Should Reform Tackle Rules and Institutions Together?

In the wake of its banking and economic crisis of 2002, Uruguay took some bold steps. Unlike other countries that squandered the commodities boom of the subsequent years, delaying fiscal reforms and, in many cases, worsening their long-term fiscal stance, the country embarked on a series of integral reforms in virtually every policy area, from public management systems to health, education, housing and even financial and labor markets.

The result was a country far better able to manage its economic affairs and achieve positive social outcomes for its people. “Prudent macroeconomic policies, strong institutions, and a commitment to diversify its markets and products have allowed Uruguay to show resilience in the face of sharp recessions in its large neighbors,” wrote the IMF after its Article IV consultation with Uruguayan officials in 2016.

How the country accomplished those reforms and, as a result, its greater resilience, was the subject of a rich presentation by Mario Bergara, the current president of Uruguay’s Central Bank and its former minister of finance at a recent event the IDB organized with the Latin America Program at George Washington University. The presentation was based in part on Bergara’s latest book “Las nuevas reglas de juego en Uruguay” (The New Rules of the Game in Uruguay).

What emerged from the presentation and the following discussion by economists and other participants, was a sense of how crucial it can be to simultaneously change both the rules of the game (laws and regulations) and the organizations that enforce those rules when implementing reform.

In much of Latin America, this has not been the case. Reformers typically advance in one realm without advancing in the other, and the approach usually results in failure.

Consider cases where changes have been made to tax laws without accompanying changes to tax administrations. The introduction of high tax rates and steep penalties for evaders, while tax administrations remain weak, often leads to steep levels of evasion and high levels of inequity among citizens. Those who find it hard to evade carry the larger burden of taxation. And distortions are introduced that affect productivity and employment; for example, when businesses decide to stay small to avoid taxation. Conversely, when tax administrations are bolstered but the rules remain the same, the effect is to enforce inefficient tax regimes that likewise lower productivity and growth in the economy.

The same thing applies to fiscal policy. When fiscal rules are changed without creating or strengthening congressional budget offices that can flag irresponsible behavior, the result has been to encourage policymakers to ignore the rules, as we describe in our book “Who Decides the Budget?

Other examples abound. When crime increases, countries rush to increase penalties. But without reformed police forces or improved judiciaries, those penalties cannot be enforced. As a result, two-thirds of detainees are yet to be sentenced in many Latin American nations. Similarly, governments may change their school curriculums, but are able to achieve little with teachers that are poorly trained and qualified. Or they may invest in technology, but are unable to boost the performance of their students with still backwards standards and curricula.

The key to Uruguay’s success, at least until now, is that it did something different: it tackled changes to rules and regulations and to the organizations that enforce them simultaneously. Hence, the tax reform was accompanied by extensive reforms in the tax administration and greater investment in it; changes to the budget law were combined with the strengthening of a unit in charge of budget execution; and the creation of an integrated national health system was pared with major organizational reforms that clarified the roles of each actor in the system and decentralized it. Similar examples can be found in labor policy, in housing, education, social security, among others.

It is probably to soon to evaluate how those reforms will pan out over the long haul and whether they will help the country overcome the challenges that still remain. But with initial successes already chalked up and acknowledged by institutions like the IMF, the country provides an example of how just important it is to improve rules and the organizations that enforce them together.

 

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The Author

Carlos Scartascini

Carlos Scartascini

Carlos Scartascini is Leader of the IDB Behavioral Economics Group and Principal Technical Leader at the Research Department of the Inter-American Development Bank. He is currently focused on expanding the use of behavioral economics at the IDB and leading many field experiments with governments in Latin America and the Caribbean. His current research focuses on the role of messages and methods of communication to affect behavior and demand for public policy. In addition to Behavioral Economics, his areas of expertise include Political Economy and Public Finance. He has published seven books and more than 35 articles in edited volumes and specialized journals. He is Associate Editor of the academic journal Economía. A native of Argentina, Carlos holds a Ph.D. and a M.A. in Economics from George Mason University.

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