OBG talks to José Ángel Gurría, Secretary-General, Organisation for Economic Cooperation and Development (OECD)

Interview: José Ángel Gurría

What kind of impact will the OECD accession process have on the progress of reforms within Colombia?

JOSE ANGEL GURRÍA: Colombia’s accession process to the OECD will serve as a catalyst for important economic and social reforms on issues such as taxation, health and the environment. The OECD’s 23 committees will be able to use their expertise to make recommendations on how Colombia can move closer to best practices in their respective areas. Membership would allow the country to participate in policy dialogues that would lead to more efficient institutions, more effective public services and improved living standards. Membership will also help Colombia build greater trust in its economy, by using international best practices to improve its regulation and its business climate, strengthen its participation in global value chains, and develop the latest tools to measure progress and promote inclusive growth.

To what extent can levels of inequality be reduced?

GURRÍA: Despite recent improvements, Colombia’s income distribution remains very skewed, and reducing inequality, both of income and of opportunity, remains a vital challenge. Experience from other OECD countries shows that one of the most effective tools is a reform of the tax and benefit system. This is especially true in a country like Colombia, where additional revenue is necessary to expand social protection programmes, which still tend to have low coverage and do little to reduce inequality.

Colombia's tax revenues in 2012 amounted to 19.6% of GDP, in contrast with an average of around 34% of GDP among OECD countries. The Colombian tax system raises insufficient revenues while it creates distortions through a combination of high marginal rates and widespread exemptions. This discourages job creation and encourages labour informality, which exacerbates income inequality. A labour market and tax policies that aim to address these issues should boost formal employment and productivity while reducing inequality. The promotion of high quality education is another key instrument for reducing inequality. Although access to education has increased, there are still important performance gaps with respect to Latin American peers and the OECD. Considering Colombia’s levels of spending on the education sector, the quality of education remains low. More infrastructure, better administration and monitoring of schools, as well as better recruiting and training of teachers, are policy priorities.

Unemployment remains high by OECD standards. How can labour market performance be improved?

GURRÍA:Colombia’s labour market outcomes are held back by high non-wage labour costs; a relatively high minimum wage, particularly in poorer regions; and few benefits from joining the formal sector. While the fiscal reform of 2013, which lowers taxes and contributions on labour, reducing the cost of formal jobs, is an important step in the right direction, more could have been done, starting with further reductions to payroll-related costs. The high national minimum wage creates significant barriers for low-skilled workers who want access to formal employment opportunities. It is possible to address this issue in a gradual manner, notably by increasing the minimum wage below inflation, as well as differentiating it by region and age. Training and active labour market policies are needed to raise labour productivity, particularly of low-skilled workers.

As in other Latin American countries, the expected benefits of formal employment are often low. Many informal workers often have patchy work histories, making it very difficult for them to qualify for a pension. In addition, for some informal workers, the risk of losing access to free health care or not receiving conditional cash transfers might create adverse incentives.

What elements of the fiscal law could be improved?

GURRÍA: Colombia needs tax reform to raise more revenue, make the tax system more progressive and reduce its complexity. Large tax expenditures are accompanied by high tax rates, which distort economic incentives, and make the tax system extremely complex, costly to administer, and easier to avoid and evade. Rich households benefit most from value-added tax exemptions for certain goods and reduced rates in absolute terms. Means-tested cash benefits targeted at lower-income households should replace these exemptions. Payroll taxes and social security contribution rates remain high, disincentivising formal job creation. Additional revenue can also be raised from environmental taxes, which in 2011 stood at 0.7% of GDP and 3.7% of total tax revenue, both low by OECD standards, as well as from mining, inheritance and real estate taxes.

To what extent can sustainable economic development be encouraged in Colombia?

GURRÍA: A fiscal reform that increases revenues is essential to boosting investments in infrastructure, education and innovation in a sustainable way. The current commodity windfall is a window of opportunity and Colombia has taken important steps to reap its benefits. Recent reforms in the allocation of royalties aim to better distribute resource-related revenues and promote productivity growth in the non-commodity economy. Also, the fiscal rule and the stabilisation fund will allow Colombia to isolate the economy from fluctuations in commodity prices. A stronger institutional framework would make these policies more effective.

Action is required to guarantee that resources are spent efficiently at the sub-national level. The government should provide assistance to municipalities and departments to help them identify worthwhile projects and advise on their implementation. Pre-feasibility studies should include provisions for project maintenance, while the monitoring and ex post evaluation of projects should be strengthened. Regarding the fiscal rule, the inclusion of public enterprises and entities in the budget would reduce the risk of fiscal slippage. The introduction of a notional “compensation account”, where deviations from the rule can be accumulated and an adjustment can be made in a given timeframe after a threshold is met, would also strengthen the fiscal framework. Another option would be to cap expenditure growth in the event that estimating reference prices or potential output complicates the implementation of structural balances. Improvements in the corporate governance of state-owned enterprises based on OECD standards would also boost public sector efficiency.

How would you evaluate the major strengths and weaknesses of the current pension system?

GURRÍA: The major strength of the pension system is its sound funding mechanism which limits the growth of fiscal liabilities as the population ages. As the system is designed around defined contribution accounts, it allows for a straightforward link between contributions and benefits. This means, however, that most risk falls onto the individual. There is a need to strengthen the safety net component as well as the payout phase around annuity markets, to provide protection from longevity risk. Additionally, there is a need to improve the supervisory framework around pension funds, in order to better protect members’ rights. Another weakness is that the public pay-as-you-go component and funded pension element compete, rather than complementing one another.

The pension system faces two additional challenges. The first is the high number of people working in the informal sector. In 2012, only 30% of the population over retirement age received a pension. Paradoxically, many of those who did are among the more affluent members of society. Similarly, fewer than 30% of those working in 2012 were contributing to the pension system, putting a large percentage of the population at the risk of poverty in their retirement. Pensions are also constitutionally linked to minimum wages. Separating the two would help increase the affordability of pension contributions for low-income workers. Therefore, it is very important that future pension reforms be designed to create incentives to join the system, rather than incentives to stay in the informal sector.