. AmericaremainswellbehindtheAsianNICsandOECD Theyconcludethatthemostprogresshasbeenmade countries,especiallyregardingtheruleoflaw(judicial inliberalizinginternationaltrade.Inthisareathetegion andpolicesystems)andthequalityofpublic hasdonealmostaswellastheAsiannewlyindustrialized administration(proceduralclarityandthebureaucracy's countries(NICs). honestyandtechnicalcompetence). Theleastprogresshasbeenmadeinreforminglabor Agreatdealhasbeenaccomplished,butcompared markets.Inmostcountriestherearestillsevere withtheAsianNICsandOECDcountries,thereisstill constraintsonhiringandfiringworkers,payrolltaxrates substantialroomforimprovement. — — Thispaper aproductoftheOfficeoftheChiefEconomist,LatinAmericaandtheCaribbeanRegion isthesecond chapterofthereportTheLongMarch:AReformAgendaforLatinAmericaandtheCaribbeanintheNextDecade,presented attheABCD-LACconferenceinMontevideo,June30,1997.CopiesofthispaperareavailablefreefromtheWorldBank, 1818HStreetNW,Washington,DC20433.PleasecontactEmilyKhine,roomNll-061,telephone202-473-7471,fax 202-522-3518,[email protected].(96pages) ThePolicyResearchWorkingPaperSeriesdisseminatesthefindingsofworkinprogresstoencouragetheexchangeofideasabout developmentissues.Anobjectiveoftheseriesistogetthefindingsoutquickly,evenifthepresentationsarelessthanfullypolished.The paperscarrythenamesoftheauthorsandshouldbecitedaccordingly.Thefindings,interpretations,andconclusionsexpressedinthis paperareentirelythoseoftheauthors.Theydonotnecessarilyrepresenttheviewofthe'WorldBank,itsExecutiveDirectors,orthe countriestheyrepresent. ProducedbythePolicyResearchDisseminationCenter ECONOMICREFORMANDPROGRESSINLATINAMERICAANDTHE CARIBBEAN' NormanLoayzaandLuisaPalacios^ WorldBank^ JELclassification:OlO,054,E60 'Thisstudy,preparedintheOfficeoftheChiefEconomistoftheLatinAmericaandtheCaribbeanRegion,World Bank,willbethesecondchapterofthereportTheLongMarch:AReformAgendaforLatinAmericaandthe CaribbeanintheNextDecadetobepresentedattheABCD-LACconferenceinMontevideo,June301997. ^TheauthorswishtothankJuanJoseEchavarriaoftheTradeUnitattheOrganizationofAmericanStates, RicardoIn^teoftheInternationalLaborOfficeforLatinAmericaandtheCaribbean,andEduardoLoraofthe ChiefEconomist'sOfficeattheInter-AmericanDevelopmentBankfortheprovisionofvaluabledata.Many thankstoAntoniEstevadeordal,LuisGuasch,PhilKeefer,DanielLederman,RossLevine,SaulLizondo,Carmen Pages(lADB),GuillermoPeny,LantPritchett,andMartinRamaforhelpfuladviceandcomments. Veryable researchassistancewasprovidedbyCharlesChang. ^LuisaPaJaciosisalsoaffiliatedtoJohnsHopkinsUniversity-SAIS. Copyrlghiedmaisnai EXECUTIVESUMMARY Afteryearsofpooreconomicmanagement,manyLatinAmericanandCaribbeancountriesare experiencing aprocessofstructural reformthatplacesthem on apathto a superioreconomic performance.' Twobasicprinciplesidentifythisprocessofeconomicreform: fiscalandmonetary disciplineandrelianceonmarketforcestodeterminetheallocationanddistributionofresources. Thepurposeofthispaperistoexaminetheexperienceofstructuralreforminfiveareasof economic activity: international trade, financial markets, generation and use ofpublic resources, governance,andlabormarkets. Themethodologicalapproachusedinthisstudyhasconsistedof developing quantitative indicators for the corresponding policy reforms and/or their respective outcomes. Theresultisanempiricalcharacterizationoftheregion'sstructuralreform. Althoughtheprocessesofstructuralreformthroughouttheregionhavesharedthesame principles,theyhavedifferedintheirtimeofinitiationandinthebreadthand depthoftheir specific reforms. Regardingthetimeofinitiation, Chilewasthepioneer ofmarket-oriented reforms in the mid-1970s. In the mid-1980s and after a macroeconomic crisis topped by hyperinflation,Boliviatookimportantstepsinensuringfiscalandmonetarystability, andsoon after it liberalized itsfinancial system and traderegime. Thispattern ofcrisisfollowedby economicreformwasrepeatedinMexicointhelate1980s,inArgentina,Peru,andNicaraguain theearly1990s,and,morerecently,inBrazil,ElSalvador,andVenezuela.^ ColombiaandCosta Ricastandoutascaseswherestructuralreformswerenotimplementedinacrisisenviroimient. Theprocessofstructuralreformhasalsobeenheterogeneousinotherrelatedaspects.Whilethe regionaswholehasadvancedincertainreformareasmorethaninothers,thesequencing,depth andcontentsofthereformshavedifferedfromcountrytocountry. (1) Tradeliberalization, orthereductionintheaveragelevelanddispersionoftariffand para-tariflFchargesaswellasthesharpreduaionofnon-tarififbarriers,iswherereformshavebeen thedeepestandmostgeneralizedintheregion.Infact,intermsofreducingpolicyrestrictionsto tradetheregionhascomequiteclosetotheAsianNICs. Thesepolicychangeshavebrought about amarked increase in the tradeintensity ofthe reforming economies.' Forthe early reformers,amongthemBolivia,Chile,CostaRica,andMexico,theexpansionofinternational tradeasashareofGDP,occurredmostlyinthe1986-89period. Inthe 1990s,theMercosur countriesofArgentina,Brazil,Paraguay,andUruguay,experiencedveryhighgrowthratesofthe volumeoftrade. WhereasColombia,Mexico,andPerusawtheirrespectivetradesharesincrease rapidly(surelyasresultoftheliberalizationprocess)intheoil-exportingeconomiesofEcuador andVenezuelatheimprovementwasnotaslarge,despitealiberalizationprogramsimilartothose oftheformercountries(especiallyColombia). Inspiteofthesubstantialincreaseinthetradeto GDPratioinLatinAmericaandtheCaribbean(LAC)countries,theregionasawholeandeven 'SeeEdwards(1995). 2BrunoandEasterly(1996)andTommasiandVelasco(1995)argueconvincinglythatinLatinAmerican countries,aswellasinmanyothers,severecriseshavehadthepotentialofpreparingthegroundforstructural reforms. ^"Tradeintensity"isdefinedasthequotientof(real)exportsplus(real)imports,over(real)GDP. i itsmostopencountriesarefarbelowtheAsianNICsinterms oftradeintensity(evenafter adjustingformostnon-policy,structuralfactorsthataffecttrade).Thisfactpartlyrevealsthatthe effectsoftradepolicyliberalizationontradeintensitytaketimetotakehold. (2) Anotherareawheretherehasbeenimportantprogressinseveralcountriesintheregionis financialdevelopment. Intermsofpolicychanges,thepatternfollowedinmostcaseshasbeen one of, first, radical liberalization and, second, implementation ofprudential norms which moderatedtheinitialliberalization. Thepolicychangesrelatedtothefinancialsystem(removalof interestratecontrols,eliminationofdirectedcreditto"priority"sectors,privatizationofpublic banks,liberalizationoftheforeigninvestmentregimeand,morerecently,improvementsinthe regulatoryframework)haveinducedgrovrthandimprovementsinboththebankingsystemand thestockmarket. Inthebankingsystem,financialreformhasledtogreaterdepthinbankingintermediation ofmedium-andlong-runinstrumentsandtomoreactiveparticipationoftheprivatesectorinboth allocating and receiving credit. Revealing the importance ofthe banking industry in their economies,PanamaandtheEnglish-speakingCaribbeancountriesoftheBahamasandBarbados havebeentheleadersinbankingdevelopmentintheregion. Chile,despiteamoderatesetbackin thesecond-halfofthe1980s,remainedtheleaderofbankingdevelopmentinSouthAmerica. At theotherendofthescale,VenezuelaandGuyana,bothofwhichbythemid-1980shadbeen amongthemostadvancedintheregion,havesincethensufferedaremarkabledeteriorationinthis area. Thankstothefinancialreformsitintroducedin1985anddeepenedin 1991,Boliviahas beenabletoachieverapidandsustainedprogressinbankingdevelopmentsincethemid-1980s. Othercountriesintheregion,particularlyArgentina,Bolivia,Brazil,Colombia,Ecuador,Peru and Paraguay, also benefited from financial reform and fi"om macroeconomic stability, and experiencedgradualprogressinbankingdevelopmentinthe1990s. In stockmarkets, theresultoffinancial reformhasbeen an increaseinstockmarket capitalizationrelativetoGDP,anevenstrongerincreaseinvaluetradedinthestockexchange, and adeclineinmarket concentration. Inotherwords, larger, moreactive and liquid stock markets havebeentheproductoffinancial reforms. Inthisregard, Chilehasshown steady progresssince 1985. Inthe 1990s,Brazil,Mexico, andPeruhavealsoachievedremarkable progress,whereasduringthesameperiodVenezuela'sperformancedeclined,nodoubtduetoits macroeconomiccrisis. ComparisonswiththeAsianNICs andwithOECD countriesshowsthat, despitethe improvementinfinancialperformanceinthelastfewyears,LACstilllagsfarbehindthosehigh performingeconomiesinallindicatorsofbankingandstockmarketdevelopment. (3) Thethirdareaofreformconcernstheproperuseofpublicresourcesandtheefficient generationofpublicrevenue. InLACcountriestherehavetraditionallybeentwomaindeficienciesintheuseofpublic resources.Thefirstisthatalargeportionofgovernmentresourceshasbeenspentonabloated andineffectivebureaucracy;andthesecondisthepervasivenessofpublicenterprises,mostof whichincurredmajorlossesanddeliveredservicespoorly.Ontherevenueside,taxsystemshave ii dependedexcessivelyontradeandoninefficienttaxesforrevenue,andtaxenforcementhasbeen weak.Recentreformshavebeenattemptingtoremedythesedeficiencies. (i)Publicadministrationandexpenditures. Afewcountriesintheregion,namely,the DominicanRepublic,ElSalvador,Peru,andUruguayhaveshownacleartendencyinthelastten yearstocommitfewerresourcestopayfortheservicesofthebureaucracy. Bytheearly1980s, Chilehadalreadycuttolessthan20percenttheshareofpublicprimaryexpendituresusedto financewagesandsalariesofpublicemployees. Clearly,thesalary-to-expenditureratiointhe public administration depends not only on whether the bureaucracy is bloated but also on structuralcharacteristicssuchaswhetherthegovernmentisrequiredtospecializeinproviding labor-intensive services. Nevertheless, it is interesting to note that the Chilean public administration,whichenjoysastrongreputationforefficiencyintheregion(asdescribedinthe sectionongovernance),hasbeenabsorbingashareofprimaryexpendituresthatisamongthe lowestinLatinAmericainthelasttenyears. Alsoworthnotingisthemarkeddifferenceinthis respectamongthedifferentlevelsofgovernment(federal,stateandlocal)inArgentinaandBrazil, thetwomostdecentralizedcountriesintheregion. Inbothcountries,theratioofsalariesto primaryexpendituresissignificantlyhigheratthestate(orprovincial)levelthanatthefederal level. LACcountriesonaveragearededicatingalowershareoftheirprimaryexpendituresto publicadministrationsalariesthantheywereinpreviousyears. However,attheregionalleve:l,the percentageofprimaryexpendituresdevotedtopayingpublicadministrationsalariesiscloserto thatof Malaysia(36percent)thantothatofKorea,whoseleanbureaucracyabsorbsjust 12 percentofprimaryexpenditures.Thisisanareathatclearlydeservesmoreresearchandaction. (ii)Publicenterprisesandprivatization.Thereformresponsetothepoorperformanceof publicenterpriseshasbeenaprocessofprivatization,which,itwashoped,wouldbefollowedby strongprivateinvestment,particularlyintheareasofpublicutilitiesandinfirastructure. Most countriesintheregionhaveparticipatedintheprocessofprivatization. Themostsignificant caseshavebeenArgentina,Belize,Bolivia, Chile,Jamaica,Mexico,Nicaragua,Peru,Trinidad andTobago,andVenezuela. Formostofthecountriesthatconductedamajorprivatization program,theshareofprivateinvestmentintotalinvestmentrosesignificantly,approaching80 percentinChile,Argentina,MexicoandPeru. Inthisregard,Bolivia'sexperienceisarather disappointingone,fordespiteastrongprivatizationeffort,itsprivateinvestmentshareactually droppedfromitslevelin1985andthenremainedabouthalfaslargeasthatofothercountries withasimilarprivatizationeffort. IntheLatinAmericaandCaribbeanregion,privatesector participationininvestmentstilltrailstheleveloftheAsianNICs. Althoughthedifferenceinthis respectbetweenthetwogroupsofcountries(fivepercentagepointsonaverageinthe 1990s) doesnotseemtobelarge,itbecomesindeedimportantwhenitisconsideredthattheproductivity ofpublicinvestmentismuchlargerintheNICsthaninLatinAmerica. (iii) Public revenues. The basic principles oftax reform have been, first, tax rate unificationandlowermarginalrates;second,de-emphasisofsteeplyprogressiveratestructuresof incomeandpropertytaxesinfavorofbroadlybased,low-ratetaxesondomesticconsumption, suchasthevalueaddedtax(VAT); and,third, strengtheningofthetaxadministration. The centerpieceoftaxreformintheregionhasbeentheimplementationofavalueaddedtaxsystem; itsachievementsasarevenuegeneratorhaveallowedtheeasingofthetaxburdenontheformal sectorandthereductionoftradetaxes,atthesametimeasithashelpedtheratiooftaxrevenue iii toGDPapproachahealthy15-20percentrange. InordertoevaluatetheefficiencyoftheVAT system,thepaperexaminestheVATrevenueproductivityratio." Thisratiocontainsinformation onboththecoverageoftheVATandtheefficacyofthetaxadministrationtopreventevasion. Especiallysince1990,thisproductivityratehasimprovedinmostcountriesintheregion, and particularlyinArgentina,Bolivia,CostaRica,Paraguay,andPeru. Formostcountries,however, thereisstillmuchroomforfurtherprogress. Onlyafew countries ~Brazil, Chile,-Bolivia, Paraguay, El Salvador, and Guatemala ~ have achieved moderate VAT productivity rates between40 percent and 50 percentin contrast to theratesforOECD countries, which are normallybetween50percentand70percent.^ (4) Thefourth areaofstructural reform deals withgovernance andpublic institutional reform. Inthisareaprogresshasbeenmoremodestandlesswidespreadthatintheprevious threereformareasprevouslymentioned. Theapproachtakeninthispapertoassessprogressin governancehasbeentorelyonsubjectiveindicatorsprovidedbytwoindependentinternational country risk evaluators. They are International CountryRisk Guide (ICRG) and Business EnvironmentRiskIntelligence(BERI). Thesesourcesprovideinformationrelatedtotwoaspects ofgoodgovernance. Thefirstisthequalityofpublicinstitutions(evaluatedbythevariables "corruptioningovernment"and"qualityofthebureaucracy"),whichdescribestheabilityofthe statetoimplementitspoliciesthroughanappropriatestructureofgovernmentandthroughhonest andtechnicallycompetentbureaucrats. Thesecondisthequalityofpublicservices(evaluatedby the variables "rule oflaw", "enforceability ofcontracts", and "expropriation risk"), which determinean environmentwhere contractual obligationsarerespectedbyboththestate and privateagents,wherelegaldisputesareeffectivelyresolvedinthejudicialsystem,andwherelegal rulesforinvestment,employment,andtaxationarenotarbitrarilymodifiedbythestate. Theassessmentofprogressintheseaspectsofgovernancedifferssomewhatamongrisk evaluators. WhereasBERIdrawsapictureoflimitedprogressexceptforahandfulofcountries~ Argentina, Chile, Ecuador and Peru ~, ICRG provides an optimistic appraisal ofprogress throughouttheregion. Althoughbothsuggestthattherehasbeengeneralimprovement,acloser examinationoftheunderlyingindicatorsoftheICRGgovernanceindexrevealsthatby1995Latin America'sstandardsofgovernanceremainedwellbelowthatoftheAsianNICsandtheOECD countries. Thisgapisparticularlylargeintheareaoftheruleoflaw(judicialandpolicesystems) and in the quality ofthe public administration (technical competence and honesty ofthe bureaucracy,aswellasproceduralclarity). ThedifferencebetweenLatinAmericaandtheAsian NICsandOECDcountriesissmallerregardingrespectofpropertyrights,includingtheriskof nationalizationofenterpriseequity. (5) Theareawheretheleastprogresshasbeenmadeislabormarketreform. Exceptfor ChileandtheEnglish-speakingCaribbeancountries,mostcountriesintheregionhadratherrigid anddistortedlabormarketsinthe1980sandearly1990s;excludingafewnotablecasesoflabor marketreform,thesituationintheregionby1995remainedbasicallythesame. Themainfactors TheVATrevenueproductivityratioisdefinedasVATrevenueoverGDPdividedbyaverageVATrate. 100percentwouldimplyaVATwithoutexceptionsandfiillenforcement. iv generatingdistortionsinlabormarketsinLatinAmericaarethefollowing:severeconstraintson thehiringanddismissal ofworkers, highsocial security contributionrates (andno clearlink betweenindividualbenefitsandcontributions),thelackofmechanismsfornon-disruptivelabor disputeresolution,andthepredominanceofpublicemploymentintheeconomy. Despitetheneed forlabormarketreforminmostcountriesintheregion,onlyahandfulofthemhavemadesome progressinthisarea—Argentina,Colombia,Ecuador,Panama,andVenezuela—andonlyinone country,Peru,havethepolicychangescoveredallrelevantaspectsoflabormarketreform. Theregionsufferedfrommisguidedpublicpoliciesandweakpublicinstitutionsforseveral decades. These policies and institutions inducedprofound distortions in the formation and allocationofphysicalcapitalandhumantalent,aswellasagradualerosionofoverallefficiency. Asaresultimplementingstructuralreforms(and,thus,alteringthemodesofproductionandthe system ofeconomicincentives) iscostly and evenpainful. And yet, these reformshave the potentialtoraisesubstantiallythelivingstandardsofmostpeopleintheregion. Thereisindeed someevidencethatthereformsinitiatedinmostcountriesinthelate 1980shavealreadyborne finitintermsofanimprovedgrowthperformance.* This,however, shouldnotallowanyone forgettothateconomicreformisalongandarduousprocess,whichrequiresbothpoliticalwill andsocialsensibilityfi-omthegovernmenttobesuccessfullyfulfilled. ^SeeEasterly,LoayzaandMontiel(1997),Fernandez-AriasandMontiel(1997),andBarreraandLora(1997). ECONOMICREFORMANDPROGRESSINLATINAMERICAANDTHE CARIBBEAN Inthe late 1980s, after decades ofpoor economic management, many Latin American countries*startedaprocessofeconomicreform. Althoughthebreadthanddepthofthisprocess differedfromcountrytocountry,itsbasicprinciplesweresimilar:fiscalandmonetarydisciplineand relianceonmarketforcestodeterminetheallocationanddistributionofresources. Althoughmuchhas beenaccomplished,ithasbecomeclear,particularlyinthewakeofthe1994Mexicancrisis,thatthe reformprocesshasalongwaytogoinmostcountriesintheregion. Thepurposeofthispaperisbothtoassessthestateofeconomicreformandtoprovidean evaluationofeconomicprogressinareasunderreform.Economicreformsfollowacomplexand multifacetedprocess, proceedingatdiflferentspeedsinseveralareasofpublicpolicy. Economic reformsentailpolicymodificationsthat, withtime, bringaboutchangesintheperformance and structureofeconomicactivity. Therefore,reformscanbeassessedbyexaminingtheircorresponding policymeasuresortheiroutcomes. Inprinciple,bothelementsarerelevant. Inthispaper,however, moreemphasisisplacedonoutcomemeasurestoevaluatetheadvanceofeconomicreforms. There aretworeasonsforthisapproach. Thefirstisdataavailability: PolicymeasuresarediflSculttoisolate andquantifyobjectively,whereasinmostcases,outcomeindicatorsofreformareavailable. The secondreasonisthattheultimatetestfortheadvanceofeconomicreformliesinitsimpacton economicactivity. Nevertheless,wheninformationisavailable,policymeasuresarealsoincludedin theanalysis. Naturally,notalleconomicprogressinthelastfewyearscanbeinterpretedasresultingfrom reforms;thisprogresscanalsobetheresultofthenormalprocessofgrowthanddevelopment. This paperisnot,however,concernedwithisolatingtheportionofeconomicprogressthatisduetoreform. Rather,theanalysisinthispaperofeconomicperformancefiilfillsthedualpurposeofassessingthe stateofreformandevaluatinggeneraleconomicdevelopment,underthehypothesisthatintherecent experience of Latin American countries, economic development is largely a reflection of macroeconomicandstructuralreforms. 'Inthisdocument,theterms"LatinAmerica"and"LatinAmericaandtheCaribbean"areusedinterchangeably. 1
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