eotN.377U UruguaySources ofGrowth Report No.31737-UY Report No. 31737-UY Uruguay Sources of Growth Policies for the Development of Human Capital, Public Disclosure Authorized Authorized Disclosure Disclosure Public Public Integration, Competition and Innovation
June 14, 2005
Poverty Reduction and Economic Management Unit Latin America and the Caribbean Region Public Disclosure Authorized Authorized Disclosure Disclosure Public Public Public Disclosure Authorized Authorized Disclosure Disclosure Public Public
Document of the World Bank Public Disclosure Authorized Authorized Disclosure Disclosure Public Public
ICT Information and Communications Technology IDB Inter-American Development Bank IMF InternationalMonetary Fund IMM Municipality ofMontevideo INMvIE National Institute for Minors INDA National Food Institute INE National Statistical Office INIA National Institute for Agricultural Research I" National Institute for Youth IPR Intellectual Property Rights LATU Technological Laboratory ofUruguay MECAEP Full Day Schools Program MERCOSUR Southern Cone Common Market MEVIR Rural Housing Program MFN Most Favored Nation MPYMES Micro and Small and Medium-Size Companies MSP Ministry of Health MTOP Ministry ofTransport and Public Works MTSS Ministry of Labor and Social Security MVOTMA Ministry of Housing, Land Organization and Environment NBC New Commercial Bank NGOs Non-government Organizations NPLS Non-performing Loans NIS National Innovation System NTBs Non-tariff Barriers OECD Organization for Economic Co-operation and Development ORT ORT University PAE School Feeding Program PAYG Pay As You Go PISA International Program for Student Evaluation PNCA National Program for Food Supplements PPP Purchasing Power Parity PSP Private Sector Participation PROJOVEN Young Training Program R&D Research and Development SAAC Food Assistance Service for Collectives SEBRAE Brazilian Support Service for Micro and SMEs SCOT Supervision System for Objective Work Conditions SICE Integrated State Purchasing and Contracts System SME Small and Medium Enterprise NIS National Innovation System SR Remuneration System TCC Thermal Combined Cycle TFP Total Factor Productivity UdelaR University ofthe Republic UI Inflation Unit UNESCO United Nations Educational, Cultural and Scientific Organization UNIT Uruguayan Institute ofTechnical Standards URSEA Power and Water Services Regulatory Unit URSEC Regulating Unit for Communications Services UTE Electric Plants and Transmissions Company UTU Uruguayan Technical University ACKNOWLEDGEMENTS
This report has been prepared by a team led by Daniel Oks (Task Manager, LCSPE) based on contributions fiom World Bank staff and consultants during October 2003 and June 2004. The team benefited fiom the cooperation of various government officials as well as from participants of the private sector, think tanks, NGOs, political parties and academia in various seminars and workshops organized between December 2003 and December 2004 in Montevideo; in particular it appreciates the comments received from the current Minister of Economy, Danilo Astori, and the former minister of Economy, Isaac Alfie, during the seminar held in December 2004.
The main contributors to the chapters of the main report were: Daniel Oks (Macroeconomics, LCSPE), Julio NoguCs (Trade, Consultant), Omar Chisari (Infiastructure, Consultant), Alvaro Clarke (Capital Markets, Consultant), Guillermo Rozenwurcel (Small and Medium Enterprises, Consultant), Jean Guinet (Innovation, OECD consultant), Raimundo Soto (Factor Productivity, Consultant), Lisa Bhansali (State Reforms, LCSPS), Truman Packard (Social Sectors, LCSHS), Alvaro Forteza (Pensions, Consultant), Carlos Winograd (Competition Policy, Consultant), Alejandro Guerson (Debt Management, LSCPE) and Luis de la Plaza (Banking, FIPSI), The report also benefited from contributions by: Alejandro Guerson (Macro Section and Data), Eduardo Siandra (Capital Markets, Consultant), Germin Lambardi (Infiastructure, Consultant), Carlos Casacuberta (Factor Productivity, Consultant), Nora Lusi (State Reforms, Consultant), Cristina Flood (Social Programs, Consultant), Carlos VClez (Infrastructure, LCSFW), Pablo de Silveira (Education, Consultant) and John Fiedler (Health, LSCHH).
The report was enhanced by the valuable comments by peer reviewers responsible for the official review of the document- Luis ServCn and Marcel0 Bisogno, as well as by the following participants at discussion meetings and/or readers of the document at its various stages: Axel van Trotsenburg (Director, LCC7), Guillermo Perry (Chief Economist, LCRCE), Juan Gaviria (Sector Leader, FPSI), Carlos Vdlez (LCSFW), Phillipe Durand (LCSFE), Carlos Winograd (Consultant), Jesko Hentschel (Sector Leader, LCSHD), Emiliana Vegas (LCSHE), and Mauricio Carrizosa (Sector Manager, LCSPE), who improved this report, as well as those who participated in the meetings to discuss the principal aspects of the report. Yanina Budkin (LCC7C) was in charge of communications with media and the logistics of seminars and workshops. Jesica Zupnik and Mariela Alvarez (LCC7C) helped organize the seminars and workshops. In the concluding stages valuable comments and various editorial suggestions were received fiom James Parks (Sector Leader, LCC7A). Mariela Alvarez and Florencia Liporaci were responsible for formatting and compiling the final document. PREFACE
Selected technical background papers prepared for this report were edited in a separate volume and are available upon request fiom the task manager; they can also be found on the regional website (www. bancomundial.ora.ar). The following background papers were included: “Fiscal prudence and debt management - reducing macroeconomic volatility in Uruguay” by A. Guerson; “Long- run growth and productivity changes in Uruguay - Evidence fiom aggregate and plant level data” by R. Soto and C. Casacuberta; “Trade negotiations for growth and development” by J. Nogues; “Cost and price of infrastructure - A computable general equilibrium appraisal of gains for Uruguay” by 0. Chisari and G. Lambardi; “Infiastructure sectors - Suumary diagnostics” by 0. Chisari and G. Lambardi; “An anhlisis of the capital market in Uruguay” by A. Clarke; and “Options for pension reform” by A. Forteza. CONTENTS
EXECUTIVE SUMMARY ...... i
CHAPTER I:INTRODUCTION ...... 1 Structure of the Report ...... 2
CHAPTER 11: SOURCES OF GROWTH AND EQUITY -...... 4 GROWTH STRATEGY...... 4 2.1 GROWTH.CAPITAL FLOWS AND REGIONAL VOLATILITY ...... 4 2.2 FACTORSOF PRODUCTION AND PRODUCTIVITY GROWTH...... 5 2.3 GROWTH.EMPLOYMENT. POVERTY AND EQUITY ...... 9 2.4 SOURCES OF GROWTH .STRUCTURAL FACTORS ...... 11 2.5 THE 3-PILLAR GROWTH STRATEGY ...... 14
CHAPTER 111: FROM RECOVERY TO GROWTH-CONSOLIDATION OF MACROECONOMIC STABILITY AND SOCIAL PROTECTION .PILLAR 1... 19 3.1 RECENT REFORMS AND MACROECONOMIC DEVELOPMENTS ...... 19 3.2 REFORMS AND FISCAL SUSTAINABILITY - MACROECONOMICSTRATEGY ...... 22 3 . 3 DEBTMANAGEMENT ...... ~9 3.4 DE-DOLLAFUZATIONAND MONETARY POLICY ...... 31 3.5 STRENGTHENING BANKS ...... 33 3.6 DEVELOPINGCAPITAL MARKETS ...... 35 3.7 LABORMARKETS ...... 39 3.8 REFORMING SOCIAL SECURITY AND THE SOCIAL SAFETY NET ...... 44
CHAPTER IV: SUSTAINABLE GROWTH . INVESTMENT CLIMATE . PILLAR 2 ...... 51 4.1 TRADEPOLICY AND INTEGRATION...... 51 4.2. FOSTEFUNGEFFICIENCY THROUGH COMPETITIONIN INFRASTRUCTURE ...... 56 4.3 COMPETITION POLICY ...... 67 4.4 HUMANCAPITAL DEVELOPMENT AND EQUITY-HEALTH AND EDUCATION...... 69
CHAPTER V : INNOVATION-DRIVEN GROWTH .PILLAR 3 ...... 80 5.1 PRIVATE SECTOR DEVELOPMENT (PSD) ...... 81 5.2 SMES AND INNOVATION ...... 84 5.3 DEVELOPMENTOF A STRATEGY FOR THE NATIONALINNOVATION SYSTEM ...... 88 5.4 MODERNIZINGTHE STATE ...... 94
CHAPTER VI: CONCLUSIONS...... 100 Bibliography ...... 102 Statistical.. Annex...... 105 Tables
Table 1 .Sources ofgrowth in Uruguay ...... 6 Table 2 - Decomposition ofchanges in productivity ofmanufacturing plants -...... 8 Table 3 - Comparative Goveament Indicators, Latin American Countries, in % ofGDP for 2001 ...... 13 Table 4 - Selected macroeconomic indicators ...... 20 Table 5 - Debt Sustainability - Deterministic Simulations ...... 24 Table 6 - Impact on Primary Fiscal Balance 2005-12 - Reform Scenario ...... 27 Table 7 - Debt Sustainability - Stochastic Simulations ...... 29 Table 8 - The Uruguayan Banking Sector ...... 33 Table 9 - Uruguay’s capital markets in international perspective ...... 36 Table 10 - Investor protection ratings...... 36 Table 11 - Payroll Taxes for Pensions and All Social Insurance ...... 43 Table 12 - Principal Risks to Human Capital Formation and Uruguay’s Policy Interventions ...... 46 Table 13 - Access to Public Services in 2002 (% oftotal population) ...... 57 Table 14 - Ex-refinery Prices (November 2004) ...... 60 Table 15 - Uruguay: Generated and Exchanged Energy (Gwh), 1997 and 2002 ...... 64 Table 16 - Simulations of the computable general equilibrium model...... 66 Table 17 - PISA Ratings ...... 74 Table 18 - Science and Technology Indicators, Year 2000 ...... 85
Figures
Figure 1 .Uruguay’s per-capita GDP relative to USper-capita GDP (PPP prices) ...... 4 Figure 2 .Productivity ...... 7 Figure 3 - GDP growth, unemployment and poverty ...... 10 Figure 4 - Real Multilateral Exchange Rate ...... 21 Figure 5 - Pension funds (funds under management) - millionpesos ...... 37 Figure 6 - Funds administered by open-ended hds(thousands ofUS$) ...... 37 Figure 7 - Macroeconomic Trends, Labor Market Adjustments, and Sector Shifts in Uruguay...... 42 Figure 8 - Spending on Social Protection (Social Insurance and Welfare) as a percentage ofGDP, Selected LCR and OECD Countries in 1998 ...... 45 Figure 9 - Trade flows ...... 53 Figure 10 - Intemational comparison ofelectricity prices, 2001 ...... 59 Figure 11 - Public Enterprise Efficiency ...... 60 Figure 12 - Private Investment in Infrastructure ...... 60 Figure 13 - National expenditure in health -Selected Countries ...... 70 Figure 14 - Average Number ofYears ofEducation, Uruguay and Selected Countries .. 73 Figure 15 - Educational Attainment ofUruguay’s Employed Labor Force, 1986-2002 . 75 Figure 16 - Comparison ofbusiness climate ...... 82 Boxes
Box 1 .Pro-cyclical Fiscal Policy in Uruguay ...... 14 Box 2 - Pillars of the Growth Strategy...... 18
Diagrams
Diagram 1 .Sources of Knowledge and Innovation...... 91
EXECUTIVE SUMMARY
1. Uruguay, with a prosperity built on beef and other meat exports, was amongst the fastest-growing economies in the world at the turn of the twentieth century. In parallel with economic successes driven by exports under a liberal trade regime, early in the 20th century Uruguay had already began developing a strong and efficient welfare state. Even following the growth decline experienced from the 1930s, Uruguay’s per capita GDP in 1955 was higher than that of Italy, slightly below France’s and 44% of that in the United States. By contrast, the slowdown in per capita GDP growth has been more severe in the past 40 years (over 1961-99 per capita GDP growth averaged 1.1% which is two-thirds of the rate achieved by Latin America) -except in the nineties when Uruguay (temporarily) grew at a faster rate than the region. In the 1961- 1999 period, the rate of growth has been less than half that of industrial countries, and less than one-fourth of that of East Asia. At this pace, it will take 70 years for per capita income to double.
2. Despite this slowdown in growth, public expenditure has been on a long-term upward trend - its share to GDP has risen from under 20% in the 1960s to 36.8% in 2001 (this includes interest payments and capital expenditures by state-owned firms). The bulk of the increase in public expenditure in the 1990s is accounted for by the explosive trend in social security expenses, and pensions in particular. As a result of the relative economic deterioration, the welfare state has become increasingly burdensome for the economy.
3. Uruguay must consolidate its incipient economic recovery following a prolonged and deep recession: the economy shrank 17% and household incomes dropped over 20% in real terms over 1999-2003. The number of poor has doubled since 1999 to represent 31% of the population in 2003. Of those that were employed, 25% were not registered under social security. Without sustained economic growth, the adverse trend in these indicators is unlikely to be reversed. In the first half of the 1990s poverty and unemployment indicators improved, driven by growth. However, fast growth over 1996-98 did not have a similar effect in terms of social improvements -poverty levels remained stagnant, unemployment increased and income distribution deteriorated, Uruguay still has one ofthe most equitable income distributions in the region and there is virtually universal access to education, health and all basic infrastructure services. However, changes in the economic and social structures - growing informal employment, rising unemployment and poverty - have revealed the need to reformulate and strengthen Uruguay’s social safety net.
4. The economy has bounced back strongly since mid-2003 and GDP growth in 2004 is estimated at 12.3%; the level of unemployment fell from almost 20% at the end of 2002 to 12.1% at the end of 2004. However, there is a qualitative difference between economic recovery and sustained growth. The latter requires sustained investment in physical and human capital to drive growth beyond existing capacity constraints. This in turn requires improving the investment climate - the investment-
i GDP ratio hovered around 15% in the 1990s (low for sustained growth) and dropped to 13% in 2000-03. Uruguay’s relatively poor growth performance over the last half century can be traced to several key structural weaknesses:
0 Pro-cyclical fiscal policy - intrinsically associated with lack of flexibility in social spending - which led to rising debt levels and sharp interruptions of growth periods;
0 A high and growing dependency ratio (between retirees and the working age population) -worsened by emigration by young people- and increased levels of informal employment (given in part to high taxes on labor) limits the possibilities of financing contribution-based social benefits;
0 Financial fragility and costly bail-outs linked to inadequate and insufficient bank regulation, weak supervision, and a strong process ofdollarization;
0 Vulnerability to regional instability - worsened by the increased trade integration promoted by MERCOSUR in the 1990s;
0 Lack of effective competition in infrastructure sectors dominated by the public sector and - in a related manner- the setting of tariffs with a fiscal criterion that limits incentives to increase efficiency -and, in particular- to pass on such gains to consumers and companies, contributing respectively to welfare .and global competitiveness;
0 A less than enabling environment for private sector development; for example, lack oftransparency limits protection to retail investors, the high cost of setting up companies, the difficulties of courts in dealing with complex economic matters, and inefficient bankruptcy processes;
0 A widening gap between performance and investment in some sectors of social security, education and innovation in relation to the trends in more developed countries, and in successful developing countries.
5. The objective of this study is to help develop a “shared” vision of growth with equity in Uruguay. Unless shared, the policies and reforms discussed are unlikely to be implemented, maintained or to be credible. Many ofthe policy options proposed have already been discussed in seminars and workshops with wide participation of technical experts, govemment officials and private sector and civil society representatives. Speeding up reforms in support of a broad-based growth agenda will require: (i)active participation by key social stakeholders, as well as those in the private sector, to increase awareness of the issues and help generate consensuses; and (ii) increased transparency and better social communication about the costs and benefits of reforms and their counterfactuals.
.. 11 Growth strutegy
6. The growth plan proposed contemplates three pillars which correspond broadly with policies and reforms for consolidation of macroeconomic stability (Pillar l),improvement in the investment climate (Pillar 2), and modernization of the state in support of growth driven by the private sector and innovation (Pillar 3). The timeframe over which benefits from policies based on pillars 1,2 and 3 are expected to consolidate their impact corresponds broadly with the short, medium and long term, respectively. Nevertheless, the correspondence is far from full. For example, macroeconomic and financial stability is an essential requirement for the short, medium and long term. Policies aimed at improving the investment climate are relevant even in the short term, and must be deepened in the long term. And policies regarding innovation, which because of their institutional nature will no doubt require lengthy terms for implementation, should therefore be given priority over the short term.
7. The first pillar involves policies leading to fiscal and financial stability, the efficient operation of factor markets (capital and labor), and the strengthening of social protection. It is expected that such policies will enable the consolidation of economic recovery and alleviate the social situation of those more vulnerable by means of the use of idle capacity and the reallocation of factors towards more productive companies and sectors -the main drivers of productivity in coming years- as well as a more efficient use ofthe resources assigned to social protection.
8. The second pillar of policies and reforms aims at the creation of an investment climate that is favorable to the accumulation of physical and human capital; it includes trade and integration policies, the development of a competitive framework -particularly in infrastructure sectors; and policies on education and health for the development of human capital. The commercial integration strategy plays a particularly important role in the process ofexpanding export markets, investment and growth. It must be matched by improvements in the efficiency of infrastructure services to contribute to Uruguay’s global competitiveness. New investments will be linked to the incorporation of new technologies; the accumulation of factors and technology will be the drivers ofgrowth in the medium term.
9. The third pillar is formed by policies and reforms to promote growth driven by innovation; it will require a thorough transformation of institutional capabilities, entrepreneurial culture and the system of innovation. The benefits of some reforms, such as deregulation to encourage private sector development, could begin to materialize in the short term. Other benefits, requiring profound institutional transformations, could probably be seen in the mid to long term, depending on the commitment and perseverance with which the program of reforms is implemented. Although it is assumed that innovation will lead to increased productivity in the short term, it is likely that the benefits from policies on innovation will only be able to be capitalized on in the long term; hence the priority that ought to be granted to the pursuit of such policies.
... 111 10. Broad-based growth is defined as growth with wide social participation in both the generation of transformations and in the scope of the benefits. The policy and reform options proposed in this report highlight the importance of social participation in the definition and implementation of the growth strategy. First, an attempt has been made to evaluate the impact of key policies and reforms on poverty and welfare. For example, increased competition in infrastructure can lead to higher real wages; reducing bureaucratic obstacles and improving the incentive framework in the labor market can encourage business to create jobs; pension reform proposals may help to improve inter- generational equity. Second, health and education policies -impacting the development of human capital- constitute an integral part of the growth agenda. Third, proposals to reformulate the social safety net take into account the important changes that have occurred in the productive structure including the rising share of uncovered informal workers and self-employed.
Macroeconomic stability and social protection - Pillar 1
11. The main policy goal in the first pillar is fiscal consolidation to finance social spending and service the debt. High initial levels of sovereign debt (92.2% of GDP in 2004) and high pension deficits will severely constrain fiscal options over the medium term. Uruguay has already performed a drastic fiscal adjustment, achieving a primary fiscal surplus of 3.8% of GDP in 2004. Nevertheless, sustaining the current level of primary surplus over time will require structural reforms. This is due to the pro-cyclical nature of public expenditures, infrastructure investment requirements, and the need to simultaneously strengthen the social safety net to support the significant share of the population that has fallen below the poverty line. Key reform options that the government could consider include: revision of the retirement benefit formula (an increase in the retirement age, reduction in the replacement rate and a revision of the formula for pension indexation), a reduction in redundant public sector employment, the deepening of ongoing procurement reforms, efficiency gains in infrastructure services, and increased tax and social contributions compliance.
12. Financial stability is a key ingredient of macroeconomic stabilization. Banking crises have been a source of both fiscally expensive bailouts and financial dis- intermediation with a negative impact on growth. The challenge is to simultaneously pursue policies and reforms which would foster efficient financial intermediation and reduce banking sector fragility. Financial stability requires: prudential regulations to induce financial institutions to better internalize currency, liquidity and country risk; autonomy of the banking supervisor; completion of the ongoing restructuring of public financial institutions; and cautious implementation (including fimding) of the recently approved deposit insurance scheme. Policies and reforms that the government may consider include the de-dollarization agenda, a gradual process parallel to the increase in confidence in the local currency, granting greater autonomy to the Central Bank, a monetary policy designed to ensure price stability (for example by means of inflation targeting) and the promotion ofinflation-indexed instruments.
iv 13. In the short term, output growth is likely to stem from increased capacity utilization and from shifting existing factors of production to new or expanding firms. This is usually cheaper than new investment. A basic condition to facilitate the reallocation of factors of production is to ensure the efficiency of factor markets (capital and labor). For example, flexible labor markets can facilitate the reallocation of existing factors of production from non-competitive firmslsectors to competitive ones. Bank credit and capital markets can help mobilize resources ofthe most productive sectors and companies. The role of capital markets is particularly important as they are less constrained than banks after the crisis (they do not suffer restrictions on currency and maturity mismatches, nor fiom the same degree of risk aversion) and they are intrinsically flexible in adapting to market needs -as the emergence of instruments to finance farm and construction activity or to dispose non-performing loans of banks have already shown.
14. Efficient banks and capital markets will also make it possible to underwrite the required new investments in skills, capital and technology - these are the backbone of employment creation and growth. Among the policies and reforms that the government may consider to help develop capital markets are: strengthening linkages between stock markets; de-mutualization of stock exchanges; improving rights of minority shareholders; fill legal voids in security trading; increased autonomy of regulators and supervisors; allowing further diversification of pension fbnd’s permitted portfolio of investments; and correcting rather severe regulatory asymmetries in insurance.
15. Sustained and broad-based economic growth is the “best” social safety net. However, the sharp increase in poverty and social vulnerability both due to structural reasons and to the severity of the recent crisis poses a more immediate challenge. One of the most urgent objectives during the recovery phase is reinforcing ofthe social safety net to protect the large proportion of the population that has fallen below the poverty line. It will be important to avoid an irreversible process of exclusion with direct adverse implications for human capital accumulation. The proposal to be considered is to increase non-contributory programs through conditional cash transfers to be financed from savings to be generated in the social security sector. Programs like food assistance to the poor and full-time schools are well targeted but coverage is low; they could be scaled up, thereby directly benefiting the lower income quintiles. Other food and health programs may need to be refocused to benefit the most vulnerable. Recently launched workfare programs may also prove effective as long as they carry an explicit sunset clause.
16. The mismatch between instruments and risks in the social security system can be illustrated by Uruguay’s public pension system. Savings systems are an efficient insurance mechanism when the risk is predictable andor frequent. For example, predictable longevity gains and population ageing make saving an efficient mechanism for providing cover against job losses in old age. On the other hand, risk pooling - as under the PAYG public pension system - is economically unsuitable to mitigate lost earnings ability that arises in old age. In this regard, the 1996 pension reform represented a step in the right direction by introducing a saving pillar. If defined-benefit type
V pension systems are politically the only viable option, the govemment may consider re- defining “old age” through the introduction ofa mobile retiring age.
17. Despite a welcome downward trend in the unemployment rate, it remained at relatively high levels at the end of 2004 (12.2%). Past performance in Uruguay and in other countries suggests that even the resumption of growth may not suffice for rapid reductions in unemployment. Furthermore, the increase in. the informal sector -in part related to the high level of taxation on labor- means that a high number of new jobs will be of lower quality, and will not grant workers the benefits of contributory social security. In this context, a review process of regulations and institutions in the search of better growth and employment opportunities is due. This report examines several such regulations and institutions including job security regulation and public employment policies. A more extensive review of labor legislation is desirable to help design sector specific reforms which may also help to reduce unemployment faster as well as to redress informality and emigration trends.
Climate of investment and human development - Pillar 2
18. Addressing Uruguay’s key structural weaknesses will be conducive to translating the strong economic recovery underway into sustained medium-term growth. Among the key weaknesses are: the high exposure to MERCOSUR volatility; limited access to industrial country’s agricultural markets; the high cost of infrastructure services; and difficulties for equitable access to high quality health and education.
19. In a small country like Uruguay, the framework conditions imposed by global trade and integration links are a key factor determining market access and investment. Slow progress in the multilateral trade negotiations has prompted many countries to negotiate bilateral and regional trade agreements. In that context, the difficulties of MERCOSUR to expand its regional outreach - only very recently have announcements been made of FTAs with Peru and other Andean countries - has had negative effects on agricultural exports of member countries like Uruguay. Uruguay would need to carefully evaluate pros and cons ofalternative trade policy options.
20. Strengthening MERCOSUR’s internal trade links and promoting greater MERCOSUR trade integration with the rest of the world should be considered a priority. This requires deepening intemal commercial lids -at present trade policy within MERCOSUR is limited to little more than the adoption of a common external tariff -and making more aggressive progress on trade agreements with other countries and regions. This strategy could be complemented with bilateral initiatives to reach trade agreements with other countries or trading blocks in the context of Uruguay’s commitments to MERCOSUR - e.g., as Uruguay has done recently with Mexico. Uruguay’s most dynamic export markets are developing countries - even after excluding MERCOSUR. Uruguay’s free trade agreement with Mexico led exports fiom Uruguay to increase more than fourfold. At an institutional level, the highly complex nature of the negotiation agenda also highlights the need to strengthen communications between public
vi bodies and links with the private sector, as well as the development of the institutional capacity to evaluate trade agreements - and in particular their non-trade aspects.
21. The strengthening of competition in infrastructure services is a key element of the investment climate. Uruguay ranks high in the region in terms of infrastructure coverage and overall efficiency, though less so in terms ofcost. While coverage is high, a gap may surface increasingly in terms of quality, delivery standards and prices as technological change and the sophistication of demand continues to increase. Competition plays an important role in fostering efficiency and, at least as important, in ensuring that efficiency gains are passed on through lower prices to firms and households - thereby enhancing the economy’s competitiveness and social welfare. Uruguay’s large investment needs for sustained growth and the severe budgetary constraint imposed by high debt is yet another important reason for increasing the role of the private sector in infrastructure. Uruguay has already moved - gradually - in that direction - as private sector participation in telecommunications, transport and gas shows. The opening of infrastructure to private sector participation in other sectors has been slow compared to OECD and many emerging market economies, including those within the region.
22. The lack of a competitive framework in various sub-sectors of infrastructure is due, among other factors, to institutional and regulatory shortcomings:
Uruguay should clearly segregate the three independent functions for the definition of policies, regulations and operations. Although some recent reforms (such as the regulatory framework for energy and communications) have enabled certain progress to be made in the separation of these functions, there is still a long way to go. In particular, significant conflicts in policy definition subsist. Although the Executive can and should set regulatory policies, the definition of tariffs should be a function of an independent regulatory agency. In Uruguay, however, it is the Executive that in the final instance sets tariffs, and it does so in pursuit of fiscal objectives instead of seeking efficiency, competitiveness and welfare. The political and financial independence of the leading regulatory bodies from the Executive needs to be increased.
0 The presence of the public sector in all vertical components of the supply chain, as well as in regulation, could discourage private operators. Non-competitive practices and market foreclosure could stem from distortions due to cross subsidization and biased price and quality standards aimed at favoring competitive advantages of public sector enterprises, The vertical separation of public monopolies could contribute to the development of competition, at least in those segments where economies of scale do not operate as a restriction on the entry of new competitors. In those segments recording such restrictions, a system ofaccounting regulation could contribute to transparency and benchmarking, with a beneficial effect on company efficiency.
vii 0 There is an absence of regulatory frameworks for gas distribution and ports. Regulatory rules are determined by previous concession contracts or general practices, more than by specific laws and regulations. Contract incompleteness could be a source ofcostly renegotiation and unfair competition.
Regulators URSEA (energy and water) and URSEC (communications) have already developed a reputation of transparency by placing all major proposals, decrees and regulations under public consultation processes. Publication and broader dissemination of performance and comparative efficiency indicators of regulated public firms could make the management and boards of these firms more accountable, Similarly, increased transparency on the cost of access to networks - e.g., interconnection fees for telephone services, energy transmission prices, railway tolls - could pave the road for greater competition.
23. Sustainable growth requires human capital accumulation through better and more equal access to health and education. All Uruguayan youth should be able to exercise their right of access to schooling and be prepared to enter the labor market to meet the demands of a competitive economy. Progress toward this objective may be assessed by: (i)how quickly the current alarming rates of repetition and especially of desertion from secondary school - particularly among students from lower-income households - can be lowered; (ii)improved and more equitable (across income segments) learning performance in primary and secondary schools based both on domestic tests and on international tests; and (iii)a faster pace of growth of university graduations and shorter average stay at the state university. Policy options which the government could consider include: up-dating the curricula, improving teachers’ and schools’ incentives to perform, demand side interventions (to lower school leaving and improve opportunities), and addressing more systematically cost effectiveness, efficiency and equity across all segments ofeducation.
24. The main obstacle to growth posed by current health policies and institutions lies in the unsustainable health insurance and care-delivery system. Uruguay has one of the highest relative levels of health expenditure in the world (in relation to GDP). While it also offers some of the best coverage and health-outcome indicators in the region and among middle income countries, there is increasing evidence of eroding quality of care and even inequity in the system. The system is a complex array ofoften overlapping and fragmented institutions, some of which are noted for their inefficiency. In addition, the health care model is increasingly unrelated to the country’s epidemiological profile. Reform options to be evaluated include: (i)changes to the regulatory system, (ii)a greater focus on prevention, and (iii)limiting the scope for private providers to shift risky cases to the public system,
Institutional development and innovation-driven growth - Pillar 3
25. Sustained economic growth will require above total factor productivity growth. In fast-growing countries innovation has become the most important source of total factor productivity growth; and the bulk of innovation activity in these countries is
viii produced by the private sector. A strategy for innovation needs to be placed within the broader context of a strategy for private sector development and state reforms that would permit implementing a modem system of innovation.
26. Uruguay has well established property rights, relatively low corruption and a well established Judiciary. These are all important elements of an enabling environment for private sector development. However, there is still substantial scope for simplifgng regulations and reducing the number of steps needed to start a business - to start a business in Uruguay is far more expensive than in Argentina or Chile. Laws, regulations and the quality of public institutions that enforce them make up the investment climate impacting the private sector. One ofthe problems is a lack of efficient public institutions to deal with complex commercial disputes in the enforcement of contracts. Bankruptcy legislation must be updated, facilitating rehabilitation processes for economically viable companies. For example, passage of the bankruptcy reform bill currently in Congress could help to establish a better legal framework for private sector development, especially if accompanied by adequate reinforcing ofthe Bankruptcy Courts.
27. The new global environment for innovation is characterized by a growing globalization of R&D activities, rapid development of markets for knowledge, high mobility of highly qualified labor, and regional integration of innovation systems. A forward looking innovation system for Uruguay could entail targeting the following broad strategic objectives. A first priority is ensuring political and budgetary commitment to sustained and balanced - vis-&vis the private sector - investment in knowledge, A second priority is identifying under-exploited potential and associative gaps, identifying “role models” in areas with potential and encouraging industry-led collective initiatives to difhse the associated good practices, and promoting “clusters” and public-private partnerships in applied science.
28. The experience of the successful innovator countries - many of which are developing countries - provides useful lessons for Uruguay: they are generally small in size, have sound macroeconomic fundamentals and are very open economies. In addition, such countries are noted for: (i)above average improvement in innovation performance linked to a high rate of investment in education, information and telecommunications technology, R&D, and a high share of business financing of R&D; (ii)an increasingly diversified base of innovators, with a greater role for Small and Medium Enterprises (SMEs), improved linkages between science and industry and a high level of networking among innovators; and (iii)financial systems that are supportive of innovative activities. These are some of the most important challenges for the development of Uruguay’s innovation system.
29. The capacity to design and implement policies in the fields of innovation and private sector development is closely linked to state reforms in various areas such as the professionalism of the civil service, the ability to link the budget to strategic objectives, and the state’s procurement system. Among the policies needed to increase the professionalism of the civil service, the government could consider the linking of performance evaluations, bonuses and promotions to compliance with the targets
ix of the executing units. The capacity to decide strategically in the area of innovation in turn depends on the integration of the budgetary process with strategic objectives and results. Important state reforms have streamlined budgetary procedures. However, Uruguay is far from having results-based budgeting. Lastly, completion of rules on government procurement is not only necessary from the point of view of the significant fiscal saving that it generates, but also because of its potential impact on the competitiveness, efficiency, quality and innovative development ofthe SME sector.
X CHAPTER I:INTRODUCTION
30. Uruguay, with a prosperity built on beef and other meat exports, was amongst the fastest-growing economies in the world at the turn of the twentieth century. In parallel with economic growth driven by exports under a liberal trade regime, early in the 20th century Uruguay had already begun developing a strong and efficient welfare state. The relative efficiency of the state, limited corruption and egalitarian distribution of income distinguished the country fiom most others in the region. In turn, the benefits ofthe welfare state help to explain the strong identification of both citizens and politicians with it. The significant economic development achieved explains how even following the growth decline experienced from the 1930s, Uruguay's per capita GDP in 1955 was higher than that ofItaly, slightly below France's and 44% of that in the United States.
31, The slowdown in per capita GDP growth has become severe in the past 40 years -per capita GDP growth has averaged 1.1%, less than half the growth rate of the 1900-30 period. This equals about half the growth rate ofbetter regional performers like Chile and Brazil and is well below that ofmost industrialized countries. At this pace, it will take over 70 years for per capita income to double. As a result of the relative economic decline, maintenance ofthe welfare state became increasingly burdensome. It should also be mentioned that growth has been erratic, as in 1990-1998 Uruguay grew at an average rate of 3.9%; the recession that took place in 1999-2002, with an annual average decline of4.6% wiped out many ofthe gains ofthe previous decade.
32. Uruguay is facing the challenge to consolidate its recovery after a long and deep recession. The economy shrank by 17.5% and household income dropped over 20% in real terms in 1999-2003. Since 1999 the number of poor has doubled -to 849,000 in 2003 (around 21% ofhouseholds and 3 1% ofthe population) -while indigence increased two and half times to 76,000.' After peaking at almost 20% in late 2002, unemployment fell to 16.9% in 2003 and 12.1% in the last quarter of 2004. Of those that were employed, over 25% were not registered under social security. Without a return to a sustained growth path, the adverse trend in social indicators is unlikely to be reversed.
33. The economy has recovered strongly since mid-2003, and GDP growth in 2004 reached 12.3%, after a recovery of 2.2% in 2003. Nevertheless, there is a qualitative difference between economic recovery and sustained growth. The latter requiring sustained investment in physical and human capital to drive growth beyond existing capacity constraints; this in turn requires an enabling investment climate. And there is also a qualitative difference between growth and broad-based growth - the latter
' The definition of poverty for Uruguay suffers fiom certain difficulties -the deflator being based on the price of food and beverages- and in addition it is substantially higher than that used in international comparisons. For example, on the basis of a mean used in international comparisons of US$2 per day, the percentage ofthe population below the poverty line in Uruguay was 3.9% in 2000, compared with 15.1% in Argentina in 2001, and 26.3% in Mexico in 2000 (World Development Indicators, 2004). According to the official definition of poverty, in 2000 17.2% ofthe populationwas below the poverty line.
1 referring to participation in both the productive transformation and the resulting benefits. As in the past, growth alone is unlikely to suffice to reverse adverse social trends. Policies and institutions that promote broad-based growth together with the reformulation of the social safety net will be critical to reduce unemployment and poverty over the next decade.2
34. This study aims to help developing a “shared” vision of growth with equity in Uruguay. Unless shared, the policies and reform options discussed are unlikely to be implemented, maintained or to be credible. Many ofthe policy options proposed have already been discussed in a series of seminars and workshops3 held in Montevideo with wide participation oftechnical experts, government officials, and representatives from the private sector, political parties and civil society; in some instances, these alternatives are a result ofthe mentioned activities, The findings from this report were incorporated into Policy notes discussed with the incoming administration in January, 2005 and formed the core analytical basis for the new Country Assistance Strategy to be discussed by the Board ofExecutive Directors in June. The focus on wide participation across the political spectrum during these seminars and workshops was linked to the objective ofraising the awareness ofkey social and economic stakeholders in relation to the rationale, costs and benefits ofthe reform options examined.
35. More specifically, the goals of this report are to:
a. Evaluate past growth and productivity performance in Uruguay.
b. Assess the role of policy, institutional and structural factors constraining Uruguay’s growth potential.
c. Identify policy and reform options to consolidate macroeconomic and financial stability and reduce poverty.
d. Identify policy and reform options to improve the investment climate for private sector development and sustained growth.
e. Identify options for sustaining growth through state reforms and development of the national innovational system.
Structure of the Report
36, Chapter I1 describes growth trends and identifies structural factors underlying low per capita income growth in Uruguay over the last half-century, It breaks down
See for example, Aart Kray, “When IsGrowth Pro-Poor? Evidence fiom a Panel of Countries”, World Bank, 2003, memo. After launching a general seminar in December, 2003 at the Central Bank, a series of 5 workshops took place between April and September, 2004 covering the following themes: social sectors, innovation, state reforms, capital markets and trade policy.
2 output growth into its sources: human capital, physical capital and total factor productivity (TFP). It concludes with a summary description ofthe growth strategy.
37. Chapter 111 discusses policy and reform options for pillar 1 ofthe growth plan: fiscal and banking sector policies to ensure macroeconomic and financial stability; policies to increase the efficiency offactor markets -capital and labor, as well as policies to adjust and strengthen social protection, The section evaluates the sustainability of public debt under alternative scenarios, and proposes alternatives for reform with a fiscal impact on the medium term -pensions, private sector participation in infiastructure, state reforms. In addition, options are identified for the strengthening ofthe banking sector, to promote the development ofcapital markets and increase the flexibility oflabor markets. Lastly, it evaluates alternative strategies to strengthen social insurance mechanisms and social programs to better meet the needs ofthe most vulnerable sectors.
38. Chapter IV evaluates policy and reform options in relation to pillar 2 of the growth strategy; it envisages the improvement ofthe investment climate through policies and reforms for: trade integration, increased competition and efficiency in infiastructure services, and development of human capital in the areas ofeducation and health. Trade policies in particular play a crucial role in ensuring conditions for sustained growth by making it possible to improve access to external markets, increase domestic competition and incorporate technology - all these factors could result in a significant increase in factor accumulation, In addition, it is argued that the opportunities for investment in infiastructure services in a competitive environment will make it possible to increase global competitiveness ofUruguayan fwms as well as social welfare.
39. Chapter V describes policy and reform options for pillar 3 of the growth plan aimed at fostering growth through innovation. It focuses on the enabling environment for private sector development and possible strategies for catching up on innovation policy, It also discusses reform options to increase the efficiency ofthe state and its civil service and the government procurement system -particularly effective in increasing competitiveness and innovation in the SlME segment. Increased State efficiency is essential to be able to implement the modernization ofthe national system for innovation.
40. Chapter VI summarizes the conclusions.
3 CHAPTER 11: SOURCES OF GROWTH AND EQUITY - GROWTH STRATEGY
41. The slow growth by Uruguay in the last half-century -with the transitory exception of the 1990s- can be traced to a series of structural and institutional determinants, as well as to adverse conditions at the internationaland regional level. The growth strategy proposed in this document arises from analysis ofthose determinants and conditions and their potential impact on the growth factors of the economy -physical capital, human capital and total factor productivity (TFP).
42. This chapter addresses these matters in the following sections. First, it describes growth trends and possible linkages with past capital flows and regional volatility. Second, it decomposes output growth into its aggregate sources: human capital, physical capital and total factor productivity (TPF). Third, it discusses the relationship between growth, employment, poverty and equity. Fourth, it summarizes the principal hypotheses on the impact of structural, institutional and external factors on the factors of growth. And fifth, it provides a summary ofthe 3-pillar growth strategy,
2.1 Growth, capital flows and regional volatility
43. The economic performance of Uruguay in the last 50 years has been disappointing. Per capita GDP in 1955-2003 grew on average close to 1% per year - well below the more dynamic countries in Latin America or in East Asia. Relative to the US per capita GDP, adjusted for PPP prices, Uruguay's per capita GDP has declined steadily except for a transitory recovery in the 1990s (Figure 1).
Figure 1 - Uruguay's per-capita GDP relative to US per-capita GDP (PPP prices)
60% I
20% 1 , ,, 195;' a 1466 '' 1980'' ldw ' 2000 ' 1955 1965 1975 1985 1995
Source: World Bank staffestimates.
4 44. Uruguay suffered sharp fluctuations in growth rates across decades: average per capita GDP growth was 0.4% in the 1960s, 2.6% in the 1970s, -0.7% in the 1980s and 2.7% in the 1990s. Growth was strongly correlated with trends in capital flows in and out ofthe region - strong capital inflows in the late 1970s-early 1980s were followed by the sharp contraction in flows and growth for most of the 1980s - the so-called “lost decade” associated with Latin America’s debt crisis, Strong private capital flows and growth in the 1990s were interrupted abruptly after 1998 - as happened in most emerging markets - and this was associated, together with other factors, including the sharp devaluation of various regional currencies, with a prolonged recession over 1999-2001 followed by crisis in 2002.
45. Close integration with Argentina explains the very high output correlation between both countries - around 90%. However, what distinguishes Uruguay fi-om high performers in the region - specially Chile over the last 20 years - is that under favorable circumstances (1990s) growth has been at best moderate and under less favorable external circumstances (1999-2002) economic contractions have been prolonged and severe. Poor average growth performance in Uruguay is explained in part by regional shocks and contagion episodes but in part also by its own structural features.
2.2 Factors of production and productivity growth4
46. The factors of economic growth are human capital (skilled labor), physical capital, and the “technology” used to combine these factors. “Technology” includes technological processes, such as management and organization, and the innovation system that permits the development, transfer and adoption of such processes. Growth in output by worker, which reflects household income and welfare, averaged 0.9% during the period 1955-2003 (Table 1, Soto and Casacuberta, 2004). The contribution by factors of production to worker’s productivity growth was: human capital (0.2%), physical capital (0.3%) and technology (0.4%).
47. At a level of approximately 15% of GDP in the 1990s and 13% at the beginning of the 21” century, the level of investment in Uruguay is too low to support high rates of sustained growth. Hence the importance of developing a favorable investment climate, including: a predictable and stable macroeconomic environment, fluid access to international markets, efficient labor and capital markets, and in general, laws, regulations and institutions that enforce property rights and are compatible with the market economy.
48. Physical capital includes infrastructure assets; there is evidence that infrastructure is an important growth factor. Uruguay has a well-developed infi-astructure base, with a broad coverage. In some sub-sectors the private sector plays a dynamic role -for example, in transport and telecommunications; in the remaining sub- sectors, infrastructure services are still dominated by public monopolies. An adequate
Estimates by Soto and Casacuberta (2004) as background for this report,
5 competitive fiamework is in general desirable to induce efficiency gains and at the same time ensure that such gains result in benefits -through lower prices and improvements in quality- for both producers and the consuming population in general. Modernization of infiastructure through the strengthening and development of the competitive fkamework represents one of the main challenges to consolidate improvements in the investment climate in Uruguay.
Table 1 - Sources of Growth in Uruguay
I Average annual I Average annual I Contribution by growth in laborgrowth in TFP Physical capita; Human capital productivity (YO) (YO) (YO) (YO) 1955-2002 0.9 0.4 0.3 0.2
1955-1981 0.6 0.0 0.3 0.3 1955-70 0.0 -1.0 0.4 0.6 1971-8 1 1.4 1.1 0.2 0.1 1982-2002 1.3 0.9 0.3 0.1 1982-91 0.1 -1.1 0.3 0.9 1992-03 12.2 12.1 10.6 1-0.5 Latin America I 1.3 10.0 10.7 10.6 (1960-85) USA. 1.3 0.5 0.3 1.o 1960-85 OECD 2.4 1.4 0.3 0.7 1960-85 East Asia 4.7 2.9 0.8 1.o 1960-85
49. The deveiopment of human capital is not only desirable in itself, but is also a critical component of sustained economic growth. Loayza, Fajnzylber and Calderh (2002) estimate that 90% of the economic growth in Latin America and the Caribbean during 1961-2000 can be attributed to human capital. In the case of Uruguay, different estimates come up with different results, in part because of the difficulties in measuring human capital. According to Soto and Casacuberta (2004), human capital explains close to one quarter of the growth in labor productivity in Uruguay in the period 1955-2002; according to de Brun (2000), this contribution is significantly higher. Government intervention through policies on education, health and risk management can assist households to form, update, maintain and protect their investment in human capital. Links between social policy and growth have been well established on an empirical basis. Such interventions could lead to both growth and greater equity. For example, Ardente and others (2004) discovered that in Uruguay broad educational coverage had a favorable impact on the long-term distribution of income.
6 Factors of productivity: 1955-03
50. As Figure 2 shows, total factor productivity (TFP) has been an important explanatory factor of labor productivity in Uruguay. Labor productivity growth depends on TFP growth, the accumulation of physical capital and the accumulation of human capital (Table 1). Out of the 0.9% of annual growth in productivity in Uruguay, TFP growth accounted for around 45%. Other studies have identified human capital as the main source of output growth in Uruguay, e.g. de Brun (2000)’. In successful East Asian and European economies the rate of TFP growth accounts for approximately 60% ofproductivity growth.
1959 1967 1975 1983 1991 1999 Per working-age person GDP -Total Factor Productivity
Source: Soto and Casacuberta (2004).
5 1. In the 1955-1981 period, labor Productivity grew very slowly (0.6%). At this rate, it would take over 100 years to double productivity levels. When breaking down this period into decades, it becomes clear that the 1960s and 1970s were different. In the 1960s, the effort in accumulating physical and human capital was undone by declining TFP levels. Negative growth in TFP may have stemmed fiom cyclical factors and microeconomic policies (e.g., trade protection) that led to an inefficient use of resources. The 1970~~on the other hand, marked an important reversal in policies and saw the resumption of growth. Physical and human capital expanded pari passu with GDP, but economic growth was largely driven by TFP which recovered at 1.1% per year. The economy expanded until the debt crisis of 1982.
’ Measurement of the contribution by the various factors of production varies according to the methodologies adopted to build the human capital and physical capital series.
7 52. The 1982-2003 period reproduces the pattern of the previous period, the first decade (1982-1991) characterized by a significant use of physical and human capital and declining TFP and the second decade (1992-2003) marked by a substantial recovery in fixed capital formation and TFP levels (Table 1). Also, like in the 1970s, the 1990s were characterized by structural reforms which may account for faster TFP growth, particularly trade liberalization, Also, significant differences were recorded between decades. First, the declining contribution of human capital to GDP in the 1990s was itself the direct result of lower employment levels. The second difference with previous periods is the significant rate of growth in TFP observed in this period (2.2%). This was the only time TFP grew faster that the benchmark economy (the United States), at rates closer to those ofEast Asian economies (Table 1).
Productivity factors in the manufacturing sector
53. Examination of a pane1 of Uruguayan firms in the manufacturing sector over 1985-1999 shows fast productivity growth until 1994.6 The methodology employed allows to break up manufacturing TFP growth into: the utilization effect (intensity with which existing endowments of factors are used); the reallocation effect (ability of producers to reallocate factors of production fiom low- to high productivity frms); the markup effect (the increase of input utilization across sectors stemming fiom differential market power) and - residually obtained - technical change,
54. During the 1985-94 period, the increase in TFP levels arising from data on manufacturing companies can be ascribed primarily to reallocation of factors and technical change (Table 2). This coincides with the period offast trade liberalization and stabilization. Productivity gains fiom factor reallocation may reflect the fact that manufacturing frms substituted capital for labor during the 1990s - in response to the rising relative price oflabor (in turn associated with the real appreciation ofthe peso), The 1995-99 period presents a very different situation: productivity increased by a mere 0.8% per year and this is entirely accounted for by a substantial use of capital and labor. Reallocation continues to be significant as a productivity factor, but at a lower pace. On the other hand, there has been a strong impact fiom increased competition (lower market strength) on TFP growth, i.e., as competition strengthens, firms are induced to increase their productivity to maintain their margins.
Table 2 - Decomposition of changes in productivity of manufacturing plants - average annual growth rates
Change in Change in Change in laborReallocation of Residual Period observed effort and capital markups inputs technical change productivity utilization 1985-89 8.3% -0.4% 0.1% 3.1% 5.6% 1990-94 7.2% 0.2% -0.1% 4.1% 3.0% 1995-99 0.8% 0.9% 0.9% 1.3% -2.3%
Soto and Casacuberta (2004).
8 55. As a benchmark for comparison, data from manufacturing plants in Chile over the 1979-97 period show that productivity grew around 5% per year. In the Chilean case, factor reallocation derived largely from market liberalization and trade opening, a process that was largely completed by the mid-1980s. The Chilean experience shows how over 1979-85, factor reallocation was the main driver of productivity growth whereas over 1986-97 technological change became the key driver. As in the case of Uruguay over 1988-96, the figures illustrate the importance of allocative efficiency gains following a period oftrade liberalization.
56. The implication in Chile is that initially -in response to trade reforms- companies concentrated on the reallocation of factors, and that only as these gains were exhausted did technological change (associated to new investments) become a more significant factor for productivity increases. In Uruguay, both the reallocation of factors and technological change played an important role in 1985-94 -the period of greatest increases in productivity; in the period 1995-99, competitive pressure began to play a more important role.
2.3 Growth, employment, poverty and equity
57. Growth per se cannot be assumed to result in poverty reduction, particularly when inequality increases.’ The experience of Uruguay during the second half of the 1990s helps to illustrate this (Figure 3). Poverty initially declined fiom around 29.7% in 1990 to 15.3% in 1994; however, thereafter it rose during the 1995 and remained at around 17% over 1996-98 while the economy was growing strongly. The latter may be related with the deterioration ofincome distribution - the Gini coefficient increased fiom 41.1% in 1991 to 43.8% in 2001. While Uruguay still has one of the most equitable income distributions in the region, the increase in inequality may account for the reduced impact of growth on poverty.
58, As a result of the prolonged and deep recession in 2002, both unemployment and poverty shot up. Unemployment rose sharply to 15% in 2001 peaking at nearly 20% in late 2002. This, and the strong depreciation ofthe currency that was associated with a sharp increase in the cost of the basic basket of goods consumed by the lower-income sectors, helps to explain the rapid increase in poverty, from around 18.8% in 2001 to 24% in 2002 and 3 1% in 2003.
59. Social policies play a crucial role in the equalization of opportunities. The providing of adequate health, education and social protection for all promotes social mobility and ensures that during economic liberalization processes andlor at times of increased competition, all segments of the population can benefit fiom reforms, In particular, policies or reforms that increase the relative price of labor -as took place in
’De Ferranti, David, Guillermo Perry, Francisco Ferreiray Michael Walton “IneguaZity in Latin America and the Caribbean: Breaking with History?”, World Bank Latin American and Caribbean Studies, Washington, DC, 2003.
9 Uruguay during the 1990s -could benefit relatively more skilled workers, accentuating the inequality existing in relation to less qualified workers.' This reinforces the importance of developing an inclusive education system and providing egalitarian access to higher education and high quality education for those less privileged. This may require in some instances specific interventions and programs such as conditional cash transfers targeted to those attributes ofthe poor which tend to perpetuate poverty.
Figure 3 - GDP growth, unemployment and poverty
135. , 10
-I----:-6 10 ...... - 5 ...... tQ, v 0 -15
--Poverty % +Unenpbyment % -m-GDParowth %. riaht scab Source: INE.
60. One distinctive feature of growth during the 1990s in Uruguay is its low- employment intensity, particularly during the second half of the decade. Despite relatively fast growth in the 1990s, unemployment rose fiom under 9% in the early 1990s to 11% in the late 1990s. However, these figures need to be analyzed with caution since the 1990s were also characterized by a sizable increase in the employment index - fiom 57% in 1990 to around 60% in the late 1990s; this was mainly due to the rising participation ofwomen in the labor force - up from 47.4% to 52.5% in 2000.
61. Unemployment may stem from regulatory barriers, abrupt appreciation of the exchange rate or high labor taxes. Casacuberta et al. (2003) found that in response to trade liberalization in the 1990s there was fast job destruction and job creation in manufacturing; however, there was on balance net job destruction driven by downsizing and firm exit. Consideration must thus be given to how and how fast reforms, laws and regulations may impact on job destruction and job creation, as these processes will drive unemployment. In general, policies that remove barriers to the setting up of new businesses or expansion ofexisting ones, as well as the hiring of labor in the forma4 sector, in addition to macroeconomic policies that help prevent strong fluctuations in competitiveness conditions, will foster job creation and social protection (the benefits of which are strongly biased in favor ofthe formal sector).
For example, trade liberalization has benefited skilled workers in Latin America - e.g., de Ferranti, Perry, Walton and Ferreira (2004), World Bank - and in Uruguay - e.g., J. de Brun (2000).
10 Growth and emigration
62. During its golden years, Uruguay relied heavily on immigration. In contrast with the past, emigration became more common during the second half ofthe 20fh century - between 1964 and 1981, net emi ration was estimated at 3 17,000 people or about 12% of the population. Recent estimates!F show a small negative outflow ofpeople in the 1990s followed by a sharp rise in 2000-2002 of around 70,000 people - this is above the annual increase in population of between 20,000 and 22,000. Uruguayan emigrants are mainly male and young adults and their educational attainment is middle and high compared to a similar age group. This shows that the challenge is not just to encourage investment in human capital but also to create conditions to retain andlor attract skilled labor. Apart fiom the obvious growth implications, reversal of this process of emigration could help to remedy the country's chronic fiscal imbalances originating in the high ratio between beneficiaries (mainly the elderly) and contributors (mainly those in work) in the public health and pension regimes.
2.4 Sources of growth - Structural factors
63. The importance of structural reforms to growth is widely documented; in the case of Uruguay in particular there is econometric evidence for this relationship. Applying an econometric fiamework to various countries, Loayza et al. (2002) found that fast growth in Uruguay during the 1990s can be ascribed to macroeconomic stabilization and structural policies in education, trade and infiastructure. Deeper financial intermediation contributed to explaining the per capita GDP increase between the 1980s and the 1990s. Using a similar model Loayza and Soto (2002) showed that average per capita GDP growth could rise 0.5% due to education catch-up, 0.6% due to infiastructure catch-up, and 0.7% due to catch-up in credit deepening and trade openness.
64. The quality of institutions is an important determinant of long-term growth"; structural reforms aimed at strengthening institutions contribute to the design and implementation of sectoral policies. Uruguay enjoys a good reputation within the Latin American and Caribbean region in terms of institutional achievement. Continued institutional progress will be key to growth performance. As laws and regulations change rapidly with technology, globalization and social demands, there is an increasing need for rapid adjustment and reform of existing institutions to support the goal ofgrowth driven by improvement in the investment climate, development ofhuman capital and innovation.
65. Uruguay has two types of structural weaknesses which could impair long-term growth: macroeconomic, financial and commercial factors which have exposed Uruguay to regional and international volatility (factors i) to iii) described below); and institutional restrictions and regulatory framework deficiencies that limit the development potential of the private sector and innovation (factors iv) to vi)).
Pellegrini and Vigorito (May 2003). loWorld Development Report, World Bank, 2003.
11 i. Weak fiscal funda~entals. Growth spells in the 1970s and 1990s were associated with pro-cyclical fiscal policies (Box 1) and rising sovereign debt levels, processes of real exchange rate appreciation, and low domestic savings which ultimately proved unsustainable in the face of external shocks and contagion episodes. Lower public debt ratios could have dampened sharp exchange rate fluctuations, thus limiting costly bailouts ofthe financial system and sharp contraction in real income. The increasingly high cost of the pension system -which accounts for half of all public spending (or approximately 15% of GDP), the high cost of intervention in banks (an accumulated cost of approximately 20% of GDP in 2002-03) and interest on the debt (close to 6% of GDP) represent a heavy fiscal burden that cannot be sustained, particularly in the absence of steady growth. In addition, there is a negative fiscal impact fiom an ageing population, and a rising level of informal employment affecting vast sectors of the population (implying lower contributions and less social protection). As a result of all this, Uruguay has one of the highest public spending to GDP and tax to GDP ratios in the region, representing a possible barrier to investment and sustained growth (Table 3).
ii. Failures in banking regulation and supervision. Sharp fluctuations in credit associated with fmancial crises have amplified macroeconomic volatility and represent a heavy fiscal burden. The main regulatory failures during the last crisis (2002) were the inadequate protection against foreign exchange rate risk, particularly in view ofthe high level of dollarization of savings, as well as against country risk (especially as regards investments by Uruguayan banks in Argentina). Structural problems include lack of autonomy (including financial autonomy) for supervisory authorities, failure to implement a deposit guarantee system, and the dominant role held by public banks (60% of the system), which limit the potential for the development and stability ofthe fmancial system. iii. High exposure to regional volatilig. Uruguay is a small country that is heavily integrated with two large and historically volatile economies - the GDPs of Argentina and Brazil are respectively 10 and 40 times larger than that of Uruguay. During the 1990s, the mRCOSUR increasingly fostered trade and financial links, further increasing Uruguay’s exposure to exchange rate, financial and output volatility in the region. The GDP growth correlation coefficient between the Uruguayan economy and that of Argentina is in the order of 90%. MERCOSUR’s path of trade liberalization has been weakened by exchange rate asymmetries and unilateral protective actions by its larger members. Largely as a result ofBrazil and Argentina’s recent crises, the share of Uruguay’s exports accounted for by MERCOSUR dropped from over half in 1998 to less than a quarter in 2004, Although this indicates that currently Uruguay is less exposed to regional volatility, it is also an indication of the size of the historical vulnerability to crises within MERCOSUR. The vulnerability of Uruguay to regional volatility has been exacerbated in recent decades by strong agricultural protectionism in industrialized nations that has had the effect of limiting the potential for commercial integration with the rest ofthe world.
12 iv. Weaknesses in the regulatory envir~nment in relation to the business climate. These include the high cost of business creation, high taxes on labor, complex licensing and certification procedures, lack oftransparency that limits the protection provided to small investors, lack of a judiciary qualified to handle complex economic cases, inefficient bankruptcy procedures resulting in costly contract enforcement, weak anti-trust and consumer protection bodies, and limited coordination between companies and government in the area ofinnovation."
v. Lack of a competitive regulatory framework for infra~~uctureservices hamper private sector ~artic~utionand development. While infrastructure coverage is among the highest in developing countries, its relatively high cost (for fuel, water and electricity) and in some cases its high inefficiency (e.g., water) hampers competitiveness of the private sector and consumer welfare. Vertically integrated state monopolies also constrain private opportunities for business in several infrastructure sectors.
vi. Relative inefficiency of the State in areas of social security, education and innovation. While Uruguay still ranks among the top performers in Latin America in terms of health coverage, life expectancy, literacy and education in general the high costlfiscal burden (Table 3) and the relative inefficiency with which some these services are being delivered as well as growing concerns on coverage and quality risk compromising the maintenance of such leadership in the future. Taxes on labor are the highest in the region, and are even higher than the OECD average. The rapid surge in unemployment over recent years suggest that institutional rigidities may have become more binding during periods ofsevere stress. There is a widening gap in performance and investment in education and innovation systems compared with the trend in the more developed countries, and in successful developing countries.
I Argentina 1\ Brazil 2\ Chile 3\ Colombia 4\ I Costa Rica 5\ Ecuador 6\ Uruguay 7\ Non-interest ~UDIIC 25.0 20.9 23.0 28.3 12.0 19.6 34.0 Expenditures 1 1 1 Tax Revenue 11.6 15.3 17.2 1 19.2 12.3 I 12.3 I 21.8 Total Revenue 23.1 22.7 22.6 1 29.6 12.5 I 24.7 I 32.7
Notes: 1\ Consolidated Public Sector, 2\ Federal govemment; 3\ Central government; 4\ Combined Public Sector; 5\ Central government, 6\ Non-financial public sector; 7\ Consolidated Public Sector. Source: IMF,
World Bank, Doing Business, 2004.
13 Box 1 - Precyclicai Fiscal Policy in Uruguay Fiscal policy in Uruguay has been strongly pro-cyclical. The first graph shows that the cyclical component of primary expenditures and of GDP" follow the same cyclical pastern, with public spending cycles having the same length and duration as that of GDP. The second graph shows that the same pattern holds true when the cyclical component oftotal revenues is compared to the behavior ofprimary expenditures.
Cyclical Behavior of Primary Expenditures (1980-2003)
-.3~,,,,,,,,,,,,,,,,,,,~,,I -.204,, , . , , . , ~, , , . , , , , , , , , , 1 1980 1985 1990 1995 2000 1980 1985 1990 1995 2000 Primary Expenditures ---- Revenues 1 -Primaw Exoenditures ---- GDP 1 1 - 1 The graphs below show that the response ofprimary expenditures to a positive cyclical shock on real output and revenues is contemporaneous and statistically significant (as can be inferred fiom the two standard deviation intervals in the figures), and tends to have a persistence of about three years (generalized impulse response functions). Generalized Impulse Response Functions (1965-2003)
Response of Cyclical Primary Eqenditures to Generalized One Response ofcyclicalPrimary wndituras to Generalized One S.D. Cyclical Revenues Innovation S.D. Cyclical GDP Innovation
1 2 3 4 1 2 3 4
Source: Guerson (2004)
2.5 The 3-pillar growth strategy
66. The proposed growth plan is based on three pillars that correspond to policy and reform options for the consolidation of macroeconomic and financial stability and attention to the social emergency (pillar l),the development of a favorable investment climate and the accumulation of human capital (pillar 2), and the strengthening of
'* Cyclical components were calculated using the Hodrick-Prescott filter on the logarithm of real revenues, primary expenditures and GDP.
14 institutions in support of the development of the private sector and innovation (pillar 3).
Sequential impact of policies and reforms
67. Policies included under the first pillar include fiscal management, the financial sector, capital and labor markets, and social security. These policies can enable consolidation of the economic recovery by means of using idle capacity and reassigning factors to more productive companies and sectors -the main factors for increased productivity in the short term. The maintaining offiscal discipline and financial stability is a necessary condition for sustained growth, and therefore such policies should be maintained in the short, medium and long term.
68. The second pillar of policies and reforms is intended to create a favorable investment climate for the accumulation of physical and human capital. It includes policies for trade and integration, the development of a framework for competition to ensure the efficiency of infrastructure services, and policies on education and health for the development of human capital. Although second pillar policies and reforms need to be considered in the short term, and some of their benefits may also materialize in the short term, the most significant benefits will probably only become evident in the mid to long term. The accumulation of physical and human capital that can encourage an improvement in the investment climate is associated with the incorporation of new technology and an increase in competition -all of which are drivers of growth in the medium and long term.
69. The third pillar is based on policies and reforms for innovation-driven growth. It includes policies for the development of a national system for innovation, and policies for the modernization ofthe State and the development of the private sector. Some ofthe policies for the development ofthe private sector, such as the simplification ofregulations and increased efficiency of the legal system, are an inseparable component of the investment climate and could have an economic impact even in the short and medium term. In addition, the benefits of the profound transformations that are needed in institutional capability, the development ofan entrepreneurial culture and a system of innovation will materialize on the basis of the commitment and constancy with which the program of reforms will be implemented. Although innovation can generate an increase in productivity in the short term, it is only in the long term that knowledge and innovation are likely to become the main drivers ofeconomic growth.
70. In short, the plan advocates the simultaneous pursuit of the various policies and reforms under the three pillars. The timeframe over which benefits fiom policies are expected to consolidate their impact in the short, medium and long term correspond broadly with pillars 1, 2 and 3 respectively. However, there is no full correspondence ' between the pillars and the short, medium and long term. For example, as already mentioned policies and reforms described under pillar 1 (fiscal consolidation, financial stability, social security) are expected to have a strong impact over the short term but will remain important over the medium and long term. Policies and reforms aimed at improving the investment climate can be important even in the short term, and must be deepened
15 in the long term. Capital and labor market reforms, although having a certain short-term priority, will be crucial elements in defining the investment climate in the medium and long term. Innovation policies, precisely because they will take longer to mature, for this reason need also to be given priority in the short term.
Consolidation of macroeconomic stability and social protection - Pillar 1
71. The structural weaknesses described have hindered the creation of a stable macroeconomic framework Fiscal imbalances have been the most significant obstacle. For this reason, Pillar 1 assigns priority to fiscal strengthening as the principal instrument for achieving macroeconomic stability. Maintaining the fiscal gains fkom 2002-04 over the medium and long term will require undertaking significant structural reforms with fiscal impact in critical areas such as pensions, reform ofthe state and participation by the private sector in infkastructure. A second source of macroeconomic instability has been &agility of the financial sector and the fiscally costly recapitalizations that it has been subject to in the past, For this reason, the strengthening ofthe financial sector also constitutes a priority area for macroeconomic stability. A third priority is the strengthening the social safety net to protect the most vulnerable sectors of society. Reformulating the social safety net can provide cost-effective protection to the vast segments of the society that have fallen through the formal security net.
72. Initially, continued growth is more likely to stem from increased capacity utilization and from shifting existing factors of production to new or expanding firms than from (more expensive) new investment -except in the case of the more dynamic exporting sectors. This raises the significance of improving the efficiency of factor markets. Flexible labor markets can facilitate the reallocation of existing factors of production fkom non-competitive firmslsectors to competitive ones; this will be a fundamental contribution to reduction in unemployment. Bank credit and the appearance of new products on capital markets can help to reallocate resources to sectors and companies with the greatest potential. Possibly in the short term, capital markets and the internal sources of financing of companies -their profits- will play a more important role than banks, given the high aversion to risk shown by banks and borrowers following the crisis. Capital markets have already demonstrated - during the recent crisis - considerable versatility in the development of new products for the dairy industry, construction and the disposal of non-performing bank loans. Over the medium and long term, both bank credit and capital markets can play a fbndamental role in the financing of the new investments required in terms of human competencies, capital and technology -the backbone of employment and growth.
Investment climate and development of human capital - Pillar 2
73. Sustaining growth requires creating a favorable investment climate that will help to raise the level of investment from 15% of GDP to approximately 20% of GDP over time. The investment climate has been defined by the 2005 World Development Report as “government policies and behaviors by relevant players influencing the
16 opportunities and incentives for fums to inve~t”.’~Incentives and opportunities for private investment are strongly influenced by global trade and investment links, the ftamework for competition and the efficiency ofinfrastructure. The investment climate also encompasses incentives and opportunities for households to invest in human capital; in this context, social policies can play a critical role in creating equal opportunities to access health and education.
74. Some of the factors conspiring against the creation of a favorable investment climate in Uruguay are: high exposure to regional volatility, difficulty in gaining access to agricultural markets in industrialized countries, the high cost of the service infrastructure, and unequal access to high-quality education. The second pillar of the growth strategy centers precisely ofpolicies aimed at dealing with such aspects: trade and integration policies, a competitive framework to encourage efficiency and low costs in infrastructure services, and health and education policies. These constitute the basic policies with an impact on the investment climate, although a good investment climate also incorporates pillar 1 policies -such as macroeconomic and financial stability- and pillar 3 policies -such as institutional development and the regulatory ftamework for the development ofthe private sector,
Institutional develo~~entand growth driven by innovation - Pillar 3
75. Evidence from fast growing emerging markets and industrial countries shows that innovation is the most important factor behind long-term productivity growth; the bulk of innovation activity is produced primarily by the private sector and is backed by significant institutional developments in the State (Guinet, 2004). The implication is that a strategy for innovation should thus be placed within the broader context ofa strategy for private sector development and reforms ofthe State that facilitate institutional developments. In the field of innovation, the role ofthe state is to design and implement innovation policies and provide an enabling environment for private sector development. Pillar 3 thus focuses on state modernization, development of an enabling environment for private sector development and catch-up on innovation policies to close the wide gap that separates Uruguay ftom successful innovators.
76. To sum up, the plan contemplates three pillars which correspond broadly with: consolidation of economic recovery, continuity of sustained growth by means of a more appropriate social and investment climate, and long-term innovation-driven growth. The “vision” of growth under the 3-pillar growth plan is encapsulated in Box 2, which illustrates the key objectives, sources of growth, agents of growth and policies for the short, medium and long term.
Designing and i~lementingreforms in Uruguay
77. Gradualism -and sometimes slow progress- in reform in Uruguay can be linked to multiple factors. These include: the consensus approach deeply rooted in Uruguay’s institutions (which is in itself desirable); the generous benefits of the welfare state
l3World Development Report, 2005, Chapter 1.
17 including job security at public enterprises and the central administration; non- programmatic political parties -which could generate problems with representation; lack of cohesion and leadership in the private sector, and -more generally- the lack of a shared vision of growth and welfare. A number of factors may help to accelerate the pace of reform during the next years. Governments are usually empowered to introduce reforms during their frst year in office. High levels of public debt will impose fiscal discipline, which can in turn can create pressure for undergoing certain reforms. Access to power for the first time in more than a century by a third political party brings with it an air of renewal, and possibly an increased commitment with the restrictions imposed by economic and social reality. These factors can be leveraged if government and society place greater stress on ensuring transparency and improving communications to generate participatory processes to help foster consensus; as well as on greater policy coordination and policy reviews at high levels ofgovernment to ensure the internal consistency ofthe strategy to be fo 110 wed.
Box 2 - Pillars of the Growth Strategy Short term 1 Medium term Long term Pillar 1 High High High Implementation High High Medium Impact Pillar 2 High High High Implementation LowlMedium High High Impact Pillar 3 Medium Medium High Implementation Lowhledium MediudHigh High Impact Investment climate Macro stability GDP to GDP) Innovation-drivengrowth Objectives Social protection (15% 20% Development of human capital Use of idle capacity Sources of Accumulation factors Processes for innovation Absorption of (physical and human capital), and the development of growth unemployment Competition and technology human capital (productivity) Reassigning of factors Innovative entrepreneurs in Agro-industrial activities with various sectors with access Agricultural, forestry, increased added value. to regional and global fishing sectors, Agro- Biotechnology markets. Joint public-private industry. Export services Export of services (data associations for R&D. Agents of (tourism, software) processing, software, tourism, growth Knowledge industries Backward and forward banks) (biotechnology, software, linkages with exporting Foreign investment in wood medicine, agricultural sectors pulp, transport, technology, transport, telecommunications. tourism, banking).
18 CHAPTER 111: FROM RECOVERY TO GROWTH- CONSOLIDATION OF MACROECONOMIC STABILITY AND SOCIAL PROTECTION - PILLAR 1
78. The first pillar of the growth strategy includes policies leading to fiscal and financial stability, the efficient operation of factor markets (capital and labor) and the strengthening of social protection. It is expected that such policies will enable consolidation ofthe economic recovery and an improvement in the social situation ofthose most vulnerable through the use of idle capacity and the reassigning of factors to more productive businesses and sectors -the main drivers of productivity in coming years- as well as a more efficient use ofthe resources allocated to social protection.
79. This chapter puts forward and analyzes policy and reform options for Pillar 1 of the growth strategy. First, the macroeconomic context and the status ofthe reforms is described. Second, the sources ofmacroeconomic instability are analyzed, and alternatives are provided for reform to ensure fiscal sustainability in the mid to long term. Third, aspects of the monetary, fiscal and de-dollarization strategy are analyzed to ensure macroeconomic consistency. Fourth, evaluations are made of the alternatives for strengthening and promoting the efficiency of the banking sector. F@h, reforms are identified to promote the development of capital markets. Sixth, the behavior of the labor market is analyzed, and options are considered for an improvement in its efficiency. Seventh, alternative strategies are evaluated for strengthening the social security mechanisms and the social programs to meet the needs ofthe most vulnerable sectors.
3.1 Recent reforms and macroeconomic developments
80. Growth in the 1990s. The relatively fast economic growth averaging 4.4% over 1990-98 was associated with a process of reforms and macroeconomic stability in conjunction with significant flows of capital to the region -Uruguay received US$550 million of capital flows annually on average in the period from 1993 to 2001- favorable terms of trade, and a regional environment characterized by economic growth (Table 4). Moderate fiscal deficits (between 1% and 1.5% of GDP during 1995-98) and a gradualist monetary policy helped reduce the rate ofinflation fiom over 40% in 1994 to single digits at the end of the 1990s, in a context ofmacroeconomic stability -the public debt-to-GDP ratio hovered around 40% of GDP during the decade, and Uruguay was able to achieve investment grade for its sovereign debt issues -the risk premium standing at approximately 200 basis points prior to the 2002 crisis.
81. Growth was favored by trade, financial and state reforms. Even before joining MERCOSUR in 1994, Uruguay had unilaterally liberalized much of its trade regime, with an average external tariff that declined from 17% in 1986 to below 5% in 2002, Under MERCOSUR, Uruguay freed inter-regional trade and adopted the common external tariff. Uruguay passed an important social security reform in 1995- strengthening contribution requirements for benefit eligibility of the PAYG system, increasing the retirement age
19 for women, and introducing a defined-contribution funded pillar covering approximately one quarter of all pension contributions. State reforms helped to reduce public employment by around 10% and to improve financial management. Despite the passage of legislation to introduce competition in electricity, there were no private entrants in the sector. On the other hand, it was possible to introduce participation by the .private sector in the gas, transport and telecommunications sectors -although this was not always linked to the introduction of a regulatory fiamework to promote competition.
82. Despite significant reforms and moderate deficits, weaknesses in the regulatory framework of the financial sector and the pro-cyclical nature of public pending persisted. In the financial sector, regulation and supervision were strengthened and intervened banks were privatized. On the basis of open financial markets, strict bank secrecy laws, and relative macroeconomic stability, off-shore banking flourished, mostly serving Argentine clients. Since the mid- 1990s, legislation has been introduced supporting capital market development. However, weaknesses persisted in prudential regulation and supervision of banks -for example, country risks and currency risks were not duly internalized by regulation, and supervision tended to be biased in favor of public institutions- and of capital markets. Such weaknesses and high levels of dollarization exposed bank vulnerability during the 2002 crisis, when the flight of 50% of deposits in the system left the Central Bank virtually without reserves and led many banks into technical insolvency. Furthermore, despite maintaining moderate deficits, the pro-cyclical nature of fiscal policy meant that in absolute terms sovereign debt grew fiom approximately US$4,4 billion in 1990 to around US$9 billion in the early ~OOOS.'~
Table 4 - Selected macroeconomic indicators 1990-1998 1999-2003 2004 Est. Real GDP Growth 3.9 -3.2 12.3 Gross Domestic InvestmentlGDP 15.1 13.5 13.3 CPI inflation 53.7 9.6 9.2
Exports of Goods & Services (% GDP) 19.5 20.3 30.4 Imports of Goods & Services (% GDP) 19.1 20.9 27.8 Current Account Balance (% GDP) -0.8 -0.9 -0.8
Primary Expenditure (% GDP) 29.2 32.0 26.2 Primary Balance (% GDP) 1.o -0.4 3.8 Overall Balance (% GDP) -1.4 -4.0 -2.2 Public Debt I GDP (%) 39.4 68.3 92.2 GDP (billion USD)' ' 16.6 16.6 13.2
83. The prolonged recession over 1999-2001 ended in an economic collapse in 2002 with GDP contracting nearly 20% over 1999-2002. The recession can be partially attributed to a sharp contraction in capital inflows to the region and a strong real currency appreciation following the Brazil devaluation in 1999 and that of Argentina in 2002 (Figure 4). Fiscal and financial indicators deteriorated during the recession and particularly during
l4The share to GDP declined fiom 70% in 1990 to 36% in 1996 due to the Brady Plan, fast growth and real peso appreciation; thereafter it rose to 54% in 2001 due to real peso depreciation and the recession.
20 the 2002 crisis, Fiscal deficits rose above 4% of GDP and, following the floating of the peso in mid 2002, the public debt-to-GDP ratio doubled to 101.5% in 2003. Non- performing loans (NPLs) in public institutions rose fiom 41% in 1999 to 54% in 2001 -and provisions covered less than.40% of the amounts involved. The high level of dollarization - deposits in foreign currency accounted for 89% of total deposits- represented a significant source of vulnerability: although loans in foreign currency amounted to 81% of total loans, very few were granted to individuals or companies with genuine income in foreign currency, or to exporters. The country risk premium skyrocketed to over 2000 basis points at the end of2002 and into early 2003.
Figure 4 - Real Multilateral Exchange Rate - 1995=100 I 160.00
140.00
100.00
80.00
60.00
40.00
20.00
0 00
Source: BCU.
84. The government confronted the crisis decisively. It promptly intervened to restructure andlor liquidate troubled institutions and committed to a program of fiscal adjustment and enhanced social protection. The primary fiscal balance was turned fiom a deficit of 1.2% of GDP in 2001 into a 3.8% surplus in 2004. In spite of an almost 100% peso devaluation, the pass-through to inflation was only 25.8% in 2002 and 10.2% in 2003, falling below 8% in 2004. A US$3.7 billion multilateral support package was tied to structural reforms in fiscal, financial and social areas, and included the creation of a Fund for the Stabilization of the Banking System with sufficient funding to back fully all US dollar sight and savings deposits at public and intervened banks. Time deposits of state- owned banks were re-programmed and their maturities stretched over a three-year period, maintaining the currency in which the deposits were denominated. A radical restructuring of the National Mortgage Bank (BHU) -the second largest and deeply insolvent public bank- was initiated (with almost all its assets denominated in local currency -or adjusted on the basis ofthe performance ofwages- the devaluation had a devastating impact on the net worth of this institution). BROU, the largest public bank, started a process of portfolio clean-up, organizational rationalization and modernization of its credit and risk management functions. Four deeply insolvent domestic private banks were suspended on a permanent basis, and work began on their orderly liquidation -although this ended up taking longer than expected.
21 85. Following a successful debt exchange with private bondholders for around US$5.4 billion -extending maturities for an average of five years without raising the interest rate- country risk dropped to around 600 basis points and an incipient economic recovery ensued as from the second half of 2003. On the demand side, growth was driven by a strong rise in dollar exports -around 30% in 2004- and a significant recovery in investment and consumption. On the side of supply, a rapid process of import substitution took place with a particular impact on the industrial sector. Gross international reserves have quadrupled since early 2003 to close to US$2.5 billion at the end of 2004, and around half of resident’s deposits in foreign currency that had left the system returned. Country risk fell further (below 400 basis points), and immediately after the successhl exchange Uruguay regained access to international capital markets, placing a 3-year inflation-indexed peso-denominated US$ 150 million bond. The unemployment rate dropped from 19.8% in November 2002 to 12.1% at the end of2004.
3.2 Reforms and fiscal sustainability - Macroeconomic strategy
86. Macroeconomic instability is the single most important factor limiting the development of a favorable climate in Uruguay; high debt - in turn - is the consequence of past fiscal imbalances and is one of the main sources of fiscal vulnerability and potential future macroeconomic instability. Although the debt fell from 101.5% of GDP in 2003 to 92.2% in 2004, this level is still high. Uruguay, in addition, must face sizable amortization on its debt with international multilateral lending agencies in the 2005-07 period.
87, The benefits of maintaining a strict fiscal policy and gradually reducing the debt go well beyond the objective of ensuring debt sustainability. The fiscal breathing- space gained provides freedom for the BCU to manage monetary policy without sacrificing inflation objectives or burdening the private sector with excessively high interest rates or episodes of abrupt exchange rate appreciation. A good example of this combination of policies is provided by Chile during the 1990s when strict fiscal policies led to a reduction in the debt and were conducive to achieve competitive interest and exchange rates. Instead, when in 1998 Chile tightened monetary policy to target the exchange rate while fiscal policy was (temporarily) relaxed, interest rates rose to unsustainably high levels and the country fell into a recession. In the medium term, as debt servicing declines, the fiscal surplus generated will make it possible for Uruguay to increase on a sustainable basis social spending, investment in human capital and in research and development.
88. In the absence of structural reforms, it will be difficult to reach and sustain primary fiscal surpluses consistent with debt sustainability. In the absence of reforms, the primary fiscal surplus is highly likely to decline over time. Pro-cyclical public spending (pensions in particular), the need for public investment to make up for limited private sector participation in infrastructure, possible future bank interventions and the impact of an aging population on spending and income related to the health and pension system are some of the factors indicative of this trend. In this scenario -without structural reforms- assuming (i)the primary surplus declines to 3% of GDP and stabilizes around that
22 (historically high) level, (ii)GDP growth falls to its long term average of 2% (after 2008), and (iii)the average real rate ofexchange appreciates in real terms compared with the end of 2004 to approximately the average of 1982-2003 - the debt to GDP ratio is projected to decline slowly to 72% ofGDP in 2014 (Table 5, Scenario 2).
89. If the primary surplus declined further (to 2% of GDP) or if the exchange rate would stabilize at the end-2004 level, public debt would decline initially (as a share of GDP) but then would increase permanently. Such an increase is partly explained by the rising financial cost ofsubstituting multilateral financing sources by more expensive bonds carrying a higher spread (600 basis points) and partly by low growth and an inadequate fiscal stance. In such cases, debt could rise to 84% ofGDP (Table 5, Scenario 3) or 88% of GDP respectively by 2014 (Table 5, Scenario I)).The implication is that in a scenario without reforms, high debt will continue to be a factor of vulnerability in the presence of external or domestic fiscal shocks thereby leading to increased uncertainty for investors and government financing.
90. On the other hand, in a scenario of structural reforms it would be possible to achieve and maintain a primary fiscal surplus consistent with debt sustainability and estimated to be in the range of 4% of GDP in the medium term. Reforms are necessary both to achieve fiscal targets and to foster growth through efficiency-enhancing measures. Under this scenario, growth is projected to converge to 3% over the medium term and country risk to stabilize at around 400 basis points (the level of March, 2005) or below. Assuming the same level ofreal exchange rate appreciation as in the no-reform scenario, the debt to GDP ratio could decline to around 60% in 2010 and 48% in 2014 (Table 5, Base Scenario).
91. Nevertheless, even in this optimistic scenario, it is estimated that debt wiU fall gradually, which implies a certain degree of vulnerability to possibie shocks during the transition. Under adverse shocks, rather than converging to lower levels, public debt- GDP ratios may diverge. For example, employing a stochastic fkamework (Guerson 2004) in which the exchange rate responds endogenously to simulated external shocks -based on past experience - there is a 12% probability that over the next 10 years the debt ratio could grow above 100% (Table 7).
23 Table 5 - Debt Sustainability - Deterministic Simulations 2004e 2005 2006 2007 2008 2009 2010 2014 Base Scenario Stock of public debtiGDP 92.2 77.5 72.3 68.0 65.3 62.6 59.8 48.2 Stock of public debt, US$ billion 12.2 12.2 12.1 11.9 11.7 11.6 11.4 10.3 Debt ServiceiGDP 11.7 13.1 15.3 13.1 10.8 10.1 11.0 9.6 Debt ServiceiRevenues 39.0 43.9 49.2 41.1 33.4 31.5 34.3 29.7 Multilateral DSlTotal DS 50.2 53.3 56.7 69.3 52.4 52.1 44.2 29.5
Base Scenario Assumptions GDP real agrowth rate (%) 12.3 6.0 4.0 3.5 3.0 3.0 3.0 3.0 Nominal GDP, UR$ billion 379 422 461 499 532 567 604 780 Public Sector Primary Surplus, % of GDP 3.8 3.5 3.7 4.0 4.0 4.0 4.0 4.0 Sovereign spread 1170 400 400 400 400 400 400 400
Alternative scenario 1
Stock of public debtiGDP 92.2 87.9 86.6 84.5 84.3 84.3 84.5 87.6 Stock of public debt, US$ billion 12.2 12.4 12.5 12.6 12.9 13.1 13.4 15.1 Debt ServicelGDP 11.7 14.6 18.0 16.0 13.9 13.8 15.6 17.9 Debt ServicelRevenues 39.0 48,7 57.6 50.0 43.0 42.8 48.4 55.4 Multilateral DSiTotal DS 50.2 53.3 55.6 66.1 47.8 45.4 37.4 19.7
Low case scenario assumptions GDP real agrowth rate ("?) 12.3 6.0 3.0 2.5 2.0 2.0 2.0 2.0 Nominal GDP, UR$ billion 379 379 399 428 452 477 503 625 Public Sector Primary Surplus, % of GDP 3.8 2.5 2.7 3.0 3.0 3.0 3.0 3.0 Sovereign spread 1170 600 600 600 600 600 600 600
Alternative scenario 2 Stock ofpublic debtiGDP 92.2 78.5 75.1 72.8 72.2 71.8 71.4 71.6 Stock of public debt, US$ billion 12.2 12.4 12.4 12.5 12.6 12.8 13.0 14.1 Debt ServiceiGDP 11.7 13.1 15.6 13.9 11.9 11.7 13.2 14.6 Debt ServiceiRevenues 39.0 43.9 50.4 43.5 37.0 36.5 41.1 45.3 Multilateral DSiTotal DS 50.2 53.3 55.9 66.9 48.8 46.8 38.8 21.2
Scenario assumptions GDP real agrowth rate (%) 12.3 6.0 3.0 2.5 2.0 2.0 2.0 2.0 Nominal GDP, UR$ billion 379.3 422.2 456,6 489.1 516.3 545.1 575.4 714.7 Public Sector Primary Surplus, % of GDP 3.8 2.5 2.7 3.0 3.0 3.0 3.0 3.0 Sovereign spread 1170 600 600 600 600 600 600 600
Alternative scenario 3 Stock of public debVGDP 92.2 79.0 76.3 75.0 75.6 76.4 77.4 84.3 Stock of public debt, US$ billion 12.2 12.5 12.6 12.8 13.2 13.6 14.1 16.6 Debt ServiceiGDP 11.7 13.1 15.7 14.1 12.3 12.4 14.2 17.1 Debt Servicekevenues 39.0 43.9 50.7 44.2 38.4 38.7 44.2 53.2 Multilateral DSlTotal DS 50.2 53.3 55.6 65.8 47.0 44.1 36.1 18.0
Scenario assumptions GDP real agrowth rate (%) 12.3 6.0 3.0 2.5 2.0 2.0 2.0 2.0 Nominal GDP, UR$ billion 379.3 422.2 456.6 489.1 516.3 545.1 575.4 714.7 Public Sector Primary Surplus, % of GDP 3.8 2.0 2.0 2.0 2.0 2.0 2.0 2.0 Sovereign spread 1170 600 600 600 600 600 600 600
Source: World Bank staff calculations.
92. Structural reform options considered under the proposed growth strategy - consistent with the target for a primary fiscal surplus converging to 4% of GDP on average - include: parametric and structural reforms to the pension system, reforms to the system for government procurement, improvements to tax collection and social security contributions in particular, increases in the efficiency of public infrastructure companies,
24 reforms to public banks, and increased private sector participation in providing infiastructure services. Other reforms proposed under the growth strategy will on the other hand involve fiscal costs: finding of the deposit guarantee scheme, modernizing of institutions, research and development costs, reforms to the education sector, and the social emergency program. The main reform options are described below, As a summary, Table 6 presents an estimate of the incremental quantitative impact of each reform on the reference primary surplus (3.8% of GDP in 2004).
Reform scenario - Fiscal impact of structural reforms
93. Modernization and increased autonomy of the Tax Administration Department @GI) and coordination with the Banco de Previsidn Social (BPS) could lead to improved compliance with tax and social security obligations. The government is already committed to overhaul the organization and procedures ofthe DGI, improve staff training and increase incentives. It is also important to proceed with the establishment of a special unit for dealing with large tax payers and ensure that DGI officials are employed on a hll-time basis. There are even greater prospects for enhancing revenues from social security contributions which declined fiom 6.2% of GDP in 2000 to 4.1% ofGDP in 2003, Better coordination between the DGI and the agency which administers the social security system (BPS) could result in a recovery of revenues (IMF, 2004). Combining these reforms with cyclical factors could contribute to raising revenues by the equivalent of 1.2% of GDP (Table 6) on average during 2005-12 (ofwhich 0.7% would be due to cyclical factors).I5
94. Cost reductions could enable public utilities to reduce tariffs while, at the same time, increasing their dividends for the government (Chapter rv). Such savings are expected to arise from cost efficiency gains in the energy and water sector (World Bank, 2003) - 0.3% of GDP - and greater private sector participation in telecommunications and also in the power sector. On the other hand, there are likely to be contingent liabilities in the rail and Mega concession (Irwin, 2004) and investment costs for the new Thermal Combined plant, In net terms, there are estimated to be potential gains for fiscal accounts in the order of 0.6% ofGDP (Table 6).
95. Deepening of procurement reforms and in the civil service could contribute to the efficiency of the state and lead to significant savings in public spending. The greatest challenge from the point ofview ofthe efficiency ofthe state are the reforms ofthe civil service (Chapter V); this presumes among other matters a professional up-grading, including a review of the salary structure for the sector, In fiscal terms, net gains are expected from a reduction in public employment (around 0.1% ofGDP on average); part of these savings will be offset initially by the need to finance severance payments, Similarly, the government has committed to important procurement reforms -on which it has made fum progress. Nevertheless, reforms remain pending that estimates by CEPE suggest could lead to potential gains in the order of 0.3% of GDP (Chapter V).
IsThe new administration has promised to introduce a personal income tax, and this could provide an important new source ofrevenue. Nevertheless, personal income tax is administratively complex and will require to be planned and drafted with care if it is to be applied efficiently and fairly. Implementingthe procedures and the administrative structures for the collection of such a tax will require time, as well as a significant level of coordination with the BPS.
25 96. Pension expenditures account for approximately 50% of public spending in Uruguay, and explain most of the growth in expenditures over the last ten years. Parametric reforms including retirement age, years of contribution, replacement rates and the system for adjustment or indexation could lead to significant fiscal savings. For example, an increase offive years in the retirement age, in line with the age requirement in comparable countries, could in the medium term generate savings ofaround 0.4% ofGDP (Forteza, 2004). The raising ofthe retirement age could be combined with a reduction in the requirement for years ofcontribution that would reflect the reality ofthe labor market and its trend towards informal hiring - the alternative would mean the state having to assume contingent liabilities in the face of a growing number of retirees not meeting minimum years of contribution requirements. A second -and equally difficult to implement- reform option would be to change the indexation of pensions from a wage- based system to one based on prices, or a mixed basket based on both prices and wages. This could provide additional financial relief to public finances estimated at around 0.3% ofGDP (Forteza, 2004). A change in the pension indexation mechanism could contribute to protecting the real value of pensions in the face of strong fluctuations in real wages recorded in recent decades.
97. In addition to the state pension system, Uruguay has a wide range of social protection programs that need to be restructured and targeted more specifically, to better meet the needs of the population as a whole. In many cases, instruments ofsocial protection do not adequately cover the more vulnerable groups, which include self- employed workers, those informally employed, and the unemployed. Specific proposals for an improved targeting of social security and social assistance could yield the necessary fiscal savings. Nevertheless, the growing needs arising fiom vast segments of the population falling below the poverty line will probably imply an increase in social (non- contributory) transfers. The net effect has been estimated at an increase in the order of 0.2% ofGDP on average in 2005-2012.
98. Furthermore, there are a series of pro-growth reforms that will necessitate additional fiscal disbursements (estimated at 0.9% of GDP on average). These include in particular the need for investment in areas such as institutional modernization, research and development, and the fimding ofa deposit insurance scheme.
26 Table 6 - Impact on Primary Fiscal Balance 2005-12 - Reform Scenario
Cyclical and Structural Sources of Annual average impact on primary surplus Fiscal Expenditures and Revenues (as YoGGDP) A. Cyclical Factors 1) Cyclical Increase in Primary Expenditures -1.5% 2) Cyclical Increase Taxes/Social Security con~ibutio~ +0.7% A. Total (1 +2) -0.8% B. Net Fiscal Gains from Structural Reforms I)Financial sector - net gains +0.2% 2) Pensions +0.7% - Raising retirement age (net of impact of ageing, +0.4% - Replacing wage indexation by mix of price/wage index. +0.3% 3) Infrastructure +0.6% - Combined cycle plant -0.1% - Mega- and rail concession contingent liabilities -0.1% - EfJiciency gains energy/water +0.3% - Concessionfees/ toll-roads, ports cannons, etc. +0.1% - Savings by AFE, reducedpublic investment in roads +0.1% - Increased Private Sector Participation (Telec., energy) +0.3% 4) Social safety net -0.2% 5) Increased compliance: tuxredsocial security +OS% 6) State reforms +0.4% - Reducedpublic employment +0.1% - Procurement +0.3% 7) Increased spending in R&D -0.4% 8) Funding Deposit Insurance -0.2% 6 -0.3% B. Total (1+2 ...+ 9) +1.3% Net Impact Primary Surplus (AtB) +0.5% Primary Surplus 2004 +3.8% Primary surplus over 2005-12 +4.3% I
99. The pro-cyclical nature of public spending contributes to macroeconomic volatility. Uruguay could reduce pro-cyclicality through specific reforms -for example, by modifying the pension indexation mechanism- but it could also adopt anti-cyclical fiscal policies. Such anti-cyclical fiscal policies aim to increase the fiscal pressure (difference between tax revenue and expenditures) during growth periods and lower it during periods ofcontraction. There are discretional anti-cyclical policies, and the possibility also exists of adopting anti-cyclical fiscal rules. The latter could contribute to the credibility of fiscal policy as long as the rules adopted are observed, e.g., Chile has in 2001 adopted and observed a fiscal rule consisting ofmaintaining a structural fiscal surplus equivalent to 1% of GDP,
27 100. To illustrate the impact on the debt of anti-cyclical policies, scenarios were simulated assuming the adoption of a rule for a structural primary fiscal surplus in a stochastic framework (see below). Under such a rule, the level of primary public spending is adjusted only in response to permanent changes in revenues. This implies that transitory revenue fluctuations are compensated through debt issuanceldebt cancellation thereby helping to smooth out primary expenditures along the cycle. A structural primary balance rule equivalent to 4% of GDP was simulated using the stochastic model described above (Guerson, 2004). The scenarios tested are consistent with debt sustainability (Table 7). After 10 years the projected debt-GDP ratio would fall to 70%; the advantage of adopting this rule (vis a vis the alternative of a fixed primary surplus) is that at the same time as it reduces the debt it makes it possible to smooth out the fluctuations in primary public spending (particularly in social areas) over the length ofthe cycle.
101. Using the same simulation model, a policy for a fixed primary surplus equivalent to 4% of GDP makes it possible to reduce the debt to a comparable level (75% of GDP in 10 years, Table 7); while such a policy is not anti-cyclical, it has the important advantage of reducing debt volatility. For example, after 10 years the probability ofdebt rising over 100% is 12% under the fixed primary surplus rule whereas it is 14% under the structural fiscal rule. In this regard, it is conceivable that as long as debt remains high, it may be fiscally more prudent to adopt a constant primary surplus rule; as debt declines to more manageable levels, a structural primary surplus rule could be adopted.
102. To bring debt down faster and maintain an anti-cyclical fiscal policy, Uruguay could consider combining the adoption of a primary surplus rule incorporating debt capitalization (a debt-equity swap). This capitalization could take place by means of the sale of public assets -such as the Nuevo Banco Comercial- from associations between public and private companies or concessions. Selling an interest in the to-be-constructed combined cycle power station is also conceivable. Whatever the case, public debt capitalization would allow a faster reduction of debt and would reduce volatility, For example, a debt-to-equity swap that decreases debt by 30% combined with the adoption of a structural primary fiscal surplus of 2.8% would allow a reduction of expected debt to 53% ofGDP in 5 years; debt volatility would be reduced in a similar manner (Table 7).16
l6Simulations using a stochastic dynamic model are reported in Guerson (2004). The 2.8% structural primary surplus balance is calculated endogenously as the level required to obtain a public debt to GDP ratio of 50% in five years.
28 Table 7 -Debt Sustainability - Stochastic Simulations 1. Constant primary fiscal surplus Assumptions Fiscal Rule Effective primary surplus Long-term growth, annual %rate 2.1 Spread, basis points 500 Share Public Debt in Dom Currency 0.0 Primary surplus target (% GDP) 4.0 Public Debt Dynamics At year 5 At year 10 At year 15 At year 20 ExDected Public debt I GDP ratio 75.3 74.9 76.1 72.9 Standard deviation 18.4 24.2 33.0 36.1 Probability debt ratio < 100% of GDP 0.88 0.82 0.79 0.78 2. Structural primary fiscal surplus rule Assumptions Fiscal Rule Structural primary surplus Long-term growth, annual % rate 2.1 Spread, basis points 500 Share Public Debt in Dom Currency 0.0 Primary surplus target (% GDP) 4.0 Public Debt Dynamics At year 5 At year 10 At year 15 At year 20 Expected Public debt I GDP ratio 73.6 70.4 68.9 61.6 Standard deviation 23.3 34.6 49.6 60.1 Probability debt ratio < 100% of GDP 0.86 0.79 0.76 0.74 3. Rule for structural primary fiscal surplus + debt-for-equity swap (reduces debt by 30% at end of 2004) Assumptions Fiscal Rule Structural primary surplus Long-term growth, annual % rate 2.1 Spread, basis points 500 Share Public Debt in Dom Currency 0.0 Primary surplus target (“76 GDP) 2.8 Public Debt Dynamics At year 5 At year 10 At year 15 At year 20 Expected Public debt I GDP ratio 52.8 50.0 48.4 42.4 Standard deviation 18.5 28.6 41.8 51.7 Probability debt ratio < 100% of GDP 0.99 0.90 0.90 0.89 Source: Guerson (2004).
3.3 Debt management
103. Debt management objectives include (among other factors): reduction in the cost of financing and the risk of re-financing, minimizing the exchange risk and ensuring continued access to capital markets. The following considerations are relevant in the case of Uruguay:
29 (i) Currency risk. Based on the stochastic simulation model used, volatility of the debt ratio could be reduced by one-third if Uruguay’s public debt were 50% denominated in foreign currency - compared to nearly 100% currently (Guenon, 2004). However, the authorities will have to evaluate whether the probable increased cost (in terms of interest rate) of issuing more peso-denominated debt is justified in the face of the reduction in volatility ofthe debt associated with the shift towards peso denominated debt.
(ii) Access to markets - Diversification of financing sources and i~~ments. Diversification ofsources and instruments of financing can improve the chances and terms of accessing markets at all times and can help to deepen domestic capital markets. For example, pension funds may prefer long-maturity inflation-protected instruments, while money market funds prefer low volatility short term instruments. Uruguay has already successfully explored the market for medium-term index-linked securities in pesos. At present, almost half of Uruguay’s debt is with multilateral lending agencies. As long as Uruguay can preserve its access to capital markets, a reduction in the exposure to such bodies could be justified. This would provide a greater margin for access in the undesirable event ofa new crisis.
(iii)’ Risk of refinancing - Maturity and repayment peaks. Long-term debt carries with it a liquidity premium. Nevertheless, short-term debt can exacerbate the risk of re- financing. Uruguay succeeded in lengthening the maturity ofits commercial debt by over 5 years under the 2003 bond exchange. To minimize the refinancing risk it is advisable to avoid concentration of principal payments during a given period. There is still scope for lengthening average maturity and avoiding peaks in repayment.
(iv) Liquid@ risk - Policy on reserves. International reserves can help to minimize rollover risk, exchange risk and the risk oflosing access to markets. Uruguay’s Central Bank has currently a relatively large stock of international reserves covering 85% ofpublic debt service falling due the last quarter of2004 and the frst 3 quarters of2005, and equivalent to over 9 months of imports. However, international reserves need also to be measured against potentia1 demands fiom the dollarized financial sector. Foreign reserves are approximately 100% offoreign currency deposits held by non-residents, but barely one-fourth ofthe total stock of foreign currency liabilities ofthe financial system as a whole. To build up its liquidity cushion, Uruguay could establish international liquidity requirements for foreign currency deposits, higher for non- residents and inversely related to the maturity of the deposit (it has already adopted differential reserve requirements for foreign and domestic currency deposits). Uruguay could also seek international liquidity insurance schemes, e.g., a fee-based international liquidity facility like the one Argentina obtained fiom private banks in the 1990s.
(v) Optimal degree of inde~tedn~ss.Several papers argue that emergin economies should target debtlGDP ratios ofless than 30% ofGDP in the long term.‘ Large debt ratios are associated with high interest rates and spreads through their impact on sovereign risk, adversely affecting economic growth. Following a decade of debt reduction,
l7See Reinhart, Rogofiand Savastano (2002).
30 Chile has reduced its public debt-to- GDP ratio to around 12% (excluding the debt of the Central Bank); this has been one of the pillars of its stellar growth performance and ability to conduct anti-cyclical fiscal policy, particularly in response to high international commodity price volatility - copper revenues finance a substantial portion of Chile’s budget.
(v$ Inst~tutjon~laspects. Although Uruguay was successfully able to cany out a debt exchange covering 92% of its debt with private creditors, the Ministry of Economy does not possess a department that is equipped and trained to carry out planning, monitoring, evaluation and management of the debt on the basis of pre-determined objectives. The government could analyze various options ofinstitutional design to be able to ensure continuity in the administration of such a strategically sensitive area.
3.4 De-dollarization and monetary policy
104. The objective to issue more peso denominated debt is closely related to the broader issue of de-dollarization. It is widely perceived in Uruguay that the widespread use of the dollar for fmancial transactions (over 90% of bank deposits and public debt are denominated in foreign currency) has been a source of instability. That instability is all the more acute because there is a currency mismatch between the assets and the liabilities of many fmancial institutions and the foreign currency obligations of many households and frms are not covered by secure sources of foreign exchange income. De-dollarkation appears to offer a way out ofthose problems but that can only be achieved by reversing the policies that gave rise to dollarization in the first place.
105, The fundamental reason why the dollar has been so widely used for financial transactions in Uruguay is that the citizens lack confidence in the value of the peso. A successful program of de-dollarization will depend, therefore, upon building up confidence in the peso as a dependable store of value. That, in turn, will depend upon following sound macroeconomic policies consistently over time so that inflationary expectations and, hence, peso interest rates, can be kept low. In particular, adopting an inflation target regime can help restoring confidence in the currency; both Chile and Brazil have recently achieved successful results with this.
106. The government has already taken actions to facilitate adoption of inflation targeting. The Central Bank (BCU) currently pursues a policy ofmonetary base targeting which carries implicit inflation targets. To impart greater flexibility to monetary policy operations, the BCU has established a repurchase (repo) mechanism to address intra- monthly variability in the demand for pesos. Also, it started a forward foreign exchange program and has increased the transparency ofthe monetary policy fiamework through the timely and more fiequent publication of data including monetary and inflation targets. The Central Bank has created inflation-indexed instruments to reduce the vulnerability of the financial sector, as well as the volatility of money demand and thereby ensure a more predictable monetary transmission mechanism (IMF, 2004).
31 107. The main challenge for effectively implementing an inflation targets regime is conceding autonomy to the Central Bank and reform of its charter to establish currency stability as its primary objective. This may require staggering terms of board members and limiting the government’s ability to interfere with BCU decisions. Eventually it will be necessary to recapitalizing the Central Bank to reduce or eliminate its quasi-fiscal deficits (around 1% of GDP). Other challenges are: the development ofan active inter-bank credit market, limiting foreign exchange interventions to exceptional circumstances and further development of the forward foreign exchange market. Regarding the latter, caution will be required, to prevent speculation against the BCU. The government could promote participation by institutional players like insurance companies or pension funds as they are typically long in US dollars.
108. The importance of fiscal discipline transcends the debt sustainability objective; by contributing to anchor inflationary expectations, fiscal austerity grants degrees of freedom to monetary policy in attaining the anti-inflation objective, Among other matters, this prevents having to resort to excessively high interest rates to halt inflationary pressure -and its fiequent consequence, exchange rate appreciation episodes induced by monetary constraints. The gradual disinflation process under way -compatible with an inflation-targeting policy- is backed by sound and consistent fiscal policy, which, if continued, will simultaneously enable the driving down of inflation without the risk of excessively high interest rates or abrupt losses of exchange rate competitiveness.
109. In addition, there are a number of other specific measures that could be taken to foster the adoption of peso-denominated financial instruments and reduce the risks linked to dollarization:
a The market may well be receptive to bonds or certificates ofdeposit denominated in pesos, if they were inflation-linked and if holders were assured that the indexation will be fair, transparently administered and strictly honored; recently UI instruments (denominated in inflation-indexed units) have been created.
a Banks which extend dollar denominated loans to businesses that do not earn foreign exchange should be required to provision against such loans at a higher rate. Foreign exchange deposited in banks should be subject to higher liquidity requirements andlor higher deposit insurance premiums.
a Prudential regulations could oblige pension fbnds and insurance companies to match the currency oftheir hture liabilities against the currency oftheir assets; this could considerably increase the demand for instruments in UI, at the same time as protecting fbture pensioners fiom exchange rate fluctuations.
a Developing a forward market in UI would allow institutions to hedge their portfolios.
a Tax rules could be revised accordingly, e.g,, income tax rates need to be based on real (rather than nominal) interest rates.
32 3.5 Strengthening banks"
110. A stable financial sector is essential to prevent banking crises and the high related cost. An efficient financial system also facilitates the reassigning of idle resources to more productive companies and the most dynamic sectors. Both these objectives form an important part ofthe growth strategies under pillar 1.
111. After the 2002 crisis, the banking sector was segmented into large, public banks with nation-wide branch networks, and a small number of mostly foreign- owned banks. The two large public banks - BROU and BHU - are being restructured with the aim of improving their credit and risk management functions and their corporate governance. The BHU is no longer authorized to take deposits (except for peso savings plans). The liquidation ofthe four medium or large private domestic banks during the crisis reduced the share of private banks fiom 60% to 40% (Table 8). Afier the bulk of BHU deposits were transferred to BROU, the latter held 48% ofall deposits and 44% ofall loans within the system.
Table 8 - The Uruguayan Banking Sector
(US$ millions) Assets % Liabilities Equity YO BROU 4,358 39 4,499 42 249 34 BHU 1,236 11 1,214 11 22 3 NBC 1,059 9 91 1 8 148 20 Total Public Banks 6,653 60 6,624 61 419 57 Private Banks 4,518 40 4,204 39 314 43 TOTAL 11,171 100 10,828 100 733 100
112. The authorities have made a substantial effort in overhauling the existing regulatory framework and strengthening the supervisory institutions. A new banking law in 2002 delineated the basic operating procedures for bank restructuring andlor liquidation. It also re-defined and expanded the role ofBCU in strengthening the regulatory and supervisory fiameworks, The new banking regulatory and supervisory fiamework introduced important changes: new limits on specific borrowers and risks; higher reserve requirements for non-resident deposits; modifications to creditor classification, accounting for the value of guarantees and loan provisioning; regulations to encourage banks to account and adequately provide for foreign exchange risk; minimum capital requirements computed according to mark-to-market criteria including adjustments for inflation, price volatility, foreign exchange risk, country risk and interest rate risk; and in general, the strengthening and modernization ofthe BCU's supervisory function.
Section based on de la Plata and Sirtaine (2004).
33 113, The challenge will be to develop a system that can mediate efficiently and effectively between savings entities and takers of credit; at present the banking sector operates with high levels of liquidity. In different circumstances this could appear to be a sign of strength, but in the current situation of Uruguay it is a sign that there is still a crisis mentality that is deeply ingrained in the financial sector, Bank liabilities are largely made up by sight deposits and could, therefore, flee the system at the slightest sign of trouble. Conversely, and partially as a consequence ofthe concentration ofshort term liabilities, the banks’ lending policies are broadly restrictive, tending to concentrate on the export sector and in short maturities. As of end-2003, bank lending to the non-financial sector as a share of GDP, was only 22%, versus 57% at the end 2001. In 2004, lending by private banks to the non-financial sector increased around 8%, but credit to the private sector continued to account for a low share of bank assets (28%). In terms of flows, risk aversion is causing lending to occur predominantly within the financial sector, with 62% ofthe total loan book being among financial institutions. Thus, the banking system is not fulfilling its mission of transforming savings into long-term lending and channeling capital to more productive investments.
Strategic policy options
114. To strengthen the banking sector and to encourage bank intermediation, the government may consider the following policy and reform options:
i. Funding and implementing a limited deposit insurance program. A partial deposit insurance program was established by law in 2002; it still needs to be funded and implemented. It would help to increase confidence among small depositors and establish a more level-playing field among banks -at present public banks have the guarantee of the state. The proposed scheme is a partial guarantee system designed to be funded by all banks with contributions based on the relative risk of each institution. An issue to be resolved is the treatment of the asymmetry caused by the full guarantee on BROU deposits.
ii. Increasing competition. The government should accelerate the necessary steps towards the privatization ofNBC - the new public bank created by combining the good assets and the liabilities of three liquidated domestic banks. A modern and professionally run NBC will provide a benchmark with which to measure BROU’s performance. Government could consider strict enforcement of public laws regulating public enterprises to improve corporate governance at BROU (e.g., separation of board fi-om management function, technical credentials for directors rather than political criteria for board appointments). A subsequent step which the government could consider is the accounting separation of commercial and developmental roles of BROU -declaring in its budget the elements of implicit subsidy in its development activities- and, eventually, consideration should be given to placing the BROU under commercial law.
iii. A more autonomous regulator and supervisor. It is important that BCU’s supervisory function is isolated fi-om potential political pressures. Authorities are advised to seek full technical independence of the Banking Supervision Agency. One option would be to segregate the entire supervisory function
34 within BCU (for banks, insurance, pension plans, stock exchange, etc.) into an independent agency.
iv. Evaluate options to improve bank resolution legislation. Although the new banking law facilitates the liquidation of failed banks, Uruguay still lacks a well defined process and mechanism for the closure, resolution and liquidation ofbanks. A more general kamework for bank restructuring and market exit of insolvent institutions may be required. This could entail activities ranging from adoption of regularization plans to suspension of operations, exclusion of assets and liabilities ofinsolvent banks and bank closure.
V. Bank credit to SMEs. Standardization of financial information of SMEs and a review of whether there is an anti-SME bias in prudential regulations may be conducive towards mobilizing more bank credit to SMEs. Access to finance by SMEs may benefit om the strengthening ofasset and debt registers and a regime that effectively protects personal data - a legal and regulatory fiamework for private credit bureaus. Enhancement of SME guarantees could be attained through a corporation of reciprocal guarantee backed by a Guarantee Fund, e.g., as the one created in Argentina.
3.6 Developing capital markets
115. Capital markets have a significant potential for the development of innovative products and the mobilizing of resources towards expanding firms and sectors. Even during the recent crisis, a number of new products have emerged, e.g., investment certificates for dairy farmers, non-performing loan sales, and banking certificates of deposit. Capital markets (exchanges) are less constrained than banks by currency and maturity mismatches between assets and liabilities. Similarly, they are intrinsically flexible (as the market is constantly setting the price at which transactions are performed) and they adapt to market needs and opportunities, Capital markets are thus called to play an important role both in sustaining the economic recovery and the growth process.
116. Capital markets are necessary for the development of institutional investors. Pension funds depend on capital markets for the investment ofthe finds that their members save for retirement and the savings ofthose who have already retired and opt for a system of programmed withdrawals. Insurance companies offer retirement insurance for those whose only asset is the accumulated saving in the social security system during their working lives, which in turn is invested in the market. In this situation, in view ofthe social responsibility implicit in a mandatory saving system for specific ends, it will be crucial to develop an efficient and reliable capital market.
117, Capital markets in Uruguay are relativety small (Table 9), although growing due to the rising importance of pension funds and their individual capitalization accounts. The share of savings managed by private pension finds in individually capitalized accounts has been rising steadily, reaching a level of 13% of GDP in 2003 (Figure 5). The opposite happened with knds intermediated by investment hnds which collapsed in 2002 and remained at insignificantly low levels during 2003
35 (Figure 6). Uruguay’s most dynamic segment of securities markets is the market for sovereign debt - outstanding sovereign debt securities represented nearly 60% of GDP in 2003. New corporate debt and equity issues are exceedingly low; outstanding corporate debt issues (under US$200 million at present) have declined to one third of the level in 1999. Insurance companies are the second most important institutional investors, with their investments amounting to 3% of GDP; their business is dominated by casualty and property premiums (around two-thirds) and the sector is heavily monopolized by BSE - State Insurance Bank.
118. Uruguay lags behind on matters of regulatory and legal frameworks for its capital markets. For example it is behind both developed countries and developing countries in terms of shareholder and creditors’ rights (Table 10). The rule of law and the judicial system, although ahead of the developing country sample sample, are well below the developed country average.
Table 9 - Uruguay’s capital markets in international perspective Variable Colombia Brazil Chile Mexico Uruguay Market capitalization of listed companies 11.90 27.40 74.20 16.20 0.82 (% of GDP) Stocks traded, turnover ratio (%) 0.60 3.40 0.90 1.50 0.50 Assets held by Pension Fund (% of GDP) 60.60 5.80 12.70
Table 10 - Investor protection ratings.
Source: La Porta, Lbpez-de-Silanes et al. (2002).
36 Figure 5 - Pension funds (funds under management) - million pesos
30,000
20,000
10,000
0 1999 2000 2001 2002 2003
Source: BCU.I9
Figure 6 - Funds administered by open-ended funds (thousands of US%)
, .. . .., .. ". ,." ..... ", ...... , . ... , ".., I ., . i
2510.000 mom0 150.000 1oo.mo 50.~10 0
119. The lack of independence of regulators and the limited enforcement powers restrict the potential for development of securities markets, the insurance market and the pension fund system:
i. Independence of Regulators. Subordination of capital market regulators to BCU gives rise to potential conflicts of interest - given the role of the BCU as both an issuer of securities and regulator. The problem gains in significance as the BCU is not independent i?om the Executive which is in turn a provider of financial services (BSE and BROU-owned pension fund -AFAP Rep~blica).
ii. Regulatory enforcement capability. The capacity of supervisors to apply the regulations is in general low. Examples ofthe difficulties that exist include delays in the provision and publication of information, and the absence of sanctions or difficulties in enforcing them. In particular, physical and legal resources assigned to l9 In spite of the devaluation, savings managed by the pension fimds (largely dollar-denominated) also increased in dollar terms over 1999-2003.
37 inspection work are limited. Legislation does not grant special powers ofsupervision, such as the ability to require changes or corrections to accounting entries, inspect installations and records, appoint external auditors or initiate proceedings in the ordinary courts.
Strategicpolicy options for the ~tre~gtheningof capitaI markets
120. Apart from strengthening the autonomy of the regulator and the regulatory enforcement capability, the government could consider the following policies and reforms to support the development of its securities markets, pension funds and insurance sectors:
Developing linkages between the two stock exchanges and consider their de- mutualization. This would enable the exchanges to more adequately resolve conflicts of interest arising out of their ownership structure, raise capital for their development, and compete more flexibly on the international market.
Filling legal voids in the area of securities trading in the stock exchanges. There is specifically the need to feel a void in the case of the regulation of the traders themselves, for example, in relation to the treatment of conflict of interest in the case of dealing for their own account, the precedence of orders and their execution,
Establishing objective criteria in law for the application of criminal penaIties in areas such as insider trading. This entails improving specification oftreatment of the use of insider trading, including the nature of such inside information, presumptions and penalties.
Strengthening corporate governance. The rights of minority shareholders and related parties in general are poorly safeguarded, and procedures for the take over of control, the existence of independent directors or justifications for the right of withdrawal, among other matters, are not contemplated. Integration to international markets could be facilitated through the enforcement of international standards in accounting, disclosure, and governance.
Promotion of new instruments. The recent development of financial instruments for the agriculture and livestock sectors could be replicated to other sectors. High innovation sectors, such as information technology (IT) and biotechnology, could be good candidates to receive finding fiom venture capital markets. Other possible alternatives for analysis include the possibility of issuing warrants -bonds convertible into shares, leasing, factoring and transferable certificates ofdeposit. On the basis ofthe confidence that they generate in themselves, public companies could play a stimulating role in capital markets through the issue of securities for their own fmancing. Issue requirements will in turn force improvements in the transparency and practices ofcorporate governance in such companies.
38 (vi) Strengthening competition among pension funds. The government could consider several options: eliminating the guaranteed minimum return (which favors the state AFAP as in the eyes ofworkers, it can count on the guarantee ofthe state); and separating the account management fbnction - where economies ofscale exist - ftom the investment fbnction - where stronger competition is both feasible and desirable.
(vii) Improving risk diversification of pension funds. The government could evaluate the benefits and risks of lifting several restrictions on portfolio investments by pension funds. Risk diversification could, for example, imply raising the percentage of investments in foreign assets or in local assets in pesos outside the state sector. The latter would benefit the development of the local capital market. In addition, the introduction of prudential regulations as regards currency mismatching limits (between assets and liabilities) for the pension funds, could induce them to invest more in peso or inflation-indexed financial instruments -as long as their fbture requirements are denominated in pesos.
(viii) Eliminate supervisory asymmetries in insurance which privilege the state Insurance Bank (BSE). Such asymmetries could risk the solvency of existing companies and discourage the entry of new competitors. An independent regulator could help to impose market discipline on BSE, for example, by establishing profit benchmarks. In addition, the government is advised to evaluate the cost and benefit ofmaintaining BSEs legal monopoly on work accident insurance.
Improving insurance regulation. In the field of regulation, the possible areas for improvement include: control over the solvency ofannuities and establishment of a criterion for matching flows in relation to term and currency.
Developing business opportunities for capital market players. To contribute to the development ofbusiness opportunities, consideration could be given to allowing insurance companies to expand their distribution base, mainly through the use ofthe banking system. In addition, the possibility of insurance companies granting loans could be considered.
Consolidated supervision. The potential synergies between banks and insurance companies would be yet another reason to support a shift towards consolidated supervision -the strong links that exist between banks, AFAPs and stock market traders are the main reason behind the need to coordinate and eventually consolidate supervising agencies.
3.7 Labor markets”
121. Performance of a country’s labor market can impact on economic growth at the aggregate level and at the household level. At the aggregate level, a country’s output increases with the share ofthe population that chooses to participate in the labor market - up
2o Based on Packard (2004).
39 from 57% in 1990 to 60.6% in 2001 and then down to 58.1% in 2003 - as well as the hours that they devote to work. At the household level, labor regulations - employment protection legislation, wage bargaining systems, labor taxes, and pensions - affect incentives to work and thus can also impact on growth.
122. Uruguay's labor market functions relatively poorly when compared to that of its neighbors. Estimates ofthe impact ofeconomic growth on employment, show that relative to countries in the region, a substantially greater increase in real output is required to raise employment in Uruguay, and a greater number ofjobs are lost in economic downturns than are gained during periods of growth.21 During much ofthe 1990s, when growth was rapid, there was a rising trend in unemployment (Figure 7). The quality of employment has also deteriorated as evidenced by the notable increase in informal employment, both non- contractedunregulated salaried employment and self-employment. The fastest increase in self employment has been in short-term, low-income enterprises requiring little or no capital investment.
123. The duration of unemployment has increased. The highest increases have been in relatively higher age cohorts, among those aged 40 and over. Unemployment duration remains higher for younger job seekers and for women, as well as for the economically active from poorer households. Since 1990, the increase in the duration of unemployment for workers with less than seven years of education has been greater than for other groups (Amarante, 2003).
124. Changes in labor markets over 1990-2003 have stemmed from shifts in the orientation of economic policy, from out-dated labor market institutions and from the interaction between these two factors. Stabilization and structural adjustment policies in the mid 1980s brought price stability and shifted the economy away fkom protectionist import substitution, and toward an outward orientation reliant on exports. Shifts in the macroeconomic climate were accompanied by a real appreciation of the peso during the 1990s that forced changes in the largely non-competitive manufacturing sector. This resulted in a shift in the sector allocation of labor away fiom manufacturing, towards export production and services. The share of labor in the manufacturing sector fell from 21% of employment in 1990 to only 14% in 2001.
125. These changes were accompanied by an increase in the share of the population that is economically active, largely attributed to a steady rise in the number of women choosing to work outside the home. The rate of economic activity ofwomen in Uruguay increased -from 43.5% in 1990 to 50.9% in 2001. Further, the structure ofproduction became less centralized. There was an increase in the concentration of employment in small firms. At the end ofthe decade, almost half of all private employment was in companies with five or fewer workers; a large proportion was informal. As shown in Figure 7, during the same period public-sector employment declined, while the share of the labor force privately employed, employed informally, and self employed has notably increased (Amarante, 2003).
In 1994, when the economy grew by 7.3% employment only grew by 2.7%. In contrast, in 1999 and 2000 a contraction of -2.8% and 1.4% led to a fall in employment of -2% and 1.3%, respectively (Amarante, 2003).
40 126. Higher unemployment, increases in unemployment duration and evidence of distortions and segmentation can (at least partially) be traced to institutional and regulatory factors. The minimum wage in Uruguay is low and not mandatory, and since 1992 wage negotiations have been decentralized and take place at company level, without government participation. Nevertheless, various other institutional factors hamper the efficient operation of labor markets. Public sector unions remain strong, and high dismissal costs arising from formal job protection (severance payments are one month salary per year of employment) may be dissuading employers fiom creating formal sector jobs (Heckman and Pages, 2000; Forteza and Rama, 2002). Regulation of public sector employment may be sending detrimental signals to the labor market. In 2001, public workers earned 36% more than formal private workers. Women and low-skilled workers in particular, earn relatively more in the public sector. Amarante, et al, (2003) found that the wage premium and wage rigidities in the public sector have exerted a negative impact on employment as a whole, and particularly among individuals who have only some or completed secondary education.
127. The share of public sector employment in Uruguay is still relatively large. Despite a steady fall in public employment since 1990, in 2001 the public sector still accounted for 16.5% ofjobs. Among its neighbors, Uruguay has the highest share ofworkers in public sector jobs. Even when compared to similar countries in the OECD, the size of Uruguay’s public sector employment seems large.22 Public employment in Uruguay (at 6.9% of the total population) is considerably higher than the average for Latin America -although this figure is influenced by the high number of employees still working for the public enterprise sector in Uruguay. During periods of crisis, job losses are more evident in the private sector, while few public sector employees can be dismissed due to strong union activity and regulatory protection.
128. Another factor which has impacted negatively on labor market performance is the high level of payroll taxes (Table 11). To meet the demands of its generous social security and, especially public pension regime, Uruguay had to maintain relatively high levels ofpay-roll tax. The pay-roll tax for social insurance in Uruguay is about 3 percentage points higher than the average of selected OECD countries, and 7 percentage points higher than the average of Latin American countries. Total labor taxes represent 40.5% of the gross wage in Uruguay, compared with 28% on average in Latin America and 35% in the OECD. Such high rates ofpay-roll taxation not only hinders competitiveness, but also may be fueling the rise in the share of workers who take up informal employment aggravating segmentation in the labor market (Packard, 2001).
22 Only 16.1% of Italy’s workforce, 15.2% of Spanish workers, 14.4% ofworkers in the UK and a mere 12.1% of workers in the Netherlands were publicly employed in 1995, when the share ofUruguay’s workforce in public employment stood at 19.1% (Gregory and Borland, 1999, as cited in Amarante et al. 2003).
41 Figure 7 - Macroeconomic Trends, Labor Market Adjustments, and Sector Shifts in Uruguay
200.0 20.0 190.0 180.0 15.0 170.0 160.0 150.0 10.0 140.0 130.0 5.0 120.0 110.0 100.0 0.0 90.0 80.0 -5.0 70.0 80.0 50.0 -10.0 40.0 30.0 -15.0 20.0 10.0 0.0 -20.0 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1998 1997 1998 1999 2000 2001 2002 2003
GDPGrow th (annual %, right scale) Unenploymnt (% of labor force, rlght scale) Employment (%, right scale) Rtvate Employment (index) --c-- -Public Bnploymnt (index) tirployers (index) -Seif Employment (wlo capital, index) Self Employment (wlcapltal, index) Non Pad Labor (index) o RealWagehdex hflation (cff)
Source: Amarante (2003), World Bank (SIMA), IMF (IFS), INE,
Strategic options to improve labor market efficiency
129. Consideration of a possible reduction of payroll taxes would have to be part of a comprehensive review of social expenditure financing which evaluates the relative efficiency of alternative financing instruments as a function of the risk which specific expenditures finance and the overall budgetary constraint. The motivation for a reduction in employer contributions and increased participation in non- contributive social benefits is based on the one hand on the creation ofincentives in favor offormal employment -via a reduction in contributions- and on the other on the reduction of subsidies or transfers to workers in the formal sector -as these are financed in part by their contributions and in part by general tax revenue (BPS deficits are fmanced out of general revenue). In assessing the impact of a rise in non-contributory benefits -better social coverage- it is essential to take into account the impact on the trend towards informal employment -non contributory benefits could encourage those who are currently contributing to cease to do so.
42 Table 11 - Payroll Taxes for Pensions and All Social Insurance Selected OECD and Latin American Countries
As % of Gross Wage: As % of Labor Costs: All. Social All Social Country Employer Employee Insurance Pension Tax Insurance Pensions Tax Taxes Taxes
Austria 12.6 10.3 22.8 45 .O 17.8 35.2 Belgium 8.9 7.5 16.4 38.9 13.0 30.9 Canada 3.0 3.0 6.0 15.2 4.9 13.9 France 10.0 7.0 16.0 51.0 12.0 38.0 Germany 10.2 10.2 20.3 42.0 17.0 34.0 Greece 13.3 6.7 20.0 34.5 16.1 27.9 Ireland 14.4 13.0 Italy 21.3 8.3 29.6 56.7 20.1 38.5 Japan 8.3 8.3 16.5 29.1 14.1 24.9 Netherlands 0.0 32.1 32.1 56.0 28.9 50.5 Portugal 23.8 11.0 34.8 37.8 27.4 29.8 Spain 23.6 4.7 28.3 38.3 21.4 29.0 United Kingdom- 13.9 13.0 United States 6.2 6.2 12.4 21 .o 10.4 18.5 Argentina 16.0 11.0 27.0 46.0 21.0 35.0 Colombia 10.1 3.4 13.5 33.8 10.7 26.7 CostaRica 4.8 2.5 7.3 27.0 6.1 22.7 Chile 0.0 13.0 13.0 21.0 12.9 20.7 Ecuador 2.4 7.0 9.4 18.6 8.6 17.0 Mexico 10.9 4.6 15.5 26.0 6.5 21.5 Panama 2.8 6.8 9.5 18.0 9.2 9.7 Peru 6.0 3.0 9.0 24.6 7.6 20.7 Brazil 20.0 11.0 31.0 31.0 24.1 25.0 Venezuela 10.0 4.0 14.0 25.5 12.0 21.8 Average OECD11.7 9.6 21.3 35.3 16.9 28.4 Average LCR 7.7 6.8 14.6 28.1 11.7 22.8 Average All 9.9 8.3 18.2 32.3 14.5 26.1 Uruguay 14.5 13.0 27.5 40.5 22.1 32.5
Source: Social Security Programs Throughout the World -1997, "International Patterns of Pension Provision" by Paiacios and Pallares-Miralles (2000).
130. Similarly, a possible review of severance pay regulations would be an integral part of the review of the broader social safety net. While reducing the cost to the firm ofseverance payments would contribute to labor mobility in general, this may have to be compensated by some combination of saving instrument (e.g., fimded by workers andlor employers such as the system recently introduced in Chile) and a more effective
43 unemployment insurance regime (currently only 15% of unemployed benefit)23 or a similar income protection device to cover unexpectedly long periods oflost income.
131. The distorting impact on labor markets of public wage setting and public employment regulations needs to be taken into account in the analysis of civil service reform options. The wage premium and wage rigidities in the public sector exert a negative impact on the operation of labor markets and have a potentially regressive distributional impact on individuals who have not completed secondary education.
132. The performance and the flexibility of the labor market have suffered from the impediments imposed by employment security rules, the secondary effect of public employment policies and high employer pension contributions. Improving the efficiency of labor markets is crucial to improve incentives for investment in human capital and to ensure that such investment is not wasted, as those who obtain the qualifications could emigrate in search of a higher and more secure return in other countries.
3.8 Reforming social security and the social safety net24
133. Where households do not have a sufficiently wide array of tools with which to protect against shocks, their human capital may suffer and as a consequence growth as well. When such social and economic risks materialize, households are condemned to spend precious resources recovering f?om shocks rather than devoting these resources to productive use.
134. Uruguay surpasses its neighbors in social spending by far. Spending is almost 6 percentage points of GDP more in the social sectors than Costa Rica (the next biggest social spender in the region), 8 percentage points of GDP more than Brazil and almost 10 percentage points of GDP more than Argentina. The unusually high levels of total spending in the social sectors are driven by the cost of social protection, particularly, public pensions (Figure 8). Other social spending (although relatively higher in health and relatively lower in education) is comparable to that of other countries in the region,
135. Various factors explain sizable expenditures of the public pension system and their fast increase over the last decade. These include the low retirement age (60 for men and women); moral hazard in the benefit structure (workers can opt for either a 35 year contribution scheme available at 60 or a 15 year contribution scheme available at 70 - since the replacement rate is similar, most choose the second “more generous” pillar); wage indexation of pension benefits; high payroll taxes (which encourage informal hiring); and very high population and social security system dependency ratios because of the longevity ofthe population, a low birth rate, and the emigration ofyoung people. At
23 Eligibility for unemployment insurance is based on contributions to the BPS in the twelve preceding months. Based on Packard (2004).
44 34.5%, Uruguay’s population dependency ratio (population aged 60 or more over population between 20 and 59) is slightly above the average OECD ratio and about twice the level ofcomparable Latin American countries. Its system dependency ratio (ratio of pensioners to contributors) of 70% is more than twice the average of comparable countries in the region and over 40% higher than in selected OECD countries.
136. Uruguay has a wide range of social protection systems and programs to protect human capital from different risks along the life-cycle (Table 12). The largest of these, social security offered through BPS (“Banco de Previsih Social”), provides generous old age, disability and survivor pensions, unemployment insurance, medical insurance and cash transfers to families with dependent children. Between 1997 and 2002, the share of old pensions declined to just under three-quarters of total BPS expenditures, whereas the shares of unemployment insurance and family allowances increased reflecting the anti-cyclical nature ofthese social transfers.
Figure 8 - Spending on Social Protection (Social Insurance and Welfare) as a percentage of GDP, Selected LCR and OECD Countries in 1998
1
15 0
10 0
50
00
Source: World Bank (SIMA) and OECD.
137. Although Uruguay’s social protection system is more comprehensive than that provided by many governments in the region, international comparisons with emerging countries that have undergone crises in the late 1990s-early 2000s (World Bank, 2003) show that Uruguay has had the second highest increase in unemployment and one of the highest increases in poverty as a result of the crisis. During 1999 - 2002, poverty increased by more than 8 percentage points and it worsened krther in 2003. To cope with losses fkom the recent crisis, households cut critical spending both in education and health; the safety net -though - was able to provide basic social outcomes.
45 b b 8 LLLL 24 lb
ea'I
00 00000 000 I
AA A A IA A Ah A AB e ae % -? 9 0 2M
46 . 0. ...
onn
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47 138. One factor contributing to the severity of crises in Uruguay is that social protection instruments do not cover adequately the most vulnerable groups. In addition to the unemployed and the heads of large households, the most vulnerable to poverty include the self employed, workers in informal employment, and those working in the construction sector. Since these groups are engaged in activities in which they are not paying pay-roll taxes, they are not gaining rights to formal social protection. This “truncation” of the social protection system is not unique to Uruguay, and becomes apparent with the shifts in production and growth of self employment and informal salaried employment seen in the region (de Ferranti, Perry, Ferreira and Walton, 2003).
139. The inequity is aggravated because “contributory” social insurance systems that deny even minimum benefit levels to individuals without a history of explicit contributions, pay benefits to those who are covered in excess of their contributions. This is dramatically apparent in pensions and unemployment insurance systems. Financing the public portion of old age pensions places a huge fiscal burden on tax payers: only 60% of benefit expenditures are currently covered by contributions.
140. Uruguay has non-contributory transfer programs for the poor and programs like workfare that do not require a formal employment history; however, they are relatively small in size. Social assistance spending rose from 11.7% of consolidated social spending in 1999 to 13.8% in 2002. Social assistance programs in 2002 were allocated as follows: housing programs 40%, social assistance and food 30%, unemployment insurance 18%, family allowances 9%, the rest went into smaller programs. Among the social assistance programs aimed directly at vulnerable groups are: programs in feeding and nutrition, youth training, housing, day care and cash transfers. Some of these programs - such as the Full Day Schools (MECAEP), Rural Housing (MEVIR), PROJOVEN and CAIF day care centers - are well-targeted to the poor, though coverage of some programs is still very low.
141. Among the social assistance non-contributory programs is a means-tested pension program that pays benefits for old age, survivor and disability. The target population is composed of persons aged 70 and above whose personal earnings do not reach a certain threshold or target pension, and do not have close relatives who could support them. About 29% of benefits are for old age. Beneficiaries of the non- contributory pension program represent 9% ofall pension recipients. The benefit is about 60% of the average contributory benefit.
142. Other non-contributory programs are poorly targeted and outdated. For example, INDA food programs need to be better focused and improve their systems and controls - until recently, there was no registry of beneficiaries. The PAE food program spends only 46% ofresources on its main target: children fiom the third (lowest) segment of income levels. The program of family allowances -while recently reformed to extend benefits to informal poor- still leaves a large number of informal poor uncovered. In addition, there are problems of duplication between the programs offered by the federal government and those provided by municipalities.
48 143. During the recent crisis a number of social programs focused on the most vulnerable. For example, various non-contributory social programs have been protected (Le., cuts in real terms avoided) in the 2003 budget, Also, a number ofthese programs25 have been evaluated to help to improve their design andor adjust their scale.
Optionsfor re~ormulatingthe social insurance network
144. The government may need to review the existing supply of instruments provided by the state (social insurance and social assistance) to ascertain whether they are correctly matched to the risks they seek to cover, examine ways to correct possible miss-matches, and investigate the extent to which there may be duplication in the protection offered by the various instruments.
145. There is an urgent need for flexible programs that protect the consumption of vulnerable groups that are not completely covered (or uncovered) by the current system. Vulnerable groups comprise the self-employed (who are the ones showing the lowest levels of coverage ofcurrent programs), the informally employed, and those who lost employment fkom either ofthese groups.
146. In this context, the government could consider extending C‘non-contributory” programs. These could include workfare type of programs and targeted conditional transfers (as proposed for the education sector). These programs have several beneficial features: (i)they provide an income stream that protects consumption of the poorest segments during hardship, at least of the basic goods; (ii) they offer protection irrespective of work status (Le., coverage is not restricted to formal workers); and (iii) they prevent families fkom taking actions deleterious for their long term welfare (dis- investment in education and health).
147. Housing, employment and food programs - the historical base of social protection in Uruguay - could be adapted to the new social conditions. For example, food programs managed by INDA and PAE need to be better targeted to benefit the most vulnerable. On the other hand, programs like food assistance to poor children up to 4 years and their mothers (CAIF), full time schools (MECAEP) and young training programs (Projoven) are well targeted but their coverage is low. Government may consider up-scaling these programs. The family allowances program may need to consider targeting more the informal sector - recent efforts to extend family allowances to poor households irrespective ofwork status point in that direction.
148. To finance additional non-contributory programs and to increase the sustainability of Uruguay’s PAYG system, the government could consider re- defining age” through changes in the retirement age, and perhaps even the
25 These included: “Apoyo a Instituciones Ptiblicas y Privadas” -AIPP -,“Programa Nacional de Complementacih Alimentaria” -PNCA-, “Centro de Atencidn a la Infancia y a la Familia” - CAIF, and “Servicio de Asistencia Alimentaria Colectivizada” -SAAC- executed by INDA (“Instituto Nacional de la Alimentacih”); (ii)SIAV; and (iii)“Asignaciones Familiares” (executed by BPS, “Banco de Previsih Social”).
49 gradual introduction of a mobile retiring age - to be adjusted with gains in longevity. By re-defining (raising) the threshold for access to “old age” andor making changes to the replacement rate -possibly defining new parameters for the ratio on the basis of years of actual contribution, the government may help to reduce fiscally costly assistance to BPS. This would also help to reduce intergenerational inequity - in 2002, 50% ofthe population aged 0-18 years was under the poverty line, whereas only 5% of the population aged 65 or more was.
149. Extending by one year the effective retirement age would reduce financial assistance to BPS by 0.2 percentage points of GDP (Forteza, 2004). Raising the minimum age of retirement would have a smaller impact because this requirement is non- binding for many workers. The minimum age for retirement would have to be increased to 63 (fiom the current 60) to lower BPS financial assistance by 0.25% of GDP. Whether it pursues this option or not, the government cannot afford to ignore the most obvious measure to make public pensions more affordable and thereby contribute to reduce the current regressive bias in the pension regime - old pensions are paid out of general tax revenue through BPS assistance.
150. Much more important as a potential source of fiscal saving would be modifying the current pension indexation system -based on an average index for wages in the economy- to one for which the index is based on the consumer price of a basket of goods, or a mixed basket of prices and wages. It is estimated that the change in indexation for a rule whereby the index is based on both wages and prices could generate fiscal savings in the order of 0.4% of GDP on average in the medium term (Forteza, 2004). Were there to be social and political consensus for this reform - indeed it would require a change to the Constitution - it could be introduced on a gradual basis, and could be linked to expanding the non-contributory social security channel. The new system would be in line with the systems in several reforming OECD and emerging market countries and possesses the virtue of protecting the purchasing power of pensions over the duration ofthe economic cycle.
151. Under any circumstance, the reduction in the imbalances of the BPS requires a strengthening of compliance with the existing legal requirements for contributory public pensions.
50 CHAPTER IV: SUSTAINABLE GROWTH - INVESTMENT CLIMATE .. PILLAR 2
152. Policies and reforms under the second pillar are targeted at creating a favorable investment climate for physical and human capital accumulation; in particular to be able to grow in a sustained manner at high rates, Uruguay must increase its historically low level of investment (15% of GDP on average in the 1990s) to 20%. This is the main challenge to be addressed by the policies and reforms of pillar 2 ofthe growth strategy. New investment is associated with incorporation of new technology, which together with factor accumulation represent the basis for sustainable growth. An open trade environment, good access to foreign markets, a well-functioning competition fiamework, and efficient and cost-effective infiastructure provide an ideal framework for a favorable investment climate. An investment climate for the development ofhuman capital includes opportunities and incentives for families to invest in their health and their skills. This in turn requires efficient and modern education and health systems that provide access on the basis ofequality ofopportunity.
153, This chapter puts forward and evaluates policies and reforms for pillar 2 of the growth strategy. First, the focus is centered on the trade integration agenda. Trade policies play a crucial role in ensuring conditions for sustained growth by enabling improved access to external markets, increasing domestic competition and incorporating technology. Second, options are examined for the development of infrastructure services -crucial for both productive efficiency and welfare. The focus is on conditions for the development of a regulatory fiamework that promotes competition in the various infiastructure sub-sectors. Investment opportunities in a competitive environment for infrastructure services will enable an increase in global competitiveness and social welfare in Uruguay. Third, options are examined for strengthening the protection of competition in general, including institutional aspects. Fourth, policy options are put forward for the development of human capital in the areas of health and education. Although in both health and education Uruguay has reached a relatively high level of development compared with the region, there is still a large -and possibly growing- gap compared with more developed countries. The challenges are ofan institutional nature, in both health and education, and point to the need for a profound review ofthe regulatory fiamework in the case ofhealth.
4.1 Trade policy and integrationz6
154. Uruguay has gone a long way in terms of unilateral trade liberalizationwhile MERCOSUR has contributed to deepen regional trade links. However, there is still significant scope for deepening integration both within MERCOSUR and through bilateral, regional and multilateral trade initiatives. There is ample scope to participate in
26 Based on Noques (2004).
51 the growing web of fiee trade agreements (FTA) to minimize adverse trade diversion effects of FTAs between other countries andlor regions. In the last 5 years, non- MERCOSUR developing countries -including Mexico, with which Uruguay has signed an FTA- have been the largest growth markets for Uruguayan exports. Trade integration with the rest of the world, either via MERCOSUR or through bilateral agreements, represents the principal channel through which Uruguay will be able to accelerate and sustain economic growth. The gains can be measured in terms of greater market access for agricultural and agro-processed products, but also in terms of better integrated and more stable policies and regulations as well as modernized institutions.
155. To reduce its exposure to regional volatility while improving access to extra- regional markets for its products, Uruguay can benefit from deepening trade and economic links with the rest of the world. Trade and integration policies can help provide an impulse to growth through at least four three channels: by reducing Uruguay’s vulnerability to regional volatility and fluctuations in terms oftrade; by facilitating access to cost-effective and high quality and technology intermediate and capital goods; and by improving access to Uruguay’s products in foreign markets - including those where access is currently limited by agricultural protectionism; and by generating competitive pressure in the domestic market -competition is the principal incentive for efficiency and innovation.
Recent trade policy an~p~~or~nce
156. Growing trade flows until 1998 and the sharp decline thereafter can be traced back to trade policy, international prices and macroeconomic performance (Figure 9). Trade policy includes the unilateral trade liberalization of the late 1980s and early 1990s, as well as the formation of the MERCOSUR following the 1991 signing of the “Tratado de Asuncih” and the implementation of the intra-regional liberalization program by late 1994. In 1987, Uruguay’s average tariff rate was 32% and unlike many other countries in Latin America, its import regime had few non-tariff barriers (NTBs). Its unilateral reform policies implied that a few years later, the average tariff rate had declined drastically. Using the MERCOSUR average tariff structure as a proxy for that of Uruguay, shows that by 1993 the average rate with third countries had declined to 13%.
157. Import liberalization measures reduced the prices of intermediate inputs and capital goods, thereby contributing to productivity and GDP growth. Exports of tradable services, particularly tourism, grew rapidly and the balance of trade in services was in surplus. Tourism exports rose fiom US$238 million in 1990 to US$827 million in 1997 (when it represented 60% of all services exports). In the late 1990s, services represented over 30% of Uruguay’s total exports.
52 Figure 9 - Trade flows
5,000 600 1 4,500 500 4,000 400 3,500 300 3,000 200 2,500 100 2,000 0 1,500 -1O( 1,000 -20(
i 500 -30(
~ 1 f hternal balance on goods and services (current US$ MM) - left -&ports of goods and services (current US$MM) il- lnports of goods and services (current US$ MM) Source: Nogues (2004).
158. After 1998, the macroeconomic picture of the region deteriorated, initially at a slow pace and then more rapidly following the devaluations of Brazil's Real in early 1999, and Argentina's Peso in early 2002. Such devaluations were related to fiscal difficulties, problems with competitiveness, and the dramatic decline in capital inflows to Latin America from around 3% of regional GDP in 1998 to around 0.5% in 2002. Regional crises had a severe impact on exports by Uruguay.
159. Exports to MERCOSUR countries declined more rapidly than to other destinations - the share of exports to MERCOSUR dropped from 55% of total exports in 1998 to an estimated 24% in 2004. A complicating factor has been the introduction of an important number of non-tariff barriers (NTBs) within MERCOSUR, For example, Argentina initiated on average 18 anti-dumping investigations every year over 1995-2001. Also, over 1995-2000 Uruguay initiated 50 dispute resolution consultations. Most often they correspond to agricultural and agro- industry products for which the index of trade complementarity of Uruguay with Argentina and Brazil is usually high indicating comparative advantage on the side of Uruguay27. The average MERCOSUR tariff rose fiom 11% in 1995 to 14% in 2000.
160. Uruguay's exports to developing countries outside MERCOSUR have grown at a faster pace than exports to developed countries. The pattem of Uruguay's - mostly agricultural - exports growing faster to developing countries is consistent with patterns of agricultural protectionism in industrial countries. Uruguay has a strong comparative advantage in agricultural and agro-industrial products - meat, cereals, dairy
'' Vaillant et al. (2001).
53 products, and fish. Among exports ffom the non-agricultural chapters, the most important ones (in 2000) were textiles and clothing, skis, fbrs and their articles,
161. Existing simulations for Uruguay show favorable impact effects of liberalizing world trade in agriculture. These effects depend crucially on which scenario of world trade liberalization is simulated. Recent simulations of the liberalization of agricultural trade (NoguCs, 2004) show that under the various liberalization scenarios, all Uruguay’s export goods would benefit. Increases are larger under the multilateral and US proposals. At an international level the greatest price hikes would be experienced by dairy products -of importance for Uruguay- mainly because they can count on high protection in industrial countries. The international price of beef, which accounts for around 50% ofUruguayan agricultural exports, is simulated to rise 8.5% (under the US proposal), and by 3.2% on the basis ofthe European Union proposal. Uruguay’s agricultural exports are estimated to increase 14.5% under the US proposal; the categories accounting for the bulk ofthis improvement would be beef, rice, dairy products, sheep meat and citrus fruits.
162. The benefits for Uruguay of a liberalization of world agricultural trade would be more significant than those registered by the simulation analysis carried out. Simulation results do not take into account the impact that new investment in response to the new opportunities opened up for commerce could have on trade -for example, opportunities to exploit economies of scale and scope and increased productivity as a result ofthe adoption of new technologies. The inclusion of dynamic effects in simulation models can improve the positive static effects oftrade liberalization by a factor that ranges between 2 and 4.28
Strategicpolicy options
163. The decisions that Uruguay will take in relation to its trade and integration strategy growth will be a key factor for the flow of investments in coming decades; investments in turn will have a strong impact on the development of trade trends. The following strategic considerations are relevant:
164. A significant Doha Round would reduce the need for regional and bilateral agreements; important trade diversion effects could be avoided. There is a growing sentiment among efficient agricultural producers (G-20) that no agreement would be better than an unbalanced agreement. In matters of agricultural trade, the interests of Uruguay are consistent with those ofother efficient agricultural producers and, in fbture Doha Rounds, Uruguay may want to consider joining with them to strengthen the lobby for more liberal trade in agricultural products.
165. A FTA with the US - and by extension FTAA - could bring significant gains to Uruguay, not only through better market access for its agricultural and agro- processed products, but also, and perhaps more importantly because of its eventual impact on investment, incentives to modernization and increased stability of policies
28 World Bank (2001).
54 and regulations. An FTA with the EU could bring similar benefits. There have been on- going discussions about possible FTAs between MERCOSUR and the USA and between MERCOSUR and the EU. While export subsidies and domestic assistance by the United States remain a barrier for the FTAA, in terms of impact on MERCOSUR’s exports, the costs of these policies remain a ftaction of the potential benefits of improved market access. A deep analysis of costs and benefits of this as well as the other potential agreements deserves carehl attention by policy-makers. It is important to note that most Latin American countries are supporting the FTAA - as evidenced by an increasing number of regional FTAs with the US including Mexico, Chile, Guatemala, El Salvador, Honduras, Nicaragua, Costa Rica, Panama, Colombia, Ecuador and Peru. One characteristic of these FTAs is the high degree of market access which will result eventually in fieer intra-regional trade in agricultural products.
166. MERCOSUR’s relative slowness to advance with regional integration agreements is harming efficient agricultural producers due to trade diversion effects produced by recent and forthcoming trade agreements. In global trade, MERCOSUR has seen its share ofworld’s global exports decline ftom 2.3% to 1.5% between 1985 and 2001 respectively. To take advantage of this growing web of regional FTAs Uruguay may consider deepening MERCOSUR internal links and simultaneously play an active role in promoting new FTAs between MERCOSUR and other countries or regions.
167. One approach to deepen MERCOSUR’s trade links is to lower the common external tariff (CET), develop broader commercial policy objectives and accelerate the signing of trade agreements with other countries with lower or less binding trade restrictions. Uruguay has obtained an exemption ftom the CET for imports of capital goods; this is of great importance for investment and growth. Just recently announcements have been made of FTAs with Peru and other Andean countries. More agreements with developing countries are needed and the ongoing efforts to cement closer ties with China, India and other developing countries with low comparative advantage in temperate agriculture, could become promising negotiations. MERCOSUR could also consider strengthening internal trade links beyond the CET. This could encompass, for example, adopting common health and sanitary standards, developing common safeguards, advancing mutual recognition agreements, and adopting common rules on subsidies, countervailing regulations and dumping.
168. In parallel, Uruguay could consider, within the context of its MERCOSUR commitments, negotiations with other countries or regions that it considers hold the potential for the greatest trade gains. Additional trade agreements like the one signed with Mexico recently could boost the exports of goods where Uruguay has a clear comparative advantage. Uruguay also faces the concern that the FTAs that the US has recently signed with Central America as well as its upcoming agreement with the Andean Community are harming its exports in the region, An FTA with the United States or the FTAA would halt and could potentially reverse such trade deviation effects.
169. The highly complex nature of the negotiations agenda points to the importance of institutional development. It would help, for example, to strengthen
55 communications among public bodies and links with the private sector, as well as to gain a better understanding of the economic costs and benefits of the FTAs, as regards both their trade aspects and those that are not strictly trade-related (rules of origin, health and phytosanitary standards, copyright laws). Formulation of a development and integration strategy with clear political support, together with these institutional developments, will contribute to enhance the capacity and quality ofthe country’s trade negotiations with the rest ofthe world.
4.2. Fostering efficiency through competition in infrastructurez9
170. Uruguay’s infrastructure development is a critical element of the growth strategy. By reducing transport and communications costs, infrastructure development contributes to integration with world markets, thereby enhancing Uruguay’s growth potential. Competitively priced energy improves the expected return on private investment in general. Regional integration of transport networks is critical for potentially positioning Uruguay as a transport hub within mRCOSUR, while integration of regional energy networks will enable diversification of the supply risk. Universal access to basic infrastructure services at competitive prices will contribute to improving the competitiveness ofcompanies, as well as overall welfare and income distribution.
171. International experience suggests that market mechanisms are conducive for the development of modern and efficient transport, energy and telecommunication systems. In Uruguay the private sector is playing an increasingly important role in the modernization of transport, gas and telecommunications networks. Private sector participation (PSP) in infrastructure has been shown in general to contribute to increase cost-efficiency. However, experience and research show that effective competition must accompany PSP to ensure that increased efficiency is transferred to users -both companies and consumers.
172. Uruguay ranks well in the region in terms of infrastructure development. While coverage is high, a gap may surface increasingly in terms of quality, delivery standards and prices as technological change and the sophistication of demand continue to increase. Competition is thus called to play an important role in increasing efficiency in Uruguay; this is not only because of efficiency and welfare considerations, but also because of the fiscal constraints ofthe state in the medium term.
Status of infrastructure in Uruguay
173. Uruguay’s infrastructure services are noted for their high levels of coverage, access and quality, especially in the provision of basic services. Be it telephone or road density, or energy, water and sanitation coverage, Uruguay ranks above its regional neighbors (Table 13). The main concerns in terms of access are in sanitation through connection o the public sewerage system, where coverage averages 52% (82% in Montevideo). There are also some problems with access in the natural gas market, mainly
29 Based on Chisari and Larnbardi (2004).
56 due to the small size of the distribution network. In the case of more sophisticated services, the penetration is much lower, although it has risen fast in some areas in recent years.
Table 13 - Access to Public Services in 2002 (“hof total population) Sanitation* Improved water Electricity Kms Of Paved roads GDP per capita, (“hof source (YOof (YOof mainlines (per Roads per Country Per PPP (current population population with population ‘Oo0 worker** international US$) with access) access) with access) 1,000 people) eo le Argentina 85.0 79.0 90.0 175.9 6.1 5.8 11,703 Brazil 77.0 87.0 90.0 111.6 10.8 2.4 6,869 Chile 97.0 94.0 98.0 164.4 5.5 2.3 8,163 Mexico 73.0 86.0 95.0 99.9 3.3 2.9 7,839 Uruguay 99.0 98.0 100.0 223.7 2.7 5.5 8,486
174. Quality has improved in the last decade in most of the infrastructure areas, as well as the commercial services to users, particularly in the electricity and telecommunications markets. Potential or actual competition may have operated as a trigger to improve the productive and the commercial side ofsome public enterprises like UTE (electricity) and ANTEL (telecommunications). Progress has been much slower in water and sanitation. Users are generally satisfied with infrastructure services, although the perception is that tariffs could be lower.
175. Although international comparisons are difficult -both because the exchange rate has been very volatile and because the government sets high public tariffs as a revenue source - in some sectors prices are relatively high; and the efficiency of some companies is notably lower than that of other countries in the region. There are large differences between infiastructure sectors and public services in matters of efficiency, quality of service and prices. Until 2001, prior to the steep devaluation in 2002, energy prices were relatively high compared with levels observed in countries both within and outside the region (Figure 10). International comparisons have become more difficult since the devaluation of the currency. Electricity rates for industrial and commercial establishments are among the lowest in Latin America. On the other hand, transmission and distribution losses are higher than those for other countries in the region, except Brazil and Colombia. In the area of water supply and sanitation services, the relatively high number of OSE employees indicates a relatively high source of inefficiency (Figure 11). Similarly, the relatively high price of oil products in Uruguay suggests that ANCAP is less efficient than potential external suppliers (Table 14).
176. Transport infrastructure is an exception to this general rule, as it records high levels of efficiency and service quality, The primary highway network is in a
57 better state than that ofany other country in the region, largely due to policies that assign priority to maintenance. Port services have improved considerably as a result of the reforms carried out in 1992, with a consequent 160% increase in container traffic since 1993. The cost of container movement is comparable to that of other ports operating as concessions in Latin America, and only slightly higher than the average for Southeast Asia. Rail services have also improved as a result of reforms to the sector, although freight volumes are low and the sector has a long way to go to be able to provide a competitive service.
177. The increasing efficiency of transport services in Uruguay, particularly roads and ports, is directly related to the reform of the sector, and provides a good example of what could be done in other sectors of infrastructure and public services if a similar approach were to be adopted. The purpose ofthe reform ofthe transport sector was to modernize and improve the provision of services, increase investment and take advantage of new sources of financing. It placed the formation ofpolicy, planning and supervision ofregulations firmly in the hands ofthe government, at the same time as it encouraged the participation of the private sector and public-private consortia in operations and the provision of services. Although the Transport Ministry did not abandon all its operating activities, these are now secondary to its policy and regulatory role. The reformed institutional framework has turned out to be a very effective way of reinforcing efficiency and improving the competitive position ofUruguay in transport.
178. There is still ample scope for increased private sector participation in infrastructure services; participation by the private sector in Uruguay is much lower than in other comparable countries. For example, private investment in infrastructure was on average equivalent to 0.5% ofGDP between 1990 and 2003 (Figure 12), compared with investment of 1-3% in a number ofcomparable countries. Most of this investment took place in the context of concessions or “green field” projects. Although the population appears satisfied with the current arrangements, it will be important for competition and private sector participation to continue to form part ofthe debate on public policy. Greater competition in inti-astructure services will create incentives for investment and the adoption of more efficient methods of production, as well as the transfer ofsuch gains into lower prices,
179. The government has been gradually introducing competition and improving regulation in some sectors of infrastructure; however, key sectors are still dominated by vertically-integrated public companies. In Uruguay, the sectors in which increased competition could take place include electricity sector, where the state company UTE (“Administracibn Nacional de Usinas y Transmisiones Eldctricas”) controls transmission, distribution and is the sole player in generation; the petroleum sector where the public company ANCAP (“Administracibn Nacional de Combustibles, Alcohol y Portland”) controls the distillery, storage and importing infi-astructure; and telecommunications where the public company ANTEL (“Administracicin Nacional de Telecomunicaciones”) controls the fvred lines.
180. Cellular and international long distance services have been opened to competition. Private sector participation has been strong in the unregulated gas sector
58 and, as indicated, it has been rising significantly in highway maintenance, ports and airports. In the rail sector, although the Ministry ofTransport owns the networks and its usage is open to any operator since June 2002, the sector does not have clear rules to ensure competition -which explains the lack of effective private sector participation in the sector to date.
Figure 10 - International comparison of electricity prices, 2001
Grenada Grenada Barbados Barbados Denmark Denmark Surinam Surinam Jamaica Jamaica Netherlands Netherlands Uru uay Uru ay tuba 8ba Gel"y Germany Panama Panama Portugal Port ug a 1 Njcaragua Nicaragua Switzerland Saitzerland Spain Spain UK UK Peru Peru Ireland Ireland ominican Rep, )ommican Rep United States United States Chile Chile Ar entina Ar entina turkey +urkey El Salvador El Salvador Poland Poland Guatemala Guatemala Finland Finland Honduras Honduras Mexico Mexico Taiwan Taiwan Norway Nonvaq South Korea South Korea Greece Greece Hun ary Hun ani Biti iaiii Bo1 i v 1a Boli%ia Costa Rica Costa kca Colombia Colombia Slovakia Slovakia Paraguay Paraguay C28T cZe:;;h"t;ae"P" New Zealand New Zealand Ecuador Ecuador South Africa South Africa kin. & Tobago Trin &Tobago Kazakhstan Kazakhstan 0 0.05 0.1 0.15 0.2 0.2s 0 0.05 0.1 0.15 0.2 0.25 u%sI kWh u$s I kWh
Source: Chisari and Lambardi (2004).
59 Table 14 - Ex-refinery Prices (November 2004) Estimated Import Parity ANCAP Ex-refinery price Difference Product price (USWm3) (USUm3) Gasoline 95 425 495 16% Diesel 465 486 5YO Kerosene 457 539 18% Fuel oil 282 213 -24% LPG (US$/tn) 634 506 -20%
Figure 11 - Public Enterprise Efficiency (number of employees per thousand water connections)
Source: Uruguayan authorities.
Figure 12 - Private Investment in Infrastructure
Average private investment as a percentage of GDP 1990-2003
3.0%
2.0%
1.O%
0.0% Argentina Chile hdonesia &xico Wru Thailand Country
Source: World Bank (2004),
60 181. The government has created multisector regulators, URSEA for water and sanitation, power, natural gas and petroleum products and URSEC for communications. Although these bodies have a certain degree of autonomy, some of the more important functions are restricted. In addition to the lack offinancial autonomy, the agencies have the capacity only to recommend tariff changes while the ultimate say on tariffs remains with the Executive - an authority established in the Uruguayan Constitution.
182. Several factors have held back against private investment in infrastructure. These include: an unstable macroeconomic environment, a political process which generates multiple veto points which has led to blocking important PSP reforms approved by Congress, and the relatively small sue of the market with respect to efficient scales (although horizontal and vertical separation of dominant public operators and technology can sometimes offset this).
183. There are multiple factors that depend on the government, and which help explain limited PSP in key infrastructure sectors. The presence ofthe public sector in all vertical components of the supply chain, as well as in regulation, and tariff setting ultimately decided by the Executive branch discourages private operators. Non- competitive practices and barriers to entry could stem from distortions due to cross subsidization as well as biased price and quality standards aimed at favoring competitive advantages of public sector enterprises. For example, rules of dispatch of generators could favor UTE, and contracts of ANTEL with public enterprises could preempt private competition. Some prices and contracts in the telecommunications sector are still not transparent and could work as a barrier to new operators. Autonomy of regulatory agencies is limited due to, among other factors, scarce resources (particularly staff.) One example of this is telecommunications where the regulatory agency URSEC is highly dependent ofthe advisory assistance of ANTEL on technical issues.
Infrastructure efficiency and competition - Cross-cutting issues and policy options
184, The vertical separation of state assets may help to promote competition. This is the case for the vertical separation between electricity generation, transmission and distribution by UTE that could contribute to entry by private generators. Similarly, while cellular competition is clearly underway, the (accounting and financial) separation of ANCEL accounts from ANTEL may help to hrther strengthen cellular competition and eliminate the presumption of discriminatory pricing by ANTEL to its current cellular division. In addition, contracts between ANTEL and other public sector entities could be opened to bidding with the participation ofprivate sector suppliers.
185. Some important reforms and regulatory frameworks have not been completed yet. In general, an effective way to improve efficiency consists in clearly differentiating the three independent roles of policy definition, regulation and operations. In the case of gas distribution and ports, initial concessions have allowed PSP, but regulatory rules are still determined by previous concession contracts or general
61 practices, more than by specific laws and regulations. Contract incompleteness is a source ofcostly renegotiation. The regulatory framework in gas is needed to ensure fair competition in the future expansion of the gas network, the development of regional interconnections, and a well functioning market for medium and long term gas supply contracts. In the case of ports, Uruguay has steadily moved away from a model in which ANP is both owner and operator, tending toward a leasing model under which ANP owns the basic port infrastructure (piers, docks and storage areas), and the private concession- holders build superstructure facilities such as office buildings, provide equipment such as cranes, and operate the port installations.
186. URSEA and URSEC have already developed a reputation of transparency by placing all major proposals, decrees and regulations under public consultation. Publication and broader dissemination of performance and comparative efficiency . indicators ofpublic firms would make the management and boards of these firms more accountable, thereby contributing to efficiency. Increased transparency on the cost of access to networks - interconnection fees for telephone services, energy transmission prices, railway tolls -would pave the way for greater and more fair competition.
187. One aspect of the reform process that needs to be sufficiently addressed is universal service. Reduced public sector involvement in infrastructure provision requires rethinking social aid. While in some cases universal service obligations may not be required (cellular phones) in others they may need to be explicitly incorporated (access to water and energy). Ifonly public enterprises face universal service obligations and grant subsidies to the poor, they will not be able to compete on a level playing field. In some cases, adoption ofa social tariff - possibly backed by a state subsidy - may be desirable. In others, concessionaires may be able to absorb the cost ofuniversal service obligations in exchange for other benefits. In general a clear separation of social obligations from the core business can help strengthen competition and efficiency,
188. Limited autonomy of regulatory bodies in charge of defending competition and vaguely defined competencies to address competition and consumer protection issues - especially where legal monopolies exist (railways, airports, ports, energy) - can constitute a major barrier for competition and private entry. In this context, a strong competition agency could play an important role, e.g., preventing “capture” ofthe regulator by politically strong and financially dominant state-owned incumbent firms.
189. Inefficiencies in state-owned firms are sometimes ascribed to differences in the legal framework for public and private companies, e.g., labor practices, taxes, procurement and contracting. Placing public firms under commercial law may improve incentives to perform. However, this would not be a risk-free path as long as regulatory and supervisory agencies lack the capacity to monitor, evaluate and sanction such firms. While application ofcommercial law and PSP may in some cases be desirable over the medium- and long-term, over the short term a more realistic and potentially more effective approach may be to ensure the enforcement of basic rules already applicable under public law. For example, existing criteria to appoint boards of directors ofpublic firms based on technical capability are not in general followed in Uruguay. Similarly, the
62 mechanisms to ensure accountability of directors in public firms are rarely applied. A clearer separation of the board from the day-to-day management and explicit prohibition of board members to be involved in politics would also help. This would represent a step prior to the possible placing ofpublic companies within the orbit ofcommercial law.
Issues and strategic options in selected infrastructure sub-sectors
I. Power
190. In mid-1990, Uruguay launched a reform program aimed at increasing the efficiency of the sector by means of the vertical division of the industry (generation, transmission and distribution) and the horizontal separation of generation, to promote competition and PSP. It also adopted a regulatory fiamework that was to allow the transfer of the expected benefits to customers by means of lower prices. The authorities have promoted the entry ofprivate investors into electricity generation, calling for tenders for the construction of a new combined cycle thermal power station (TCC). As no bids were received, the construction and operation of this power station was awarded to UTE -the state electricity monopoly. Generation therefore continues to belong to the state (UTE and the Salto Grande Hydroelectric Power Station), Depending on weather conditions affecting hydro generation, imports from Argentina can become substantial (Table 15). UTE is responsible for high-tension transmission and operates a single distribution company that administers the network maintenance activities, as well as the sale of electricity. Dispatch is in the process of being decentralized by the Electricity Market Administrator (ADME),an independent operator.
191, Important actions could encourage vertical separation in the industry and horizontal separation in generation. The first step to increase competition could be the effective operation ofthe ADME and the formulation of detailed dispatch rules to avoid discrimination against potential entrants. Another measure that could be considered is to enable large users to purchase energy directly on the Argentine wholesale market; this would be a significant step and an efTective test of access to the UTE transmission system. In addition, if the new TCC generating plant that is planned were to be built and operated by a public company not linked to UTE, this would encourage competition and better prepare the ground for increased PSP in the electricity sector.
192. Uruguay faces the challenge of energy scarcity, diversifying available sources and developing a cost-effective strategy. The country is highly dependent on hydraulic factors (the weather). Supply fiom Argentina is also volatile and uncertain (because of the regulatory uncertainty in that country). A solution to these multiple constraints will need to recognize costs of diversification of sources (including possibly more costly inter-connection with Brazil) to minimize risk and to promote competition. The reaching of long-term agreements to expand interconnection with Argentina and Brazil is a policy option deserving serious consideration, Nevertheless, if regular gas supply fiom Argentina were to be restored, the best economic option would be to expand electricity generation locally using natural gas, keeping oil as a second option in emergencies caused by a shortage ofnatural gas.
63 Table 15 - Uruguay: Generated and Exchanged Energy (GWh), 1997 and 2002 Type 1997 2002 Hydroelectric (I) 6213 7108 Thermal 602 26 Own production 6815 7134 Argentina 43 559 Brazil -18 0 Net exchange (purchases less sales) 25 559 Total supply of electrical energy 6840 7693 (1): Includes the Salto Grande dam. Source: UTE.
193, Final prices of energy imported by Uruguay have been particulariy low and this does not seem to be a long-term sustainable situation. The analysis of future prices of electricity and gas imports is crucial to the cost-benefit analysis of the new thermal combined-cycle plant andlor private generators. This analysis would also be relevant for future public and private investment. Also, there is a need to internalize true risks ofnatural gas supply fiom Argentina.
194. The fact that UTE is the legal public monopoly in transmission and distribution, and the sole player in domestic generation does not in principle prevent URSEA from applying regulations to improve the efficiency of the company. This could be done for example through yardstick competition andlor price-cap regulation with an X-efficiency factor to allow for productivity gains. The price cap would be applied in this case on a notional tariff since the effective tariff is set by the Ministry of Economy based on fiscal objectives. The efficiency gains which are not captured by the state could then be passed on to frms and consumers.
195. In addition to regulatory and institutional changes, the government could consider measures to increase energy efficiency and reduce losses. Electricity consumption could be substantially reduced by encouraging greater energy efficiency. For example, the possibility should be analyzed of introducing incentives for the purchase and installation of energy efficient appliances, and adapting the regulatory fiamework to encourage efficient energy consumption. The potential gain exceeds the annual increase foreseen in the demand for electricity. Increased energy efficiency could cut energy imports and the need to invest in additional supply. As a result of the economic crisis, electricity losses have increased significantly in Uruguay. One way to reduce such losses would be to further improve the distribution installations and enforce legal connections. This measure would be especially effective if it is combined with measures to encourage the efficient use ofenergy.
64 2. Hydrocarbons
196. The import of crude oil and refined products, the refining of crude, and the transport, storage and sale of oil derivatives are an ANCAP monopoly. The price of delivery at refinery is significantly higher than the import parity for most oil derivatives. This provides protection to ANCAP but weakens competitiveness of the economy as a whole. The payment of subsidies on liquid gas places natural gas at a competitive disadvantage. The tax structure of gasoline, diesel and fuel oil distorts the market and generates an increased consumption of diesel oil. As a result unnecessary refining costs are incurred to meet the demand for diesel.
197, Policy options include: (i) reducing price distortions generated by discriminatory taxes; (ii) increasing the efficiency of ANCAP; and (iii) increasing the use of natural gas. Import price parity for oil derivatives would encourage ANCAP to improve its efficiency and would lead to lower prices for gasoline, diesel and kerosene. The efficiency of ANCAP could improve with the vertical separation of its different businesses and the application of regulator accounting. This could be complemented by open access to port and storage facilities3'and the sale of loss-making businesses. The market for industrial and residential gas would also benefit from the elimination of subsidies on fuel oil and liquid gas.
3. Tollroads
198. Highway transport is the preferred mode of freight and passenger movement in Uruguay. The highway network is one of the densest in Latin America, with a coverage comparable to that of other middle-income countries, but low in comparison to that of high-income countries. In 1993, 86% ofthe highway links with Argentina and Brazil -critical for regional integration- were in an average, good or very good state of conservation. As regards maintenance, only 3% of international corridors and 7% ofall paved roads are in a poor state. Secondary and rural networks have suffered the greatest deterioration.
199. A significant success of the highway sector reform has been ensuring that user tolls are used to finance highway maintenance and investment. Participation by the private sector has contributed to achieve this objective. Nevertheless, the private sector does not represent yet a significant source of investment in the sector.
200. Under the Megaconce~sion~~,highway maintenance and expansion is financed jointly out of toll income and general revenues. The rest of the network (secondary and rural roads) remains within the orbit of the Ministry of Transport's National Highway Bureau (DNV). To improve the concession framework, the government could consider various options:
30 A 2004 referendum rejecting the association of ANCAP with private firms also precluded open access to fyrt and storage facilities belonging to that company. A country-wide road construction and road and infiastructure maintenance concession awarded to a state- owned company that operates under private law.
65 1. Evaluating and incorporating into the budget contingent fiscal liabilities fiom minimum revenue thresholds to concessionaires.
ii. Minimizing the “cost-plus” issue stemming from the complementary subsidy under the Megaconcession (by eliminating the incentive to reduce costs) by conditioning the subsidy to specific cost and technical efficiency targets.
iii. To hrther encourage PSP, leaving out DNV from the allocation of subcontracts for construction, maintenance, and operation under the Megaconcession.
Effiency and competition in infra~tructure- Evaluation of the impact on welfare using a co~ut~blegeneral e~uilibrjummodel
201. Simulations on the basis of a computable general equilibrium model make it possible to demonstrate how potential efficiency gains in infrastructure sectors could be translated into faster growth and greater welfare (Table 16). Specifically, the simulations show how, in a scenario in which efficiency gains of 25percent are assumed and 40% of the efficiency gains are transferred to prices -from the effect of a competitive fiamework, - GDP could increase by 2% and overall welfare by 1.7% of GDP (last column ofTable 16). The stronger the transfers ofefficiency improvements to prices, that is to say, the stronger the competition, the greater the gains.
Table 16 - Simulations of the computable general equilibrium model
Gains in efficiency - 25 %
Unemployment (reference 15.00 19.40 17.70 level 16%) Total welfare percentage of 3.23 0.71 1.67 GDP
Note: Household and government welfare is measured in terms of Equivalent Variation. The change in GDP is measured in 1997 dollars. Source: Chisari and Lambardi (2004).
202. Even if public companies dismiss workers, under full price flexibility the dynamic effect on employment of efficiency gains (from increased competitiveness) could lead to a reduction in unemployment (second column of Table 16). Under a
66 competition regime lower demand for labor in basic services sectors, given the greater labor productivity, is compensated for by an additional demand in the rest of the economy stemming fiom productivity gains and lower infiastructure prices. This demonstrates why competitiveness policies can be essential to improve employment prospects.
203. The industries that could most clearly benefit from improvements in the competitiveness in infrastructure sectors are very significant for Uruguayan exports. Although all economic sectors benefit from efficiency gains, sectors such as “Food Production”. “Cellulose and Wood”, and “Metal Products and Minerals” in particular stand to gain. All these sectors account for a significant share of Uruguayan exports. As they are sectors that make an intensive use ofpublic services, they obtain the greatest reduction in spending on inputs, and as a result obtain the largest gains in their rates ofreturn.
4.3 Competition policy
204. Competition between companies provides incentives for achieving productive efficiency and for passing on efficiency gains to consumers and users in general. Competition policy as such has never been given a significant place on Uruguay’s political and economic agenda, and until recently there was no legislation on the matter. In part, this could be the result of a history of strong state intervention, and in part to a lack of a competitiveness culture. This situation appears to have begun to change as a result of Uruguay’s joining the World Trade Organization, as well as of obligations arising from its status as a member country ofMERCOSUR.
205. The first legislation on competition was passed in 2000. Under the law “all companies of whatever legal form performing economic activities must comply with rules on competition, without affecting any limitation that might be established by law and for reasons of interest or which arise from the nature as a public utility ofthe activity in question.” In addition, the law specifies: “When market distortions were to cause any significant harm to the general economic interest, all accords and practices established by economic agents shail be forbidden, as well as the decisions taken by business associations, and any abuse ofa dominant position by one or more economic agents that results in a restriction, impediment or distortion ofcompetition and fi-eedom ofaccess to the market for the production, processing, distribution and sale ofgoods.” The Executive appointed the General Bureau of Trade (DGC) as the body responsible for the implementation ofthese regulations.
Co~etitionpolicies in small economies
206. A minimum efficient production scale in small economies usually implies higher concentration levels - and an increased presence of monopolies or oligopolies- in most of its industries. The fact that there is less room for efficient-scale producers could impose an additional barrier to entry, leading some companies to produce at sub-
67 optimal levels. As stated by Gal (20011, the competition policies in small economies should be understood as a means for promoting economic efficiency ofparticipants in the market -at the same time as allowing consumers to receive the benefits of such improvement.
207. In small economies competition policy needs to be based on rules and assumptions which, applied on a case-by-case basis (following the “rule of reason”), assign to efficiency considerations a central place. Competition laws in small economies should be very cautious when including per se rules such as those usually present in legislation in larger economies - e,g., limits on concentration ratios, structure regulation and, more specifically, merger and acquisition control. A high degree of flexibility is needed as far as implementation is concerned, with the focus on a case-by- case approach.
208. There are significant obstacles to the application of a “case by case” rule. In the first place, it requires a compromise between flexibility (required for individual treatment or case by case) and the discretion with which such flexibility can be used. The risk is the potential unpredictability, as well as the opportunism, particularly in the case of influential interest groups. Second, applying a “case by case” competition policy can require fairly intensive use of highly-qualified human resources. Third, lack of competition culture may imply that agents do not understand how some conducts and decisions are in opposition to the competition policy’s objectives. To minimize the problem ofabsence of a competition culture, the authorities can play an active part in so- called “competition advocacy”. This entails communicating the most significant decisions on competition protection to the public with the rationale being stated as clearly as possible, clearly identifying the resulting potential winners and losers.
Strategicpolicy options
209. The general objective of completion law could be restated. The government could consider including in the legislation an article expressly stating that the purpose of Uruguay’s competition policy is to protect competition in order to promote efficient market performance and benefit consumers.
210. Legislation could more clearly specify the subjects bound by the competition law. So far, only companies which may have legally become a monopoly would not be bound by the competition rules. However, even in these cases, the scope of the exemption is unclear. The state in Uruguay often performs simultaneously, through its agencies and institutions, a dual role of market agent and regulator. Although such distinction is generally subtle, the competition regulations could be made applicable whenever it may be determined that the state is not exercising any regulating powers but acting as a supplier or buyer.
21 1. The government could consider strengthening the institutional framework. The competition authority could be made more independent fiom political pressures and
68 financially autonomous; the latter would facilitate recruiting, training and retaining skilled staff. Specific options for institutional development include:
i) Legislation could specify procedures required for decision making.
ii) The competition regulator could be made the last administrative authority in that field so that its decisions are not reviewed by political authorities.
iii) Consideration could be given to the creation of a permanent judicial court specializing in competition protection issues or, alternatively, an intermediate appeal mechanism composed ofan ad hoc jury, e.g., composed ofa federal judge and independent specialists,
212. The agency in charge of defense of competition could coordinate and complement its activities with existing infrastructure regulators. Its greater independence and financial autonomy may allow it to perform different functions than those agencies. In the case ofpublic infiastructure monopolies, and in coordination with existing regulators, it could for example promote yardstick competition and develop benchmarks of efficient enterprises. This could entail comparative cost studies and evaluate the scope for international competition. In those sectors in which competition is open, the competition agency could play a role in evaluating barriers to PSP imposed by pub1ic monopolies ,
4.4 Human capital development and equity-Health and education32
213. Sustained growth requires opportunities and incentives for individuals to invest in human capital. Government policies and direct interventions in education and health can help households build, maintain and protect their human capital investment thereby contributing simultaneously to human capital development and equity. Equity in access to quality health and education is a key dimension ofequality ofopportunity; and as more people get access to higher education and better health, prospects for human capital and growth improve too.
a) Health
214. Uruguay dedicates a generous portion of its income to health. At 11% ofGDP (including the private and public sector) Uruguay’s health expenditure is greater than Argentina, Chile, Ecuador, Venezuela, Mexico, Brazil and Costa Rica. The government covers about 46% of this expenditure, either directly or through subsidies. The total amount Uruguay spends in health is in fact more typical of mid-range OECD countries than the average Latin American country (Figure 13). The main obstacle to growth posed by current health policies and institutions lies in the potentially unsustainable investment in the health insurance and care-delivery system.
32 Based on Packard (2004) and contribution of the Human Development Team of the World Bank.
69 215. Uruguay's health system offers some of the best coverage and health- outcome indicators in the region and among middle income countries. Uruguay has the lowest infant mortality and maternal mortality rates in Latin America. Uruguayans outlive most oftheir neighbors, which, added to a long history of low fecundity, and the strong emigration by young people, has resulted in the highest ratio of elderly to working age population in the region.
Figure 13 - National expenditure in health - Selected countries
$. Gom"nt expenditure on health as % oftotal expenditure . .. Source: Packard (2004).
216. Health care coverage is almost universal, and the private sector is an important partner in providing both financial protection and medica1 care. The private health insurance and care providers, the IAMCs, are mostly owned and managed by physicians and cover the population by direct enrollment or as collective members through the BPS. Overall, the IAMCs cover around 46% of the population (INE 2003), especially homes with medium and high income levels. The Ministry of Health (MSP) along with other public institutions ("Hospital de Clinicas" and municipalities) cover about 41% of the population, principally the poor. Together with the healthcare system for the armed forces and the police, cover is provided by the public sector to around 5 1% of the population (INE 2003). Around 3% of the population is attended to by other providers.
70 217. The country has achieved significant improvements in the performance of its health services in recent years. Both the Ministry of Health and the National Resources Fund (FNR) have improved their effectiveness and efficiency. The Ministry has expanded its coverage for low-income families. It has substantially reduced the number ofunnecessary hospitalizations and consultations, and has reformed its procedures for the purchase of medical materials. In addition, the FNR has gone from recording losses to a surplus by lowering unnecessary services and costs.
218. However, there is still significant inequity in the distribution of fiscal subsidies for healthcare, including direct fiscal subsidies paid to the health insurance of the social security institute and important direct subsidies paid to the IAMCs. The’IAMC’s compete to affiliate low risk segments of the population (the young, relatively well-to-do and healthy), leaving higher risk segments (the elderly, poor and unhealthy) to the public sector. In addition to aging ofthe populatio~~~the high costs of health services is attributable to, an excessively complex institutional structure with an overlapping of responsibilities and high transaction costs which reflects a system that is not fdly in line with the health needs of the population. Primary and secondary prevention is marginalized within the healthcare system, thus increasing the cost of complex treatments at tertiary level. Only 7% ofthe ofthe Ministry ofHealth’s budget is allocated to public health programs.
219. Despite the subsidies and the marked increase in monthly premiums in the last ten years, most IAMCs have steadily built up long-term debt, and seven of them have failed since 1999. Almost one quarter of the IAMCs recorded operating losses in 2003 equivalent to 25% or more of their income. Factors explaining such results include the existence of a deficient IAMC regulatory system -which provides families neither financial protection nor adequate information for decision-making purposes (Fiedler, 2004). Another factor is the existence of a highly distorted medical labor market noted for oversupply of doctors stemming in part fiom regulations that encourage part-time work.
Strategicpolicy options
220, Policy goals. The goal of health policy in Uruguay is to harmonize the system so as to ensure more equitable access to and use of services, improved quality of care and increased financial protection (preventing poverty as a consequence of health problems), while at the same time reducing the financial burden ofthe system.
221. In this context, one important strategic need is to improve the framework of incentives for all players in the system (consumers, healthcare service providers, State Health Services Administration -ASSE and IAMCs). Key to the improvement in incentives is the need to reduce fragmentation and increase the effectiveness of fmancial incentives and regulations for greater efficacy and equity. The government must determine the specific strategy to ensure harmonization. Options could include: (i) improvements in existing incentives and regulations, essentially maintaining the current
33 Over 13% of the population is over 65.
71 organization of the system; (ii)a “virtual” single risk-pool -a reformed system in which there are multiple insurers but all of them will be subject to a single set of rules with respect to the benefit package, the portability of benefits, and access to public and private providers; and (iii)a single (actual) risk-pool such as the system in the British National Health or the French system. Many ofthe countries in the region have been confionted by similar options. Decisions taken by countries in the region have been based both on historical and cultural preferences and fiscal constraints,
222. Regardless of which of these three key strategic options the new government chooses, a transitional phase is advisable to meet the urgent need to move towards a more efficient framework of incentives for the system. There are at least five key reforms that the govemment could consider in its progress towards a system of more harmonious and effective healthcare.
First, is the priority to achieve a better balance between insurance and prevention. There appears to be insufficient emphasis on prevention for a country with significant challenges in the area of chronic non-transmissible diseases.
Second, is the importance of simplifying and applying the regulatory fiamework of the IAMCs. The system needs to be made more effective in providing: (a) consumer protection and (b) mandated, guaranteed coverage for all members. This includes ensuring access to key health services and ensuring that health events do not push IAMC affiliates into poverty.
Third, is a definition ofthe guaranteed coverage that is explicit and obligatory for all beneficiaries of public subsidies. The fiscal subsidy in the absence of such regulations or an explicit coverage contributes significantly to the lack of equity and the inefficiencies ofthe system.
Fourth, reforming the existing fiscal subsidy policy (including the creation of mandatory coverage) is a priority, as it is inequitable and inefficient. Subsidies to any insurer (public or private), when necessary, need to be re-targeted to those participants with the greatest needs. There are many ways of defining and establishing stages for the redesign ofthe system.
Fifth, are reforms within the Ministry of Health that deserve to be deepened including, in particular, a provider payment mechanism reform for the ASSE that will link financing with the actual provision of services to Ministry of Health beneficiaries.
223. Difficult decisions await regarding the medical labor market, one of the most complex in the world. This appears critical to managing the fiscal burden of the health sector, and especially to improve the fiamework of incentives for the IAMCs. Current labor market legislation complicates cost management for many institutions that operate in the sector, and encourages the proliferation of part-time jobs. Physicians have on average 3.5 different jobs. This proliferation of part-time employment has affected the
72 efficacy and quality ofhealthcare in Uruguay. Another important consideration linked to labor market reforms involves requirements for training, licensing and continuous training of physicians. Here also the objective and primary purpose of the reform is to improve quality in healthcare.
b) Education
224. Education indicators in Uruguay are positive, in particular when compared with Latin America (Figure 14). The country was a pioneer in the region by introducing nine years ofmandatory education for all in 1973. Almost all students begin schooling at the age of four and continue to attend school for the following eight years. There is almost universal coverage of basic education including for poorer segments of society. Around 90% ofprimary school graduates enter the first year of secondary school, Real expenditure in primary education rose 50% between 1995 and 2003. Uruguay has seen rapid increases in enrollment with a 25% increase in primary school students from 1985 to 2003, and a 65% increase in secondary school students in the same period. Importantly, this surge has been progressive, as half ofnew students who entered primary education and over 40% of current secondary school students live in households in the lowest income quintiles (MECAEP, 2004).
Figure 14 - Average Number of Years of Education, Uruguay and Selected Latin American Countries, (population 25 years and older)
8.0 7.0 6.0 5.0 4.0 3.0 2.0 1.0 0.0 Argentina Bolivia Brasil Chile Paraguay Uruguay
m1960 111980 132000 Source: Amarante (2004).
225. Various policies and interventions were conducive to improvements in education performance. These included improved access to pre-primary school and the program of full-time primary schools - which helped both to improve learning performance and to diminish the learning gap between low income and more privileged students. A new culture of evaluation has developed along with the implementation of national assessments oflanguage and mathematics skills in primary schools. In secondary schools, learning assessments in language, mathematics, natural and social sciences, and English language were implemented, Curricular changes in the second cycle of
73 secondary education included a better articulation between tracks in technical and traditional secondary education, as well as new options for diplomas.
226. According to the 2003 results of the International Student Evaluation Program, Uruguay recorded a better performance than the other countries in the region that took part, although it was still significantly below the OECD level (Table 17). Steady growth founded on a knowledge-based economy implies that Uruguay aspire to achieve the standards ofOECD countries. A permanent increase in the rate of growth will be dependent on the effectiveness of Uruguay in improving its results in the field of education, especially at secondary and tertiary level.
227. Public spending on education in Uruguay amounts to 3.6% of GDP, a considerably smaller percentage than the average of 4.5% for Latin America, and lower also than the average of 5.3% in high-income countries. Investment in education may need to increase over time if Uruguay is to establish a high level of education for all its children and young people. Additional resources on their own will not produce the desired improvements as regards access, equity and quality of education. It will be important to achieve improvements in the delivery of education services, including strengthening of the organizational and institutional structure of the education system, to ensure that additional resources will be used in an effective manner.
Table 17 - PISA Ratings (2003)
Source: OECD.
228. Uruguay’s education system is dominated by the state - almost 90% of all students (pre-primary to tertiary levels) attend state-managed facilities. Pre- primary, primary and secondary public education is administered by ANEP (“Administracih Nacional de Educacicin Publica”) and tertiary public education by UdelaR (“Universidad de la Republica”) - both operate as largely autonomous state
74 agencies with scarce influence fiom the Ministry of Education. This Ministry has regulatory and supervisory powers over private sector nurseries and private sector Universities - supervision of primary and secondary education is the responsibility of ANEP. This structure is reflected in budgetary allocations: ANEP received 9.4% ofthe 2004 government budget whereas the Ministry of Education received a small 0.9%. UdelaR was allocated 0.7% ofGDP on average over the last decades.
Figure 15 - Educational Attainment of Uruguay's Employed Labor Force, 1986 - 2002
40.00 l
h 35.00 'o-- 0 4 30.00 B* 9 f 25.00 w 'c 20.00 .LP E e 1500 I?
10 00
5 00
0.00 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002
-0- Rimry Complete -Secondary lncornplete --a- Secondary Complete Technical Qualfication +Artesan Qualification -Unnrersity lnconplete +Unlverslty Conplete -Other ource: Amarante (2004).
229, Uruguay's long legacy of investment in education is borne out in comparative statistics. The stock ofhuman capital (proxied by the average number ofyears ofeducation in the population over 25), grew steadily over 1960-2000 and is currently one ofthe highest in the region - about 8 years (Amarante, 2004). Further, there has been a marked increase in the human capital of Uruguay's labor force in the last two decades. The share ofworkers with only primary education has fallen steadily, in tandem with an increase in the share with completed secondary and some tertiary education (Figure 15). There have also been gains as regards the progressiveness of academic performance. In at least three national evaluations
75 (1996, 1999, and 2000) on sixth-grade use of language and math skills, the lower-income segments were improving at a faster rate than that of the higher-income groups. This can be attributed to a progressive structure ofeducation spending and specific programs targeted at the poor, such as the full-day schooling model.
230. At the tertiary level, until 1985, Uruguay had just one university -UdelaR. The opening of the first private university that year marked the start of a period of rapid growth in coverage -from 62,000 in 1988 to over 80,000 in 2002; in 2002 there were 5 private universities and 8 university-level institutes. The UdelaR still attracts 89% of university students. At the same time, there has been a diversification of programs and diplomas. In 1998, all MERCOSUR countries launched a process of regional accreditation for university programs.
Issues in education
23 1. Against this favorable background, the following trends can be noted:
i. Access and equity. Most worrying are increasing levels ofschool desertion at the secondary level. Out of 100 entrants to secondary school, only 55 will remain after four years, and only 35 will finish the fill six-year course. School desertion is not evenly distributed among the population. These indicators are worse among those at the lower end of the income distribution. While 80% of high school students in the highest income group will complete their secondary education, only 30% of students in the lowest income group will do so (Opertti, 2004.) In spite of the rising number of university students, take-up of higher levels of education has declined dramatically. The rate of growth of the population with tertiary or professional qualifications is one ofthe lowest in the region. Whereas tertiary qualifications in the population aged 29-59 rose less than 2% on average in 1990-1999 in Uruguay, growth in comparable countries in the region has been far more rapid - 4% in Brazil, over 5% in Argentina, 6%, in Chile, Colombia and Paraguay, and in Mexico over 9%.
ii. Equity. Tertiary education provides a clear case of lack ofequity. Only 0.8% of households from the lowest income quintile include people with tertiary education (da Silveira, 2004). The equivalent figure for the highest income quintile is 32.2%. Since the bulk of enrollment is at public universities finded by general tax revenue, public expenditure in tertiary education is regressive.
iii. Quality. In primary schools, concerns extend to the quality of learning. In 2002 tests, 33.7% of primary school students did not reach a minimum level of sufficiency in language and 5 1.7% in mathematics. Learning performance also varies by income level - only 39% ofstudents in schools that primarily serve low- income students obtain a high score in mathematics, compared to 85% in schools serving high-income populations. Returns compared to OECD countries show a significant gap in basic competencies of reading, math and science.
76 iv. Efliciency. Public expenditure inefficiency is an issue, particularly at the tertiary level. The average time to completion at UdelaR is about 50% higher than the expected time, and average dropout rates are about 70% oftotal enrollment. With 11% ofenrollment, private universities contribute 16% of graduates (da Silveira, 2004.) University efficiency is also low when measured in terms of scientific production.
Strategic policy options
232. A key objective of education reforms is to ensure that ail Uruguayan youth have access to quality schooling and may enter the labor market prepared to meet the demands of a competitive, increasingly knowiedge-based economy. The education system can be structured to meet this objective in a way that fulfills its obligation to compensate for differences in socio-economic backgrounds among students. Progress toward this objective may be assessed by: (i)how quickly the current rates of repetition and especially of desertion fi-om secondary school - particularly among students &om lower-income households - can be lowered; (ii)improved and more equitable (across income segments) learning performance in primary and secondary schools based both on domestic tests and on international tests - such as PISA; (iii)a faster pace of growth of university graduations and shorter average stay at the state university; as well as (iv) a more equitable distribution oftertiary and technical education graduates according to the needs ofthe labor market.
233. Reform of the curriculum. The government could consider analyzing steps to re- equip the educational system so that it provides the human capital that is most relevant to current and future economic demands. This could be achieved through changes in the curriculum, placing greater emphasis on learning skills than on specific content, and granting increased attention to technology to give students skills they need to become employable (Opertti, 2004).
234. Teacher incentives. It is important to achieve a better understanding of the teacher labor market in Uruguay. Much could be learned from analyzing teachers’ incentive structures and by seeking answers to key questions, such as: How are teachers selected? How are they assigned to schools? What are the promotiodcompensation criteria? Deeper understanding of these issues would help elaborate on the following policy options:
0 Autonomy and responsibility for school directors. They could for example be given a greater role in the selection of teachers. Criteria for evaluation of principals could take into account, for example, evolution ofdropouts, repetition and learning rates, and controlled according to characteristics ofthe student body.
0 Role of director vs. role of inspector. This role could be strengthened, for example, by modifying the rules that currently grant more weight to the judgment ofthe inspector than the evaluation ofteaching performance by the director.
77 Teacher evaluation. Changes could include an evaluation of individual performance (e.g., judgment ofthe director, ability to successfully integrate with the educational community, improvement in results) as well as indicators of impact that measure the educational success of the school where they work (evaluation of grade failures, desertion rates, controlled against the socio- economic characteristics ofthe students).
Teacher commitment. Teacher’s time commitment to working at a specific school could be extended, cutting teacher rotation and increasing accountability.
0 Remuneration. The basis for teacher remuneration could be expanded beyond seniority. For example, they could receive a basic wage and a series of complements related to improvement in academic performance, teacher re- training and educational and curricular updating.
235. Incentives for schools. Education authorities could assign every school a basic budget that would make it possible to pay a core teaching staff and essential operating costs. This basic amount could be determined on the basis of the average number of students enrolled in the school in previous years, but it could also be linked to a series of performance indicators in relation to academic achievements, desertion and grade repetition rates. To prevent an increase in inequality -with schools recording the worst performance receiving the least resources, leading to a further deterioration in performance- the government could consider transferring additional resources to such schools based on the agreement ofan improvement program with ANEP.
236. Efficiency. ANEP could promote increased transparency in cost structures, teaching approaches and academic results. This could also help to raise awareness of school directors and teachers regarding the need for reforms.
237. Cost-efficiency. There is room for improving cost-efficiency in tertiary education. For example, stricter curriculum requirements could be established to reduce the number of students taking advantage of the generous public university system. At present the only requirement to be registered as a student is to pass one subject every two years. Limits could also be placed on the number of times a person can enroll on fiee graduate courses.
238. Equity. Reform of higher education could retain the positive elements of the current system while improving equity in the opportunities available for students from homes with different income levels. Widening access to credit would reinforce efficient investment in human capital. Such a system should bear in mind the need for: (i) equilibrium between technical and professional studies; (ii)greater flexibility in the financing of public education -especially higher education, where there in increased ability to pay; (iii)synergies between universities, research centers and business undertakings; and (iv) subsequent reforms of the public university system, including for example, the creation of a national university accreditation entity (as required by
78 MERCOSUR), and competitive allocation of public resources for research (without discriminating between public and private uni~ersities).~~
239. Intervention on demand. High levels of desertion among lower income groups, points to difficulties of poorer households to fmance education. Uruguay may benefit from growing experience in the region with demand-side interventions such as conditional cash transfers targeted at the neediest households to keep poorer students in school. Similarly, a better return could be obtained from the generous public transfers to finance fiee tertiary education, targeting subsidies to create better opportunities and incentives so that students fiom poorer homes complete their secondary education and enter the university, whether by means of direct (means-tested) transfers or loans. Improved incentives for students to complete their secondary schooling and enter university could reverse the relative decline in numbers of those entering higher education in Uruguay.
240. Administration of public education. Administration of public education in Uruguay is in the hands of ANEP, an autonomous body. Within the ANEP, primary, secondary and technical education are administered separately, each by an independent council formed by members appointed at a political level, The three councils are coordinated by the Central Directive Council, formed by five members appointed by the legislature. The organization of the management structure into three separate administrative councils leads to compartmentalization of the educational system, hampering global planning and reducing the effectiveness of the ANEP. It would be usefbl if the revision of the education administration in Uruguay were to center on simplifying the structure ofANEP, so as to enable a better planning and administration of the education process as a continuum from pre-schooling through graduation fiom high school. One option would be to strengthen the role of the director of ANEP vis-&vis the councils.
34 There is much to be learnt from countries such as Colombia, Mexico and Chile in these areas.
79 CHAPTER V: INNOVATION-DRIVEN GROWTH - PILLAR 3
241. Sustained economic growth over the long term will depend on rapid total factor productivity growth driven by processes of innovation and knowledge development. Innovation has been the most important source of productivity growth in fast growth countries. Many successful innovating countries are small, open economies with sound macroeconomic fundamentals. Catching-up on innovation vis-&vis these countries will hinge on a comprehensive strategy including modernizing education, increasing expenditure in R&D, high business sector participation in the financing of R&D, and providing an enabling environment for private sector development and financing of innovative activities. Development of a diversified base ofinnovators, with a major role for Small and Medium Enterprises (SMEs), requires improved linkages between science and industry and a high level of networking among leading players in the area of innovation (companies, research centers, universities, state agencies) both within the country and around the world,
242. The state has a crucial institutional responsibility in the promotion of innovation-driven growth. This includes designing innovation policies and strategies, and providing an enabling environment for Private Sector Development (PSD). In order to be able to perform the latter, the state faces the challenge to modernize itself both by transforming its institutions to be able to assign resources strategically, and developing a skilled, adaptable and motivated civil service - that will ultimately be in charge ofdesign and implementation of policies in close coordination with the private sector. Reform of the state in support of innovation-driven growth could create opportunities for SMEs to improve the quality, design and innovation oftheir products.
243, Many of the profound transformations required for institutional development will take time to mature. Several of the proposed reforms could entail significant fiscal cost, such as, for example, increased investment in R&D - even though the private sector is expected to cover most of the additional investment. In view of the strategic significance of the objectives, which cannot be delayed, the implication is that priority should be assigned to the introduction ofthose reforms that are slowest to mature (civil service, business culture, interconnection within the innovation system), postponing those with a greater fiscal impact. In addition, there are significant reforms -such as that of the state procurement system- which in addition to efficiently serving the innovation process, can also have a favorable fiscal impact even in the short term.
244. This chapter describes the policy and reform options for innovation-driven growth - pillar 3 of the growth strategy. First, emphasis is placed on improvements to the business climate to encourage PSD, Second, an analysis is made ofpolicy options to favor development of SMEs. Third, an outline is provided of a strategy for the development of a national innovation system (NIS). Fourth, reform options are analyzed to increase the efficiency of the state, and particularly its civil service, the government procurement system, and the development of a results-based budget -essential for
80 allocating resources coherently with the adopted strategy. Increased efficiency by the state can underpin modernization ofthe NIS.
5.1 Private sector development (PSD)35
Legal, regulatory and instit~tionalenvironment
245. Laws and business regulations, and the quality of public institutions that enforce them can have a strong impact on growth (World Development Report, 2004.) This impact directly on the structure of incentives faced by the private sector in conducting regular business, new investments and innovation activity. The security provided by property rights, predictable legislation and trade regulations with a low compliance cost contribute to linking investment efforts by agents to the rewards and benefits derived fiom them.
246. Uruguay in general ranks relatively well in terms of laws, regulations and institutions. Uruguay has relatively stable institutions and perception of corruption is relatively low - it ranked 2nd in Latin America in Transparency International’s Corruption Perception Index. However, there are important areas for action to improve the potential for PSD and innovation.
247. An evaluation of a comparative database indicates that legislation in Uruguay contains significant shortcomings as regards market entry and exit and protection of small investors - mainly because of the lack of transparency (Figure 16). Starting a business in Uruguay requires companies to comply with at least 11 separate procedures, takes about 45 days, costs 48.2% of income per capita. These indicators are slightly better than the region average but well off the average of OECD countries. Uruguay compares unfavorably with the region in terms of the minimum capital required to start a business - 181.6% of income per capita. The information disclosure index is half the level ofthe region’s average level.
248. There are also drawbacks to the legal framework in Uruguay for bankruptcy. In addition to a problem caused by the existence of different legal procedures, depending on the type of debtor, disadvantages include:
0 Timeliness and efficiency of bankruptcy proceedings. A bankruptcy procedure takes approximately 4 years, costs 8% ofthe estate and an efficient outcome is not generally achieved in value terms.
0 The “acuerdo preventivo” - the main restructuring mechanism for economically viable companies under bankruptcy procedures - does not work For example, the debtor files a petition even when it is certain to default.
35 Based on Rozenwurcel(2004) and Guinet (2004).
81 Most SMEs do not use bankruptcy protection. Among the reasons for this are the high cost and poor accounting records.
Figure 16 - Comparison of business climate
48.2 50 -
27.4
16, 11.5 117 n
1 Cost of enforcing contracts (Oh ofvalne of debt) M-
Nmy USA Chile Spain mnba 8rmd Cslombm MeXim U~guay
I Source: “Doing Business”, Database, World Bank, 2005. Note: The index ranges between 0 and 7, the higher values indicating greater disclosure. Other countries showing the greatest disclosure of information at world level are Israel and the United Kingdom.
249. Uruguay also ranks below the region’s average in terms of cost and time for registering property, and procedures and time to enforce contracts. Some ofthese issues have to do with performance of the judiciary. Although the independence ofthe judiciary is long-standing in Uruguay, the system is often slow in its actions. Uruguay is also noted for having a limited number of alternative mechanisms for resolution of commercial and administrative disputes, and a lack of technical capacity and legal
82 training to deal with complex economic cases. Economically important and strategic specialized courts, such as the two bankruptcy courts, are under-funded and lack adequate facilities and professional staff. The clearance rate -the ratio between the number of cases solved and the number of cases initiated each year- is an indication of the judiciary’s capacity to produce in relation to the demand for service. Evidence indicates that the average resolution rate for commercial and administrative disputes over the 1995- 2000 period was under 1%.
Policy and reform options
250. Many of the reforms to create a favorable environment for PSI) could be implemented and generate benefits in the short term. The options that the government could consider for improving the legal and regulatory environment for PSD include:
a Simplification of procedures and regulations and reduction of the number of steps needed to start a business. A review ofthe implications ofthe tax system for new firms could help to determine if some taxes on companies and labor could be deferred in the first few years ofoperation.
Promotion of cooperation between businesses through legal instruments. Cooperation could help to address high unit transaction costs, improve the bargaining power of micro businesses and SMEs for purchases including public services.
Expanding the use of IT for doing business with government. The development of the legal fiamework for government procurement could be designed to develop quality standards on a continuous basis and promote purchases fiom SMEs.
Improving contract enforcement. This could be achieved by simplifying and reducing the number ofprocedures to enforce contracts.
a Reducing court involvement in business matters. Educating the private and public sectors on the benefits of alternative dispute resolution mechanisms - in and out ofcourts - could help.
a Bankruptcy legislation could be updated -e.g., along the lines ofthe proposed legislation already sent to Congress- facilitating rehabilitation processes for economically viable companies. This includes the unification of bankruptcy proceedings among other actions.
Training of judges: Specialized training and programs for continuous legal education would help judges to handle economically complex cases.
a A special unit or committee could be set up in the Presidency with the specific purpose of contributing to improve the business climate. Its function,
83 authority and responsibility should center on issues of deregulating and simplifying commercial procedures.
Modernizing aspects of the judicial system to guarantee more effectively the rights of the individual -property rights in particular. The agenda could include measures to improve the administration of cases, increase the use of hearings, and simplify the notification and appeals process.
5.2 SMEs and Innovation
251. In 1997 micro businesses and SMEs contributed nearly half of GDP and accounted for 71% of Uruguay employment, of which 27% corresponded to micro, 25% to small, and 19% to medium-sized firms. These percentages are similar to those observed in other countries of the region; however, the average number of workers per enterprise (around 4) is substantially lower than the region average (around 10).
252, The micro enterprise and SME universe is highly heterogeneous. The bulk of micro enterprises and SMEs have practically no managerial, technological or marketing capacities, and a high proportion ofthem operate informally. Nonetheless, there is a small core of innovative enterprises with a scientific and technological base, well established in the software and information technology sectors, which is dynamic and has an international projection.
253. Between the two extremes there is a host of enterprises; most are companies with limited managerial, technological or marketing capacities, lacking an innovative approach and having little or no presence in international markets. However, also within this category, there is a minority of dynamic and innovative SMEs with an associative inclination and an exporting disposition, concerned about enhancing their capacities and the quality of their products and processes - these are found more fiequently in: natural resources, foods and non-food agro-industry, chemistry and pharmaceuticals, health, animal and vegetable sanitation, transport and logistics, and tourism.
254. Most SMEs have a very limited innovative capacity. A recently published report - DINACyT (2003) - which presents the results of the 1998-2000 innovation activity survey, shows that only one of every three Uruguayan industrial companies carried out innovative activities during the mentioned period, of which only 30% obtained innovations in products or processes. These indicators are much lower than those of Argentina, where 78% of companies studied in a survey covering the period 1998-2001 carried out innovative activities, with 56% of these managing to produce innovations.
255. Uruguay’s science and technology indicators are a long way from those of advanced countries and, in most cases, lag behind those of regional comparators (Table 18). R&D expenditure, both in per capita terms and as a share of GDP, and the
84 invention coefficient (patents per thousand inhabitants) are significantly below the average in the region , as well as lagging behind the levels achieved by Chile, Argentina and Brazil. The R&D to GDP ratio was 0.24% in 2000 compared with a regional average of 0.58% (which in turn was around one third of the level in the European Union), However, Uruguay fares relatively well - region-wide - in terms of number of researchers, and shows a relatively high percentage of private participation in R&D.
Table 18 - Science and Technology Indicators, Year 2000
Source: Rozenwurcel(2004). * Year 1999. ** Patent applications by residents per 100,000 inhabitants. *** Corresponding to total innovation activities. The rest is R&D.
256. There are several favorable factors that could serve as a basis for the development of the SME sector and the future NIS:
Qualified human resources are in general available (see Chapter 4.4). According to UNESCO (2000), in 2000, Uruguay had the second highest secondary school attendance level in Latin America, with a 97% literacy rate, one ofthe world’s highest.
0 Strong ties between R&D and production in some sectors. This is the case particularly in agriculture where local R&D has played a significant role in the re- conversion of Uruguayan livestock in the last decade, as well as in other traditional and non-traditional agricultural activities. Similar capacities can also be found in the chemical industry and its applications, forestry, information, biotechnology and communications technologies.
0 A strong dynamism has been observed in “new” sectors with a high participation of SMEs. Such is the case of software and information services and
85 cultural industries. According to CUT1 estimates, the Uruguayan software industry exported US$83.5 million in 2001, with an accumulated annual increase of 62.3% between 1989 and 2001. In 2000, cultural industries sales contributed US$555 million to GDP and directly or indirectly absorbed 50,000 employees.
Dynamic traditional sectors. Renewed dynamism is observed in the following sectors (only partly due to improved relative prices since the devaluation): beef, leather and textile manufactures, wine production, citrus fruits, forestry activity, fine chemicals and tourism.
A growing number of companies have certified quality standards. According to a study by the Uruguayan Institute of Technical Standards (UNIT, 2002), Uruguay had 230 companies with an IS0 9000 certification, a high number in comparison with other countries in the region after adjusting for relative size.
Programs to support SMEs and the NIS
257. The DINACyT (National Directorate for Science and Technology) was created in 2001 as the unit responsible for coordinating, managing, executing and evaluating policy instruments relating to science, technology and innovation. CONICyT (National Innovation, Science and Technology Council) is the advisory committee, which puts forward plans and policy guidelines in relation to innovation processes, science and technology. It also promotes the development of research in all areas ofknowledge, as well as actions leading to the strengthening ofthe NIS. CONICyT is also responsible for the evaluation and approval ofprojects.
258. As regards specific programs for innovation and support to SMEs, Uruguay would benefit from a clearer strategic vision and stronger coordination between the various institutions responsible for its implementation. Services have been under- utilized and there are important mismatches vis-his private business needs. Institutional challenges include the need for more autonomy in terms of operational guidelines and improved incentives for staff. Also, there are important overlaps and duplications in certain areas, while in other areas - there has been a lack of adequate coverage (Sutz, 1998). Among the latter, is the inability ofthe financial system and funding agencies to address needs of innovative ventures.
259. One significant institutional weakness of the NIS is that the main agencies are located within the orbit of the Ministry of Education. Since the Ministry is focused on educational themes, these offices are not duly ranked and are inadequately articulated with other areas of government. In addition, their budget has proven vulnerable to frequent cuts during periods of crisis. There is also a lack of program evaluation culture.
260. The NIS also reveals some strengths. These include recent attempts -although not perhaps on a desirable scale- to improve the strategic focus and internal consistency ofthe system. The development ofcloser ties between important research institutions and
86 private business, and various private or mixed projects which, although recent, may have a strong impact on Uruguay’s innovation potential, There has been, for example, an incipient articulation among some institutions providing support to SMEs - including “Red ProPyme” and sectoral programs like FOMIN (wine production and software). Recent initiatives include the launching by the government in 2001 of a Program for Technological Development with the aim of mobilizing the innovating potential of SMEs. The measures supported by the Program provide greater strategic and operational coherence to the NIS, including the process of planning and execution of the various programs and their related funds. The program also intends to improve coordination between research and commercial applications, and in more general terms, between the public and private sectors. After three years, however, execution needs to be stepped up.
261. UdelaR has implemented various successful initiatives which illustrate how public-private initiatives can be fostered within the boundaries of existing institutions. Perhaps the most successful research institute - based on institutional design, continuity, governance structure, professional staffing and administration, performance, and network experience - is INIA (National Institute for Agricultural Research). Apart fiom managing its own budget, it administers specific funds allocated under competitive procedures. There are a number of private and mixed projects which have emerged more or less spontaneously - though often with some kind of government support - and which are at the fiontier of innovation in the areas of information technology, software services and in general knowledge-based sectors. These include: (i) a software testing center at the Pando Technology Pole with support received by UdelaR fiom the EU; (ii)installation of an information technology business incubator stemming fiom an agreement between LATU and ORT University; (iii)the United Nation’s EWRETEC incubator program; and (iv) creation of the Information Technology Industry Academic Center (CAITI) with participation of all the institutions involved in the development ofthe sector.
Options to reformulate SME programs
262. The government could consider consolidating existing funds into a single Fund for Competitiveness and Innovation. Its main aim would be to co-finance programs and projects based on competitive mechanisms, with transparent rules for presentation and evaluation of proposals, and strict mechanisms for follow-up, control and evaluation of results. The Fund would offer partial funding or matching grants decreasing over time. Technical assistance services would complement funds for investment or to develop projects.
263. Innovation programs could be guided by three objectives:
a) Strengthening the managerial base
i) An Entrepreneur Development Program consisting of projects submitted via institutions such as UdelaR, ORT, LATU, EMPRETEC, etc. to train and develop
87 technical, commercial and financial networks and other key activities for companies just starting up.
ii) A Quality Program aimed at improving company access to consultancy and specialized training. This could be achieved by strengthening existing institutions, such as the Red ProPYMES.
iii) An ITDiffusion Program for SMIEs.
b) Promotion of innov~tionand produc~ionnetworks
i) Development Program for suppliers and clients of large companies to improve access to knowledge, markets and quality standards. Benefits may also include shared training and consultancy services, Good examples include the programs developed recently in Argentina, such as the program for suppliers ofRepsol- YPF or the program for the development of Techint customers.
ii) Program for the development of clusters - a network of companies and institutions that interact at a physical location defined on the basis of cooperative and competitive relations. The main challenge will consist of stimulating relationships between the various players, such as researchers at technical schools or universities and companies or commercial associations. Good examples of this include the SEBRAE initiative called “Arranjos Produtivos Locais” that is having a significant impact in various regions and sectors in Brazil, and the IDB FOMIN MIF programs in Latin America which include support for wine-growers in Uruguay.
iii) Allocation of scarce funds for innovation and R&D in a strategic manner, favoring the formation of consortia between universities and companies in the private sector, and large companies with SMEs. One important objective would be to strengthen relations between R&D institutions, agricultural producers and agro-industries, which could contribute to the change in focus in primary production in favor ofprocessedagricultural products.
c) ~nternationalizationof SMEs
i) Program for the Promotion of SME Exports. In coordination with the Ministry of Foreign Relations, the program could consider market diversification, the promotion of new exports, and the formation ofexport groups.
5.3 Development of a strategy for the National Innovation System
264, Challenges of innovation policy. Business innovation is not limited to the acquisition oftechnology or the purchase ofcapital assets that embody it. It comprises as well tacit knowledge generated at the firm through experience and which, by its nature, is
88 difficult to transfer tolor be absorbed by other firms. In general, creating dynamic competitive advantages involves the generation, dissemination, transfer and adaptation of coded and tacit knowledge, as well as the development of new ways of linking actors, particularly links between private companies, going fbrther than traditional market relationships might imply. A well functioning innovation system thus incorporates fluent interactionshelationships between: universitiesltechnology centers and business companies; SlMEs and large corporations; corporations and suppliers of technological consulting and training services; business and scientific-technological languages; and companies, networks and local systems to adapt and transfer knowledge.
265. Good innovation policies reflect the new global environment for innovation, characterized by growing globalization ofR&D activities, rapid devebpment of markets for knowledge, high mobility of highly qualified labor, and regional integration of innovation systems (e.g., EU). In this environment, innovation policy design in advanced countries shares the following minimum set ofguidelines (Guinet, 2004):
e New steering and fbnding mechanisms for public education and research (innovation networks and consortia, technology market-places);
e Shifting support from large to small firms (project-based, business incubators, regulations to encourage SME relevant public research);
e New policy tools to support innovation: e.g., Public-Private Partnerships to foster industry-science relationships in OECD countries (risk and cost sharing, improved procurement, complementarities between public and private R&D);
e New policy targets: networks or clusters instead of individual frms or sectors (cluster programs, innovation cooperation programs.)
266. Bottom-up/top-down approach. Innovation policy design comprises actions at the microeconomic level - incentives and support for R&D activities, development of technology competencies, business networks and systems to help create regional and sector clusters - and at the institutional level - enhancement ofthe institutions and spaces for the interaction of agents. A modern innovation system combines a bottom-up approach, which is responsive to the needs and demands oflocal systems and businesses, with a top-down approach leading to adjustments in the institutional and regulatory fiamework (Guinet, 2004). Diagram 1 summarizes the main sources of knowledge and innovation - technical, organizational and institutional - as well as the set ofpolicies to foster the generation and systematic application ofknowledge within and across sectors - cluster policies, Public-private partnerships, and policies to strengthen innovation competencies, as well as R&D and linkages between innovation systems.
267, Uruguay can draw valuable lessons from the experience of the most successful innovator countries - many of which are developing countries:
89 0 They were generally small in size, with good macroeconomic fundamentals and very open economies.
0 They record above average improvement in innovation performance linked to: a high rate of investment in education, Information and Communication Technologies (ICTs) and R&D, and a high share of business financing of R&D.
0 They have an increasingly diversified base of innovators, with a greater role for SMEs, improved linkages between science and industry and a high level of networking among innovators.
0 Their fmancial systems support innovative activities.
268. It should be noted that being small is not a barrier -and could in fact be considered an advantage- perhaps because small countries can be flexible in adjusting to dynamic changes in global innovation. Uruguay faces the challenge to: (i) introduce reforms to its education system (especially higher education), (ii)raise the level of its spending on R&D, (iii)increase private participation in R&D, (iv) diversify the innovator base, (v) connect innovators by means of networks, (vi) improve linkages between SMEs and R&D activities and (vii) promote the financing of risk capital and start-up capital. All ofthese represent significant efforts.
269. In addressing these challenges, Uruguay could draw on specific lessons from countries which have established best practices:
A strong policy governance of the innovation system, including an effective coordination between policy instruments and institutions (Finland, Korea);
Development of a diversified set of innovative clusters around large firms or know ledge institutions (Finland) ;
Promote cooperation among SMEs to compensate for the lack of large firms as engines of innovation (Denmark, Taiwan);
Promote science-based innovation and innovation in services to extract more value fiom natural resources (Iceland, Norway, Chile);
Exploit innovation synergies between services and manufacturing to create competitive advantages in fast growing global market niches (Australia).
90 Diagram 1 - Sources of Knowledge and Innovation
I Sources of knowledge and innovation I
I I Technical Organizational Institutional
P Research in science and ~ Technological adoption and > Institutionsare integral to the technology expands the stock workplace learning depend structure and governance of of formal, codified knowledge on human capital and ‘national innovation systems’ P Knowledge evolves more organisational effectiveness that link knavledge and broadly through structured 9 High performance wd wealth creation pmcesses collaboration, networking, systems release creativity 9 NIS are constituted by spill-overs and diffusion > Organizational knowledge linkages between public is generally tacit is a major agencies, research and factor in productivity education and companies I II I
Generation and syslemalic appllcatian of knovAedge within and across soc!ors
I Cluster
I
in scienca and
Public -private partnerahips
Source: Guinet (2004).
Refor~ulatinginnovation policy in Uruguay - Catching-up strategies
270. Designing a forward looking NIS in line with the experience of successful innovators involves targeting the following broad strategic objectives and implementing the related tasks:
271. First, avoiding the “low equilibrium trap” in R&D and investments in knowledge entails the following:
0 Check framework conditions (competition policy, regulations, taxes, intellectual property rights) that affect incentives to innovate and private returns on innovation;
0 Stimulate private initiative without replacing it; instead of a “magic bullet,” aiming for a group ofwell-coordinated instruments;
91 0 Look for leverage points at the interface between public research (including public companies) and private research, and between education and in-house firm training;
0 Avoid expensive generic financial support and differentiate the specific needs of different types ofenterprises (SMEs) and technological areas;
a Articulate and balance top-down and bottom-up approaches for local and national initiatives through instruments such as public-private partnerships for innovation or network and cluster-based policies.
272. Second, ensuring political and budgetary commitment to sustained and balanced investment in knowledge involves efforts to:
0 Protect investments in knowledge from macroeconomic instability;
0 Continue to invest in the scientific base; free-riding is not an option;
0 Leverage limited national resources through intensified international cooperation and linkages in areas ofeconomic relevance;
a Focus on scientific excellence and improve responsiveness of public educative and research organizations to social and economic needs by adopting internationally proven best practices regarding steering and fimding of public research.
273. Third, bridge “innovation islands”, and build “innovation polders” through action to:
0 Diagnose the NISto identify under-exploited potential, and associated gaps;
0 Avoid picking “winners”, instead identify “role models” in areas with potential and encourage industry-led collective initiatives to diffuse good practices;
0 Promote cluster development by providing platforms for discussion and through schemes to stimulate knowledge exchange, reduce failures of information and strengthen cooperation among firms in the fields of market intelligence, design and branding, knowledge management (for example copyright) and the development ofhuman and technological resources;
0 Reduce financial obstacles to new undertakings, especially in the field of techno logy;
92 0 Encourage international partnerships in order to access complementary foreign competencies, and to ensure that the innovation strategy is consistent throughout the value chain, particularly when part of it is located abroad;
Maximize national participation instead of national benefits when designing innovation programs.
274. Effective innovation policy creates conditions for an innovation process which can be sustained over time. In this regard, developing a common vision shared as broadly as possible by the state, businesses, innovation agents and civil society may be an important pre-requisite. Chile’s “Pro Growth Agenda” (“Agenda Pro-Crecimiento”), a public-private partnership aimed at creating conditions for fast growth and innovation, , is a good example of a shared vision leading to a combined bottom-upltop-down approach that detects and pro-actively meets the needs ofprivate companies. The second, ongoing, phase of the “Pro-Growth Agenda” in Chile places greater emphasis on innovation, including the promotion of risk funds.
275. A strong institutional framework and effective coordination of policies help avoid overlapping, atomization and wasting resources; this ideally points to a centralized policy design in a single agency, not subordinated to ministries or other agencies which do not have innovation as their main mission. Such a body, including private representation on its board, could establish priorities, define instruments and assign resources. On the other hand, the implementation of policies and programs could be widely decentralized across a network of local or sectoral institutions with a strong private sector presence.
276. It is important to ensure transparent allocation of public resources in accordance with pre-established project selection criteria. At least in the first stage, the main recommended vehicles are subsidies or grants, decreasing over time and granted on the basis of co-fmancing (matching grants). Equally important is the continuous monitoring of programs - technical, financial, results evaluation - on the basis of predetermined parameters and adoption of strict criteria to terminate those programs or projects which do not provide the expected results. Programs should include criteria for the evaluation of their costs and impact. This is a basic criterion for control and transparency in the use of resources, and also helps with the process of institutional learning -it could help in broadening, reducing or reformulating programs or projects.
277. The success of programs will ultimately depend on the quality of the institutions that apply them. Public funds may be partially assigned to institutions taking into account the extent to which these contribute to their own sustainability, e.g., through charges to beneficiaries. This would help to leverage public resources and commit beneficiaries to actions they carry out.
278. By way of example, a model institutional framework for Uruguay could be centered on the creation of the “Fund for Competitiveness and Innovation” -funded out of the resources of existing programs. The proposed institutional setup to
93 coordinate and provide coherence to the different programs for SIME: development and innovation would be anchored by the creation of a “National Network for Business ‘Development and Innovation” made up of the following organizations: 36
0 An Agency for Business Development and Innovation (ADEI), the hub of the network, could be a second tier institution which mission would be to develop a system of national, local and sectoral institutions in charge of business development and competitiveness. ADEI could be managed by representatives fiom the Executive and Legislative Powers, local governments and private business. It would administrate the Fund for Competitiveness and Innovation.
0 A Business Development and Innovation Cabinet, directly under the President of the Republic, would fbnction as an area of coordination of all the national government organizations involved with competitiveness,
0 An autonomous Office of Deregulation for Competitiveness would be in charge of evaluating public regulations with the aim of securing a level-playing field and improving conditions for business development.
5.4 Modernizing the state3’
279. Successive governments have demonstrated an . ability to effectively build upon past state reforms. State reforms have tackled areas such as the budgetary process, procurement, the civil service and administrative reform. Despite progress achieved, there is still a vast agenda of reforms to improve the efficiency ofthe state. Inefficiency is not related only to the cost of provision of public goods and services, but also to the ability of the state to design and implement policies and complex reforms as well as to decide strategically on the reforms to be promoted,
280. This section centers selectively on those areas of the state modernization of the state that are particularly relevant for the design and implementation of of innovation policy. These include results-oriented budgets -crucial for the use of the budget as a strategic tool- a government procurement system -directly relevant to innovation- and the reorganization of the civil service. The importance of these reforms clearly transcends their impact on the processes of innovation and PSD. Reforms to the system of government procurement and to the civil service could also have a potentially significant fiscal impact thereby contributing to macroeconomic stability.
~odernj~ngthe state (I)- Results-Based Budgeting
28 1. Results-based budgeting policies can contribute to improve the Executive’s options for strategic planning and results monitoring. At present, the budget process
36 Details of the proposed institutional setup are provided in the background paper “Una Propuesta de Politica para el Desarrollo Empresarial en Uruguay’’ by Guillermo Rozenwurcel, World Bank, 2004. 37 Based on Bhansali (2004) and Valladares (2004).
94 includes an annual review of activities, targets, and management indicators defined by executive units. This allows for some possibility for correction, if necessary, or adaptation to new circumstances in the budget preparation process, which is generally done prior to each Review ofPublic Accounts before Congress. The process ofbudgeting by results adopted in Uruguay -part of the process of state reforms- includes regulations, information systems, and procedures.. Initial progress became evident in the 1998 Review of Public Accounts and in the management plans for the 2000-2004 national budget.
282. Although there have been evident improvements in controls on spending and the implementation of results-based budgeting, these have mainly involved establishing the basis for evaluating the efficacy, efficiency and quality of services. So far neither the Central Administration nor the Legislative branch seems to have internalized this system in its operations, neither for preparation ofthe budget nor for the evaluation of results. In the last Review of Public Accounts, reported performance indicators were on average less than satisfactory - 40% of 324 efficacy indicators, 20% of 164 efficiency indicators, and only 4% of 29 quality indicators showed positive results in relation to their targets,
Options to strengthen results-based budgeting
283. The government could consider the following options to assist in improving its results-based budgeting system:
0 In order to operate efficiently, the targets of the performance evaluation system could be defined by the respective units or departments. It may be necessary to standardize different incentives in different executive units. Technical and political leadership is important in defining management goals and indicators, as well as in evaluating results.
0 Specific targets and indicators which reflect efficiency and quality could be made public so that the population can evaluate the public sector’s performance. This system would provide a greater level of objectivity in the evaluation of budget allocations, and would help to measure the level of political will in the Executive and Congress.
The government could introduce procedural reforms to the timetable for evaluating budgetary goals and results. Legislation establishes that the President must submit to Congress the report on the execution of the Budget -and the evaluation of results- for the previous year by June 30. Since the Congress decisions are retroactive in nature, Le., approval of the budget is given months after execution has begun - the execution ofthe budget by the line ministries and departments is complicated when the Congress modifies the targets, making implementation difficult and inconsistent with government’s priorities. Although the budget must be presented on or before June 30, there is nothing to prevent a focused discussion prior to that date.
95 Modernizing the state (2) - Public procurement
284. Modernization of procurement helps lower public expenditure and also promotes competition and innovation. SMEs may improve their access to government purchases through competitive purchase mechanisms. Technical and quality standards required by the government may also contribute to improve the quality of SME goods and services and the processes through which they are produced.
285. The Central Administration’s recurrent purchases and investment in 2002 reached approximately US$500 million; approximately half of these purchases wer.e channeled through regular procurement procedures, and the rest was channeled through direct purchases. Direct purchasing is faster and can therefore be justified in some cases; however, the prices obtained through calls for bids are usually considerably lower than those for direct purchases. Prices for direct procurement in 2002 were on average between 38% and 58% higher than those obtained through calls for bids, and on some occasions have been double those obtained though tenders.
286. CEPRE (“ComitC Ejecutivo para la Reforma del Estado”) has estimated the potential cost reduction for the Central Administration by purchasing products at cheaper prices resulting from competition and calls for bids vs. non-competitive means, such as direct purchasing. The potential amount of cost reduction was estimated at close to US$52 million. This potential reduction is equivalent to 10% of the total amount of procurement by the Central Administration in 2002.
Options to improve government procurement
287, The government could consider full implementation of the Project for Modernization of state purchasing that currently exists. Congress is currently studying a bill to modify procurement legislation, including new procedures which seek to generalize the substantial reduction in costs already achieved.
288. The SICE (Integrated State Purchasing and Contracts System) could be brought into a more general use among the executive units, or at least those within the Central Administration. This would facilitate the standardization of procurement procedures and compliance with the country’s legal ftamework. Bringing SICE into general use would provide a guarantee of compliance with procedural rules, such as the obligation to publish on the website and ensure payments by the state are recognized for purchasing. It would also allow for a more wide-ranging control of the calls for bids and the extension of such calls, an aspect that is currently difficult to control in Uruguay. Generalized implementation of the system would also be usefkl for keeping suppliers up to date with their tax payments,
96 Modernizing the state (3) - Human resources (Civil Service) management
289. “The greatest weakness in the state apparatus and in the government personnel system in Uruguay is ineflciency. This is not like the situation in other Latin American countries in that it has to do with deficient peflormance by employees and with the low level of their professional profile. The low productivity of personnel is due partly to aspects of organizational culture, people having a second job, and low levels of application to the job, and also very much to the fact that many professionals are working in functions and positions which have little to do with their specific knowledge. jJ8
290. Uruguay stands out among the countries of Latin America for having a large percentage of public employees as a percentage of the total working population. In 2002, public sector employment in Uruguay represented 23% of total employment - general government accounting for 16.7%. These high figures follow a period of downsizing - an 11% reduction of public employees over 1995-2002 as a result of the Administrative Reform that took place in Uruguay in that period. The general government wage bill in Uruguay represented 9.9% of GDP in 2002, above the regional average (7.1%), but below the OECD average (11.6%).
291. The reduction in public employment in recent years was not followed by a decrease in the expenses for compensation of employees. In the central government, where public employment decreased 5% between 1996 and 2002, there was an increase in wage expenses of2% in real terms. This can be explained by the fact that most of the savings in the executive units can be used inside the same executive unit as payment of performance bonuses, or for financing highly specialized positions andlor positions of greater responsibility.
292. The Central Administration’s human resources management is heterogeneous and unarticulated with regard to results evaluation. This is particularly true in the area of salaries, which depend to a considerable extent on each individual agency and do not reflect equal pay for equal work or responsibility. Furthermore, wage setting in the public sector may be distorting private labor markets, particularly at the lower end of skills. According to CEPRE, average hourly pay for public employees is generally higher than (for medium and lower categories) or the same as (for higher categories) payments to personnel in similar categories in the private sector. In the case of the most highly qualified group of public sector personnel, the average wage is 79% of that paid in the private sector. Nevertheless, if Public Health Ministry employees are excluded, the average hourly wage is 13% higher than in the private sector. The overall compensation received by public employees - especially low skilled workers - would be greater if other benefits which public employees enjoy are taken into account (i.e., job security, holidays).
38 La Economia Politica de la Reforma del Servicio Civil en Uruguay: 10s aiios 90, F. Filgueira, B. Heredia, P. Narbondo and C. Ramos (2002).
97 293. A system of performance incentives (awards) was created in 1996. It established a monetary payment to employees who were rated as “excellent” or “very good”. The same evaluation for incentive payments is used for rating the employee’s substantive career path. However, a considerable number of executive units have found the system difficult to apply, leading to delays in calculating and paying the awards. From 1998 to 2001, despite having a budget surplus available for incentive awards in 57 executive units, only 40% paid the incentives on time every year. The performance evaluation of public employees in Uruguay appears unrelated to whether (or not) the units to which they belong achieve their targets. Supervisors have used the system of performance management not to promote competition with the aim of achieving an overall improvement, but mainly to maintain, and eventually raise, levels of motivation among a core group ofemployees who are better trained and more engaged.
294. Further adding to the complexity of incentives in the public administration, public employees in Uruguay have been hired under different regimes. Formal public sector employees (those “budgeted”) represented 70% of personnel in the public administration. These employees are part of the formal career structure for civil servants and cannot be dismissed without authorization of Congress. This represents a rigidity in the public sector labor force, as dismissal is virtually impossible. The remaining public sector employees are hired on contracts and, although they can be dismissed, in practice they also have de-facto job security adding to the rigidity of the system, The way different types of contracts coexists fbrther distorts civil service incentives - permanent contracted employees function as a parallel structure to the public sector career, involving hiring, appointment, promotion and dismissal.
Optionsfor civil service rejiorm 39
295. The following options for civil service reform could be considered:
0 Define which activities are to be provided by permanent employees, and which ones could be executed by temporaries or other categories of employees. This would require a better definition of the regime for permanent employees to ensure consistency between the various public sector employment regimes.
0 Create a “civil service decision committee’’ - along the same lines as CEPRE - to set consistent remuneration policy. Efforts are needed to include all employees in the Remuneration System (SR) in the Central Administration.
0 Extend the Supervision System for Objective Work Conditions (SCOT) to all units on the Central Administration and implement its direct connection to the payroll. Information about attendance gives more control on civil service and should have direct consequences on the remuneration ofemployees.
39 Based on Valladares et al. (2004) - a background paper for the civil service reform chapter of “Uruguay - Public Expenditure Review”, World Bank (forthcoming).
98 0 Link performance evaluation, bonus and promotion to the achievements of the targets of the executive units. The process of implementing a budget for results should link the indicators of efficacy, efficiency and quality of the executive unit to the employee evaluation.
0 Base evaluation of employees on more objective and standardized criteria between all executive units. This is specially relevant within the Central Administration.
0 Increase control over compensation policy to reduce discretion. In order to simplify the remuneration system, with increased control and transparency, the restructuring should decrease the importance of compensation mechanisms in the total salary.
0 Continue efforts in workforce right-sizing; reallocations should take into account qualifications of public servants and the administration’s needs.
99 CHAPTER VI: CONCLUSIONS
296. Uruguay has well-educated people, stable and democratic institutions and valuable natural resources. In spite of declining growth in the last half-century, Uruguay has been able to preserve these assets. A new path to prosperity may be built around these strengths. The fast pace of global change and its own structural transformations, leave Uruguay with the challenge ofembracing a new agenda for growth with equity. As examples in the region like Chile’s “Agenda Pro-Crecimiento” or Ireland in the EU context help to illustrate, the latter is feasible but will required a shared vision, persistence and determination. Unless shared, the policies and reform options chosen are unlikely to be well designed, implemented, or be credible. Persistence and determination are needed because the benefits of many reforms are unlikely to materialize in the short or even the medium term. Much will depend on the ability of political, social and business leaders will have to demonstrate strong leadership and determination to implement the program.
297. The most immediate priority for Uruguay is to set the country on a path of fiscal and financial stability - necessary to avoid new macroeconomic crises or episodes of contagion, and strengthening of the social safety net - to protect the most vulnerable in the face of rising informal employment and increases in poverty. These are the conditions necessary to consolidate the recovery -making use of idle factors of production and reallocating factors to more productive sectors -and for sustained growth with equity. The recovery stage also demands efficient factor markets -capital and labor- to facilitate reallocation ofresources from less productive sectors and companies to those with greater potential.
298. Social security reform will improve inter-generational equity and create fiscal space that will make it possible to strengthen social programs while servicing public debt. Fiscal sustainability also requires focusing on a series of state reforms -including tax and social security revenue administration, the government procurement system, and participation by the private sector in infiastructure -to prevent the pro-cyclical nature of public spending fiom again creating episodes ofmacroeconomic instability in the fkture. Although growth is in itself an important determinant of fiscal sustainability, it would be risky to assume that it will take place in the absence offkrther structural reforms..
299. Sustaining growth over the medium term will require new investment; hence the importance of developing a favorable climate for investment including strengthened links with the global economy. Uruguay’s past prosperity was associated with its traditional comparative advantage in agriculture, an open commercial regime, and sound infiastructure (particularly in railroads and ports). The introduction of a competitive framework for infrastructure is kndamental to the improvement ofthe global competitiveness of the country, to raising the welfare of its citizens, to the creation of new business and investment opportunities for the private sector, and to a reduction in the
100 government’s borrowing requirements (in view ofthe significant needs for investment in infrastructure in the medium and long term). Sustaining growth will also demand strong links to the global economy, including both trade policies that improve access to international markets for Uruguayan exports and an efficient infrastructure to narrow the economic distance from global markets.
300. Maintaining growth depends not only on a favorable investment climate for physical capital but also, and in a related manner, a favorable climate for investment in human capital. Hence the importance of modernizing education and health policies and institutions to ensure the development of human capital - which, in turn, is intimately linked to policies leading to the development of an economy based on knowledge. Sustained economic growth will indeed require rapid growth of total factor productivity led by knowledge and innovation. In addition to creating a favorable environment for development of the private sector, this will require institutional modernization and development of a national innovation system in line with the trends in countries that are successfhl innovators.
301. To return to the path of shared prosperity Uruguayans will face difficult tradeoffs and the challenge of committing to deep reforms. On that will depend whether per capita income will double in 15 years or 100 years.
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104 STATISTICAL ANNEX
Uruguay: Key Economic Indicators est. 1999 2000 2001 2002 2003 2004 Real Sector real growth PA) GDP at market prices -2.8 -1.4 -3.4 -11.0 2.2 12.3 Investment -9.8 -13.0 -9.1 -34.5 18.0 27.0 Exports of Goods and Services -7.4 6.4 -9.1 -10.3 4.2 22.7 Imports of Goods and Services -5.8 0.1 -7.1 -27.9 5.8 24.5
GDP (billion USD) 20.9 20.1 18.6 12.3 11.2 13.2 shares to GDP (?A) Gross Domestic InvestmentlGDP 15.1 14.0 13.8 11.5 12.6 13.3 Domestic SavingslGDP 13.9 12.3 12.1 13.5 14.1 15.0
Prices and Inflation CPI inflation (% change) 5.7 4.8 4.4 14.0 19.4 9.2 Nominal exchange rate, p.a. UR$AJS$ 11.3 12.1 13.3 21.3 28.2 28.7 Nominal exchange rate, e.0.p. UR$AJS$ 11.6 12.5 14.8 27.2 29.3 26.4 Real effective exchange rate, 2000=100 99.7 100.0 98.8 78.3 60.3 65.2
Balance of Payments shares to GDP (?A) Exports of Goods & Services 16.6 18.2 17.6 21.9 27.6 30.4 Imports of Goods & Services 19.1 20.9 20.1 20.3 24.4 27.8 Net trade in Goods & Services -2.5 -2.7 -2.5 1.6 3.1 2.6 Current Account Balance -2.4 -2.8 -2.7 3.1 -0.5 -0.8 Acummulation of International Reserves 0.1 1.1 1.5 -19.0 12.3 4.3
External Debt, US$ bn. 8.3 8.9 8.9 10.5 11.0 11.6 External DebtlGDP (%) 39.5 44.3 48.1 85.9 98.4 87.8
Public Sector Shares to GDP (?A) Revenue 32.2 31.4 32.7 31.1 31.1 29.9 Primary expenditure 34.2 32.9 34.0 31.1 28.4 26.2 Primary balance -2.0 -1.5 -1.2 0.0 2.7 3.8 Interest payments 2.1 2.6 2.9 4.7 6.0 6.0 Overall balance -4.1 -4.1 -4.2 -4.6 -3.2 -2.2
Gross Public Sector Debt 30.8 35.5 42.9 83.5 101.5 92.2 Gross Public Sector Debt, US$ bn, 6.5 7.1 8.0 10.2 11.4 12.2
Source: Uruguayan authorities and World Bank staff estimates.
105 NationalAccounts Shares to GDP (%) est. 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004
GDP at market prices 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0
GDP a* factor cost 103.0 103.1 102.9 102.3 102.4 104.1 104.8 105.8 106.2 104.7 102.6 Agriculture 7.9 8.6 8.0 7.5 7.0 5.6 6.2 6.1 9.3 13.0 11.7 Industry 28.0 28.9 28.5 28.2 28.6 27.4 27.2 26.4 26.7 27.1 29.3 Services 67.1 65.5 66.3 66.6 66.8 71.1 71.4 73.3 70.2 64.6 61.6
Resource balance -0.6 -0.1 -0.2 0.0 -0.7 -1.3 -1.7 -1.7 2.0 1.5 1.7 Exports of Goods & Services 19.8 19.0 19.7 20.5 19.9 18.0 19.3 18.3 22.0 26.1 29.6 Imports of Goods & Services 20.4 19.1 19.9 20.5 20.6 19.3 21.0 20.0 20.0 24.6 27.9
Total consumption 84.7 84.7 84.9 84.8 84.9 86.1 87.7 87.9 86.5 85.9 85.0 General government consumption 11.9 11.8 12.8 12.4 12.5 13.0 13.2 13.7 12.9 11.4 10.8 Private consumption, etc 72.9 72.9 72.1 72.4 72.3 73.1 74.5 74 2 13.6 14.6 74.2
Gross domestic investment 15.9 15.4 15.2 15.2 15.9 15.1 14.0 13.8 11.5 12.6 13.3 Gross domestic fixed investment 14.5 13.5 14.0 14.4 15.2 14.5 13.2 12.5 10.1 9.4 11.4 Change in stocks 1.3 1.9 1.3 0.8 0.7 0.6 0.8 1.3 14 3.2 1.9
Net income from abroad -1.8 -1.6 -1.4 -1.4 -1.4 -1.4 -1.4 -2, I -1.0 -4.5 -4.2 Net current transfers from abroad 0.2 0.4 0.4 0.3 0.3 0.4 0.3 0.3 0.7 0.7 0.7 Gross domestic savings 15.3 15.3 15.1 15.2 15.1 13.9 12.3 12.1 13.5 14.1 15.0 Gross national savings 13.4 13.7 13.7 13.8 13.8 12.5 10.9 10.0 12.5 9.6 10.8 Gross national product 98 2 98.4 98.6 98.6 98.6 98.6 98.6 97.9 99.0 95.5 95.8 Gross national disposable income 98.4 98.8 99.0 98.9 98.9 99.0 98.9 98.2 99.7 96.2 96.5
Source: Uruguayan authorities.
NationalAccounts Real growth rates (%) est. 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004
GDP at market prices 7.3 -1.4 5.6 5.0 4.5 -2.8 -1.4 -3.4 -11.0 2.2 12.3 GDP at factor cost 5.7 -0.9 5.1 4.3 4.5 -1.0 -1.1 -2.7 -7.8 0.3 9.2 Agriculhue 11.8 5.5 9.4 -6.1 5.2 -7.5 -3.0 -7.1 5.1 10.6 12.8 Industry 3.7 -2.5 3.3 5.7 4.8 -5.0 -2.3 -6.1 -12.8 0.9 16.1 Senices 5.7 -1.3 5.1 5.8 4.3 2.0 -0.2 -0.5 -7.7 -1.6 6.0
Exports of Goods & Services 15.1 -1.9 10.3 13.0 0.3 -7.4 6.4 -9.1 -10.3 4.2 22.7 Impolts of Goods & Senices 18.3 -3.0 11.3 ' 13.2 7.6 -5.8 0.1 -7.1 -27.9 5.8 24.5
Total consumption 8.3 -3.2 7.8 5.4 6.4 -1.3 -1.4 -2.1 -15.9 1.1 11.4 General government consumption 4.5 0.2 5.0 2.3 4.0 0.6 6.3 -2.9 -9.3 -4.8 2.5 Private consumption 8.9 -3.7 8.3 5.9 6.8 -1.5 -1.6 -2.0 -16.9 2.0 12.8
Gross domestic investment 12.8 4.6 -1.0 8.3 12.1 -9.8 -13.0 -9.1 -34.5 18.0 27.0 Gross domestic fixed investment 6.3 -5.0 10.2 10.2 7.7 -8.1 -13.1 -9.4 -32.5 -11.4 32.0 Change in stocks 138.3 88.0 -50.1 -9.9 64.4 -23.4 -12.0 -6.2 -52.3 386.6 15.5
Source: Uruguayan authorities.
106 Uruguay: Balance of Payments est. 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 million dollars Exports ofGoods & Services & Income Receipts 3530 3911 4308 4808 4779 424 1 4441 4095 3146 3298 4143 Exports of Goods & Services 3248 3507 3847 4168 4061 3478 3660 3262 2693 3084 4012 Exports of Goods 1913 2148 2449 2793 2829 2291 2384 2139 1922 228 1 3025 Exports of Services 1335 1359 1399 1375 1232 1187 1276 1123 77 1 803 987
Imports of Goods & Services & Income Payments 4010 4200 4624 5130 5277 4793 5035 4622 2836 3439 4337 Imports of Goods & Services 3485 3568 3974 4390 4471 3997 4193 3722 2492 2734 3675 Imports of Goods, f.0.b. 2600 2711 3135 3498 3601 3186 3311 2915 1874 2098 2990 Imports of Services 885 858 839 892 870 810 882 807 618 636 685
Trade balance -686 -563 -687 -705 -772 -896 -927 -775 48 183 35
Net trade in Goods & Services -237 -62 -127 -222 -410 -519 -533 -459 202 350 337
Income receipts 282 404 46 1 640 718 762 782 833 453 214 131 Income payments 525 63 1 649 740 806 796 842 901 344 705 66 1 Total interest due 287 345 355 404 440 728 753 798 660 592 524 Other income payments 23 8 287 295 336 366 68 89 102 -315 113 137 Net income receipts -243 -227 -189 -100 -88 -34 -61 -68 109 -49 1 -531
Total current transfer receipts 49 84 91 83 15 55 48 48 84 91 99 Total current transfer payments 8 8 8 9 16 5 21 18 12 8 10 Net total current transfers 41 76 83 74 59 50 27 30 72 a2 89
Current Account Balance -439 -213 -234 -248 -439 -502 -566 -498 382 -58 -105
Source: Uruguayan authorities.
Uruguay: External Trade est. 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 millions of dollars Trade Balance -873 -769 -938 -1001 -1042 -1120 -1176 -1003 -103 8 35
Exports Total Merchandise Exports (fob, US$) 1913 2106 2397 2726 2769 2237 2290 2058 1861 2198 3025 Total Primary Commodities 958 1126 1327 1502 1502 1257 1233 1091 1077 1358 1750 Meat 489 562 63 1 729 729 673 699 514 543 688 887 Vegetables 248 304 408 478 478 354 255 293 270 385 497 Oils and Fat 9 9 13 16 13 11 15 8 12 17 21 Leather 212 251 276 278 249 218 264 276 251 268 345 Manufactures 956 980 1070 1224 1267 980 1057 967 784 840 1083 percenaiage change Total Merchandise Exports 10.1 13.8 13.7 1.6 -19.2 2.4 -10.2 -9.6 18.1 37.6 Merchandise Exports Quantity Index (% change) 15.1 -1.9 10.3 13.0 0.3 -7.4 6.4 -9.1 -10.3 4.2 22.7
Imports Total Merchandise Imports (cif, US$) 2786 2875 3336 3727 3811 3357 3466 3061 1964 2190 2990 Food 254 262 304 340 347 306 316 279 179 200 264 Other Consumer Goods 594 616 693 764 817 725 767 732 506 478 63 1 POL and Other Energy 320 340 452 492 512 490 462 469 342 381 503 Intermediate Goods 598 669 805 817 727 787 948 756 543 784 1034 Primary . 432 468 588 563 469 552 700 529 384 585 772 Manufactures 166 20 1 217 254 258 235 248 227 159 198 262 Capital Goods 1020 987 1081 1314 1406 1050 973 824 394 349 460 percentagc! change Total Merchandise Imports 3075 3377 3723 3847 3751 3323 343 1 3030 1945 2168 2960 Merchandise Imports Quantity Index (% change) 18.3 -3.0 11.3 13.2 7.6 -5.8 0.1 -7.1 -27.9 5.8 24.5
Source: Uruguayan authorities.
107 Uruguay: External Debt est. 1999 2000 200 1 2002 2003 2004 US$ miIIion I. By debtor Total Gross External Debt 8261 8895 8937 10548 11012 11597 Non Financial Public Sector 4733 5301 5208 7737 8787 9175 Central Government 4120 4697 4586 7161 8200 8632 Local Governments 83 105 128 136 147 151 Public Enterprises 530 499 494 440 440 392 Central Bank ofUruguay 858 79 1 621 562 770 1034 Public Banks 26 24 26 28 27 25 Private Sector 2644 2779 3082 2221 1428 1363
2. By Creditor Total Gross External Debt 8261 8895 8937 10548 11012 11597 Official Creditors 2414 2534 2551 4780 5650 5900 Multilateral 1922 2109 2223 4503 5427 5721 Bilteral 492 425 328 277 223 179 Private Creditors 5129 5508 5434 5110 4925 5265 Financial Sector 4637 5033 4953 4627 4371 4702 Comercial Banks 2239 2185 2234 1672 804 722 Other 2398 2848 2719 2955 3567 3980 Non-Financial Sector 492 475 481 483 554 563 Private 0 2 3 0 0 0 Suppliers 492 473 478 483 554 563 Other 718 853 952 65 8 437 432 *
3. By Instrument Total External Debt 8261 8895 8937 10548 11012 11597 Public Bonds 3042 3441 3150 3365 3723 4123 Bonds 2398 2848 2719 2955 3567 3980 Brady Bonds 644 593 43 1 410 156 143 International Loans 2496 2603 2625 4881 5709 5949 Suppliers 493 474 478 483 554 563 Net Deposits 1513 1525 1729 1161 590 530 Other 717 852 955 65 8 437 432
Memo: Total External DebdGDP (YO) 39.5 44.3 48.1 85.9 98.4 87.8 Total External DebtExports G&S (YO) 237.5 243.1 274.0 391.6 357.1 289.0
Source: Uruguayan authorities.
108 Uruguay: Public Sector Finances In UR$ millions 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004
Revenue 26463 36998 48688 61739 76592 76427 76347 80866 81137 98180 113574 Tax revenue 16814 23471 31821 42334 50044 50030 50774 54008 57831 70096 83002 Social security contributions 6214 8548 10491 12185 14350 14967 14879 14381 12836 11794 12865 Nontax revenue 1298 1539 2156 2383 6352 6505 5849 5250 5274 6200 7831 Operating surplus of public enterprises 2137 3440 4220 4837 5846 4925 4845 7227 5196 10090 9876 Primary expenditure 27322 36108 47894 60674 74378 81192 79964 83954 81065 89529 99349 Wages and salaries 5582 7605 10876 13290 16016 17026 17221 18074 18158 19701 23416 Goods and services 3730 5231 6237 7923 11510 13120 11260 12833 12057 15031 16297 Transfers 13572 18548 25074 31994 37007 40936 43053 43964 44437 46989 50333 Social Security 11763 17116 23299 30391 35622 39558 40992 41907 42818 44218 47395 Other 1809 1432 1775 1603 1385 1378 2061 2057 1619 2771 2938 Capital Expenditure 4438 4724 5707 7467 9845 10110 8430 9083 6413 7808 9303 Primary balance -859 890 794 1065 2214 -4765 -3617 -3088 72 8651 14225 Interest payments 1726 2593 3187 3998 4463 4867 6308 7276 12163 18881 22666 Overall balance -2585 -1703 -2393 -2933 -2249 -9632 -9925 -10364 -12091 -10230 -8441
Source: Uruguayan authorities.
Uruguay: Public Sector Finances As a percentage ofGDP 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004
Revenue 30.0 30.2 29.8 30.1 32.7 32.2 31.4 32.7 31.1 31.1 29.9 Tax revenue 19.1 19.2 19.5 20.7 21.4 21.1 20.9 21.8 22.2 22.2 21.9 Social security contributions 7.1 7.0 6.4 5.9 6.1 6.3 6.1 53 4.9 3.7 3.4 Nontax revenue 1.5 1.3 1.3 1.2 2.7 2.7 2.4 2.1 2.0 2.0 2.1 Operating surplus of public enterprises 2.4 23 2.6 2.4 2.5 2.1 2.0 2.9 2.0 3.2 2.6 Primary expenditure 31.0 29.5 29.3 29.6 31.7 34.2 32.9 34.0' 31.1 28.4 262 Wages and salaries 6.3 6.2 6.7 6.5 6.8 7.2 7.1 7.3 7.0 6.2 6.2 Goods and services 4.2 4.3 3.8 3.9 4.9 5.5 4.6 5.2 4.6 4.8 4.3 Transfers 15.4 15.1 15.3 15.6 15.8 17.3 17.7 17.8 17.0 14.9 13.3 Social Security 13.3 14.0 14.2 14.8 15.2 16.7 16.9 17.0 16.4 14.0 12.5 Other 2.1 1.2 1.1 0.8 0.6 0.6 0.8 0.8 0.6 0.9 0.8 Capital Expenditure 5.0 3.9 3.5 3.6 4.2 4.3 3.5 3.7 2.5 2.5 2.5 Primary balance -1.0 0.7 0.5 0.5 0.9 -2.0 -1.5 -1.2 0.0 2.7 3.8 Interest payments 2.0 2.1 1.9 2.0 1.9 2.1 2.6 2.9 4.7 6.0 6.0 Overall balance -2.9 -1.4 -1.5 -1.4 -1.0 4.1 -4.1 -4.2 -4.6 -3.2 -2.2
Source: Uruguayan authorities.
109 Uruguay: Financial System 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 millions ofpesos Net Foreign Assets 22784 29879 41600 51807 29683 32261 35507 45898 20831 48809 5543 1 Net Mmestic Credit 30224 44071 57203 73143 115139 129824 131699 141894 243488 224075 223278 To Government 5940 7269 7758 7419 7418 11261 7170 7975 69456 83537 83240 Government Budget 23 12 2555 2102 961 1215 5025 920 1022 56766 73467 73206 Other OEcial Entities 3628 4714 5656 6458 6202 6236 6250 6952 12690 10070 10034 To Rest ofEconomy 24285 36802 49445 65724 107721 118564 124529 133920 174032 140538 140038 Private Sector 21027 32392 43843 58630 96094 105766 111088 119465 155248 125369 124923 Other !inancia1institutions 3258 4410 5602 7094 11627 12797 13441 14455 18784 15169 15115 Total Assets & Liabilities 53008 73950 98803 124950 144822 162085 167206 187793 264319 272884 278709 Money and Quasimoney 33259 46243 63 147 81059 102777 116221 124540 148169 189915 213574 218133 Other Liabilities 19749 27707 35656 43891 42045 45864 42665 39623 74404 59310 60576 million dollar Net Foreign Assets 4517.1 4706.1 5218.4 5487.0 2834.5 2845.1 2934.5 3446.1 979.9 1730.3 1931.2 Net Domestic Credit 5992.2 6941.4 7175.7 7746.7 10994.9 11449.4 10884.2 10653.5 11454.5 7943.4 7778.7 To Government 1177.7 1144.9 973.2 785.8 708.3 993.1 592.5 598.7 3267.4 2961.4 2900.0 Government Budget 458.4 402.4 263.7 101.8 116.1 443.1 76.0 76.7 2670.5 2604.4 2550.4 Other Official Entities 719.3 742.5 709.5 684.0 592.3 550.0 516.5 522.0 597.0 357.0 349.6 To Rest of Economy 4814.7 5796.5 6202.5 6961.0 10286.6 10456.3 10291.6 10054.8 8187.0 4982.0 4878.7 Private Sector 4168.8 5101.9 5499.8 6209.6 9176.3 9327.6 9180.8 8969.5 7303.4 4444.3 4352.1 Other financial institutions 645.9 694.6 702.7 751.3 1110.3 1128.6 1110.8 1085.3 883.7 537.7 526.6 Total Assets & Liabilities 10509.3 11647.5 12394.1 13233.7 13829.5 14294.5 13818.6 14099.6 12434.4 9673.6 9709.9 Money and Quasimoney 6593.9 7283.5 7921.3 8585.1 9814.5 10249.7 10292.6 11124.7 8934.2 7571.1 7599.5 Other Liabilities 3915.4 4364.0 4472.8 4648.6 4015.0 4044.8 3526.0 2975.0 3500.2 2102.5 2110.4 shares to GDP (76) Net Foreign Assets 25.8 24.4 25.4 25.3 12.7 13.6 14.6 18.6 8.0 15.5 14.6 Net Domestic Credit 34.3 36.0 35.0 35.7 49.1 54.7 54.2 57.4 93.3 71.0 58.9 To Government 6.7 5.9 4.7 3.6 3.2 4.7 3.0 3.2 26.6 26.5 21.9 Government Budget 2.6 2.1 1.3 0.5 0.5 2.1 0.4 0.4 21.8 23.3 19.3 Other official Entities 4.1 3.8 3.5 3.2 2.6 2.6 2.6 2.8 4.9 3.2 2.6 To Rest of Economy 27.6 30.0 30.2 32.1 46.0 50.0 51.2 54.2 66.7 44.5 36.9 Private Sector 23.9 26.4 26.8 28.6 41.0 44.6 45.7 48.3 59.5 39.7 32.9 Other financial institutions 3.7 3.6 3.4 3.5 5.0 5.4 5.5 5.8 7.2 4.8 4.0 Total Assets & Liabilities 60.1 60.4 60.4 61.0 61.8 68.3 68.8 76.0 101.3 86.4 73.5 Money and Quasimoney 37.7 37.7 38.6 39.6 43.9 49.0 51.2 59.9 72.8 67.7 57.5 Other Liabilities 22.4 22.6 21.8 21.4 17.9 19.3 17.6 16.0 28.5 18.8 16.0
MemorandumItems: Net Foreign Assets (end year - US%) 3204 3429 4143 4789 2556 2578 2404 1687 711 1852 1908 Source: International Financial Statistics, IMF.
110