Thursday, April 27, 2006

Colombia Needs an Irish-Style Economic Tonic

This seems a perfect place to reproduce this magnific article by MARY ANASTASIA O'GRADY, hope you have time to read on. Comments if you wish are appreciated.

April 8, 2005
BOGÓTA -- In an address to a mournful nation here on Saturday, Colombian President Alvaro Uribe likened His Holiness Pope John Paul II to a "gladiator of democracy." Mr. Uribe recalled an audience he once had with the head of the Catholic Church. Colombia , he said, with "its difficulties and tragedies, its possibilities and unique people, occupied a special place among the concerns and affections of the Pope."

Surely, the feeling was mutual. It's hard to think of another country in Latin America where the Pope's message to "be not afraid" in the face of tyrannical terror so powerfully resonated. Colombian security has been greatly enhanced under Mr. Uribe's courageous leadership, and though the war is far from over, he must now address another of the Pope's great concerns: the poor. Indeed, as the president himself has said, the resolution of the conflict is not purely military. To secure the gains of democratic security, Mr. Uribe needs to deliver free-market capitalism.

To that end, Mr. Uribe need look no further than Ireland, a Catholic nation once hopelessly mired in poverty, dominated by socialist thought and somewhat fatalistic toward what seemed a hopeless plight. It is true that Ireland wasn't fighting a guerrilla war in 1987 when it began to think outside the box of conventional wisdom, but its fiscal picture was no less grim. Spending cuts helped, but it was the adoption of a rather unorthodox approach to tax cutting that gave the country an almost surreal boom. At the end of the 1990s, Ireland had a higher GDP per capita than Great Britain or Germany.

If Ireland can be the Celtic Tiger there is no reason why Colombia can't become the South American Puma. It is the perfect Latin American candidate for the job, with a popular democratic leader, a sophisticated business community, and a prime location in the region. It is equally distressing to note that if Colombia loses the opportunity it has to make big changes with this president, a return to left-wing populism and guerrilla domination is almost certain.

Mr. Uribe has already put the country on the right path by greatly improving security. Moreover, the World Bank report "Doing Business in 2005" ranks Colombia among the top performers world-wide in deregulatory reform at the micro level. The president's proposal now in congress to cut entitlement spending through pension reform is also constructive.

In 2004 Colombia grew at about 4%. Yet that pace of growth is not sufficient to seriously reduce the ranks of the poor and secure the president's other gains. To do that Colombia needs to bring down its debilitating tax rates. Mr. Uribe has been discouraged from doing this by both the local "experts" and by the U.S. government. The U.S. ambassador here is known to complain that Colombia's effective tax burden of 21% of GDP means that Colombians are not paying enough for government.

This is ridiculous. The Colombian tax burden is roughly equivalent to Chile's. If the U.S. wants to be constructive, it should point out that a top marginal rate equivalent to more than 38% on corporate profits and individuals, and a 16% value-added tax, are impediments to growth. It is doubtless true that these rates and the complexity of the Byzantine tax code, some of which Mr. Uribe has made worse, invite enormous evasion and discourage economic activity. A lower, flatter code would most likely expand revenues.

U.S. pressure on tax collection is of a piece with the standard static analysis that says that since Mr. Uribe has been unable (some say unwilling) to cut spending sufficiently, taxes have to be high and collection methods draconian. But interestingly enough, this is not the path that the Bush administration has taken to deal with the U.S. deficit. Expecting Colombia to swallow this bitter medicine reflects the soft bigotry of low expectations directed at a lesser-developed U.S. ally.

Benjamin Powell, a George Mason University Ph.D. candidate in economics, detailed the Irish experience in the Cato Journal's Winter 2003 edition. The parallels with Colombia are impressive, beginning with the disaster that Keynesian policies wrought in the 1973-1987 period.

Much of what Ireland first tried when it faced budget deficit problems will be familiar to Colombians, including tax hikes that managed to cut the primary deficit in half but also suffocated growth. By 1986 the debt-to-GDP ratio was 116%. "High levels of government debt, interest payments, and expenditures put the Irish government in a precarious fiscal position," Mr. Powell explains.

Unable to raise taxes further, the government began in 1987 to cut spending. The reduced size of government together with a relatively open trade policy produced a welcome return to respectable growth. By 1989 Ireland's economy was growing at 4%. "That level of growth was impressive compared with the 1.9% growth between 1973 and 1986 when the government had been pursuing activist fiscal policies," Mr. Powell explains.

But spending cuts had their limits and Ireland -- like Colombia today -- was still far short of the minimum and consistent 6% GDP growth needed to actually move people out of poverty. From 1990 through 1995 GDP growth averaged 5.14%. But the "tiger" growth came in the latter half of the decade. From 1996 through 2000 the average rate of growth was a mind-boggling 9.66%.

What differentiates those two periods is the change in Ireland's tax regime. In 1996 the corporate tax rate was 40% but by 2000 it was down to 24%, making Ireland a magnet for capital. There was "also a special 10% corporate taxation rate for manufacturing companies and companies involved in internationally traded services," Mr. Powell explains. When the European Union pressured Ireland to eliminate the special 10% rate, it obliged but lowered the standard rate to 12.5% in 2003.

Naysayers will claim this is politically impossible in Colombia . But what's missing in Colombia is an application to supply-side growth of the kind of unyielding commitment that Mr. Uribe applied to security. Should he change course, the Irish miracle would be the best blueprint.
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