According to the World Bank, the fiscal deficit is the greatest challenge for the economies of Latin America, since it makes it difficult to leave behind the recession

In Latin America, the relative exchange and inflation stability is a reasonably new phenomenon. As the region leaves behind the recession, it is necessary to make structural adjustments to shield the progress that has been made from the evils of the past.

Leer en español: La reforma fiscal debe ser prioridad para las economías de América Latina

For Carlos Végh, chief economist for Latin America at the World Bank, the structural adjustment that leads to this end is fiscal reform, the main macroeconomic challenge facing the region today.

"Latin America has taken about 30 years to achieve control over the rate of inflation, but all advances are at risk if the fiscal deficit that is currently present in the region is maintained," Végh said in a presentation entitled "Fiscal adjustment in Latin America and the Caribbean: costs in the short term, benefits in the long term?”

For Latin America, reducing public spending can be crucial to guarantee the continuity of the progress made during the last decade, particularly in regard to inflation, which despite notable exceptions in Venezuela and Argentina, is under relative control through the region.

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This is because a reduction in the fiscal deficit would offer two considerable benefits to the Latin American economies. First, it would allow countries to access cheaper loans that allow public works to be executed with a direct impact on the production capacity and welfare of the population.

In the second place, a better fiscal balance would allow the economies of the region to adopt countercyclical policies to lessen the effects of the cycles of the world economy; particularly, the commodity cycle, which conditions the economies of Latin America since they still depend on their exports of raw materials to remain profitable and growing.

Finally, Végh considers, a reduction in public spending would also allow states to be in a better position to face natural disasters, cases in which it is necessary to have liquidity in public reserves to act immediately and effectively.

"We must do the impossible to preserve social gains and protect the most vulnerable sectors," says Végh, because for him, between 2002 and 2015 the region has achieved "immense progress" in reducing inequality and fighting against poverty.

A very encouraging present

In the World Bank’s perspective, the situation is serious, according to its latest report for Latin America and the Caribbean, 31 of the 32 countries in the region found themselves in a position of fiscal deficit during 2017.

However, compared to what was usually expected in Latin America, the landscape is encouraging and a reduction in the fiscal deficit would be a huge step in the right direction to restore investor confidence in the region and to continue reducing social gaps.

Whereas in the past the region resorted to the issue of currency as a way to adjust wages and fight poverty, without ever thinking about the damage that this could bring by means of inflation, Végh ensures that this behavior is no longer seen.

"That has changed and now we are in an environment of low inflation, with an average of 3.5% (except for Venezuela), compared to an average of 200% in the 1980s," says Végh.

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An arithmetic problem

Although the recommendations of the World Bank seem reasonable, one of the greatest obstacles to its implementation lies in the variety of political positions adopted by the countries of the region today. Particularly, the governments of social democrat, socialist or populist, who are interested in increasing public spending precisely as a means to reduce inequality.

Végh acknowledges that the World Bank cannot comment on politics, but argues that the problem of fiscal deficit "is not a problem of ideology, but of arithmetic".

Latin American Post | Pedro Bernal
Translated from “La reforma fiscal debe ser prioridad para las economías de América Latina”