RICARDO LAGOS: Rules of the game
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RICARDO LAGOS: Rules of the game

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Fiscal reform is key if Latin America is to accommodate its fast emerging middle class, says former Chilean president Ricardo Lagos

Latin America is emerging from the global crisis in much better shape than other regions, especially in the developed world. For one thing the region can disclaim any responsibility for the crisis, whereas in the past it was one of the centres of economic crises.

Partly because of our history, we have learnt something about financial crises. Our banking system in general was much better prepared and this is why now we are in a stronger position.

The crisis came after six years of tremendous growth in Latin America. But that growth came about not so much because of what we did, but rather – simply – because of the engine of growth in China and other Asia economies. Prospects remain good so long as the Chinese engine keeps working.

Even though we are in much better shape, the outlook depends on us – and on whether we understand that most of today’s revenues have to be invested in long term projects and not channeled to current fiscal expenditure.

It is important to understand that now is the time for Latin American countries to introduce some sort of structural rule on fiscal surpluses. We have to save now for the future. Most of the region’s surplus relates to natural resources, whether mining, oil or agriculture. It is not advisable to use this for current expenditure.

This new Latin America is a middle income Latin America. A number of countries now have per capita income on purchasing power parity of about $15,000 according to IMF figures. A number of countries are going to break the $20,000 mark by 2020 or earlier.

When you are a middle income country, you have other demands. The landscape of Latin America has changed. Now you have a growing middle class and they have different demands from the Latin America that used to fight mainly against poverty. All those people that leave poverty behind are the emerging middle classes that have a different agenda. That agenda is education for their children, whether they will be able to reach secondary, or even tertiary education.

Latin American income distribution is still extremely unfair: it is one of the most uneven in the world. We know that it is possible to defeat poverty, but despite doing so, most countries remain extremely unequal. The big challenge is to improve income distribution.

The emerging middle classes are demanding more public goods and services from the state. It is therefore going to be necessary to have more fiscal income. We should not think that because we are experiencing sunny days today, this is not necessary: when sunny days are over fiscal budgets need to be structured in such a way that ordinary revenues will pay for ordinary fiscal expenses.

This means that we need some sort of tax increase. Taxation must represent an improvement in the short run in income distribution.

I would not say that the region should follow Chile’s example. But sound countercyclical economic policy means having a budget aligned according to a long term trend, either in potential gross domestic product or long term commodity prices.

In 2000, when the copper price was only $0.60/lb, I said that we should spend according to the long term price, something like $0.89. The moment of truth arrived in 2003 when copper prices went up to $2/lb and then $3/lb, but because of the fiscal rule, I couldn’t spend more than the long-term prices at that time. All the difference was saved for the rainy days, and they arrived in 2008 with the global crisis.

If the current commodities cycle started in 2000, then by 2020 it is going to be over. The big issue is what are we going to do during the next five years? Are we going to be able to save in order to invest in our long term growth? It is not a question of picking the winners but of whether we are going to be able to build adequate infrastructure and services as well as technology that can add value added to our exports.

An economic cycle is coming to an end in the sense that we need different tools to keep our economies going. A social cycle is also coming to an end because the fight against poverty has now become the fight for the new demands of the emerging middle classes.

Chile today is suffering the pains of this growth. And as Colombia’s president Juan Manuel Santos put it, what we are seeing today in Chile is what we will to see in the near future in other Latin American countries.

The instruments and tools that made Chile a success story over the past 20 years are not the tools and public policies that we need for the next 20 years. Because we succeeded, we changed the country, and because we changed the country we now need to change our agenda and our public policies.



Ricardo Lagos was President of Chile from 2000 to 2006.

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