Challenges and Opportunities for a State Role in the Post-Crisis

Abstract:

The global financial crisis that emerged in developed countries' markets revealed the shortcomings of an economic policy approach which believed in the self-regulation of markets and minimized the role of the State. The post-crisis reality demands a reformulation of the role of the State. Latin America and the Caribbean countries face this challenge in a context of ongoing changes in the world production structure that threaten its position in the global economy. Although many Latin American and Caribbean countries were successful in overcoming the crisis, four key areas of policymaking need to be redefined: The goals of a development-oriented macroeconomic policy and the role of the State in productive development policies in a globalized economy, in the abatement of inequalities in the labour market and of social differences caused by inadequacies of social protection institutions. Such redefinitions have to be carried out in the context of heightened demands for transparency in public and private actions, and for citizens' participation in the definition and implementation of public policies.

 

I. Introduction

The recent international crisis not only caused the greatest contraction of world economic activity since the Great Depression, but also revealed the urgency of revising how the economy and the role of public policies are regarded. The crisis laid bare the serious flaws of a policy approach that naively entrusted regulation almost exclusively to the market itself, minimizing and weakening the role of the State. It also revealed failures in ethics and transparency that characterized key market players and their scarce accountability to the societies that suffered the consequences of its actions. The world was witness to one of the biggest crises in modern history, with enormous losses of wealth and a virtual evaporation of institutions believed, until then, to be solid. In fact, at the peak of the crisis, a significant part of the financial markets in several developed countries, which for decades experienced strong growth, disappeared in just two weeks. The effect on the rest of the economy and for several less developed countries was devastating, with significant losses in production and employment and social consequences still to come and that will probably continue for a long time if we fail to understand the changes in public action that the post-crisis context demands.

In the midst of the turbulence, however, it was encouraging to see the capacity to learn from previous crises that at the time were aggravated by the inaction of the State. Even in developed countries where public action has been most questioned, the State has become the key agent in containing the crisis. Likewise, it will be public action that will bear decisively on the means and speed in which each country overcomes the current situation and addresses the challenges and opportunities that will emerge in the new global economic scenario that is already being shaped.

New challenges are arising for public policies that seek to project the region higher, in terms of production and in the social sphere, in equality, citizenship and the ethical conduct of economic players.

At the same time, new opportunities are arising to reconsider development on a more realistic basis with regard to the workings of the market and the role of the State, drenched with a clear sense of ethics, social justice and the deepening of democracy. This article will refer to the main aspects of these challenges, from the perspective of Latin America and the Caribbean.

 

 

II. The Challenges of Public Policy

 

The Goals of a Macroeconomy for Development

 

As a result of the financial crisis, 2009 was a year of setbacks in economic growth, employment and social conditions in the region. However, with certain exceptions in Central America and the English-speaking Caribbean, the region withstood the external turbulence with considerably better results than in prior crises. This was possible thanks to the important transformations in macroeconomic policies applied by a number of countries in the region years earlier.

In effect, the endemic growth instability of the 1970s, rooted in internal imbalances and in frequent external turbulence, gave rise in the mid-1990s to significant changes in macroeconomic performance. Beyond the differences between countries, the general result of these changes was a more consolidated fiscal situation, with improvements in the nature of the public external and internal debt, a reduction of external imbalances -even reaching surpluses-, a significant accumulation of international reserves in several cases and a persistent drop in inflation, with many countries recording sustained annual inflation rates of less than one digit (1).

In consequence, when the crisis impacted the region through different trade and financial channels, several countries enjoyed a margin of action for countercyclical measures to mitigate the effects of the external shock and avoid a procyclical sequence that in the past exacerbated the economic and social effects of these turbulences (2).

Illustrative of this greater economic soundness in the region is that during the current crisis, the overwhelming majority of countries did not have to seek external support for its balance of payments and the use of funds from multilateral financial institutions was very limited (3).

Nevertheless, and taking into account the differences between countries within this positive general scenario, the region should not be self-complacent with this progress, given that there are still significant setbacks, particularly in poverty, income distribution and living and labour conditions; macroeconomic performance is a decisive determinant to overcoming them.

Therefore, despite having experienced one of the longest phases of sustained growth in the past 40 years, progress in poverty reduction, income concentration and better living conditions has not been sufficient enough to merit satisfaction (4). Overcoming these problems requires actions in many aspects that go beyond macroeconomic policies, several of which are later discussed. Here we will address the main contributions of macroeconomic policy to development.

Economic growth is an indispensable, though insufficient, condition to advance towards better welfare, equality and poverty reduction in a context of reasonable stability. Stability, however, should not be understood as a one-dimensional concept of only nominal importance, such as inflation or monetary aggregates. A more comprehensive view includes real aspects such as the minimization of unemployment, or, in other words, the maximum use of available human and physical capabilities. As the painful experience in the region demonstrates, a lack of concern for unemployment can cause social tensions to rise to levels that can render useless any effort at stabilizing inflation. The first challenge, then, is for all of society to agree on the adoption of a macroeconomic policy framework that can heighten growth and open the way for the policies needed to create human capabilities, improve income distribution and reduce poverty.

The cornerstone of growth is capacity-building, understood as the accumulation of productive, scientific and technological capital, the creation of necessary infrastructure and developing human capabilities through education, strengthening learning and innovation. But as we know, our region is lagging behind in all of these key areas as a result, largely, of the weakness of the State to spearhead activities when necessary and support private entrepreneurship. Investment rates in general are much lower than those of countries that are en route to become developed nations, infrastructure is far from adequate, educational achievements - in terms of access and especially quality - are also not comparable to those countries and progress in innovation and scientific-technological development lags far behind (5).

Progressively, and especially in light of the challenges for competitiveness the region will face in the new global production order arising as a result of fast technological changes and the emergence of Asia as the main world manufacturing centre in the future, the need is clear for the region to recover the State's ability to support investment in capacity-building in the broad sense mentioned above.

Through the years and in different studies, ECLAC has stressed the need to reach a new fiscal covenant as one of the key elements in resuming the path to growth (6). This new social agreement, in terms of spending, should include recovering the State's capacity to support, directly and in association with the private sector, the creation and expansion of the infrastructure needed for development, the growing provision of quality public goods (health, education, security), social protection for the destitute, poverty reduction, especially extreme poverty, boosting the entrepreneurship of medium-sized groups seeking to increase their capital (SMEs, investment in housing) and innovative entrepreneurship, principally.

In addition, a new social agreement should establish solid foundations for addressing development needs through tax burdens compatible with each country's level of development, with equal and efficient tax collection structures. The regional experience in this area reveals serious deficiencies, with a low tax burden in relation to the level of development, the prevalence of indirect, regressive taxes, many mechanisms for tax evasion and avoidance that aggravate the system's inequality and, in general, tax revenues that make it impossible to regularly finance social programmes without incurring in deficits that would later imperil their continuity. Moreover, insofar these tax burdens are low in relation to the country's development needs and do not contribute enough to countercyclical actions, they are a source of vulnerability for the economy and living conditions in times of adverse external scenarios. Although this situation may not seem new given the disappointing growth of the past three decades and frequent fiscal imbalances, with certain exceptions during the recent period of boom, it nevertheless takes on a new urgency in the context of an increasingly globalized and competitive world and due to the new demands for equality, transparency, ethical conduct and accountability that are emerging due to greater citizen awareness and the stronger demand for participation in government decision-making processes. Also, as we know, the ability to compete in a globalized world does not rely solely on the advantages in productivity in a specific, isolated area. Competitiveness is of systemic nature and the advantages in one specific field are the result of its interaction with the components of the rest of the productive and institutional apparatus. In brief, inherent in competition in the export of services is the indirect competition of other public and private institutions in terms of their degree of efficiency and the quality of their policies. Countries will increasingly compete as well in terms of their respect for universally-accepted quality labour standards and environmentally sustainable production standards. It is in this new context that the necessary fiscal covenant has a renewed sense, which more than ever should acknowledge the systemic nature, and therefore of collective and broadly consensual origin, that should sustain a growth strategy based on competitiveness.

A predictable and sustainable path for public finances, by avoiding excess public spending, is one of the main contributions of fiscal policy to price stability. With this, monetary policy can focus on stabilization goals in the medium run without having to incur in high interest rates that make loans more costly, reduce investment and, therefore, sacrifice future growth. On the contrary, as seen in a number of examples in the region, a sustained public deficit, in conjunction with a contractive monetary policy, will lead to steep hikes in the cost of credit, production losses -particularly among SMEs- and significant reductions in investment, with lasting negative effects on growth and employment.

Furthermore, sustainable public finances over time make it possible to apply countercyclical fiscal measures when necessary, avoiding production and employment losses and thus contributing to greater stability (in the broad sense), which helps to increase growth in the long-run.

Complementary to fiscal and monetary policies, the goals of an exchange rate regime that supports stability and growth have to do with avoiding the overvaluation of national currencies that may fuel external deficits and affect resource allocation, again in detriment to exports and efficient import substitution. Additionally, this would contribute to minimize or avoid speculation against the exchange rate and provide a mechanism to mitigate the effects on the domestic economy derived from external price fluctuations and in international financial market conditions.

As theory and experience shows, there is not a sole recipe for exchange rate regimes. However, what is clear is that in the absence of fiscal and monetary policies that are coherent with the goals of growth and stability, it is not likely that exchange rate policies can attain all the objectives mentioned above.

In turn, a context of low and predictable inflation and moderate interest rates is a basic condition for the development of the financial system. Policies that favour access to financing by excluded sectors (micro-credit and guarantee schemes) and foster the development of new markets for financing investment (of companies and households) and innovation are crucial elements for a financial development strategy aimed at growth and inclusion. However, the effectiveness of these policies may be severely eroded by an unstable macroeconomic environment, which takes us back again to the strategic role of attaining a new fiscal covenant under the terms mentioned earlier.

Guidelines for Productive Development Policies

 

The prior section addressed eminently macroeconomic issues. However, as ECLAC's structuralist perspective sustains, the phenomenon of economic growth and the policies that support it have an inevitable sectoral dimension. From the beginning of economic growth theories, it has been said that growth is uneven among different productive areas: some areas drive growth during a certain time, which are later replaced by others. Other views stress that the progress made in certain technologies causes dynamic imbalances in the levels of productivity of different sectors, which, through the spread of technology, raises overall growth. The theories that focus on innovation as a source of growth state that the search for greater profits is the driving force behind creation, which, while destroying old opportunities, gives rise to new ways of increasing productivity.

The effectiveness with which the innovative drive leads to the growth of the entire productive structure depends on the characteristics of the productive and institutional structure, which determines the intensity of productive ties or the enchainment of innovative sectors with the rest of the economy and the speed and depth in which technology spreads. Enclave industries of low productive enchainment would not be particularly efficient in spreading their force to others. Likewise, the spread of technological progress will also be hampered by weak institutions, in terms of scientific and technological capacity-building and the provision of financing, as well as by legal frameworks that do not help innovators benefit from their efforts and cover the costs of the process and reach profit levels that can compensate the risks taken. ECLAC has asserted that the deep structural heterogeneity prevailing in the region, in terms of strong differences in productivity levels and capacities to create and adopt technological progress, is one of the main sources of low growth in the region. The coexistence of modern sectors with low-productivity ones is characterized by scant productive enchainment and dissemination of technological progress, which redounds in meager growth and scarce systemic competitiveness.

For this reason, productive development goals seek, in the first place, to reduce this heterogeneity by raising the productivity of the sectors lagging farthest behind and establishing an institutional framework in support of innovation and the dissemination of scientific and technological progress. This presumes elaborating strategies and policies geared at overcoming the multiple exclusions and barriers that cause differences in productivity: the segmentation of technological and financial markets, which leads to the exclusion of SMEs and different levels of access to key productive input (energy and industrial infrastructure) and export markets. In sum, policies should be adopted that foster a "leveled playing field" of opportunities for raising productivity and overcoming exclusion.

Secondly, productive development policies should focus on increasing the intensity of productive ties, promoting greater interaction throughout the productive chain among large, medium-sized and small companies through cluster policies and fomenting the association of medium and small companies as a way to gain economies of scale in production and in purchases of inputs.

Third, the creation of an institutional framework inclined towards innovation and that may support the spread of technological progress, as mentioned before, is a key aspect of growth and productive development policies. The dimensions of this challenge are vary greatly and therefore are impossible to cover in a brief essay. They range from establishing an innovation system composed of universities, company founders, appropriate financing systems (such as risk capital and direct financing lines from development agencies) and training institutes and the definition of instances for public-private partnerships for entrepreneurship, to laws that regulate intellectual property and instruments, such as patents, through which productive innovation can be encouraged.

Lastly, ECLAC has stressed the catalytical role the public sector can play by adopting modern practices and technological advances throughout the public service chain (for example, tax systems, public records, government procurement of goods and services, modern medical administration, provision of information, etc.), which, through cost reductions and improvements in quality, may heighten the overall productivity of the economy.

Main Aspects of Policies to Diminish Inequality

a. Reducing inequality in the labour market

The situation of the labour market in Latin America and the Caribbean largely explains the economic and social inequalities in our region. The amount and quality of employment, specifically wages, largely determine the material welfare of households. Also decisive is the gap between wages and the access to social protection of different segments of the labour force according to their characteristics in terms of education, experience, gender, area of residence and other factors.

Additionally, the strong structural heterogeneity of the productive structure in the region is expressed in marked differences in job characteristics according to the sector of labour insertion. In effect, people with similar qualifications may obtain very different jobs with regard to income, access to social security and labour stability. This is partly the result of the broad productivity gaps between different productive sectors and due to the fact that formal labour and social institutions cover only a part of the labour force. The informal sector represents a very high proportion of the economically active population in the region, where labour institutions are lacking. Conditions are highly precarious, wages are low and there is scant social protection. Conditions for women, ethnic minorities and youths are even more disadvantageous and less regulated.

In recent decades, many countries in the region undertook labour reforms. Many of the measures sought to deregulate and make the labour market more flexible so as to improve the allocation of human resources and thus increase the creation and quality of jobs. This goal is far from being met through these means (7). Although greater flexibility in the labour market could favour the capacity of adjustment in the short-term, in practice it has usually meant shorter contracts and greater instability in job positions. Given that the development of new knowledge and specific skills requires higher job stability, faster job rotation has in fact led to the loss of human capital and productivity gains. In consequence, the net contribution to growth of greater labour flexibility is far from certain.

It is legitimate to question the validity of the discussion, in light of the high proportion of the informal sector in job-creation, characterized by a low prevalence of formal labour relations, and therefore, high flexibility de facto. In this context, the net gains of the reforms, if they were to exist, would be marginal.

The objectives of policies aimed at fostering greater levels of equality and justice in labour (and in this way reducing inequality in households) refers to the amount of income and improvements in labour conditions, labour inclusion and the eradication of discrimination. Although there is not a sole path to attain this, ECLAC has suggested several general guidelines.

First, a lasting increase of wages relies mainly on greater productivity and better education for all, reinforcing instruments for professional development and training. The power differences that are characteristic of the labour market in the region must be counteracted, strengthening collective bargaining, not only for better income distribution but also as a means to develop sustainable socio-labour agreements.

Related to the above and despite the controversy it provokes, the minimum wage has significant distributive potential. The final result depends, however, on the specific characteristics of the wage and labour structure in each country. The incidence of jobs created by SMEs and their productivity level should be taken into account, because SMEs absorb a great deal of non-skilled workers, who tend to receive wages near the legal minimum.

Secondly, the first requisite for improving labour conditions is the institutionalization of labour relations in the formal sector, which are characterized by the lack of access to general labour rights, particularly when it comes to subcontractors, temporary jobs and work from home.

Third, the instruments that foment quality labour insertion for groups facing special obstacles must be strengthened. In the case of women, it is indispensable to apply policies to harmonize their work and family lives in order to reduce the gaps in access to the labour market as well as the conditions of that insertion. To encourage the access of youths to good-quality jobs, in addition to improving the coverage and quality of education and eliminating discrimination, mechanisms must be established to support the transition from the world of school to the labour world (practices and internships, etc.), as well as increase training and labour intermediation.

Lastly, unemployment protection mechanisms should be strengthened, which would also contribute to greater efficiency in the search for work. Few countries in the region have unemployment insurance and their absence is generally explained due to the lack of resources, even though several countries in the world introduced such systems when their income was similar to that of many Latin American countries. The vulnerability of informal workers must be mitigated through non-taxed mechanisms of social protection and productive development instruments aimed at sectors where most informal work takes place (small and micro-companies).

b. Reducing social gaps

The reflection above focuses on the labour market as the main determinant of social inequalities. Here we briefly address other aspects of the problem that are also part of the challenges for the State in the post-crisis period. The secondary distribution of income, that is, distribution principally through transferences, has two main components. First there are pension systems for retirement, widowhood or disability, and secondly, transfers by means of protection systems for the unemployed and subsidies for low-income groups, the poor and indigent.

With regard to pension systems, ECLAC has developed a number of studies and proposals. After decades of studying and combining different alternatives of pay-as-you-go and privately-administered individual capitalization models, the reform agenda today includes a greater presence of non-contributive solidary systems, uniform pensions with universal or focalized coverage (8). The objective is to avoid poverty at an older age and mitigate the degree to which pension systems inter-temporally transfer the inequalities of labour markets, which restrict and/or exclude certain segments from the possibility of generating savings for retirement. In all, as occurred with the pay-as-you-go systems, the quality of this policy will depend on the capacity to attain a fiscal covenant that may provide inter-temporary solvency to the commitments of complementary solidary systems.

On the other hand, unemployment is a scourge that affects not only household income but also the mood of people and their social integration. Unemployment insurance for workers of the formal sector is insufficient to cover the most unprotected sectors. As mentioned earlier, a broader system is needed, one capable of identifying and including the employed who lack social security. Given the complexities inherent to identifying the informal, unemployed worker, for now the most feasible options are programmes to support emergency employment and training subsidies for those looking for work.

The region has shown a progressive capacity to manage direct income transfers, thanks to the advances in the institutional framework needed for these systems to function correctly. However, different indicators point to that, although their effects are positive in terms of reducing income gaps, their magnitude in terms of resources is still insufficient to compensate the inequality arising from the diverse insertions and exclusions of the labour market.

As ECLAC has mentioned before, education is one of the key policies for reducing social and inclusion gaps with greater positive externalities for development. Coverage, quality and access to education for all of society are imperative. A pro-education agenda should aim to extend coverage of pre-school education and the school day while seeking greater high school completion rates in the lowest income quintiles. Pre-school education can fulfill the double purpose of leveling learning capabilities early into schooling, and, with the extension of the school day, can reduce the number of hours adults (especially women) spend taking care of small children. This enables better access of women to the labour market and thus raise household income. Despite improvements, the coverage of childcare services in Latin America and the Caribbean is insufficient. Pre-school coverage for children three to five years old is heavily stratified, with access proportional to household income, and in which there is less coverage for children from poor and vulnerable households.

Completing high school education is decisive for social inclusion by means of education and provides the basic knowledge and skills needed to face the labour market and overcome poverty. However, high school completion in our region is strongly stratified, and so it tends to reinforce, and not counteract, the intergenerational reproduction of poverty.

Another dimension of the stratification in access to quality education in our region is the persistence of learning gaps among students of private and public schools.

The range of education policies to diminish these gaps is broad and necessarily involves public education.

c. The territorial dimension of policies

There are territorial differences in the heterogeneities and exclusions discussed above. Policies in certain areas, such as the development of productive enchainment through clusters, support for SMEs or programmes to support low-income households, etc. have clear regional dimensions. This reveals the need to develop a means for dialogue and interaction among the different regions and the central government, particularly in establishing priorities in designing budgets, the main expression of public policies in different areas. The way in which this can be done is closely linked to the organization of the internal political structure (central versus federal), but in all cases it requires conciliating two forces that sometimes conflict. Regions have comparative advantages in identifying their needs and possibly in adapting policies to the regional environment as well. However, the central government has advantages in that it can seek the coherence and sustainability over time of its different policies.

Tensions are especially strong when it comes to regional or state government income and spending budgets. The incomplete resolution to this natural conflict could cause programmes to be inappropriately designed, without taking into account the regional variables in their design and application and/or in policies that are not coherent between each other or are not sustainable over time. The most serious case of the latter is when the means to determine regional finances leads to a situation of sustained fiscal deficit on a national scale.

 

III. Some Final Reflections

 

The recent financial crisis, which, it is worth recalling, began in several advanced countries and not as a result of the unsustainable macroeconomic performance of less developed economies, revealed the failure of the self-regulation of markets, serious ethical flaws in the conduct of some private agents and the feeble demand for accountability to society for their actions, along with the weaknesses of an approach that minimized the role of the State in the economy in general and in the regulation and supervision of certain markets in particular. However, the consequences of this crisis are not limited to the financial systems of these countries. The effects were also felt strongly in the region, even though it faced the crisis, in general, in better conditions that on prior occasions (9).

The events described above have prompted a deep re-examination of the role of the State in addressing the development challenges discussed here from the perspective of Latin America and the Caribbean. So far, the discussion has centred mainly on the strategic goals for public policies geared at growth, reducing inequality and overcoming exclusions. But in addition to demanding a reconsideration of public policy goals, the current crisis has also offered new validity and importance to the demands for change in the State itself, rooted in a greater intention to demand inherent citizen rights. This growing citizen awareness is posing two challenges for States in the region.

First, transparency has increasingly become a central issue in examining private and public conduct with respect to the way in which policies and the use of resources are decided, particularly public or semi-public funds (10). This challenge poses multiple dimensions for reforming State action, and include the obligation of informing of expenditures, the establishment of public procurement systems open to all qualified suppliers, with competitive adjudication and the publication of its characteristics, mandatory declarations of the patrimony of all public officials before and after taking office, the prevention of conflicts of interest through the early and trustworthy public revelation of ownership or family relationships with private entities or CEOs in relation to decisions the State must make that may affect them and the establishment of internal auditing systems in public services, to highlight some of the aspects under recent discussion.

These demands for transparency and ethical conduct are also reaching the private sector, especially when a private company is the privileged supplier of certain public companies and in cases in which the private sector administers other people's funds, such as banks, pension fund companies, etc. In effect, the acknowledgement of the influence of the serious flaws in governance of some private institutions in the origins of the crisis and the serious deterioration of pension funds, which in some cases has been a result of the actions of executives and the board of directors of private companies, brings new importance and urgency to governance issues of these companies.

Secondly, over the past few years there has been a greater demand for changing the way in which the State relates to citizens, calling for greater participation in the design and application of public policies. Public intervention often affects certain groups of people or certain geographical areas more directly. In both cases, the will to exercise the right to be heard so policy design and management be more participatory has been strengthened significantly.

This implies important challenges. Among them, the need for consultation mechanisms that can make compatible the search for the common good with the respect for the wishes of the majority, recognizing the rights and viewpoints of groups of citizens who may be negatively affected. It is important for the development of democracy to prevent public institutions and policies from being co-opted by corporate or interest groups that can derail the intention of those policies for their own benefit, instead of for the common good.

In sum, the current situation has been very productive in terms of questioning extreme and/or naive views regarding the functioning of markets or the role of the State, and here we have outlined the main lessons learned. A new consensus is arising that vindicates the role of public policies in overcoming underdevelopment and inequality, in a context of globalized economies with greater demands for public scrutiny and citizen participation. At ECLAC, we believe that this is great progress.

 

 

Footnotes

 

(1) These advances are documented in the issues of the Economic Survey of Latin America and the Caribbean and in the Preliminary Overview of the Economies of Latin America and the Caribbean published by ECLAC.

(2) For example, in the experience prior to this crisis, in a context of narrow fiscal margins, falling external demand resulted in deteriorating terms of trade which, in turn, lowered demand even more, reinforcing the effects of the external shock.

(3) Several countries established quota agreements with the IMF, but in practice, payment has been very limited.

(4) See issues of the Social Panorama of Latin America and the Caribbean published by ECLAC.

(5) See ECLAC, "Productive Transformation 20 Years Later. Old Problems, New Opportunities" (2008).

(6) The ECLAC document "The Fiscal Covenant. Strengths, Weaknesses, Challenges" (1998) defines a fiscal agreement as "a basic socio-political agreement that legitimizes the role of the State and the sphere and scope of government duties in the economic and social domain".

(7) For an analysis of labour institutions in the region, see Economic Survey of Latin America and the Caribbean 2008-2009.

(8) See ECLAC, "Shaping the Future of Social Protection: Access, Financing and Solidarity" (2006).

(9) See ECLAC, Economic Survey 2008-2009 and ECLAC, Preliminary Overview of the Economies of Latin America and the Caribbean 2009-2010.

(10) The demands for transparency are not limited to the use of revenues, but also to the use of semi-public resources; that is, funds from mandatory systems such as pension systems based on individual savings.

Alicia Bárcena,
ECLAC Executive Secretary