Seizing new (and old) opportunities: the pending agenda and the role of the institutional framework

At this point, the need for a growth strategy supported by the potential of technological innovations such as artificial intelligence, digitalization and renewable energies is clear. However, without solid economic foundations that drive growth steadily, the leap towards development may prove unsustainable. In this context, policies that promote investment, foster productivity gains, strengthen local productive capacities and improve physical and digital infrastructure become imperative. This will lay the foundations for a more competitive future (see chapter 2).

The most important thing is to think about inclusive wealth generation models. This is achieved by strengthening policies that ensure that all sectors of society benefit from these advances. The region has a pending debt in the reduction of inequality and the inclusion of traditionally marginalized populations, such as rural communities, women, the elderly, youth, indigenous peoples and Afro-descendant communities. To close existing gaps, it is crucial to invest in human capital, especially in education and training for the most vulnerable populations.

The region should prioritize policies that promote access to quality education and technological skills (see box 3.2), strengthening the capacity of the labor force to adapt to the demands of a digitalized global economy and a new industrial policy with an emphasis on non-tradable services.

For example, a country like Colombia, what does it want to do? We want to be the country, perhaps, of green energies, of nearshoring, we want to be the country where biodiversity can be monetized. Then, when a country understands its productive project, it can organize all the policies to make it work well. This is a first point and it does not happen in most Latin American countries, with a few exceptions. When you understand the project you want, then you design or implement policies in the sectors according to that, and that includes the human capital sector.

Based on an interview with Raquel Bernal

On the other hand, sustainability must be a central pillar of LAC’s economic growth strategy. Technological and economic progress will not be viable in the long term if it is not accompanied by responsible management of natural resources and a transition to greener and more sustainable models. Fortunately, our biodiversity, the abundance of ecosystems and the privileged atmospheric conditions of some countries can become a source of wealth that transcends the availability of raw materials. The potential for clean energy production is a clear example of how the energy transition can generate a positive balance for the region. But taking advantage of this opportunity requires policies that encourage innovation in clean energy, emissions reduction and the efficient use of resources (see chapter 4).

Advancing in the triple challenge of growth, inclusion and sustainability in LAC depends not only on the implementation of public policy reforms, but also on strengthening the institutional ecosystem that governs our societies. Central and subnational Governments play a key role in creating an environment that facilitates these transformations. Coordination between different levels of Government is essential to ensure policy coherence and effective implementation. Without a clear alignment of priorities, efforts to promote sustainable economic development can become fragmented, especially in countries with marked territorial differences and disparate administrative capacities. The challenge is to ensure that both national and local Governments work synergistically, maximizing resources and promoting stable and predictable regulatory frameworks.

Institutions also play a central role in this ecosystem. Nations with inclusive institutions tend to have greater long-term economic development, while those with extractive institutions, i.e., those that benefit only an elite, experience economic stagnation (Acemoglu et al., 2001). A solid and transparent institutional framework is crucial to generate trust among economic and social actors, promoting a favorable environment for investment, innovation and social cohesion. There is no hiding the fact that many of the institutions in LAC face problems of legitimacy and effectiveness, aggravated by corruption and lack of accountability. In order to address the challenges of inclusion, these institutions need to become more representative, transparent and effective in the provision of public services. Modernizing these structures is therefore essential for public policy reforms to materialize and achieve a lasting and transformative impact.

Institutionality and state capabilities

The success of public policies depends on the capacity of Governments to design, implement and evaluate regulations effectively. A State with strong institutions, trained personnel and efficient administrative processes can ensure that public policies are implemented in a coherent and sustained manner over time. In the opposite scenario, even the best-designed policies are destined to fail, either due to a lack of coordination in their execution, inefficient resource allocation or difficulties in adapting to changing contexts. Therefore, strengthening State capacities is a prerequisite for public policies to achieve their objectives and generate a positive impact on society.

Broadly speaking, State capabilities can be defined as the State’s ability to implement policies. What varies, depending on the literature, is how these are measured. Elissa and Fotini (2018), for example, posit that State capabilities can be measured by three functions of the State: extraction, coordination and compliance. Lindvall and Teorell (2016), on the other hand, formulate that State capabilities can be seen as the power of the State to achieve the objectives it sets for itself, contemplating how it uses and invests its resources and its ability to exercise this power throughout the controlled territory. Sanguinetti et al., 2015, frame State capabilities in four broad groups. The first, bureaucratic and administrative capacities needed to design and implement policies. The second, legal capacities, which include aspects such as the ability to enforce contracts, property rights and the existence of a judicial system to resolve disputes. Third, infrastructural capacities, which refer to the State’s ability to exercise effective control and presence over its territory, ensuring compliance with the law and the provision of public services in an equitable manner. And finally, fiscal capacity, defined as the State’s ability to collect taxes.

The Worldwide Governance Indicators of the World Bank are a source of information that addresses and quantifies three of the four dimensions proposed by (Sanguinetti et al., 2015): bureaucratic and administrative capacity, legal and infrastructure capacities. Figure 5.7 makes it evident that LAC has a long way to go in these three dimensions. The gaps can be seen by comparing the performance of OECD countries with the average of Latin American countries. For the Caribbean countries, there are also gaps with respect to developed countries, although they are not as pronounced. The regional averages hide, however, wide heterogeneities among countries. In the case of Latin America, Uruguay, together with Chile and Costa Rica to a lesser extent, show a good performance in the indicators analyzed, in some cases reaching values closer to those of OECD countries.

I think policymakers in the region really need to address the broadening of the revenue base. In general—despite higher tax rates in many emerging markets—tax collection is not the best. So, when I talk about broadening the tax base, I also mean more efforts. I mentioned digitalization earlier as a vehicle to improve collection. Efforts need to be made in that regard.

Based on an interview with Carmen Reinhart

The fiscal capacities of the countries in the region are also limited, as expected. Figure 5.8 shows that average revenue collection in LAC is close to 22 % of GDP versus 34.2 % in OECD countries. It also shows large heterogeneities in collection within the region. Argentina and Brazil are the countries that collect the most, with figures close to one third of GDP, while Mexico and Peru collect between 17 % and 18 % of GDP. The tax structure in LAC is relatively homogeneous, with a greater preponderance of taxes on goods and services. In OECD countries, the share of value added taxes is similar to that of income and profit taxes and social security contributions. This difference between regions responds to the economic and productive structure of LAC, which requires broadening the tax base and limiting tax evasion, central issues in a context of high informality.

A phenomenon closely linked to State capacities in our region is corruption, which is nothing more than the abuse of public power to obtain private benefits . And it is not necessarily acts committed unilaterally by officials. Often, corruption involves collusion between public officials and private actors, such as individuals or companies, which aggravates its impact and makes it difficult to detect and sanction (Fajardo et al., 2019).

The capacities of the State do not arise spontaneously, they are deliberate decisions. Society has to dedicate part of its resources to build that capacity, to have a better bureaucracy, to have a more efficient and professional judicial branch, and at the same time to have a greater fiscal capacity. This requires a long and continuous effort. We have tended to see the State as something residual where the same standards are not applied, the same demands that are made in many private sector companies when it comes to choosing personnel.

Based on an interview with Mauricio Cárdenas

Corruption is an obstacle to development for at least three main reasons. First, because it reduces the capacity of the State to provide quality goods and services. The second, because it compromises the productivity and growth of economies. According to Fajardo et al., (2019), approximately 2 % of global GDP is lost in bribes. And the third, because corruption weakens citizens’ trust in Government and institutions. It also discredits democratic systems. At the aggregate level, there is a negative relationship between citizens’ perception of corruption and trust in the democratic system (Fajardo et al., 2019).

The Corruption Perceptions Index 2023, prepared by Transparency International, offers a quantitative tool to compare the perception of corruption in the region with selected OECD countries. In general, the perception of corruption in LAC is significantly more negative than the average for OECD countries (see figure 5.9). Nevertheless, the region shows considerable heterogeneity. While countries such as Uruguay and Barbados show indices comparable to those of some European nations, others such as Honduras, Guatemala, Paraguay and Bolivia exhibit alarmingly high levels of corruption perception, even for the regional context.

Thinking comprehensively about State capacities in the region requires considering the capacities of regional and local Governments. Throughout the 1980s and 1990s, LAC experienced enormous decentralization, but this process has not always been accompanied by adequate capacity development, and disparate levels of autonomy coexist throughout the region. While some tasks related to environmental management and urban and rural management almost always fall within the scope of action of regional and local Governments, more complex tasks such as the provision of health or education tend to present greater heterogeneity in terms of the separation of attributions between central and subnational Governments. 

The capacities of local and regional Governments have important effects on local productivity levels, the well-being of the population and the implementation of adaptation strategies in the face of global challenges such as climate change. The performance of regional and local Governments is key to achieving the SDGs and closing social and economic gaps. Their ability to manage resources, coordinate actors and adapt strategies to local realities is essential to ensure that the SDGs translate into concrete and tangible improvements.

Therefore, advancing the State capacity agenda in LAC requires prioritizing institutional strengthening. This implies investing in the modernization of public administration structures, ensuring that State agencies have sufficient resources and adequately trained personnel.

A key aspect is the professionalization of public service. The implementation of meritocratic systems in the hiring, promotion and evaluation of civil servants would reduce inefficiency and corruption (Sanguinetti et al., 2015). The professionalization of the civil service also grants stability to civil servants and provides them with a career perspective that is independent of electoral cycles. In the case of bureaucrats, working to promote the selection of trained, motivated and honest civil servants can generate a multiplier effect: a State with integrity will be attractive to these same profiles (Fajardo et al., 2019). A recent study for Brazil highlights that the election of young officials is correlated with greater investments in long-term policies, such as reducing deforestation and GHG emissions, without leading to a penalty in terms of income (Dahis et al., 2024). ). In the case of political positions, it is vital to work on electoral systems and on the regulation of party and campaign financing. Materializing this agenda requires reducing the gap between regulatory frameworks and their implementation, for which it is key to strengthen the oversight capacities of electoral courts and other control bodies, expand the severity and scope of sanctions, and promote transparency and citizen oversight (Fajardo et al., 2019).

In addition to ensuring transparent selection criteria, incentives are also required to develop the potential of civil servants. Along these lines Fajardo et al., (2019) propose enhancing the development of civil servants, the flexibilization of the salary structure and a greater linkage of salary and career development with the competencies, skills and effort of the worker.

Another crucial aspect is the digitalization of the State. The use of digital tools can significantly improve efficiency and transparency in public management, facilitating interaction between citizens and Government, optimizing service delivery and reducing opportunities for corrupt practices (OECD-CAF, 2024). However, for these tools to be effective, it is necessary to develop an adequate technological infrastructure and ensure that both officials and citizens have the necessary digital skills to use it.

The digitalization of the State can facilitate the implementation and use of internal and external control systems that contribute to improve State management (Fajardo et al., 2019). On the one hand, because digitalization can reduce discretionality by standardizing processes and closing power gaps between officials and citizens, or carry out audits to detect and sanction irregularities, being these processes more agile and easier to monitor. On the other hand, because external control mechanisms, such as citizen participation, can be facilitated through a greater capacity to produce and disseminate information based on digital systems.

A fourth key point, linked to the previous one, involves strengthening the State’s capacity to generate, manage and analyze data in real time. This allows for more informed and adaptive policymaking, which is particularly important in a context of rapid economic, social and technological change. The creation of monitoring and evaluation mechanisms, with clear and accessible indicators, will make it possible to make adjustments to ongoing policies and ensure that the proposed objectives are achieved.

As for subnational Governments, it is essential to improve their administrative and financial capacity. Often, these levels of Government do not have sufficient resources or the necessary technical and/or legal competencies to implement effective policies. This can be addressed through continuous training programs and specific technical assistance, as well as the creation of legal frameworks that grant them greater fiscal autonomy, allowing them to generate their own resources to finance local priorities and extend their financing capacity in a sustainable manner.

The prosperity of the local regions of certain localities are perhaps 10 or 20 times richer than the poorest region of the same country. It’s a drama, isn’t it? And that drama, to a large extent, reflects the fact that local Governments also diverge enormously in terms of their capacities […] Latin America is plagued by local Governments […], high levels of corruption and disinterest in local development. And it is precisely this variety of public capacities within countries, between regions, that causes these great contrasts in human development within each country.

Based on an interview with Sebastián Mazzuca

Finally, it is important to promote coordination between the different levels of Government. To this end, it is necessary to develop intergovernmental articulation mechanisms that facilitate the alignment of national and subnational policies. The implementation of platforms for dialogue and cooperation can help to ensure that policies are better adapted to local realities and that subnational Governments play a more active role in economic and social development, promoting solutions that respond to the specific needs of each territory.

The political economy of reforms

The implementation of reforms in LAC faces great difficulties due to a combination of political, institutional and social factors (Guizzo Altube et al., 2023). First, political fragmentation is a central obstacle. Political systems in the region are often characterized by a lack of clear majorities in the legislative branches and weak coalitions. This complicates the process of negotiating and approving reforms. This fragmented scenario favors the use of the veto by those who have a vested interest in maintaining the statu quo, blocking reforms that could benefit society as a whole. Moreover, the short electoral cycle encourages politicians to prioritize short-term measures that generate immediate benefits over long-term structural reforms that, although necessary, may be unpopular at the time of their implementation. The political instability that characterizes the region often undermines the long-term planning capacity of Governments.

There is a need for parties to have and commit to programs that are not what we call physiological, the system of «take it from here to there», of everything in the short term, everything is won or lost now, in this legislature, and all thinking and energy put in the next election.

Based on an interview with Bianor Cavalcanti

Another important challenge is the resistance of interest groups that may see their privileged positions affected by political and administrative reforms in the State. Business groups, unions or bureaucratic sectors with power to influence decision-making have incentives to oppose reforms that seek to redistribute resources or change the rules of the economic game (Tommasi et al., 2010). These dynamics are evidenced by the difficulties in advancing progressive tax adjustments or labor market formalization, issues that usually face strong organized opposition. The ability of these groups to mobilize resources and exert political pressure means that the intended reforms are often weakened or abandoned altogether.

Finally, the high levels of social inequality in the region generate tensions that hinder the creation of broad consensus to move forward with structural reforms, since these, when they affect different socioeconomic groups differently, can provoke adverse social reactions, such as protests or outbursts of popular discontent. This is particularly evident in the cases of pension reforms, fiscal adjustments or increases in the prices of public services. These types of tensions are further radicalized around the equal rights agenda.

Reforms aimed at guaranteeing gender equity, legal recognition and protection of the rights of LGBTQ+ people, as well as measures aimed at preventing and eradicating discrimination based on gender identity or sexual orientation, are usually strongly rejected by conservative sectors of society. These tend to mobilize under platforms that promote the defense of traditional values and the concept of the nuclear family, based on heterosexuality and binary gender roles, limiting progress on the pending inclusion agenda. The ability of Governments to manage these tensions and articulate an inclusive social dialogue is key to overcoming these barriers and making reforms viable and sustainable.

Álvarez et al., (2020) outline actions to promote the implementation of quality reforms, taking into account the complexities of the political environment. The first step in facilitating effective reforms is to have clear and accurate information on costs and future projections, such as population aging. International evidence suggests that reforms based on rigorous technical analysis that quantifies the challenges and costs of inaction are more successful. In terms of social protection policy, the region has made some progress along these lines. Many Latin American countries, such as Chile and Colombia, have already developed tools, such as contingent liability reports and medium-term fiscal frameworks, to measure and project pension system expenditures and other components of the social protection system. These experiences provide valuable lessons for the region regarding the importance of extending the fiscal horizon and avoiding short-term biases. 

A second line of action proposed by Álvarez et al. (2020) is anchored in the gradual nature of reforms and in contemplating compensation for potential losers. In order to achieve the approval and successful implementation of reforms, it is key to adopt gradual mechanisms of change and transition regimes. From an economic perspective, structural changes, such as pension reforms, require smooth implementation to mitigate short-term financial imbalances. In addition, deterring opposition to reforms involves protecting those most affected by them in the short term. Compensation mechanisms for potential losers can prevent inequity from undermining the sustainability of reforms over time.