6.5.5. A proposal for Latin America

The previous discussion shows several items. First, in the fiscal policies in Latin America the intention to reduce the pro-cyclical bias is as important as to that of eliminating the deficit bias. The pro-cyclical bias stresses the volatility, with disastrous effects to growth and it damages especially the poorest, because it forces reductions in social spending in moments when it is most necessary. Second, the fiscal policy and the fiscal rules should be able to simultaneously solve both problems. Obviously, counter-cyclical policies contributing to the deficit bias will not be sustainable.

In addition, the rules that try to reduce the deficit bias and to achieve solvency by increasing pro-cycling of the fiscal policy, are clear candidates to be unsustainable in the mid-term.

Properly designed fiscal rules may help solve the problem of political economy and credibility inherent of the operation of pro-cyclic fiscal policies (and deficit bias). Rules so designed may help to hold back political pressures to spend surpluses in times of prosperity.

These rules may give credibility to hold deficit during periods of economic contraction, if these rules have resulted in surpluses during periods of expansion, thus increasing the probability that deficits are suitably financed.

The fact that unbalances are limited by the rule may also maintain under control the pressures to increase excessively the deficit during the periods of economic scarcity. Among different rules implemented in the region, the most convenient seems to be the maintenance of a structural balance sheet or of a modest structural surplus, as the one recently adopted in Chile.

This rule would allow the free operation of automatic stabilizer during the course of economic cycle and would avoid sudden changes in the public spending, associated with the variation of tax receipts from exportation of primary goods.

Other countries in the region would benefit from the adoption of a system similar to that of the structural balance, especially for the discussion of its fiscal policy, even if they do not adopt a rule of structural balance.

The rules of structural balance should also be a part of future intents to establish Laws of Fiscal Responsibility and Stabilization of Transferences to sub-national governments in Latin America.

Those countries that do not yet have the capacity to adopt work frameworks for credible structural balance may profit themselves considering more simple rules, such as, to limit the real growth of spending to a flexible average of real increase of tax receipts of the past. A country starting under what would be a structural balance should set goals that may allow it a gradual approach to the required level. There is no need to wait until the fiscal consolidation is reached to introduce rules that make compatible its attainment with the removal of the pro cycling of the fiscal policy.

Even more important: it would be extremely useful that the IMF, the multilateral institutions of development and analysts of the private sector started to use systematically a framework of structural balance to examine and discuss the fiscal position of the countries (the same way as the IMF does with the countries of the OECD) and fix the goals of their programs in terms of this analysis. There is no reason why these good practices applied in the first world should not be extended for the analysis and design of policies in the third world.

It was unfortunate that not only local authorities and analysts, but also international financial institutions and international markets, accepted and congratulated pro-cyclical and highly expansive fiscal policies in Latin America during the good times of the 90’s. This planted the seeds for fiscal crisis, or, at least, significant fiscal problems when the bad times arrived at the end of 1998.