Speech

The Economic Foundations of Peace in Colombia -- Speech by Eduardo Aninat, Deputy Managing Director, IMF

June 20, 2002

Colombia is one of the oldest and most enduring democracies in South America, but also the stage for the region's longest internal armed confrontation. Until the mid-1990s the conflict appeared to have had a relatively moderate impact on Colombia's economy, which had grown for years at a relatively fast pace in a context of fiscal and external stability. From the last half of the 1990s, however, both the scale and intensity of violence have increased at the same time as the economic performance has deteriorated, and the conflict has become an explicit development constraint for Colombia. President-elect Uribe has expressed his intent to address steadfastly this issue, and I certainly wish him all possible success in this endeavor.

Given these circumstances, economic policy design in present-day Colombia should address at the same time two equally important objectives:

• On the one hand, implement policies that can boost economic growth and mitigate poverty and social dislocation against the background of a continuation of the conflict;


• On the other, lay the ground for policies that will support the consolidation of peace in the hopeful event of a negotiated settlement to the conflict.

* * * * *

Policies to promote growth and employment in Colombia

I will start with the immediate policy challenges, and the background upon which they might be addressed. Colombia suffered in the late 1990s its deepest economic crisis since the 1930s. The crisis was rooted in a number of severe imbalances that eventually undermined financial stability, including a growing fiscal gap—as the large increase in spending outpaced the growth of tax revenue—and a weakening external position—with the currency appreciating in real terms, contributing to the widening of the trade deficit and the accumulation of external debt. To correct these imbalances, the administration of President Pastrana implemented, with the support of the IMF and other multilateral organizations, an extensive adjustment program that has been relatively successful in restoring macroeconomic stability in spite of the very difficult security situation: inflation was reduced from 17 percent in 1998 to 6 percent in May of this year, the international reserve position was reinforced considerably in the context of a floating exchange rate regime, and the fiscal deficit reduced from more of 5 percent of GDP in 1999 to 3 percent last year. Wide-ranging structural reforms were also initiated with the aim of boosting economic efficiency. As a result, growth was restored, and the country regained access to substantial flows of private external financing.

Nonetheless, developments in the last months have reduced the momentum of Colombia's recovery. The escalation of violence, combined with a deteriorating external environment, including the global slowdown, has trimmed near term prospects, and is putting renewed pressure on the fiscal and external positions. In the fiscal area, the conflict increases demands for security and social spending, while sluggish growth reduces tax revenues and complicates the implementation of structural reforms. On the external front, the slowdown in the two main trade partners, especially in Venezuela, has weakened exports. At the same time, social conditions have deteriorated significantly, with urban unemployment now close to 20 percent. Policies must thus be reinforced promptly to revert this process and strengthen economic performance.

I am fully aware that policy adjustment in Colombia's current adverse circumstances is a very difficult task. In particular, it may entail delicate negotiations with interest groups that in the past have successfully blocked or delayed reforms. However, it is to be hoped that the incoming administration, benefiting from large popular support, will be in a position to proceed forcefully in at least three important areas: fiscal, external, and social.

• In the fiscal area, it is essential to put the public finances on a sustainable path so as to maintain investor confidence and financial stability. This result will in turn hinge on the implementation of extensive structural fiscal reforms.


• In the external area, the key objective must be the preservation of external competitiveness.


• In the social area, the goal should be to rekindle employment growth, which depends on the elimination of existing rigidities, including an unduly restrictive labor market.

Let me elaborate briefly on some of these issues.

First, achieving fiscal sustainability.

As I said earlier, much has been done to reduce the fiscal deficit over the past few years, but much remains to be done to achieve medium-term fiscal sustainability. Certain structural deficiencies, including the growing deficit of the public pension system, pervasive revenue earmarking arrangements, and extensive tax exemptions, threaten to weaken the fiscal position over the coming years. Some important reforms have been initiated to address these issues, while others are still under preparation. Advancing resolutely with these reforms will be crucial to consolidate macroeconomic stability and strengthen confidence. In particular:

• A comprehensive pension reform is essential for the longer-term viability of the public finances. Without this reform, the deficit of the public pension system will continue to fuel an undesirable expansion of the public debt. The present outgoing government has initiated the reform process, and it will be important for the new government to carry on with it more forcefully and complete it.


• The adoption of a fiscal responsibility and transparency law would increase accountability and help limit the scope for the corruption and administrative inefficiencies that still characterize many Latin American tax systems, including Colombia's.


• The reduction of revenue earmarking arrangements, that now account for about 46 percent of tax revenue, would increase the flexibility of fiscal policy and the scope for sound fiscal management.

A second key issue is the preservation of external competitiveness. The maintenance of external competitiveness is a key requisite for growth in open economies like Colombia.

The peso has appreciated by an important percentage in recent months, and this could threaten the vigorous growth of Colombia's non-traditional exports. These exports have already been key to diversifying Colombia's export base, and to fostering the growth of productive, income-generating employment opportunities. Different factors have contributed to the peso appreciation, including some over which the authorities have little control, like the sharp depreciation of the Venezuelan bolivar.

• In the event, the authorities have eased monetary policy appropriately, although with little impact on the peso so far.


• Pressing ahead with the fiscal adjustment would also help sustain the improvement in competitiveness.


• In the trade policy area, I am very encouraged by the steps being taken in the U.S. Congress with regard to the Andean Trade Preference Act, since they have the clear potential to broaden considerably the range of Colombian exports that will be granted duty-free access to the United States. Trade is the engine for growth, that we all value and respect in the Americas.

* * * * *

Policies to Consolidate Peace In the Event of a Negotiated Settlement of the Conflict

Let me now pass to the economic policies that will be required to consolidate peace, in the event of a negotiated settlement. These policies would be framed by two elements:

• First, the peace dividend, or the economic benefits that can be derived from peace;


• And second, the costs of peace, or the programs that would have to be implemented to make peace durable.

I will start with the peace dividend.

While Colombia has managed to grow in the midst of internal conflict in the past, the late 1990s saw a slowdown in growth and a deterioration of social conditions as the conflict intensified. It is difficult to estimate what have been the economic costs of violence in Colombia, but they have clearly been substantial.

• For example, it has been estimated that the conflict took 1½-2 percent off Colombia's annual growth rate before its intensification in the late 1990s. [the source for this data is Colombia's planning agency]


• Another study calculates the net costs of urban violence at about 3-4 percent of GDP every single year. [source: 1995 Colombian research paper]


• About one-fourth of Colombia's health expenditure is attributable to intentional injuries, compared to 3 percent for the rest of Latin America. [source: Ministerio de Salud]


• It is said that some 1½ million persons also have had to migrate to other regions of the country because of the conflict. Over 3 million Colombians have simply left the country since 1994.

An end to this conflict between brothers will clearly produce a significant "peace dividend", as it will free up substantial public and private resources that are now allocated to the armed conflict, to security, or to the fallout from the conflict. Peace should foster an improvement in business confidence, in private investment, and in growth.

The short-term costs of peace.

But these benefits will mostly be felt over a number of years. Over the near term, however, peace will likely entail sizeable financial costs.

• These costs are associated, first, with the reconstruction of physical and institutional infrastructure damaged by the conflict.
• In addition, large groups of people whose main skills and experience are now related to violence will have to be reintegrated into peaceful productive activities. In El Salvador, Guatemala, and other countries that emerged from armed conflicts in the 1990s, nonpolitical violence and urban crime in fact had increased after the peace agreements. This was partly due to the migration of former combatants from rural areas (where the armed conflict took place) to cities where jobs were scarce and underemployment widespread. Managing this transition will require extensive programs to provide intelligent retraining and job opportunities, and an active social policy structured around social protection networks in key rural areas.


• Consolidating peace will also demand deep institutional reforms, and dedicated efforts to replenish the social capital that was depleted during decades of conflict and violence.

The fiscal costs of peace will likely outrun the available fiscal resources, at least in the initial transition years. There will thus be an important policy tension between maintaining the fiscal sustainability that is essential for growth, and on the other hand, funding social and economic policies essential to consolidate peace.

Several potential options can be combined to meet this challenge:

• For instance, it should be possible to finance a number of initial measures with the proceeds from privatization projects that had been put on hold because of the conflict.


• The initiatives in support of peace will make it all the most urgent to enhance tax collection, control non essential public expenditure, and give priority to investments that generate synergies with pro-peace programs (including spending on infrastructure and housing, and focused social expenditure).


• The international community must certainly be prepared to contribute. It is now recognized that the Colombian conflict concerns the regional and international community at large, and that peace in Colombia will provide benefits far beyond the country's own borders. Peace can be considered as a global public good. The international community should mobilize knowledge, financing, and international best practices to make international assistance in post-conflict situations effective. Colombia, in turn, should redouble its efforts to secure multilateral and bilateral support to help finance the peace process, and do it by designing and proposing sound programs.

It is my sincere hope that the new administration will be able to find ways to mobilize the multiple talents and goodwill of the Colombian people, and put the country back on a path of peaceful social progress.