Sunday, February 20, 2011

Korea’s Fiscal Management for Economic Development

The Republic of Korea (here within known as “Korea”) has nine provinces and seven administratively separate cities—Seoul, the capital, along with Busan, Daegu, Daejeon, Gwangju, Incheon and Ulsan. With 48.6 million people, Korea has one of the world’s highest population densities with the 81% of total population living in urban areas (CIA Factbook 2008). Major population centers are located in the northwest, southeast, and in the plains south of the Seoul-Incheon area.

The country has seen extraordinary growth rates over its recent history and much of this has been produced due to major planned action by the public administration. This paper will describe the economic growth, fiscal policy and the planning models that the country has conducted. Furthermore, it will review the countries decentralization attempts and review its current fiscal policies as it strives to continue growth into the twenty-first century.

The market
Originally uploaded by heydee

Early economic development planning and political struggles

Before Korea was known for the “Asian Miracle” by the World Bank and others in the international community, there were several long passes of uncomfortable historical moments which explain the incredible growth figures. This included exploiting the working class and managing a deeply inter-connected business clan called the “chaebol.” Vittas and Je Cho (1996) highlighted the different phases of directed state efforts to shape the national economy. They included mainly in the 1950s and 1960s assemble of export and industrial investments; the 1970s focus on particular industries targeting specifically heavy and chemical industries; 1980s concentrated on industrial and financial restructuring of companies and sectors in distress.

Even before Park Chung-hee’s 1961 military coup established strong state interventions to meet its goal of rapid industrialization (Minns 2001). The strong state approach began with the Japanese as they colonized the peninsula in 1910, especially when they abolished the Korean aristocratic landowners—yagban. Additional separation of workers and elites was declared after large protests in 1946, just as the national government announced its title of the People’s Republic. The national labor unions were organized and therefore sought political demands, which made the state’s role stronger (Minns 2001). More radical left sympathizers simple left the country for the north as the developmental state was transforming.

Unlike the Syugman Rhee’s administration in the 1950s when the country began its rebuilding efforts after the war, the military did not use foreign aid to industrialize (Minns 2001). Instead, highly orchestrated finding from state run banks like the Korea Reconstruction bank used both principle and interest on foreign loans that the government guaranteed. Furthermore heavy sough was Foreign Direct Investment (FDI) for major sectors of the economy. The Park regime used Free Export Zones (FEZs) and managed major concessions and tax lifts in order to generate more investments from outside the country. Between 1961-1972, subsidized credit was easily available established to strengthen large firms. For examples Heavy and Chemical Industry Plan (HCIP) focused on largely defense-related products such as steel, petrochemicals, nonferrous metals, electronics and shipbuilding was an area of strong interest.

Beginning in 1974, major concessions were made due to the oil price shocks and the recession that hit the country, creating raising interest rates and unprecedented lack of necessary capital for further development. Therefore the country’s economy saw a major slow down. Minns (2001) highlights that the state became ruthless of selective firms allowing many to go bankrupt and strengthening mergers and accusations.

Monetary policy and Centralized control over financial services

Credit policy became a strong tool for development in Korea in the 1980s. “The government used a strong package of tax and financial incentives to encourage firms with minimal equity funds to enter priority industries and it used control of the banking system to exert strong leverage on the behavior of firms” (Vittas and Je Cho 1996). Centralized control of decisions made the state become a vital tool for the development of the country. The state run Economic Planning Board (EPB) gave the country an unprecedented power to organize and nationalize the banking system, targeting industrial sectors and managing fiscal policies.

The commercial banks in Korea functioned as development banks with large portfolios. Non-bank financial institutions operated freely, without sufficient regulation and expanded the financial operation of the country. In the 1980s the chaebol became so successful that there was regular discontent from the working class. With the excessive accumulation of wealth, the workers demanded more redistributive and welfare polices from the government.

The funding sources included deposits of the central bank, foreign capital for financing, loans from FDI into Korea and simple guarantees from the national government. Although encouraging huge inflows of foreign capital and technology, this also perpetuated government intervention in the banking sector. To avoid default, the government would absorb and reschedule the domestic bank loans, giving preference to larger firms and not providing accessible credit to small and medium size firms. This led to high-growth rates until the government became overambitious. High risk sharing schemes between creditors and borrowers led the Korean government to take on dangerous balance sheets leading to near financial collapse.

1997 Economic Crisis

Much like the current housing market collapse and financial stresses in the United State, the Korean government was hit hard in 1997. The central government was quick to assess their internal problems. Aided by the international community, the government took out internationally financed loans from the World Bank and others to meet the private sectors demands and reconstructing the national economy. Areas of the financial reforms included competition, export, and private sector ownership of some key industries. Another area of reforms included providing credit to small and medium businesses, which also served as a political reform and appeasement to the newly emerging middle class. Further decoupling of the business elite was done by applying pressure from the commandist state in the economic management of the country. “Ironically, an economy which had neoliberals enthusing about its export-led strategy now required the largest IMF bail0out in history: US$57 billion in December 1997 and another $10 billion to follow” (Minns 2001.) Furthermore international pressure, the economic crisis and the bailouts were all factors, which lead the decline of the developmentalist state in Korea.

Public Administration Reforms

Yet, not before Dae Jung Kim’s administration were there vast changes in the public administration (Suk Kim 2000.) Announced during the his inauguration in February 1998, were there major ambitions to respond to the crisis, which focused on for major sectors business, labor relations, finance and government administration. Reforms were taken most obviously to cutback the public sector and save in areas of the budget, but the Korean government also needed to overcome its highly centralized, non-transparent, ridged and low competitive government (Suk Kim 2000.) Coupled with global movement of new public management the government was able to embark on many of the trends of becoming a leaner and meaner government.

Nearly all types of reforms were implemented, including reorganization, providing autonomy for select government agencies, deregulation with the private sector, personal and pay reforms of government servants, downsizing and changing the cultural and behavior work environment. For example, Suk Kim 2000 sited that the “Dae Jung Kim Administration will let go 25,955 employees who account for 16.0% of the total central government workforce by the year 2001.” In additional attempts to make the government the less centralized, the government used the business like approach to public management and promoted entrepreneurial ideas to flow into the public sector.

Ha (2004) described the Korean governments efforts at decentralization, which began in the 1980s, as deconcentration, devolution and privatization. The Presidential Common on Devolution Promotion for Local Authorities was established in 1999 to transfer parastatal agencies from the national government to the local level. Some day-to-day management and operational activities were given away to local governments but genuine autonomy for making political decisions has yet to be granted. Additional in 1999 the Presidential Commission on Government Innovation was established to reduce the government workforce, implement privatization programs of the state own enterprises and finally introduce completion and performance oriented compensation packages for the public sector (Ha 2004).

Originally uploaded by heydee

Current financial industry reforms and development

The OECD reports (both from 2004 and 2007) major work is still needed for these policies to be taken serious. Particular areas of reform include the corporate and financial sectors and the fiscal policy of the country. Although, much has been done to fragment the private sector of the “chaebol,” Korean corporate leaders, there are still areas of reforms needed. For example corporate governance and transparency, promoting external auditing and improving reporting regulation for the private sector, particularly paying close attention to the financing industry. Much has been learned from the SK Global scandal, which forced the government to respond by establishing with the financial Supervisory Service (FSS), a non-profit organization that tracks corporate investments and spending patterns.

Furthermore the banking sectors capital adequacy rations need to be maintained. In the effort to not return to the necessity of the re-capitalizing the financial sector the OECD has recommended the banks to not fund such risky projects, but rather strengthen housing and mortgage financing, public funds and the like. One way to restructure this sector was by having a foreign financial service provide competition for nationalized companies. For example, OECD reports that 80 percent of the governments share in Hyundai ITC, the third largest financial service company, was sold to Prudential Financial in February 2004.

Additional developments include the recent establishment of the Korean Investment Corporation (KIC), the Korean Asset Management Corporation (KAMCO) and the Korean Deposit Insurance Corporation (KDIC), which are all areas for managing and regulating the financial sector. The OECD reports that foreign ownership in the fixed-income market is only 0.6 percent and more attraction of asset management firms could attract business development and make Korea into a desirable location for global investments.

Furthermore improved tax system will help the public sector manage their resources better. Priority is on broadening of the tax base for personal income tax, which is the lowest in the OECD, below 10 percent. One focus area is on the self-employed whose income is estimated at 50 percent higher than that in which is report. The government policy in this regard was announced in the Vision 2030 and seeks to encourage local tax systems to become more efficient. The OECD reports the need to simplify “the local tax system, which includes 16 different taxes compare to only four in Nordic countries thereby reducing compliance costs (OECD 2004:99).” These reforms are necessary if Korea will be able to set its heights on their goals established in the various five-year plans.

Seoul’s local public finances

Batten and Szilagyi (2007) suggest that Korea’s efforts at developing its bond market would be a “complementary to long term economic development while services the efficient financial and legal services.” In these efforts Seoul’s seeks to become a full international financial center, rivalry to those located Singapore and Hong Kong Current efforts are focusing on engaging the international private sector to invest in the local market. In part, reforms are still needed in the corporate coverage section, which includes creditor rights, bankruptcy procedures and contract enforcement. Furthermore additional regulations for foreign investor taxes, and stronger financial infrastructure for the reliable credit ratings and robust benchmarking yield curves still need development.


CIA Factbook, 2010, Retrieved Feb. 12

“Competitive Cities,” 1999, special issue of Urban Studies, v. 36, n. 5/6, especially articles by Begg, van den Berg & Braun, and Gordon.

Crotty, James and Kang-Kook Lee, 2002, A political-economic analysis of the failure of neo-liberal structuring in post-crisis Korea. Cambridge Journal of Economics, 26(5), 667-678

Batten, Jonathan A. and Peter G. Szilagyi, 2007, Domestic Bond Market Development: The Arirang Bond Experience in Korea. The World Bank Research Observer, 22, (2) 165-195.

Ha, Seong-Kyu, 2004, Housing poverty and the role of urbqan governance in Korea, Envormental and Urbanization 16 (1)139-154.

Hayo Bernd. 2005, Mass attitudes toward financial crisis and economic reform in Korea Socio-Economic Review 3 (3), 491–515

Kim, P. S., 2000, Administrative Reform in the Korean Central Government: A Case Study of the Dae Jung Jim Administration. Public Performance & Management Review, 24(2), 145-160

Kim, Joong-Yang, 2006, The Korean Civil Service System. Bubwoosa.

Kenyon, D. A., 1997, Mar-Apr, Theories of interjurisdictional competition. New England Economic Review, 13-28.

Krugman, P., 1996, Making sense of the competitiveness debate. Oxford Review of Economic Policy, 12(3), 17-25.

Minns, J., 2001, Of Miracles and Models: The Rise and Decline of the Developmental State in South Korea. Third World Quarterly, 22(6), 1025-1043.

Organisation for Economic Co-operation and Development (2007) OECD Economic Surveys: Korea OECD.

Sassen, S., 2006, Cities in a world economy (3rd ed.). Thousand Oaks, CA: Pine Forge Press.

Seoul Metropolitan Government website: (also Four-Year Master Plan at this site. Viewed Feb, 21. 2010.

Vittas, Dimitri and Yoon Je Cho (1996), Credit Policies: Lessons From Japan And Korea. The World Bank Research Observer, 11(2) 277-98.

Rockefeller Foundation Invites Nominations for Jane Jacobs Medal

The Rockefeller Foundation has opened the public nominating process for the 2011 Jane Jacobs Medal. The medal is annually awarded to two living individuals whose creative vision for the urban environment has significantly contributed to the vibrancy and variety of New York City.

The foundation seeks nominees for two different awards - one for lifetime leadership and one for new ideas and activism. Nominees should have opened our eyes to a new way of seeing and understanding New York City; generated new ways to think about the development and preservation of urban environments (specifically in New York City); and/or have demonstrated an innovative approach to how we think about neighborhoods and l solve the problems within them.

Nominations may be made by anyone, and should be submitted through the Rockefeller Foundation Web site. The 2011 Jane Jacobs Medals will be awarded to the recipients at a reception in the fall of 2011.

Visit the Rockefeller Foundation Web site for complete program information and nomination procedures.

Link to Complete RFP

Wednesday, February 16, 2011

Conferencia de las Américas

Debate regional al ritmo de los conflictos locales

Por Lara Bersano

La XIII Conferencia de las Américas del Miami Herald, organizado conjuntamente con el Banco Mundial, la Universidad Internacional de la Florida y el Gobierno del Estado de la Florida, tuvo una de las mayores convocatorias en sus trece años de historia y un programa marcado por debates de fondo sobre los problemas que atraviesa la región. Desde el tema de Honduras hasta la situación de Haití, pasando por la criminalidad en México y la defensa del modelo Argentino de Crecimiento, el evento fue una de las cumbres políticas más importantes del año.

La vicepresidente del Banco Mundial, Pamela Cox, el ex presidente Bill Clinton, el presidente Oscar Arias, Dan Restrepo, el enviado especial de Obama para Latinoamérica, el gobernador de Buenos Aires Daniel Scioli, el Jefe de Gobierno de Buenos Aires, Mauricio Macri, y una docena de importantes líderes de empresa, dirigentes partidarios y diputados de los países latinoamericanos, fueron el principal foco de atención de los casi mil asistentes que pasaron por la Conferencia de las Américas del Miami Herald de este año. A pesar de que el tema de la Conferencia estaba dedicado a analizar los efectos de la crisis económica en la región, el programa estuvo marcado por debates profundos en cuanto a política regional, tanto interna en cada país como en relación a los países vecinos.

Pamela Cox
Pamela Cox

Pamela Cox, Vicepresidente regional del Banco Mundial y el director de Reducción de Pobreza Marcelo Giugale, fueron de los primeros en dar su evaluación de las perspectivas de desarrollo económico y social futuro de América latina.

La principal preocupación del Banco Mundial es la atención de las clases sociales más vulnerables de la región, que se han llevado la peor parte en esta crisis, según palabras de la Vicepresidenta Cox: “Es clave que en estas discusiones sobre los desafíos políticos y económicos de cara a la post-crisis, haya una idea simple: que las preocupaciones económicas deben ir de la mano con las preocupaciones sociales”, dijo. Para el Banco Mundial uno de los desafíos es el nuevo rol que puede jugar el estado en el crecimiento regional.

"Las preocupaciones económicas deben ir de la mano
con las preocupaciones sociales”.

Dan Restrepo
Dan Restrepo

Oscar Arias
Oscar Arias

Estados Unidos y el Conflicto de Honduras

Dan Restrepo, funcionario clave de la Administración Obama para América Latina, llamó al gobierno de facto de Honduras a restaurar todos los derechos civiles y constitucionales de los hondureños: "El golpe en Honduras fue una ofensa a la esencia de los principios democráticos de América latina". Al referirse a la situación en Colombia, Restrepo reiteró el compromiso de Estados Unidos de combatir a los carteles de la droga y "la esperanzas de que los vecinos de Colombia se nos unan en esa lucha".

"El golpe en Honduras fue una ofensa a los principios democráticos
de América latina".

Oscar Arias, Presidente de Costa Rica y mediador en el conflicto añadió que “Honduras se arriesga a ser vista como la "Albania de América Central'' si no consigue resolver la crisis desatada por quienes expulsaron al presidente Manuel Zelaya antes de las próximas elecciones presidenciales” Arias dijo en una entrevista al Diario Miami Herald que la administración del presidente Barack Obama podría ejercer más presiones sobre el nuevo gobierno hondureño para que aceptara las propuestas que hizo en agosto pasado con el propósito de poner fin a la crisis, conocidas como los Acuerdos de San José.
(en la foto junto con el equipo de la Universidad Internacional de la Florida)

"EE.UU. debe ejercer más presión en el caso Honduras".

Bill Clinton
Bill Clinton

Bill Clinton y su llamado de ayuda internacional para Haití

El ex presidente Bill Clinton presentó los resultados de su tarea humanitaria en Haití y convocó a redoblar los esfuerzos por ayudar a ese país a salir del clima de pobreza extrema en la que se encuentra la mayoría de la población. Asimismo, pidió mayor coordinación de las organizaciones de ayuda en ese país caribeño, ya que, según sus palabras “es necesario que la gran cantidad de ONG que trabajan en Haití lo hagan con mayor coordinación para que la ayuda que se brinda tenga más impacto”. Asimismo, el ex presidente norteamericano señaló que existe un gran consenso en América latina y el resto del continente sobre la necesidad de ayudar a Haití a salir adelante. Y resaltó que, en cuanto a la ayuda a Haití, “incluso Cuba y Venezuela están de acuerdo en que todos deben ayudar más allá de las cuestiones políticas''. Coincidiendo con otros líderes de la región, Clinton considera que "Haití nos presenta una enorme oportunidad de hacer la región más segura y estable''.

Luego de la Conferencia de las Américas, Clinton realizó una visita de dos días a Haití con emisarios del Banco Interamericano de Desarrollo, para abrir nuevas iniciativas para empresarios y mencionó especialmente la necesidad de desarrollar rutas para el transporte, que impulsen la producción y el turismo.

“Salvemos a Haití”

Daniel Scioli
Daniel Scioli

Mauricio Macri

Mauricio Macri

Argentina y la salida de la Crisis

Tras una introducción del economista del Banco Mundial, Augusto de la Torre, fue el turno de los representares Argentinos en la Conferencia de las Américas. Daniel Scioli, gobernador de la Provincia de Buenos Aires, definió a esa provincia como "el motor productivo del país" y describió su "diversidad, expresada en un conurbano que concentra a 10 millones de habitantes, con altos niveles de pobreza y exclusión que es nuestro desafío revertir".

También indicó que las acciones de su gobierno durante la crisis se concentraron en "sostener el empleo y combatir la pobreza, sin dejar de desarrollar una lucha frontal contra el narcotráfico". Scioli sostuvo que América latina se recuperó "defendiendo la economía real y no desde la especulación financiera". Y aseguró también que "el desempleo no se sintió con tanta fuerza" como en los países centrales y fue entonces cuando planteó la primera polémica al permitirse disentir con la reciente exposición del Banco Mundial cuando dijo que no se puede tomar un período de dos años para analizar la situación de un país, y pidió que se revise la evolución de Argentina desde 2003, “cuando comenzó la etapa de mayor crecimiento de su historia", afirmó.

El gobernador sostuvo que la Argentina "está en óptimas condiciones para abrir extraordinarias oportunidades de inversión" y luego se enfocó en la descripción de su gestión, mencionando en primer término la introducción de la tarjeta alimentaria, definiéndola como "un programa contra el clientelismo político".

“La provincia de Buenos Aires es el motor de la Argentina”.

Luego fue el turno del Jefe de Gobierno de la Ciudad de Buenos Aires, quien realizó también un pronóstico optimista sobre el futuro de América latina y de la Argentina en particular. Pero fue incluyendo críticas y cuestionamientos duros a las políticas kirchneristas hacia el campo, hecho que constituyó el eje de un conflicto profundo entre el gobierno de Cristina Fernández y el sector productivo más importante del país en 2008.

"Nuestro país podría, en menos de una década, terminar con la pobreza, pero para ello necesita ser un país previsible, con reglas claras, instituciones sólidas e integrado a los mercados", comentó Macri. También criticó la pobreza que aún se registra en la Provincia que dirige Scioli: "cuesta entender ese nivel de pobreza en un país con tantos recursos naturales y humanos", dijo. Macri prefirió referirse a los modelos de Chile y Brasil como referentes de desarrollo en la región.

Tanto Scioli como Macri aprovecharon el viaje a la Florida para tener contactos de alto nivel con políticos y empresarios en busca de lazos comerciales, políticos e inversiones.

“Reglas de juego claras y seguridad jurídica".

Luis Enrique Mercado
Luis Enrique Mercado

México fue otro de los fuertes ejes del debate de la Conferencia

En un informe de Kroll Associates, la compañía advirtió que "mientras más se involucre el gobierno de EE.UU. no es improbable que compañías estadounidenses enfrenten extorsión, que gerentes locales sean secuestrados en busca de rescate, y que aumenten los secuestros de camiones''. Negocios estadounidenses podrían convertirse en blancos para los carteles mexicanos, a medida que Washington se involucra en la guerra contra el narcotráfico al sur de la frontera, de acuerdo con una importante corporación global de inteligencia y seguridad.

Luis Enrique Mercado, legislador del gobernante Partido Acción Nacional (PAN) de México, dijo que la situación mexicana se parece cada vez más a Colombia durante los días de mayor actividad en el combate al narcotráfico y que los retos que enfrenta el gobierno no son fáciles.

"Sí, México se está colombianizando. Esperemos que [el país] tenga la misma capacidad de Colombia para controlar la situación'', dijo.

"El problema de México es la droga".

Por primera vez la conferencia se pudo seguir en tiempo real por video streaming en el sitio web del Miami Herald y por Twitter en @AmericaConf.

La Conferencia de las Americas de The Miami Herald fue presentada por los siguientes sponsors: American Airlines, Burson-Marsteller y Chevron. Los medios asociados incluyen: Radio Caracol, Revista Competencia y Marketwire.

América latina en Cifras

Según el Banco Mundial:

  • Siete: es el número de elecciones presidenciales que se celebrarán en los próximos 13 meses en América latina.
  • 17.000 millones de dólares: es la cantidad de dinero que el Banco Mundial planea entregar a los países de la región este año, casi tres veces más que en cualquier otro momento.
  • 4 por ciento: el crecimiento en América latina ha bajado de 4 por ciento en el 2008 a entre -2 y -2.5 por ciento en el 2009.
  • 11 por ciento: es la reducción del volumen de exportaciones de la región, la peor baja en 72 años.
  • Entre 350,000 millones y 400,000 millones de dólares: es la cantidad de dinero que los países de América latina necesitarán tomar en préstamo en el 2010.

Fotos: Heidi Jane Smith (estudiante doctorado e investigadora del Instituto de Gestión Pública y Servicios Comunitarios en Miami, FL)

Can Local Governments be used as agents for Growth?


Heidi Jane Smith
Florida International University
Prepared for delivery at the 2009
Congress of the Latin American Studies Association
Rio de Janeiro, Brazil June 11-14, 2009

Recent local economic development initiatives in Latin America are a consequence of the decentralization processes currently underway in the region. Specific efforts to promote these policies are driven by a complex set of political and economic factors facing local areas. Some Latin American countries, such as Mexico and Argentina, have started to offer incentives as a way to attract foreign investment. Others have provided promotional advertisements to retain or encourage manufacturing and/or foreign enterprises into their areas. Still others encourage small and medium enterprises to grow by creating a positive policy environment within which to work.

The key issue is how Latin American countries can learn to foster local economic development through the appropriate government structure and incentives practices. Latin American national governments can promote competition by engaging state and local levels of government to create the appropriate programs that are effectively able to retain and expand their economic activity (Wiesner, 2003). This study uses a statistical model to evaluate which factors influence the number of businesses and new business created in a local area. It uses a survey of mayors, city council members and executives from thirteen countries in Latin America to gauge whether they implement pro-business policies to improve their local areas, considering fiscal, administrative and political autonomy, and finally, controlling for municipal environmental factors.

This paper is organized into the following sections. First, it briefly summarizes the development attempts in Latin America and describes why entrepreneurship is key for equitable growth. Second, it will provide a theoretical perspective as to why decentralization is best to promote business friendly policies and ultimately economic development. Finally, this research paper tests the proposed theoretical perspective and provides tentative conclusions.

Fiscal Federalism in Latin America: From Entitlements to Markets, edited by Eduardo Wiesner

  1. Heidi Jane Smith

Article first published online: 25 NOV 2008

DOI: 10.1111/j.1540-5850.2008.00919.x

Book Review
Fiscal Federalism in Latin America: From Entitlements to Markets, edited by Eduardo Wiesner. Baltimore and London: Inter-American Development Bank. Distributed by The Johns Hopkins University Press, 2003. 144pp. $16.95.

What is fiscal federalism and how does it apply to Latin America’s decentralization process and poverty reduction is the central question Eduardo Wiesner is addressing in this book published by the Inter-American Development Bank in 2003. While comparing current decentralization processes in Brazil, Ecuador, Bolivia, and Chile, Wiesner provides Latin American (LAC) governments with a new fiscal policy framework.

Fiscal Decentralization: Explaining Successful Local Economic Development in Latin America

Working Paper by

Heidi Jane M. Smith
Florida International University - Department of Public Administration

August 13, 2010

This study uses a statistical model to examine which institutional factors influence the number of businesses created in a local area. It uses a survey of mayors, city council members and executives from thirteen countries in Latin America to gauge whether they implement pro-business policies. The analysis considers fiscal, administrative and political autonomy as influential factors and controls for municipal environmental factors. The outcome shows that whereas political autonomy and business friendly policies at the local level are important in attracting new businesses to the municipality, administrative and fiscal autonomy are less influential. The importance of this research lies in the theoretical analysis, which evaluates whether mayors and other local authorities see themselves as agents of growth. Specifically, the following questions are addressed. Does government structure matter to support municipalities with the appropriate level of economic policies? Does fiscal, political or administrative decentralization increase the production of small and medium size enterprises (SMEs)? This paper is organized into the following sections. First, it briefly summarizes the development attempts in Latin America and describes why entrepreneurship is key for equitable growth. Second, it provides a theoretical perspective as to why local government is needed to promote business friendly policies and ultimately economic development. Finally, this paper tests the proposed theoretical perspective and provides tentative conclusions.

Keywords: Fiscal Decentralization, Economic Development, Latin America\

For full paper and abstract click here:

To Download paper click here:

Tuesday, February 15, 2011

Latin American Tax Policy Reviewed

Indeed, tax revenues in Latin America are low by international standards. The IDB reports within the region that tax revenues, excluding social contributions, were about 17 percent on average of GDP in 2005. Yet, there are very large discrepancies in tax burdens across the countries and within states (at the sub-national level). They range from the low burdens of countries endowed with nonrenewable resources like Mexico and Venezuela (about 10 percent of GDP), to high levels in countries like Brazil (36 percent of GDP).

Surprisingly, Brazil’s tax-to-GDP ratio, at 36 percent of GDP in 2004, is already closer to the OECD average than that of the other Latin American countries. It is one of the most progressive systems within the region. But in some countries, such as Peru or Mexico, government revenue is much lower, usually in a range of 10-20 percent of GDP. This reflects the inability of the government to bring more dynamic sectors of the economy into the tax net.

Within some countries, typically larger federalist ones, financial disparities also exist between jurisdictions, which create large fiscal gaps for many state economies. For example Falleti (2004) points out that within Argentina, the city of Buenos Aires raises 92.7 percent of its own revenues and the province generates 56.1 percent, while other location like Catacmarca, La Rioja and Santiago del Estero only raise about 10-15 percent. These inconsistencies also exist in Brazil, Bolivia and Mexico (Wiener 2003)

Despite these differences, there are a number of common weaknesses in the tax systems across the region. First, there is heavy reliance on indirect and payroll taxes—representing about 75 percent of the total— which results in a regressive tax system. While in developed countries the tax system helps to reduce inequality, in Latin America it exacerbates it (Gomez Sabaini 2006). Evidences suggest that Latin American states dependency on indirect taxes (such as sales tax, value-added tax (VAT), or goods and services tax (GST)) which are collected by intermediaries, i.e. a retail stores, and not from the person who ultimately carries the economic burden of the tax, make consumer not “feel the cost” of the public good which they are consuming.

Second, the tax system is a source of significant distortions in resource allocation, and reduces the region’s competitiveness relative to other fast-growing regions such as East Asia. For instance, numerous tax exemptions (especially for VATs) and various taxes on financial transactions are commonplace. More generally, the structure of the tax system does not appear to be based on efficiency criteria (i.e. the collection of point of origin or the increase of personal income and property taxes to broaden the tax base).

Furthermore, Latin America is typically associated with high transaction costs for its tax policy. According to data from the World Bank’s Doing Business report (2009), tax rates for small businesses in Latin America are higher than in several other regions. In particular, taxes on profits are on average the second highest after Sub-Saharan Africa. The combination of low tax revenues and high tax rates points to the high incidence of tax evasion. Specifically, various studies have focused on micro-enterprises and their effective tax rate, which is the largest sector to evade taxes.

Finally, state’s ability to collect taxes, or their fiscal capture, is often lost to capital flight because individuals who earn higher salaries simply save in foreign banks to avoid income, payroll and social security taxes. The loss of savings within domestic banks also creates disincentives for investments within the region.

Recent Reforms
Traditional tax analysis originates from neoclassical theory of public finances, which seeks for more efficient and equitable ways to tax. The main policy proposals have been to simplify and broaden tax bases, lower income and corporate taxes (in order to encourage business development), promote reductions in trade tax rates through trade liberalization, and emphasize the widening and implication of VAT. Later on, property and income taxes are generally encouraged precisely because they are the most progressive taxes.

Two key variables are often disputed when discussing progressive tax reforms: administrative burden and political will for reforms. Often debates revolved around the administrative capacity of lower level governments to collect taxes. When equity concerns have traditionally been downplayed, international financial institutions have encourage the use of VAT. Yet, by simplify tax regimes, reducing the hurdles and the time required to comply with bureaucratic procedures is only one step to encourage better tax administrations. Governments must be clear on their tax rates for different citizens. Ending highly regressive VAT taxes is just one area. Tax systems must also rationalize the required payments and differences between large corporations and small and medium enterprises (SMEs). Furthermore, tax collection responsibilities should be shared among different levels of government.

Future policy recommendations must take into account the historical, political and institutional factors that have established durable tax collection capacity within states.

Policy Recommendations
First, and for most, the region needs to move towards a progressive and less discretionary and distorted tax structure. Direct taxation using personal income, property taxes can increase the collection rates more than the VAT and commodity related taxes.

Another main challenge is to broaden the tax base, reducing reliance on the most distorting taxes, such as on exports in Argentina. Furthermore, resource cursed countries, like Mexico, Venezuela, Peru and even Panama with its revenues from the canal, also must diversity their tax base. Not because they need more resources to pay for public goods, but to encourage state building processes allowing citizen’s reliance on the governance system. The institutional development is essential for Latin American governments to be stronger in the future.

Finally, various economists agree that administration reforms—the management and collection of the taxes—are as important, if not more, as the kind of taxes (VAT, sale, personal income, property, social security, etc.) that a country chooses to collect. Particularly important is having sound enforcement mechanisms and an independent administration for managing collection and government re-distribution. The development and advocacy of autonomy revenue authorizes (ARA’s) are necessary, although they may not be effective to deter tax evaders. Especially with weak states, revenue collection authorities are more effective when they operate autonomously from the state (i.e. outside the finance ministries). In the same light, effective methods to deter evaders with serious consequences are also necessary and can be encouraged by the international community.


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