Executive summary

Colombia’s economy has recovered remarkably well from the COVID-19 crisis, as strong fiscal and monetary policy support have successfully averted a stronger contraction of incomes. New social programmes have saved millions from falling into poverty. Medium-term growth prospects hinge on reforms to expand social protection and boost productivity.

Over the last decades, Colombia enjoyed remarkable economic stability due to sound macroeconomic policies. A track record for prudent fiscal management, underpinned by a recently improved fiscal rule, a successful inflation targeting regime and a flexible exchange rate will lay the grounds for a continuous rebound of domestic demand. Unemployment has declined and now stands 1.5 percentage above the level of late 2019 (Figure 1). Still, deep structural challenges in the labour market remain, including high informality. Informal workers, women and youth were particularly hit during the pandemic, exacerbating long-standing inequalities.

The fiscal rule was rightly suspended during 2020 and 2021 to provide exceptional fiscal support to the economy and vulnerable households in particular. Public debt has risen by 13.5 percentage points of GDP and financing costs have risen. A recent fiscal reform will pave the way for a gradual fiscal adjustment, but part of the adjustment planned for the next two years has not yet been implemented (Figure 2). Under current plans, debt is projected to stabilise at around 59% of GDP over the next ten years, 8.5 percentage points above pre-pandemic levels. This implies lower fiscal buffers than in the past and leaves less space to react to potential future adverse events.

Tax revenues of only 20% of GDP are insufficient to meet rising social demands while preserving necessary public investment in infrastructure, education and health. Personal income taxes, which only 5% of Colombians pay, are the principal explanation behind this low tax collection (Figure 3), while widespread tax expenditures and tax evasion curtail revenues across all tax areas. High business taxes reduce investment incentives, particularly as the business sector will finance a significant part of the planned fiscal adjustment. However, the political economy of tax reform is complex, as previous plans to increase income and consumption taxes were widely opposed by social unrest in May 2021.

Looking ahead, enhanced social benefits will continue into 2022 and further underpin private consumption (Table 1). Infrastructure investment is buoying investment, while strong commodity prices and improving prospects in the main trading partners are supporting exports. Inflation has risen lately, but inflation expectations remain well-anchored. The Central Bank should continue the gradual withdrawal of monetary support to the extent that inflationary pressures intensify.

In a longer view, however, both growth and social inclusion are trapped by weak policy settings that prevent firms from growing and becoming more productive while precluding more than half of Colombia’s income earners from formal jobs and social protection. Productivity growth has been weak for two decades, including relative to regional peers and investment has weakened. Unless both can be raised, potential growth will be lower than in past decades, as support from commodity prices and demographics is vanishing.

Low and declining competitive pressures in a number of sectors are one reason behind weak productivity. Regulations hamper firm entry, while informality of firms and jobs creates both an uneven playing field and incentives for firms to remain small. Besides these domestic factors, tariff and non-tariff barriers, with high tariff dispersion and a rise in peak rates, stand in the way of stronger engagement in international trade and investment flows. Exports remain concentrated in a few commodity sectors and trading partners.

Colombia has one of the highest levels of poverty, income inequality and labour market informality in Latin America. Despite a strong crisis response, social benefits do little to alleviate inequalities, and most social spending goes to the non-poor, particularly in the case of pensions.

Over 60% of workers have informal jobs and no access to social security benefits except health. A key factor behind labour informality are high non-wage costs that finance formal-sector social security benefits and a high minimum wage whose level is close to the median wage. These put a high price on formal jobs and generates a vicious circle that perpetuates informality and exclusion.

Delinking access to social protection from worker status in the labour market is the key challenge to break the current duality in incomes and job quality. A basic and universal level of social protection should be made available to all Colombians by merging parallel schemes for cash transfers, pensions and health, combined with a more comprehensive set of benefits that can support those who can contribute more. These reforms will require shifting much of the financing of social protection gradually away from contributions on labour towards general taxation.

More equal opportunities in education are also key to raise formality and improve intergenerational mobility, which is particularly low in Colombia (Figure 4). After one of the longest schools closures in the region and in the OECD, the severe education inequalities that existed before the pandemic are likely to widen. For students from vulnerable households, virtual classrooms did little to compensate for the absence of physical classes, given stark differences in digitalisation. Early drop-out rates in secondary education, typically concentrated among students from disadvantaged socio-economic backgrounds, have risen in 2020, and are likely to rise further. Early childhood is when many of the basic skills for successful learning later in life are acquired, but pre-school education is available to only 50% of children between ages 3 and 5.

Colombia has made significant progress with recent anti-corruption efforts, but high corruption perceptions still point to significant governance challenges. Improvements in governance are key for raising public trust in institutions, which is low in Colombia (Figure 5).

Unlike many OECD countries, Colombia does not have a dedicated whistle-blower protection law. Typical high-risk areas for corruption include infrastructure projects and public procurement. A recently created centralised public purchasing body holds potential to reduce the scope for illicit behaviour, but direct purchases still represent around 70% of total public procurement transactions. Transparency in the interactions between interest groups and policymakers is not regulated by law.

Political campaigns are highly dependent on private funds in Colombia, given the limited scope of public campaign financing. This creates strong incentives for candidates to promise post-election favours and may affect spending efficiency.

Greenhouse gas emissions are relatively low in per capita terms, but have been trending upward over the last decade. Reaching emission targets will depend crucially on advances in the fight against deforestation, a main source of emissions.

Colombia has committed to an ambitious target of zero net deforestation by 2030. Nonetheless, deforestation has risen in recent years, by as much as 8% in 2020. Remarkable institutional efforts to curb deforestation have included a satellite-based early detection system, but limited resources for enforcement action only allow following up on a minor fraction of detections.

Stronger incentives for the use of non-fossil sources of energy could reduce emissions. A recently introduced carbon tax is set at a comparatively low level and covers only 25% of domestic emissions. The revenues it raises only barely exceed spending on fossil fuel subsidies, which should be phased out. Electricity generation capacity is based to 70% on renewable sources, making Colombia one of the pioneers in this area.

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