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IDB: strengthening fiscal institutions is key to development in Latin America and the Caribbean

Latin America and the Caribbean should build on the considerable social and economic development the region has made in the past two decades by taking additional steps to improve fiscal management as a path to higher productivity, innovation, and growth, according to a new book from the Inter-American Development Bank (IDB).

The publication, Fiscal Institutions of Tomorrow, describes how fiscal discipline enabled many countries to avoid the bouts of volatility, high inflation and devaluations that marked the 1980s and 1990s. The benefits of this discipline were evident during the recent global economic crisis, in which the region showed its resilience and ability to stage a strong recovery.

According to the authors, Latin American and Caribbean countries could cement these achievements if their governments shaped their fiscal institutions in ways that promote economic growth and general welfare, such as by adopting fiscal rules that take into account economic cycles, performance-based budgets, integrated financial management systems, policies to support small and medium-size enterprises (SMEs), and incentives for innovation.

"The region is transforming its fiscal institutions to prevent the crises and mistakes of the past and to unlock its potential for development," said Ana Corbacho, Senior Economic Advisor in the IDB’s Department of Institutions for Development and coordinator of the new publication.

The book lays out the argument for adopting clear and flexible fiscal rules that minimize deficits and increase savings in times of prosperity, giving governments more room to maneuver during crises and to promote recovery, including after natural disasters.

The authors also underscore the need to set clear goals in the budget process, such as macroeconomic effectiveness, efficiency in the allocation and use of resources, and transparency in their management. In order to ensure the effectiveness of performance-based budgeting, governments must put in place monitoring and evaluation systems, incentives for civil servants to align their actions with expected results, and institutional capacity building.

The book stresses that the adoption of integrated financial management systems enables countries to improve the flow of information not only by means of technology, but also through strategic management in public administration.

It also suggests that in addition to improving efficiency and administrative processes, measures to strengthen fiscal institutions will also boost the productivity of SMEs, an important pending challenge for the region.

This improvement would stem from the fact that fiscal policy, which influences access to credit and business conditions in general, is a decisive factor in SME productivity. For this reason, the book recommends that countries adopt tax policies that encourage the formalization and expansion of companies, in this way boosting economic growth.

The book concludes by discussing the problem of the lack of innovation. Given that the region’s firms invest relatively little in research and development (about one fourth as much as their European counterparts), the authors analyze possible solutions, such as direct subsidies and tax incentives.

Fiscal Institutions of Tomorrow, the first publication in the series Institutions for People, notes that while countries in Latin America and the Caribbean have a long way to go, past crises have taught them the need to improve their fiscal institutions to unlock the region’s development potential.