1. Key policy insights

The pandemic has hit Colombia hard and has left strong marks on its people. COVID-19 caused over 135,000 lost lives, set back income growth for years and destroyed over 6.2 million jobs. A significant policy response allowed cushioning the economic effects of the pandemic, through an expansion of existing as well as new social benefits, wage subsidies, tax deferrals and credit measures (Box 1.1). But healing the long-term scars of the pandemic will require even more ambitious policy responses and reforms.

As of mid-2020, the economy recovered more rapidly than regional peers, recovering pre-pandemic GDP levels by the third quarter of 2021. However, the pandemic has exacerbated many long-standing social challenges, including one of the world’s most unequal income distributions. Employment and income losses were particularly concentrated among households with the lowest incomes, whose labour incomes declined by up to 30% (Figure 1.1). About 3.5 million people became poor and many families who had managed to escape poverty in the preceding years fell back into it. Informal workers, who account for more than 60% of all workers and have no access to social protection except healthcare, were the first to lose their livelihoods during the pandemic. Women have been disproportionately affected, amplifying pre-existing employment and wage gaps between men and women.

These setbacks have occurred in many areas where Colombia had previously made significant progress. In a region characterised by economic volatility, Colombia’s sound macroeconomic policies, with a track record for prudent fiscal management underpinned by fiscal rules, a successful inflation targeting regime and a flexible exchange rate, have ensured economic stability and underpinned confidence. Poverty had fallen markedly over the past two decades, and access to education had improved. A violent internal conflict that haunted Colombia for decades has been set aside, and institutions have become stronger. Economic growth had been solid, buoyed by external demand for Colombia’s commodity exports up until 2008, bearing some similarities to developments in other Latin American and Caribbean (LAC) economies (Figure 1.2).

At the same time, trend growth was already declining before the pandemic, hinting at more structural obstacles to economic performance. Favourable demographics boosted employment and can explain much of Colombia’s growth in the last two decades (Figure 1.3). But demographics and employment will cease to support growth in the future, except for the positive effect resulting from immigration from neighbouring Venezuela. At the same time, both investment and productivity, usually the key driver of long-term growth, have been on a declining trend, related to weak competition, low trade openness and a still largely commodity-dependent export base, which leaves it vulnerable to price shocks. The only way to counteract a growth slowdown is through reforms that accelerate productivity growth. Colombia’s longer-term growth outlook will largely depend on its ability to address existing structural bottlenecks.

Colombia’s growth and social challenges are intimately intertwined. Informality precludes workers from access to social security benefits like pensions or unemployment insurance. As a result, much of the spending on social benefits fails to reach those who need it most (Figure 1.4). For many firms, informality is a response to a difficult business environment, but it cuts them from access to credit and limits productivity and growth. By staying small and informal, firms can avoid high labour charges, taxes and cumbersome regulations. Widespread barriers to competition further add to the difficulties of formal market entry, while firms that are formal face unfair competition from low-performing but informal competitors.

These challenges mutually reinforce each other and impede the flow of labour and capital to the most productive firms and activities, which would be essential for stronger growth and higher incomes. At the same time, they perpetuate the dual nature of the labour market and exclude a majority of income-earners from old-age pensions or unemployment insurance, which explains high and persistent income inequalities. Unleashing Colombia’s potential to reach higher levels of prosperity for all will require deep and simultaneous reforms across several policy areas, rather than the small patches of the past. Country-wide social protests in 2021 have demonstrated that Colombians aspire to better economic opportunities.

Reforms would have substantial payoffs, as indicated by simulations based on the OECD long-term growth model (Guillemette and Turner, 2018[1]). An ambitious package that would improve domestic regulation and competition, reduce barriers to foreign trade, reform taxes and strengthen institutions, similar to current policies in Chile, would raise GDP per capita by an additional 24% over 15 years, equivalent to 1.6 percentage points of additional growth each year (Figure 1.5). While there is considerable uncertainty around such simulations, these are large effects, as they would allow Colombia to reach the approximate per-capita GDP levels that are currently enjoyed by countries like Costa Rica, Argentina and Uruguay within 15 years. By contrast, with no boost from reforms, demographic trends would diminish the economy’s growth potential to 1.6% over 15 years, and to 0.9% over 30 years. This is significantly below the average GDP growth of 3.8% between 2000 and 2019.

Growth-enhancing reforms could be implemented in several policy areas. Strengthening institutions by reducing corruption and improving economic governance and the rule of law would be one way forward. This could be complemented by market reforms that raise competition and improve the allocation of resources, for example through more competition-friendly regulation on product markets and lower barriers to international trade. Finally, a reform of taxes and social contributions could alleviate the burden on labour income and reduce distortive business taxes, in combination with a significant broadening of tax bases across income and consumption taxes.

Finding the necessary political consensus for further reforms will not be easy, and may require a gradual approach. Country-wide social protests paralysed much of the country during May 2021 after a tax reform proposal ignited significant discontent in the context of the pandemic and a severe recession. While the reform would have concentrated the additional tax burden on relatively high-income households and financed enhanced social benefits for those with low incomes, it was wrongly perceived as affecting middle class families. Political debate is crucial for building a consensus around reforms and it is essential that the debate is well-informed by facts and evidence, including on the economic incidence of reforms across different income groups. The set of reform recommendations contained in this Survey would not imply any additional financial burden for citizens in the bottom half of the income distribution; it would instead strengthen their incomes and improve their access to social protection benefits.

Against this background, the main messages of the Survey are:

  • Ensuring fiscal sustainability and protecting uncovered vulnerable groups will require both a revival of productivity growth and mobilising additional tax revenues, particularly by broadening narrow tax bases.

  • Supporting vulnerable groups and reducing inequalities will require deep changes to social security benefits and their financing to strengthen incentives for formal job creation.

  • Continuing the fight against corruption will require changes in the areas of public procurement, whistle-blower protection and the financing of political parties.

  • Raising productivity to boost growth through the recovery and over the longer run will hinge on more competition-friendly regulations, a fairer tax system and lower trade barriers.

The Covid-19 pandemic took a strong toll on economic activity in the second quarter of 2020. GDP declined by -6.8% in 2020, slightly deeper than the regional average and unprecedented in Colombia’s economic history. Lockdowns and social distancing measures have been implemented on several occasions since March 2020. Four infectious waves led to temporary infection peaks in August 2020, in January 2021, June 2021 and January 2022 (Figure 1.6). Progress in vaccination has been steady, but is lagging behind other countries in the region, and should be accelerated.

The authorities have rolled out a wide set of relief measures aimed at cushioning the economic fallout from the pandemic. Policies have aimed at preventing the most vulnerable groups from falling into poverty, to support firms and to provide sufficient liquidity to the economy (Box 1.1). These measures help to preserve jobs, firms and capital. According to IMF estimates, the 2020 recession would have been around 1.5 percentage points deeper without this policy support (IMF, 2021[3]). In the same vein, the increase in poverty and inequality could have been more than twice as high without exceptional policy support (UNDP, 2021[4]).

GDP has recovered strongly since the second half of 2020, driven by a solid rebound in private consumption (Table 1.1). Despite mobility restrictions, GDP continued its solid expansion in the first quarter of 2021. Widespread social protests which included road blocks and caused significant disruptions to local supply chains have dented the recovery in the second quarter of 2021 as consumer confidence and retail sales plunged (Figure 1.7). This pushed a more durable recovery of private consumption and investment into the second half of 2021. Annual GDP growth is projected at 9.5% for 2021, although heavily influenced by statistical carry-over effects from 2020. At the end of the last quarter of 2021, GDP is projected to stand 4% above the last quarter of 2019. Inflation has risen since April 2021, was 5.6% in 2021 and stood at 6.9% in January 2022, exceeding the tolerance band around the 3% inflation target. Core inflation, by contrast, is below target and inflation expectations remain well-anchored. Growth is projected at 5.5% for 2022 and 3.1% for 2023, while inflation is projected to return close to the target by late 2023.

In contrast to GDP, the labour market is taking longer to recover (Figure 1.8, Panel A). The unemployment rate, which was already relatively high before the pandemic (Figure 1.8, Panel B), remains some 1.5 percentage points above the level of late 2019. By end-2021, some 95% of jobs lost during the pandemic had been recovered. As discouraged job seekers abandoned their efforts during the lockdowns in 2020, labour market participation declined substantially. At present, labour participation is around 3.8 percentage points below December 2019 levels, while the employment rate is 4.3 percentage points below. Job losses affected particularly informal workers and women, exacerbating pre-existing inequalities. Among women, unemployment is 15.1%, compared to 8.4% for men. Women’s labour participation rate is recovering slower than men’s. Real wages in the manufacturing and retail sectors now exceed pre-pandemic levels.

Looking ahead, continuous fiscal support to households through recently legislated enhanced social benefits will underpin further marginal improvements in consumption, but a stronger rebound in private consumption will hinge on improvements in the labour market. Significant infrastructure investment and strong demand in the housing construction sector will continue to support investment. Strong commodity prices and improving prospects in the main trading partners, in particular the United States and China, are expected to buoy external demand and reinforce the recovery of exports (Figure 1.9). As the vaccination campaign makes further inroads, 63% of the population were fully vaccinated in early February 2022. In year-on-year terms at the end of the last quarter of the year, GDP is expected to grow by 3.9% in 2022 and by 2.8% in 2023.

Overall, Colombia weathered the pandemic-related turbulences well and the flexible exchange rate acted as successful shock absorber. However, elevated financing needs and twin deficits on fiscal and external accounts imply vulnerabilities to external shocks and turbulences on global financial markets. Potential triggers could include a sudden drop in demand for emerging market financial assets, possibly in the context of monetary policy normalisation in advanced economies.

While direct investment inflows have been the main source of financing for the current account deficit, portfolio flows have been highly volatile, with significant outflows in early 2020 as global investors fled towards safe assets, and then again in 2021 during the social protests. As a major exporter of primary products including crude oil, Colombia remains exposed to changes in commodity prices. Exports saw a steep drop at the outset of the pandemic in 2020, amid global declines in commodity demand and prices which triggered a deterioration in Colombia’s terms of trade. In 2021, the picture reversed and Colombia’s export performance regained steam, including beyond mining and energy, which is particularly promising (Figure 1.10). The current account deficit narrowed in 2020 on account of lower investment income outflows, reflecting lower returns on foreign investments in Colombia. As the domestic demand recovers, the current account deficit is widening again. Fiscal adjustment, the dissipation of supply shocks and solid export performance, including in services, are likely to attenuate this widening over the next years.

External debt amounts to 62% of GDP according to the definition applied by the IMF, which is higher than in other countries in the region and carries considerable risks (Figure 1.11). Exposure to global financial conditions has increased, in line with developments in other countries in the region. Currency reserves of 33% of external debt (or 22% of GDP) have increased, including through currency purchases by the central government, and are mid-range in international comparison, covering almost 12 months of imports (IMF, 2021[3]). Additional external buffers come from a two-year flexible credit line arrangement with the IMF until May 2022, of which only around a third has been drawn so far, with the remaining access of USD 12.2 billion (4.5% of 2020 GDP) being treated as precautionary. In the context of the August 2021 general allocation of Special Drawing Rights, Colombia received additional SDRs worth 1% of GDP.

In mid-2021, external financial conditions tightened as risk perceptions about Colombia’s public debt were affected by the decision of two major rating agencies to downgrade Colombian public bonds below investment grade. This occurred in a context of social unrest that eventually led to the withdrawal of an ambitious fiscal reform proposal, highlighting the political challenge of building a consensus for fiscal adjustment. Sovereign bond risk spreads edged up (Figure 1.12). The value of the currency, which tends to move in line with terms of trade, lost value at the same time as the latter continued improving. Fiscal uncertainties remain a significant medium term risk that could result in higher financing costs. With 40% of public debt denominated in foreign currency, tighter global financial conditions could exacerbate this and potentially increase rollover risks.

Future developments of the Covid-19 pandemic remain another potential downside risk, given previous swings in the trajectory of infections and the potential emergence of vaccine-resistant variants. Accelerating progress in vaccine rollouts would help to mitigate this risk. Moreover, a number of medium-term vulnerabilities could affect growth outcomes (Table 1.2).

Significant uncertainties affect the future developments of asset quality in the financial sector, as the full effects of the crisis on default rates and credit portfolios remain yet to be seen. This could present risks for financial institutions, who entered the pandemic from a strong starting position. Capitalisation and liquidity indicators have improved, exceeding regulatory requirements, and compare well against other emerging economies (Figure 1.13). Mandatory compliance with Basel III rules was phased in as of 2021, which explains an increase in measured capitalisation, although some institutions have started this process earlier. Stress tests undertaken by the Central Bank suggest that in the case of a growth shock during 2021 and 2022, bank capitalisation would not fall below regulatory limits (Banco de la República, 2021[6]).

As the pandemic struck, credit quality initially deteriorated between July 2020 and January 2021. Since then, both the non-performing loan ratio and a more stringent loans-at-risk indicator have declined (Superintendencia Financiera de Colombia, 2021[7]). A first wave of exceptional grace period arrangements and enhanced flexibility in loan classifications came to an end in July 2020 and a second wave of measures in August 2021. Credit institutions have raised provisions to pre-empt a potential deterioration of their credit portfolio, with provisions currently covering 150% of overdue credit. These provisions dented bank profits in late 2020, shown by a decline in their returns on assets and equity, but much of that has been recovered since. Banks have tightened their credit standards, which may help to explain why overall credit growth came to a temporary halt in early 2021 (Banco de la República, 2021[8]). Since then, it has picked up again, and overall credit now stands at 52% of GDP.

Corporate sector liabilities have risen to 64% of GDP in 2020, 7.5 percentage points above 2019 (Banco de la República, 2021[6]). This is related to lower GDP, but it also suggests that corporates have been able to obtain financing to cover a period of contracting demand and mobility restrictions, both from domestic banks and foreign parent companies, in the case of foreign subsidiaries. Small and medium enterprises in particular were able to benefit from public loan guarantees and related schemes, but around 500,000 of them closed during 2020. Exchange rate risks can affect private corporate liabilities denominated in foreign currency, equivalent to 19% of GDP and of which around 6% of GDP are neither hedged, nor owed by exporting or foreign-owned companies. The recent decline in operating revenues experienced by many corporates could also present lingering risks for this credit segment, as around 21% of firms lacked after-tax incomes sufficient to cover their interest expenses in late 2020 (Banco de la República, 2021[9]). This percentage increased 200 basis points.

Household credit came to a temporary halt in early 2021, but its growth has since resumed, reaching 26% of GDP. One of the legacies of the pandemic may be a significant improvement in financial inclusion propelled by the electronic payment of emergency benefit programmes. The share of people with at least one financial product has risen to 88% in 2020, at a pace 10 times historical trends.

Monetary policy has built up strong credibility within Colombia’s inflation-targeting regime, by correctly anticipating increases in inflation above the 3% target in 2016, and easing financial conditions as inflation declined (Figure 1.14). This allowed a decline in the policy rate by 250 basis points as of March 2020 to a historic low of 1.75%, anticipating a steep drop in inflation to 1.6% as output and credit demand plummeted. In this context, real rates dropped below zero. Enhanced liquidity operations in domestic and foreign currency provided additional support through a more generous definition of admissible collateral and counterparts in 2020, in addition to a reduction of reserve requirements and temporary direct asset purchases aimed at stabilising markets. These measures reduced volatility, supported credit supply and ensured a swift transmission of monetary policy easing.

Inflation rose above the 3% target in May 2021 after 12 months well below it, and has accelerated to 6.9% in January 2022. Core inflation measures, however, have been significantly lower, with the main measure that excludes food items and administrated prices at 2.5% in December 2021. Rising energy and oil prices are one source of inflationary pressures, but some of the recent factors could well be temporary, such as supply chain disruptions related to global supply bottlenecks and local social protests. By contrast, prices for telecommunications services eased in the advent of a new market entrant. Inflation expectations remain well-anchored around the target over a two-year horizon.

Monetary policy has started to withdraw some of the previous stimulus with 225 basis points of rate increases since September 2021, in line with developments in other Latin American economies. The policy rate now stands at a still accommodative 4.00%. Against the background of a slow labour market recovery, the economy still has significant idle capacity and core inflation and wages will remain muted for now.

The gradual normalisation towards a neutral policy stance should continue in a context of pronounced uncertainty. As inflationary pressures intensify, monetary policy should gradually return towards a broadly neutral stance, with neutral policy rates estimated to be in the 4.5 to 5% range (Banco de la República, 2021[10]). The pace of rate increases will depend on whether additional price pressures emerge, on developments in inflation expectations and on the speed of recovery. Rising uncertainty, including about the currently planned fiscal adjustment, could be one reason to accelerate this pace, should it occur. The flexible exchange rate should continue to act as a shock absorber, as it did during the significant depreciation in 2020. Continuing a prudent accumulation of foreign currency reserves, to the extent that financial conditions allow, would provide additional insurance against a potential unexpected tightening of global financial conditions.

A significant fiscal response of around 4.6% of GDP in discretionary spending helped to protect millions of households, firms and jobs from an even more adverse impact of COVID-19. This policy response was close to the average for emerging economies, but somewhat below the response of Brazil, Chile and Peru (Figure 1.15). The fiscal rule has been appropriately suspended for both 2020 and 2021 (Minhacienda, 2021[11]). The headline fiscal balance declined to -7.8% of GDP in 2020, before improving to -7.1% in 2021. Continuous stimulus in 2021 was warranted in light of the weak labour market recovery and the resulting need to support poor and vulnerable households.

Looking ahead, fiscal policy will require a gradual adjustment once the recovery strengthens in 2022, while maintaining exceptional income support measures for vulnerable households and the most affected sectors until the labour market recovers. A fiscal reform legislated in September 2021 is an important step into this direction. The reform is expected to lead to permanent improvements of the fiscal balance of around 0.9% of GDP as of 2023, as part of an adjustment plan to bring the headline deficit below 3% of GDP over a period of 5 years (Figure 1.16). Over the period 2022-2032, central government revenues are meant to increase by 0.7 percentage points of GDP while expenditures are expected to decline by 5.2 percentage points, including the phase-out of pandemic-related extraordinary expenses (Minhacienda, 2021, p. 242[11]). The legislated reform, however, will only lead part of the way to this planned adjustment, as the frontloaded fiscal adjustment foresees an improvement in the fiscal balance of 1.0 percentage points in GDP in 2022 and 1.5 percentage points in 2023. Over a longer horizon, OECD estimates point to adjustment needs of approximately 1.5% of GDP, if public investment is to be maintained at its long-term average of 1.5%-2% of GDP.

With the currently planned fiscal adjustment, OECD projections suggest that gross public debt will stabilise at around 59% of GDP by 2030 (Figure 1.17). This is slightly below current debt levels, but 8.5 percentage points higher than in 2019. This level is below the average gross public debt of 65% of GDP for emerging market economies today, and also below today’s Latin American average of 75% (IMF, 2021[12]). At the same time, this level leaves much less space to address unforeseen spending needs or risks and it would be prudent to rebuild stronger fiscal buffers. Fiscal costs related to population ageing will be small compared to other OECD countries, given that less than 25% of those in old age have access to contributory pensions and that the cost of non-contributory pensions is only 0.1% of GDP due to low benefits and coverage.

The 2021 fiscal reform has significantly reduced fiscal risks. Still, with around half of the planned fiscal adjustment due in 2023 left for the next administration to achieve, implementation risks around the current debt projections remain in place. A lower commitment to fiscal consolidation in the future could easily derail debt stabilisation, as could a small rise in interest rates (Figure 1.17). The latter could potentially result from changing international investor sentiment toward Colombia or emerging market assets more broadly, as well as stronger domestic monetary policy tightening. In May 2021, public debt yields rose visibly after two major rating agencies withdrew Colombia’s investment grade rating, following social protests and the withdrawal of a much more comprehensive fiscal reform proposal. Permanently higher debt levels could make it more difficult to regain investment grade rating and the financing conditions enjoyed in the past. On the upside, an ambitious structural reform package along the lines of the policy recommendations in this Survey would strengthen growth (see Figure 1.5) and improve the sustainability of public debt. Colombia’s long-standing and solid track record for fiscal prudence will also support investor confidence in its fiscal accounts.

While the fiscal reform legislated in September 2021 will help to stabilise public debt, it will not entail a deeper overhaul of public spending and revenues. Current adjustment plans are largely based on expenditure cuts (Figure 1.16), involving a retrenchment of investment, a fade-out of pandemic-related social spending by end-2022 and significant expenditure restraints for the public administration including a general hiring freeze (Minhacienda, 2021[11]), some of which may be hard to uphold over the years. The only sources of additional revenues are higher taxes on corporations, which are already high in comparison to OECD economies, and welcome improvements in tax collection, which have been recommended in previous OECD work (OECD, 2019[13]).

The reform reflects a broad political compromise in the aftermath of the social protests in May, but is far from optimal in light of Colombia’s long-standing need to raise more public revenues and the exacerbation of persistent social challenges in the aftermath of the COVID pandemic. Colombia’s public sector is small in international comparison, including in the region (Figure 1.18). At only 20% of GDP, public revenues are insufficient to meet rising social demands, heal the wounds of the pandemic and preserve essential public investment. The need to raise more public revenues and address long-standing challenges in the tax system has been discussed in several previous Economic Surveys (OECD, 2019[13]; OECD, 2017[14]; OECD, 2015[15]; OECD, 2013[16]).

Colombia’s low tax revenues reflect essentially very low revenues from personal income taxes compared to other OECD economies (Figure 1.19). In turn, corporate income tax revenues are more than 2.5 times higher than the OECD average. Previous OECD tax recommendations included rebalancing the tax burden from corporate to personal incomes, simplifying the tax system, reducing tax expenditures and more ambition to reduce tax evasion, as outlined in the 2019 OECD Economic Survey of Colombia (OECD, 2019[13]) or the 2021 Tax Expenditure Report (OECD, Dian and Ministerio de Hacienda, 2021[17]).

Despite 20 tax reforms in the last 20 years, the structural shortcomings of Colombia’s tax system have not been effectively addressed and tax structures have remained fairly stable (Figure 1.20). Most of the past reforms were small and piecemeal, providing small patches to existing shortcomings, while creating others along the way.

Only around 5% of income earners (1.6 million individuals) pay personal income taxes, due to a basic exemption of around 3 times the average wage. This leaves not only the entire middle class out of personal income taxation, but also many high-income earners, and reduces the scope for progressive taxation (Figure 1.21). Colombia has substantial scope to bring more people into the personal income tax system without affecting the bottom half of the income distribution. Moreover, the current situation implies that most people do not file income tax returns, which deprives the state of an important potential targeting mechanism for redistribution through taxes and transfers (see Chapter 2). This explains the traditionally low impact of Colombia’s tax and benefit system on income inequalities, compared to other OECD countries. Lowering the basic personal income tax exemption should proceed gradually over time, in line with a reduction of the entry tax rate (currently at 19%), which is high in international comparison, and in line with the reductions in social security contributions discussed in Chapter 2. Such a reform would reduce rates simultaneously with broadening the tax base and setting a more progressive rate schedule, while strengthening the incentives for formal job creation.

An immediate priority and appropriate first step in reforming personal income taxes would be to reduce tax expenditures, as discussed in the 2021 OECD Tax Expenditure Report (OECD, Dian and Ministerio de Hacienda, 2021[17]). Exemptions of certain incomes and tax deductions, some of which increase with income, cause revenue losses of around 0.7% of GDP and significantly diminish tax progressivity (Minhacienda, 2021[11]). Most of the benefits accrue to high-income households. Mortgage interest payments, contributions to private healthcare schemes, voluntary retirement savings and severance payments can all be deducted from the tax base. Pension contributions, including to voluntary schemes, can be deducted almost without limits and most pension benefits are not taxed either, despite their highly regressive nature under the current pension system (Chapter 2). The case for taxing high pensions is strong, given the regressive nature of the implicit public subsidies. This would allow to frontload some of the savings from a pension reform. Overall income tax exemptions are currently capped at 40% of taxable income, but that number could be reduced significantly.

Dividend incomes are currently only taxed at 10% at the personal level, with a 0% tax rate on the first 3000 USD, equivalent to around one yearly minimum wage. A higher dividend tax rate and no exemption would be possible, as part of a partial shift of the tax burden on capital income from the corporate level towards the shareholder level.

A statutory corporate tax rate of 35% in 2022 is high relative to the OECD average of 24% (Figure 1.22). Gradual rate reductions as of 2021 had been legislated, before the 2021 fiscal reform implemented a 35% rate. This high corporate tax rate adds to other highly distortive taxes on businesses like the local business turnover tax ICA, all of which weaken investment incentives and are likely to have negative growth effects (OECD, Dian and Ministerio de Hacienda, 2021[17]; Arnold et al., 2011[18]). Moreover, many of the current exemptions and tax benefits could be reconsidered as a first priority, potentially raising revenues by as much as 1% of GDP while levelling the currently uneven playing field (Minhacienda, 2021[11]). For example, the lower rate and simultaneous VAT exemptions for so-called “Free Zones”, some of which consist of single enterprises, have never been subject to a systematic cost-benefit evaluation and probably generate more distortions than benefits. It is predominantly used by domestically-oriented firms. The distortive design of the business tax regime for corporations is also one factor behind the large number of unincorporated firms and should be addressed with a broad business tax reform that creates a simpler system for all firms rather than adding additional exemptions.

VAT revenues could be raised significantly by limiting the scope for exemptions and reduced rates and raising compliance (Figure 1.23), with compensation mechanisms to protect the poorest households. The overall fiscal impact of exemptions and reduced rates in VAT amounts to 4.9% of GDP (Minhacienda, 2021[11]). Zero and reduced rates and exemptions affect not only basic consumption items, but a wide range of goods and services across health, education, food, medicines and transportation, in addition to computers, tablets and mobile phones up to a price cap. The lion’s share of the foregone revenues ends up with higher income households. Instead, poor households could be compensated through means-tested benefits to improve targeting. The authorities started to roll out such a compensation benefit in 2020 (Compensación del IVA). This benefit could be better integrated with existing benefits to the poor, but once this reaches all low-income households, authorities can progressively eliminate VAT exclusions and exemptions while raising compensation benefits. The practice of declaring specific days as VAT holidays should be discontinued, as this fails to promote any legitimate policy objective.

Making these tax reforms politically viable may require a gradual implementation, and requires a clear identification of winners and losers. In combination with a benefit reform as discussed in Chapter 2, all those in the bottom half of the income distribution, and those with incomes not far above the minimum wage, would reap strong net benefits from deep tax reform. The sequencing of these reforms could be more gradual for lowering the income threshold for paying personal income taxes, which would go hand-in-hand with lower social security contributions, and more immediate for the removal of largely regressive tax expenditures. For low-income households, potential effects on purchasing power from higher VAT on some consumption items would be compensated through benefits.

Colombia has made significant progress in improving tax administration and reducing tax evasion, including continued improvements in information systems, human resource management, governance of the tax authority and improved information exchange with other countries (OECD, 2019[19]; OECD, 2015[15]; IMF, 2021[3]). Tax collection has improved as a result of these efforts. The international tax agreement recently negotiated at the OECD and the recent information exchange agreement with Panama can provide further scope for international tax cooperation.

Nonetheless, there is significant scope to reduce tax evasion and strengthen tax administration, as estimates suggest that tax evasion currently leads to revenue losses exceeding 5% of GDP (Benítez et al., 2021[20]). Both the complexity of Colombia’s tax system and the widespread informality of firms and workers are key factors reducing tax collection (Pinto López and Tibambre, 2019[21]; Benítez et al., 2021[20]). Improving trust in government would also help to strengthen tax discipline (OECD, 2019[22]). Enforcement efforts should also be scaled up, in tandem with better compliance incentives through tax reform.

One way ahead would be to build on past improvements and push for even stronger investment in databases and information technology to allow cross-checking of information across different sources. As a first step, customs and tax registries could be linked. The current taxpayer registry includes only 8% of the population, as opposed to 55% in Chile. Few of the large number of self-employed workers pay taxes at all. Bringing more people into the personal income tax system, as recommended above, would allow expanding current databases. Tax administration, including for property taxes, would also benefit from expanding the coverage of land registries, which would also help to in the implementation of the peace agreement and the fight against deforestation.

Electronic invoicing is making progress and has significant potential for raising tax collection, as shown in the case of Chile (Barreix and Zambrano, 2018[23]). The authorities could build on this progress by limiting the use of cash, which accounts for 90% of all private transactions, far above other emerging economies such as Brazil or Turkey (Pérez and Pacheco, 2016[24]). Prohibiting cash transactions above a certain threshold, or taxing the use of cash, is a measure employed in many economies to deal with tax evasion, including Mexico (Gobierno de México, 2021[25]). The current 0.4% tax on most financial transactions could be replaced by a tax on large cash withdrawals only, as recommended in past OECD Economic Surveys (OECD, 2019[19]; OECD, 2015[15]).

There is significant scope for enhancing the effectiveness of public spending by improving targeting and by evaluating existing spending programmes and tax expenditures through a systematic spending review, retaining only those found to have a positive and cost-effective impact towards well-defined policy objectives while phasing out the rest. Ongoing efforts in this direction could be accelerated. Subsidies for electricity and gas, for example, are poorly targeted to the poor households they are meant to serve. 70% of implicit subsidies in the contributory public pension system, worth 3.4% of GDP, accrue to households in the three upper deciles of the income distribution (Levy and Cruces, 2021[26]). Even when programmes are retained, reducing fragmentation could avoid duplications and generate savings. In agriculture, input subsidies divert scarce resources from extension and technical assistance services, which would be more effective for developing an enabling environment for sustainable growth in the sector (OECD, 2021[27]). In social expenditures, for example, new benefits for informal workers who lost their incomes during the pandemic and the new VAT compensation mechanism for the poor are not integrated with existing programmes, exacerbating programme fragmentation and a lack of overall coordination. A summary of the fiscal impact of recommendations is presented in Table 1.3.

A strong rule-based fiscal framework has provided macroeconomic stability and fiscal discipline over decades. Fiscal targets are established every year, with a view towards reducing the structural budget deficit gradually, while a comprehensive medium-term fiscal framework, published on an annual basis, provides consistent planning and transparency over a multi-year horizon (Minhacienda, 2021[11]). The fiscal rule in place between 2011 and 2019 put a limit on the structural deficit, but provided significant flexibility in the case of shocks to either oil prices or economic activity. This rule was suspended for 2020 and 2021 to address the COVID-19 pandemic. Despite full compliance with the fiscal rule, it has not been successful with respect to reining in the expansion of public debt, which has risen from 37% of GDP in 2011 to 50% in 2019. Negative macroeconomic shocks such as the sharp decline in oil prices in 2014 can explain part of this.

In order to address this shortcoming, the September 2021 fiscal reform establishes a new rule that includes an explicit debt anchor. More specifically, the new rule sets a floor for the structural net primary balance (SNPB, net of interest revenues) as a direct function of net public debt, defined as gross public debt net of short-term liquid financial assets (Figure 1.24).

The new rule requires primary surpluses for any debt level exceeding 53% of GDP. For the current level of net public debt, for example, the rule would require a SNPB of +1.2% of GDP. Under current parameters of the implicit interest rate and GDP growth, the fiscal outcomes mandated by the new rule will trigger a gradual conversion to a debt anchor of 55% of GDP. The required SNPB is capped at 1.8% of GDP for net debt levels exceeding 70% of GDP. At that level of debt, the required fiscal balance would still reduce debt even if the implicit interest rate on the whole debt stock were to exceed 2019 levels by 220 basis points. From today’s point of view, it seems sufficiently likely that compliance with the new fiscal rule will impede future increases of public debt and instead usher in a gradual process of debt reduction. The new fiscal rule as described above is intended to come into force in 2026. For the near term, a transitional arrangement limits the SNPB at -4.7% of GDP in 2022, -1.4% of GDP for 2023, -0.2% of GDP for 2024 and +0.5% of GDP in 2025.

Creating an independent fiscal council has been recommended by earlier OECD work and a 2017 Commission on Public Spending (Table 1.4) (Bernal et al., 2018[28]; OECD, 2019[13]). The 2021 fiscal reform sets the legal basis for the creation of an Autonomous Fiscal Rule Committee, consisting of 5 salaried external members and 2 members of congress. While this is an improvement over the unpaid experts with part-time dedication that formed the previous fiscal council, the new body’s budget and financial independence are not defined by law, which means that it is still distant from the role of a truly independent fiscal institution. In Latin America, Brazil, Chile and Costa Rica have been successful with the creation of such institutions, which typically produce regular forward-looking reports on fiscal developments and debt sustainability and estimate the fiscal costs of legislative proposals. Mimicking the success of other countries would imply creating a reasonable and stable budget, guaranteed by law, to hire qualified full-time analysts, and insulating the selection of council members from the political process.

Poverty and inequality remain severe challenges in Colombia and will require strong and sustained growth as well as deep reforms of social, labour market and education policies. Colombia is one of the countries with the highest income inequality and labour market informality in Latin America and globally (Figure 1.25). After years of decline, income inequality has been on the rise since 2017, and is now being exacerbated by the Covid-19 pandemic. The pandemic has also exacerbated inequalities of opportunity, with disproportionate effects on less privileged groups, particularly in education.

The pandemic has highlighted significant gaps in social protection, in particularly among informal workers. Informality is a complex phenomenon and must be addressed with a multi-pronged strategy, of which a deep reform of social protection systems would be a key element. Colombia has an extensive social security system for those who participate in the formal labour market. However, around 60% of informal workers have no access to these benefits, with the exception of near-universal healthcare benefits (OECD, 2019[13]; OECD, 2015[15]). On the whole, large parts of social spending are poorly targeted and give out scarce public resources to the non-poor. In the case of pensions, transitions between formal and informal work imply that more than 65% of workers who contribute to a pension will not get one (Levy and Cruces, 2021[26]). Almost 20% of public revenues is used to subsidise the pensions of only 4% of the population. Non-contributory benefits reach some informal workers, but despite a significant expansion in response to COVID-19, access is patchy and benefits are very low. Non-contributory pensions for example, are only one-tenth of a minimum wage (Levy and Cruces, 2021[26]).

As discussed in detail in Chapter 2 of this Economic Survey, Colombia’s social protection system generates a vicious circle where informal workers are excluded from most benefits, while informality is perpetuated by high non-wage costs that finance formal-sector benefits (Levy and Cruces, 2021[26]; Meléndez, Alvarado and Pantoja, 2021[29]; IMF, 2021[3]; OECD, 2019[13]). Social benefits for formal workers are largely financed through contributions and non-wage labour costs that can reach 55% for minimum wage earners and are high in international comparison (IMF, 2021[3]). Together with a high minimum wage whose level is close to the median wage, this puts a high price on formal jobs and encourages informality.

One way to break this vicious circle would be to establish single and universal non-contributory benefits for each of the three main policy objectives of eradicating poverty, providing old-age pensions for all, and supplying basic healthcare services. These single benefits would replace the current fragmented, poorly targeted and contribution-financed social benefits. The financing burden should be gradually shifted away from contributions on formal labour through a substantial reduction in social security contributions (Levy and Cruces, 2021[26]). OECD calculations suggest that in the long run, such a reform would require raising additional resources of about 1% of GDP, to be financed from general taxation (see Chapter 2). As social security contributions are reduced, personal income taxes could be expanded and the VAT base broadened. It is important to note that personal income taxes are economically different from social security contributions in this context, even if both are largely born by households. Personal income taxes cover all income sources, not only formal-sector labour income, and they allow progressive rate schedules including zero rates on low incomes.

For current formal workers, part of social security contributions would be replaced with income taxes. Reducing tax expenditures and lowering the basic deduction of personal income taxes into the vicinity of the minimum wage, which is currently more than what 50% of workers earn, provides ample scope for this. Subjecting somewhat less than half of income earners to income taxes, instead of the current 5%, would also solve a long-standing challenge in revenue collection. For formal workers with relatively higher incomes, a more progressive tax schedule would imply a higher tax burden than at present.

By contrast, informal workers and those with incomes below or around the minimum wage would benefit from better formal-sector job opportunities and take-home pay. Reductions in non-wage costs have proven an effective catalyst of formalisation in a 2012 tax reform (Morales and Medina, 2017[30]; Fernandez and Villar, 2017[31]; Bernal et al., 2017[32]; Kugler, Kugler and Herrera-Prada, 2017[33]).

A combined tax and benefit reform would have a highly progressive impact, and would undoubtedly leave the bottom half of the income distribution financially better off. Poverty would essentially be eliminated as cash benefits raise all incomes to the poverty line, provided that a strong benefit pickup can be ensured. Income inequalities as measured by the GINI coefficient would fall by 13 percentage points, equivalent to a 25% lower level of inequalities. With this reduction, Colombia’s GINI coefficient would be left around 7 percentage points above the OECD average, compared to 20 at present. This would only be the immediate effect, not accounting for long-term benefits arising from a substantial reduction of informality. In light of social unrest in 2021, enhancing the scope of personal income taxes should proceed with care and in a gradual manner, and should include strong communication efforts on which parts of Colombia’s income distribution would stand to gain and which would stand to lose for a combined tax and benefit reform. Enforcement efforts against informal employment would be an important complement to such an improvement in formalisation incentives, and should be enhanced simultaneously.

The education system was highly affected by the pandemic, exacerbating longstanding challenges. Before the pandemic hit, Colombia was grappling with low learning outcomes in secondary education compared to the OECD average (Figure 1.26, Panel A.), and a high correlation between outcomes and students’ socioeconomic backgrounds (Figure 1.26, Panel B). After one of the longest schools closures in the region and in the OECD, these inequalities are likely to widen even further.

By October 2021, around 22% of students had not returned to the classroom (Fundación Empresarios por la Educación, 2021[34]). For students from vulnerable households and rural areas, virtual classrooms did little to compensate the absence of in-person learning, given stark differences in access to digital resources and digital literacy. Only 32% of disadvantaged students have Internet access at home, compared to 93% among students from more advantaged backgrounds (OECD, 2020[35]). This supports the case for a more rapid nationwide roll-out of internet connectivity.

Addressing the unequal legacy of the pandemic will require a stronger focus on disadvantaged children. Early drop-outs in secondary education have risen by 25% between 2019 and 2020, according to preliminary data, particularly among children from public schools and vulnerable households in rural areas (Ministerio de Educación, 2021[36]). Putting in place targeted programmes will be essential to reverse the negative impact of school closures, in particular for re-engaging youth and children who dropped out during the pandemic and helping students catch up with learning loss from school closures (OECD, 2018[37]; Kraft and Falken, 2021[38]). A recent programme financed by the World Bank is a step in the right direction. Evidence suggests that targeted programmes to attract those out of school and those lagging behind in school, expanding school meals and full-day schooling programmes can reduce early drop-out, teenage pregnancy, drug use and crime and strengthen socio-emotional competencies (Llach et al., 2009[39]; Berthelon and Kruger, 2011[40]).

Allocating more resources towards the earlier stages of education should be prioritised not only to mitigate the effects of the pandemic, but also to make the education system more equitable. In 2019, slightly more than 50% of children between 3 and 5 years old were in education (Fedesarrollo, 2021[41]), compared to between 90 and 100 % for most OECD countries, reinforcing inequalities from the start. Early childhood education and care (ECEC) significantly decreases the likelihood of disadvantaged students dropping out from the education system later on (OECD, 2016[42]). High-quality ECEC services also help support children’s outcomes later in life, including in labour market participation, reduction of poverty, increased intergenerational social mobility and social integration (OECD, 2018[43]). Estimates put the cost of universal coverage for children aged 3-5 at 0.3% of GDP (Forero and Saavedra, 2019[44]).

More equal opportunities in education are key for raising intergenerational mobility, which has been particularly low (Figure 1.27). A recent decision to provide free tertiary tuition for 700,000 vulnerable students (Matrícula Cero) will enable more students from low-income backgrounds to access higher education. The benefits of this costly measure, however, will depend crucially on more equal learning opportunities from early childhood to the end of secondary education. For children from disadvantaged backgrounds, a lack of preparation and low aspirations are often just as much of an impediment for pursuing higher education as tuition fees.

As more disadvantaged schools and areas often lack high-quality teachers, improving the incentives for high-quality teachers to relocate at least temporarily can help to reduce inequalities, as the example of Chile has shown (Bertoni et al., 2018[45]; Elacqua et al., 2019[46]). However, the current 15% salary bonus offered in Colombia has proven insufficient for this. Depending on the school and the degree of remoteness, salary bonuses could be raised and combined with accelerated career progression and automatic grade increases for teachers who complete at least a 3-year assignment in disadvantaged areas (Forero and Saavedra, 2019[44]). This could be complemented by facilitating professional exchange and learning for teachers through networks, digital tools and resources, and improving contract conditions (Radinger et al., 2018[47]).

Productivity growth has been weak for two decades and Colombia has fallen behind regional peers in terms of labour productivity (Figure 1.28, Panel A). Over the last decade, growth has been entirely accounted for by the accumulation of labour and capital, while total factor productivity has actually subtracted from economic growth (Figure 1.28, Panel B) (Rivera and Robledo, 2021[48]). This mirrors developments in other Latin American economies, but stands in sharp contrast to high-growth economies in Asia. Immigration, and in particular a welcome 2021 decree that grants legal residence status to immigrants from neighbouring Venezuela, will have a positive effect on the labour force and growth, raising GDP levels by up to 0.4% (Pulido and Varón, 2020[49]). Still, population ageing will withdraw the previous boost to growth from an expanding labour force over the next years, and unless productivity and investment make up for that loss, potential growth is set to decline sharply (Figure 1.3).

One way for policies to bolster productivity is to alleviate common production cost drivers, such as infrastructure bottlenecks. Colombia has narrowed the gap to regional peers over the last decade (Misión de Internacionalización, 2021[50]). Still, further improvements in infrastructure could have significant growth payoffs (Ramírez-Giraldo et al., 2021[51]). Significant challenges remain in many areas, including ports, airports, communication infrastructure, roads and railroads (Figure 1.29). Only 25,000 km of the 213,000 km of roads are paved, and often in poor condition (Misión de Internacionalización, 2021[52]). This hurts both exports and the development of lagging regions, with less employment opportunities, especially in the formal sector. A sizeable infrastructure package designed in response to the pandemic, worth 1.4% of GDP, and a new national logistics policy will alleviate some bottlenecks, besides supporting the recovery, and build on Colombia’s extensive experience with public-private partnerships in the road sector (Misión de Internacionalización, 2021[50]). These actions will also contribute to reducing the times and costs of logistics operations. Further progress could be made in the development of intermodal transport facilities, such as rail-road connections, and reducing the handling times in ports, including those caused by customs and other agencies.

Improving incentives for businesses is another, equally important, policy agenda to strengthen productivity. Many current policies and institutional settings hamper competition, both among existing firms and from new market entrants (Jaramillo Londoño, Gómez Márquez and Rodríguez Reyes, 2021[53]; CONPES, 2020[54]). This curtails the incentives both for existing firms to innovate and adopt better technologies, and for resources to move towards more productive firms, including new market entrants. In the current situation with limited fiscal resources, moving ahead on this agenda is more relevant than ever, as reforms to strengthen competition can have strong growth pay-offs without requiring much additional public resources.

Several indicators point to weak and declining competitive pressures on Colombian firms. Perceptions of business executives suggest that many markets in Colombia are dominated by relatively few players, placing Colombia at rank 102 out of 141 countries surveyed (WEF, 2019[55]) (Figure 1.30, Panel A). When markets are dominated by a few firms, this also leaves limited space for new entrants, and indeed new market entry occurs less frequently than in other economies, according to indicators based on firm-level data (Figure 1.30, Panel B).

New market entrants in advanced economies typically face “up or out” dynamics in their first years of existence, but in Colombia, these dynamics are weakened by significant barriers to entrepreneurship and the survival of small unproductive plants (Eslava, Haltiwanger and Pinzón, 2019[56]). This may be traced back to the widespread informality of firms and jobs, which can provide a competitive edge and generates an uneven playing field for competition. Informality also holds back firm growth, as informal firms attempt to remain below the radar of enforcement agencies. This further strengthens the case for improving formalisation incentives, aside from the social considerations elaborated in Chapter 2. Early evidence suggests that the pandemic may have triggered the exit of small and less productive firms, and promoted automation (Flórez et al., 2020[57]; Bonilla et al., 2021[58]).

Firm-level data from the manufacturing census suggest that competition has weakened further between 2008 and 2018, as mark-ups, which reflect the difference between prices and costs, and operational profitability have increased by 37% and 11%, respectively. The resulting economic rents have regressive income distribution effects and may translate into political power that, in turn, reinforces monopoly power, creating a vicious circle (UNDP, 2021[59]). Firms with higher mark-ups have tended to gain market share despite being less productive and less willing to invest in information technology (Iootty et al., 2021[60]). These firms tend to be overrepresented in sectors with high trade protection (García et al., 2019[61]). Evidence of weakening competition also extends to the services sector (Iootty et al., 2021[60]), with one example being persistently high interest spreads in financial services (Figure 1.31). Empirical analysis suggests that reducing mark-ups in manufacturing and services –as a result of stronger competition- would be associated with stronger productivity growth (Iootty et al., 2021[60]).

Regulations can restrict competition, often as collateral damage in the pursuit of other policy objectives. Colombia’s regulatory policies are less competition-friendly than in most of the 46 economies covered by the OECD Product Market indicators (Figure 1.32). Specific sub-indicators suggest that Colombia is significantly more restrictive in the complexity of regulatory procedures (Figure 1.32, Panel B.). Understanding current rules is complicated by the lack of an online register of secondary legislation, and the regulatory agenda of planned approvals or modifications is not regularly published online (OECD, 2018[62]). Unlike all other OECD countries, Colombia does not grant the right to appeal against regulatory decisions.

An ongoing review by the government of the stock of existing regulations and their competition impact is a useful first step, which should be expanded and accelerated. Besides, evaluating the competition impact of new draft laws and regulations should become a systematic requirement, as it currently only applies to some secondary legislation (Jaramillo Londoño, Gómez Márquez and Rodríguez Reyes, 2021[53]). The competition authority should be given a stronger role in competition advocacy and its prowess could be strengthened by aligning its current low penalties with international practice (CPC, 2020[63]).

Entry barriers and administrative burdens on start-ups are high, reflecting Colombia’s exceptionally cumbersome license and permit requirements (Figure 1.32, Panel C). Full information on license requirements is not available online, and there is no single one-stop shop where all licenses and authorisations can be issued. Progress has been made in reducing business registration renewal fees, but these may still be one factor behind widespread informality among small firms (Salazar et al., 2017[64]). A 2018 programme has started to simplify some administrative procedures across the domains of different ministries, with likely positive effects on productivity and the scope for corruption. In addition to the progressive roll-out of one-stop shops, this is an important step in the right direction. A national entrepreneurship policy of 2020 and a new entrepreneurship law aim to overcome existing barriers to entrepreneurship (CONPES, 2020[54]).

Strong engagement in international trade and investment flows also plays a key role for productivity. Trade is another source of disciplining competitive pressures, promoting the adoption of internationally competitive production techniques, and provides opportunities for exploiting economies of scale through exports. Investment inflows are not only an important source of external financing, but they often bring in new technologies and generate significant spill-over benefits (Javorcik, 2004[65]; Arnold et al., 2016[66]), not least because foreign affiliates are generally more productive than domestic firms (Arnold and Javorcik, 2009[67]). As discussed in the 2019 Economic Survey (OECD, 2019[13]), Colombia has not fully reaped these benefits, as it participates little in international trade (Figure 1.33). Exports represent 15% of GDP, slightly below the level 50 years ago, and -despite recent improvements- remain highly concentrated in a few products and markets, with a strong natural resource content.

Colombia’s integration into global value chains is minimal (García Guzman, Rivera and Robledo, 2021[68]). Investment inflows can be key to increasing the integration of the economy into global value chains. In many emerging markets, supplying the domestic subsidiaries of foreign multi-national enterprises is one of the most promising ways for many small and medium size enterprises to increase their forward integration into global value chains (López González, 2017[69]). Although Colombia imposes relatively few restrictions on inward FDI, inflows have been stagnant since the 2014 commodity price crisis (Li and Aranda Larrey, 2021[70]; OECD, 2018[71]). Moreover, they are heavily concentrated in extractive industries, where foreign subsidiaries in Colombia are less productive, less engaged in international value chains and less more prone to generate positive spill-overs to domestic firms than in manufacturing (Li and Aranda Larrey, 2021[70]). The main challenges reported by foreign subsidiaries in Colombia include tax rates and tax administration, corruption, electricity, transport, workforce skills, licenses, courts, and competition from informal firms (Li and Aranda Larrey, 2021[70]). Analysis based on several Latin American countries suggests that key factors that influence the stock of foreign direct investment are labour costs, corruption and the rule of law and skills (Cadestin, Gourdon and Kowalski, 2016[72]). In other words, the same policy improvements that can advance productivity growth among domestic firms would also allow Colombia to reap greater benefits from FDI.

Significant trade barriers are one explanation behind Colombia’s tepid embrace of internationalisation, as successful exporting requires exposure to global competition and access to inputs, especially within value chains. Tariff barriers exceed those of regional peers. Although they have come down on average and the number of zero-ratings has increased, tariff dispersion has risen (Rivera et al., 2021[73]; García Guzman, Rivera and Robledo, 2021[68]). As a result, average tariffs mask high tariff rates in key sectors with significant domestic production. Peak tariff rates above 25% have become more common in recent years (Figure 1.34, Panel A). Concentrated in textiles, apparel, footwear, agriculture and the automotive sector, they are often applied only to narrow tariff lines relevant for specific domestic producers (Echavarría, Giraldo and Jaramillo, 2019[74]; García Guzman, Rivera and Robledo, 2021[68]), which suggests scope for a better insulation of trade policy making from domestic special interest groups (see next section).

With such dispersed tariffs, simple or weighted tariff averages do not have an easy interpretation. A more illustrative way to compare with other countries and across time is the Trade Restrictiveness Index (TRI), which measures the uniform tariff that is welfare-equivalent to a given protective structure (Anderson and Neary, 1996[75]). This index shows Colombia’s protection level closer to that of Brazil than to Chile, Mexico or Peru, with a visible increase since 2015 (Figure 1.34, Panel B). Sectors with particularly high protection include food, beverages, natural oils and the automotive sector (Rivera et al., 2021[73]).

Tariff protection is exacerbated by non-tariff barriers, which have mushroomed from 300 in the 1990s to 5120 in 2014. 61% of products and 64% of trade volumes are currently subject to non-tariff barriers (Kee and Forero, 2021[77]). These can reach ad-valorem equivalents of 20% in vehicles, 40% in footwear and up to 89% for processed rice, well above what is common in regional peers (García Guzman, Rivera and Robledo, 2021[68]; Cadot, Gourdon and van Tongeren, 2018[78]). Non-tariff barriers applied by Colombia include requiring pre-shipment inspection formalities for 1811 products, while Chile requires these only on 720 products (Kee and Forero, 2021[77]). Non-automatic import licenses apply to 1890 products in Colombia, compared to 136 in Chile. These products include cars, rice or powdered milk. Finally, one measure that is highly uncommon in the region are the authorised ports of entry requirements that Colombia applies on more than 1700 products. One example is a rule that requires all sugar imports to enter through one pacific port, although many potential suppliers could more readily access Colombia through a port on the Caribbean coast. Streamlining these requirements and eliminating those that have no technical justification such as public health or safety considerations has significant potential for reducing trade costs (Kee and Forero, 2021[77]).

Trade could also be boosted by addressing gaps in infrastructure, logistics and customs procedures. A digital single window for foreign trade has been rolled out progressively since 2004 and an increasing number of the 21 public sector entities involved in clearing foreign trade transactions now allow accomplishing procedures online through this mechanism. The programme aims at reducing import and export delays and fostering coordination between different agencies, including through joint inspections. With the ratification of the WTO Trade Facilitation Agreement in 2020, Colombia has committed to reducing the time for clearance of imports, exports and transit to 48 hours. These are all important steps that future efforts can build on. However, Colombia still has some way to go to achieve best practice (CPC, 2020[63]; Misión de Internacionalización, 2021[50]). The Single Window project could be developed further by enhancing the cooperation and information exchange between entities, for example by ensuring the interoperability of management systems between the single window and existing customs and border agencies, or the application of common risk profiles to guide inspections. The authorities have recently commissioned detailed analysis in the context of an “Internationalisation Mission”, which provides useful recommendations to follow up on (DNP, 2021[79]).

Embracing internationalisation more thoroughly would promote productivity, technology adoption and social inclusion simultaneously. Empirical evidence suggests that earlier tariff reductions have boosted productivity growth in Colombia (Eslava et al., 2013[80]). At the same time, exporting firms tend to pay higher wages and hire more workers than non-exporters (Brambilla, Depetris Chauvin and Porto, 2017[81]). Previous OECD analysis suggests that halving tariffs would boost the purchasing power of the poorest households, i.e. those in the lowest income decile, by more than 10%, while overall, average household income would increase by 3.5% (OECD, 2019[13]). The marked pro-poor feature of the tariff reduction is explained by the fact that lower income households spend more on traded goods as a share of their income.

Reforms could start with a thorough review of tariff and non-tariff barriers, beginning with the higher ones in a quest to reduce dispersion. This could be supported by further improvements in trade facilitation, including better customs logistics and coordination among different agencies, building on past progress with the Single Window. Colombia can also build on recent success with policies to overcome coordination and information failures, such as export promotion and industry roundtables, as well as technology extension services through a programme called “Productivity Factories”. A pro-active trade agenda, participating actively in plurilateral and bilateral trade negotiations could strengthen the political momentum for lower domestic trade barriers and allow improvements in market access for Colombian firms. For example, while Chile has bilateral agreements with 32 trading partners, Colombia has only 22.

Lowering trade barriers typically combines the medium-term benefits of more and better jobs with short-run adjustment costs for workers, which occur while jobs disappear in some firms and emerge in others. Policies can go a long way to reduce the burden of adjustment for poor and vulnerable households. Strong social protection networks are a key buffer in the short term, to help displaced workers across temporary spells of unemployment. Expanding the coverage of social protection, as discussed in Chapter 2 of this Survey, is therefore a key priority. The adjustment will be more rapid, and the costs will be lower, the more product and labour markets accommodate reallocations without strong frictions that impede new firm entry or new job creation (Winters, McCulloch and McKay, 2004[82]). Reducing regulatory burdens on product markets, as discussed earlier in this section, and the cost of formal employment, as discussed in Chapter 2, can help for this.

Last but not least, job movements often require new skills. Scaling up training opportunities can help workers to get ready for new jobs in expanding firms, and facilitate the transition into better paying jobs. Evidence from Brazil suggests strong benefits for the employability of displaced workers, especially when training courses are well-aligned with labour market needs (Grundke et al., 2021[83]). Evidence from Colombia also points to strong potential payoffs from training programmes (Attanasio, Kugler and Meghir, 2011[84]; Attanasio et al., 2017[85]). The recent establishment of a National Qualifications System is likely to improve the alignment of training programmes with skill needs.

Strong institutions are crucial for raising productivity and competition, but also for making growth more inclusive (Acemoglu, Johnson and Robinson, 2005[86]). Weak governance and corruption hamper growth and opportunities for ordinary Colombians by affecting the quality and coverage of public goods and services, siphoning off scarce public resources, distorting labour and capital allocations, eroding trust in public institutions and weakening governance, and maintaining excessive bureaucracy and arbitrariness (Perry and Saavedra, 2019[87]). For example, rewards for productive and innovative firms can be jeopardised when access to resources and markets depends on relationships and individual arrangements that circumvent the rule of law, rather than on strong performance. Excessively strong vested interests may also render pro-competitive reforms, including lower trade barriers, politically unviable.

Colombia has made significant progress with recent anti-corruption efforts and initiatives to foster integrity and combat corruption in the public sector (OECD, 2017[88]). However, corruption perceptions point to significant governance challenges, exceeding those of other countries in the region, such as Argentina and Costa Rica. Moreover, these perceptions suggest that the situation has deteriorated over the years (Figure 1.35). 48% of Colombians consider that corruption poses the greatest challenge for Colombia (CID Gallup, 2021[89]). Particular challenges affect the subnational level, where corruption indicators tend to be higher in local jurisdictions that receive higher transfers and royalties from central sources (Alvarez Villa et al., 2019[90]). Scope for improvement exists across a wide range of issues, including public procurement, whistle-blower protection, the regulation of campaign financing, lobbying, and law enforcement, which encompasses the functioning of the judicial system.

Public procurement and infrastructure projects are typical high-risk areas for corruption. Harnessing competition among potential providers is crucial, and requires an even playing field and full transparency. Evidence suggest that public purchases in Colombia are often characterised by a lack of competition, significant concentration among contractors, frequent contract renewals and amendments without new tenders, and unclear rules regarding conflicts of interest (Zuleta, Saavedra and Medellín, 2018[91]; Zuleta, Ospina and Caro, 2018[92]; Palacios Lleras, 2019[93]). There are more than 800 unfinished infrastructure projects, often the result of irregularities uncovered before completion, representing a sunk cost of around 2.2% of GDP (Contraloría General de la República, 2021[94]).

Streamlining bureaucratic procedures and enhancing transparency can help to insulate institutions against interest groups, as can systematic training of procurement officials on effective tender design and effective detection of collusive practices (OECD, 2012[95]). Colombia has no regulation requiring transparency in the interactions between interest groups and policymakers, as reflected in the low performance on the OECD PMR indicator on interactions with interest groups (Figure 1.36).

Centralised purchasing bodies and electronic procurement are an effective way to reduce the scope for side-payments and collusion. Colombia has made important progress in this regard by establishing a central procurement entity (Colombia Compra Eficiente), as discussed in the previous Economic Survey (OECD, 2019[13]). Still, direct purchases represented around 70% of total public procurement transactions in 2019 and 2020 (Agencia Nacional de Contratación Pública, 2021[96]). The largest component is personal services provision and management support, which tend to be correlated with the electoral cycle (Zuleta, Saavedra and Medellín, 2018[91]). Direct purchasing and the scope for illicit behaviour could be restricted through a clearer definition of instances where centralised purchasing is mandatory, including at the subnational level.

Further improvements could also stem from a thorough assessment of the laws and regulations affecting public procurement. One way ahead would be to lower the cost of participating in tenders. At present, only companies who pay an annual fee for listing on a public registry (Registro Único de Proponentes) can compete in public tenders, which unduly limits the participation of smaller enterprises in government purchases, as well as the use of centralised purchases for smaller contracts, in light of the annual listing fee of approximately USD 150. The competition authority (Superintendencia de Industria y Comercio) has taken a leading role in uncovering procurement cartels ex-post, but its action is often hampered by the limits of its statutes and of competition law (Palacios Lleras, 2019[93]). The competition authority’s fines are low and it lacks the power to disqualify those involved in bid-rigging from participating in future procurement processes (Jaramillo Londoño, Gómez Márquez and Rodríguez Reyes, 2021[53]).

Whistle-blowers are one common way to detect cartels and bid-rigging in procurement cases, but also corruption cases more widely. Brazil’s recent prosecution of large-scale corruption cases, with ramifications across Latin America, can be directly related to improvements in incentives for whistle-blowers to come forward, as discussed in OECD Economic Surveys of Brazil (OECD, 2020[97]; OECD, 2018[98]) Most OECD countries have dedicated whistle blower protection laws, like the one implemented by Australia in 2019, while Colombia does not (Sanclemente Arciniegas, 2020[99]; OECD, 2019[100]; OECD, 2016[101]). Individuals sanctioned for bid-rigging in public procurement can be criminally prosecuted according to the penal code, which is a significant disincentive. Attempts to remedy this shortcoming were not approved by Congress during the 2020-21 legislature. In one such attempt, relevant sections were excluded from a draft proposal before approval by Congress (Law 341/2020). Other similar projects that would have provided whistle-blower protection were archived (Transparencia por Colombia, 2021[102]; Transparencia por Colombia, 2021[103]; OECD, 2019[100]). This lack of ambition represents a missed opportunity in the fight against corruption.

Regulating the financing of political parties can prevent powerful special interests from capturing policy design, which makes growth less inclusive and decreases trust in government (OECD, 2016[104]). Given the limited public financing, campaigns are highly dependent on private funds in Colombia, for which there is no limit (Pachón Buitrago, 2018[105]). Private financing is particularly predominant in regional and local elections. This creates incentives for candidates to pay back campaign contributions with political favours once in office, affecting spending efficiency or the quality of politically-appointed officials (Perry and Saavedra, 2019[87]; Fedesarrollo, 2021[41]). Allegations of several large-scale cases stretching across political parties and sectors have been investigated by the judiciary (Escallón Arango, 2014[106]; Garay, Salcedo-Albarán and Álvarez, 2020[107]). The accountability of campaign financing is particularly limited for independent candidates, whose electoral campaigns are subject to weaker rules regarding registration and campaign financing and exempt are from the usual time limits for electoral campaigns (Pachón Buitrago, 2018[105]; Fedesarrollo, 2021[41]). Stricter limits and transparency requirements for private campaign contributions, for both political parties and independent candidates alike, would lessen corruption incentives, including through a full replacement of private campaign funding by public funds, allocated in a transparent manner and with strict accountability rules (Fedesarrollo, 2021[41]).

Enforcing laws and private contracts also hinges on effective institutions, especially the performance of the judicial system (Perry and Saavedra, 2019[87]). Colombia’s weak performance is related to cumbersome procedural requirements, low court automation, unlimited adjournments and little recourse to electronic case management tools. There is also scope to improve governance within the judicial system, strengthen performance incentives for judges, and improve the training of investigators, lawyers, prosecutors and judges, including in economic matters and white-collar crimes, in addition to establishing clear safeguards against political interference to protect investigations and prosecutions (Fedesarrollo, 2021[41]; OECD, 2019[100]). Finally, the low trust of Colombians in the integrity of judges in surveys suggests the need for more transparency regarding conflicts of interest (Villadiego and Hernández, 2018[108]; Pring and Vrushi, 2019[109]).

Colombia made tangible progress in the fight against impunity in the past couple of years. The Prosecutor General’s Office has been prioritising the investigation of violence against trade unionists and has introduced a dedicated investigation strategy and specialised teams. These efforts resulted in the clarification of 43% of homicides of trade unionist between 2017 and 2020. For comparison, only 30% of intentional homicides were clarified during the same period. Despite these advances, the country continues to suffer from violence against trade unionists, with 22 homicides of trade unionists reported between April 2020 and March 2021.

Improvements in governance are key for raising public trust in institutions, which is low in Colombia (Figure 1.37). For instance, trust leads to greater compliance with regulations and the tax system (OECD, 2017[110]; Batrancea et al., 2019[111]). More trust in the good use of public resources would strengthen the political support for raising additional public resources. Low trust in public institutions may also deter whistle-blowers from reporting corruption cases. 58% of Colombians consider it is unlikely that complaints generate any consequences, while 78% indicate that they would suffer retaliation if they report (Pring and Vrushi, 2019[109]). Trust in institutions may also have been negatively affected by alleged police violence during recent social protests (OAS/ CIDH, 2021[112]). In May 2021, 56% of survey respondents disapproved of police behaviour (Portafolio, 2021[113]). Colombia is one of the few countries where the police is subordinated to the Ministry of Defence, making apparent the need to adapt police forces to a post-conflict context. Integrating the police into the Ministry of the Interior, more emphasis on Human Rights training, and judging police agents in ordinary courts as opposed to a military one are useful proposals that are currently being discussed.

The implementation of the 2016 peace agreement is also key for strengthening Colombia’s institutions and has shown steady progress (see Box 1.2). Over the next decade, its completion will require substantial fiscal efforts. Total implementation costs between 2017 and 2031 are expected to reach 12.9% of GDP (Contraloría, 2021[114]).

After five years of implementation of the peace agreement, the latest report by independent observers indicates that 30% of the stipulations are fully implemented (Instituto Kroc, 2021[115]). Provisions related to land titles, supporting victims of conflict and reducing illicit drugs have shown significant progress in the past year. Many of the low-hanging fruits of the agreement have now been picked, and more ambition will likely be needed for future progress, particularly with respect to land access and use (Procuraduría Nacional de la Nación, 2021[116]). A land reform intended to facilitate land access for Colombians who need it, like former combatants, those displaced by internal conflict and poor farmers without access to land has seen relatively little progress, not least because it requires significant resources. Similarly, some commitments within the National Comprehensive Program for the Substitution of Crops Used for Illicit Purposes have not yet been initiated or show a minimal level of implementation. However, the programme covers 56 municipalities and supports close to 100,000 families that participate in the voluntary crop substitution process, 70% of which have received emergency food assistance. These areas will require constant and long-term efforts in order to achieve substantive changes that address the structural causes of violence. A nationwide rollout of the multipurpose land registry would promote a better land use, reduce legal uncertainties, foster investment and facilitate transactions (OECD, 2019[13]). This would make peace more sustainable by providing a boost to rural development, in addition to supporting the fight against illegal deforestation (see next section). At the same time, it may face opposition from powerful vested interests. As of January 2021, only 15.4% of land had updated cadastral information, up from 6% in 2018 (Procuraduría Nacional de la Nación, 2021[116]). Reaching 60% by 2022, one of the agreement’s goals, will require stepping up efforts significantly, especially in municipalities affected by conflict. In addition, more could be done to deliver on the agreement’s promise of actually distributing land to landless victims of conflict. Colombia’s arable land is not only highly concentrated in a few hands, but also under-exploited.

Corruption in the implementation of the agreement could foster distrust and a loss of legitimacy in the transition process towards a sustainable peace (Transparencia por Colombia, 2020[117]). Recent corruption scandals in which local officials undertook changes in urban and territorial planning for private gain underline the relevance of this threat. Strengthening local citizens’ oversight committees could increase transparency and enhance the legitimacy of the process.

Greenhouse gas (GHG) emissions are relatively low in per capita terms. However, net emissions have been trending upward over the last decade (Figure 1.38). GHG emission reduction goals have recently been made more ambitious, aiming at a 51% reduction with respect to the baseline scenario by 2030 (CAT, 2021[118]; UNEP, 2019[119]). This is meant to pave the way for reaching carbon neutrality by 2050, although it may not be enough to reach that goal (CAT, 2021[118]).

Historically, the largest emitting sectors have been land use and forestry, agriculture, transport and the energy sector. Emissions from land use, the largest component, have decreased significantly since the 90s, with ups and downs associated with changes in deforestation, in contrast to the generalised upward trend in the other three sectors.

Achieving emission goals will depend crucially on advances in the fight against deforestation, which is the major activity behind GHG emissions. According to government plans, deforestation is meant to decrease to 50,000 hectares per year by 2030, compared to 172,000 in 2020 (IDEAM, 2018[120]). In late 2021, a more ambitious goal of zero net deforestation by 2030 was formulated at the Glasgow summit. Colombia’s forests are an invaluable natural asset, not only due to their significant role in absorbing CO2 but also for their biodiversity and the central role they play as livelihoods for local communities. They encompass diverse ecosystems, from the Andean woods to the Amazon rainforest. Today’s deforestation generates short-term private gains that are far below its social value. Deforestation declined sharply between 2011 and 2015, before a new surge in 2016-2017 (Figure 1.39). The year 2020 saw an 8% increase in deforestation, concentrated in the Amazon region. These developments are compromising Colombia’s forest protection goals.

Causes of deforestation include the expansion of the agricultural frontier, often for extensive, low-productivity cattle breeding or simple land appropriation in the hope of a future land title, but also illicit crops. Extensive cattle breeding, based on converting forests into grassland, is one of the main causes of deforestation in the Amazon region (Murcia García et al., 2015[121]). Both in the Andean and Amazon region, much of the total deforestation is related to coca cultivation, which also drains land and water resources through excessive fertiliser use (UNODC, 2018[122]). At the same time, coca eradication attempts based on fumigation can harm not only human health and ecosystems, but might push cultivators into more remote areas, thus contributing further to deforestation. A tax on non-organic pesticides, which was recently proposed at a rate of 8% but not implemented, could help to internalise the associated external effects of pesticide use more widely and raise additional revenues (OECD, Dian and Ministerio de Hacienda, 2021[17]).

Carbon and ore extraction, part of which is illegal, has also propelled deforestation and is responsible for large releases of hazardous chemicals. Moreover, a rapid expansion of secondary and tertiary infrastructure has improved access to remote areas and thereby facilitated deforestation (IDEAM, 2018[120]).

A dramatic and highly significant increase in deforestation has occurred since 2015 in the context of the peace agreement, affecting 80% of protected areas and their buffer zones following the end of armed conflict (Clerici et al., 2020[123]). This is likely related to several reasons including the sudden retreat of guerilla forces, weaknesses in territorial control by the central government, the interest of some armed groups of dissident ex-guerillas to strengthen their position in some territories, the illicit extraction of forest resources, the expansion of the agricultural frontier, land grabbing, extensive cattle ranching, and the growing international demand for cocaine (González et al., 2018[124]).

Colombia’s institutional efforts to curb deforestation have included an early detection system based on satellite imagery and the establishment of an inter-institutional national council to combat deforestation. A new Environmental Crimes law defines deforestation, its financing, and illegal land appropriations as crimes and raises the penalties for environmental damage. A new policy document for combating deforestation and sustainable forest management has been issued to coordinate actions by 40 national entities. Based on this sound framework, additional resources for enforcement action should be deployed permanently to accelerate the fight against deforestation, as recommended in the 2019 Economic Survey of Colombia (Table 1.6, OECD, 2019[14]). At present, enforcement action only follows a minor fraction of detections. In light of the global externalities, the case for international financial support for such action is strong. Additionally, uncertainties about land ownership related to the patchy coverage of land registries in remote regions need to be resolved to avoid opportunistic deforestation, especially around natural parks.

Rising agriculture emissions are mainly related to growing livestock herds (IDEAM, 2017[125]), which is one of the causes of deforestation. Deforestation for extensive cattle breeding is not only harmful to ecosystems, but also inefficient, as it is carried out on low-productivity land that is not suitable for this activity. Redirecting part of this activity to higher-productivity land and implementing modern production techniques could leave millions of hectares for reforestation and sustainable forestry, recuperating the land and acting as a carbon sink. Zero-deforestation agreements originating from the private sector, notably the beef, dairy, palm oil and cocoa supply chains, may be part of the strategy to rein in deforestation related to agriculture.

Energy-related emissions have increased by around 73% since 1990, although this trend has started to revert more recently (Figure 1.38). These emissions originate from rising combustion of fossil fuels such as coal and oil (Figure 1.40), mostly from transport, energy production and manufacturing. Surface transport is a strong emitter and transitioning to electric vehicles and other sustainable modes of transport would help cut emissions substantially, particularly as electricity generation in Colombia is to a significant extent clean and from renewable sources. Registrations of electric and hybrid vehicles are growing at a fast pace, supported by tax benefits.

In 2019, almost 80% of electricity came from hydroelectric sources (Figure 1.41), above the OECD average in renewable generation of electricity. Non-traditional renewables such as solar energy, where Colombia has significant potential (Suri et al., 2020[126]) and wind generation, with high potential in the Guajira department (Carvajal-Romo et al., 2019[127]), are less developed than in other OECD countries, although the recent trajectory is promising. Advancing them would also decrease the exposure to droughts and support energy security.

Shifting some fossil energy consumption, especially coal, towards cleaner energy holds significant potential for emission reductions. Industrial users have room to replace coal (30% of total consumption) by natural gas, although that would require additional investment in regasification plants. Furthermore, households source 38% of their energy consumption from wood, part of which could be substituted by electricity, natural gas or liquefied petroleum gas (LPG) for rural areas.

Colombia’s fossil fuel prices fail to internalise the associated environmental and social impacts by a wide margin (Fedesarrollo, 2021[41]). A first important step be to eliminate all fossil fuel subsidies, which currently amount to 0.4% of GDP, while implementing measures to protect low-income households against real income losses. Making wider use of the carbon tax could also be part of a strategy towards shifting production and consumption patterns. Colombia was the third Latin American country to introduce a carbon tax in 2016, which has potential for significant CO2 reductions in Colombia (Calderón et al., 2016[128]). The tax currently covers around 25% of domestic emissions. The most important items not covered are coal, including in thermal power plants, natural gas and LPG for non-industrial uses (MADS, 2017[129]).

Expanding the carbon tax to coal and natural gas could help to reduce emissions and air pollution, and contribute to further shifts towards renewable energy use in electricity generation. At USD 5 per ton of CO2 equivalent the carbon tax is also significantly lower than in other countries with similar income levels (Federsarrollo, 2021[130]). This explains why environmentally-related taxes, which in Colombia also include taxes on vehicle sales, represent only 0.6% of GDP, well below the 1.6% OECD average. Aligning the tax rate with current OECD average levels over several years could lead to additional revenues on the order of 0.2% of GDP, part of which could be used to compensate low-income households for the associated price increases. (Carbon Pricing Leadership Coalition, 2019[131])An emission trading scheme does currently not exist, although the legal basis for this was created in 2018 (Sousa et al., 2020[132]).


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