The Two Main Electoral Issues Must Be Education and Fiscal Reform

This economist analyzes recent data on the economic and social situation in Central America, particularly Nicaragua, highlighting our huge education deficits and the need for profound change in our unfair taxation systems.

Arturo Grigsby

The most recent analyses by international finance organizations and socioeconomic institutions that study Central America are now sounding an optimistic note. Their optimism is based on proof that Central America is managing to weather the global economic crisis better than expected. Central America has certainly been affected by the global crisis, suffering a significant decrease in its economic activity together with a significant increase in unemployment during 2009, but there are now signs of recovery. All the Central American countries expect to end 2010 with positive economic growth. The regional economy will grow 2.5% over 2009. Given the magnitude of the international crisis, the initial forecasts were that our region would enter a prolonged period of economic recession and stagnancy, but it hasn’t happened like that.

Just like the Chilean miners, we can say we managed to get out of the hole and have seen the light. Now, the question is whether this is enough to set Central America on the path to sustainable productive development with social equity. This is the Central America desired by its people for a long, long time, a desire so powerful it led us to a decade of war, yet didn’t even become reality on signing the peace accords. The most recent data indicate that while we’ve made it out of the hole of the international crisis, the fundamental Central American inequalities still exist. They’ve survived all the wars and all attempts at reform and have actually spread in some cases during the current crisis.

Post-conflict changes in the
Central American economies

In the post-conflict economic growth model, which is still being applied to Central America, our economies have gone from depending exclusively on traditional export products (coffee, bananas, meat, sugar and once cotton) to being somewhat more diversified thanks to the growth of maquilas (sweat shop assembly plants for reexport), tourism and remittances from our emigrant workers in other countries. The income generated by these activities has already surpassed that generated by traditional agricultural products and has changed the face of the Central American economy.

The end of the armed conflicts of the 1980s also benefited the reactivation and expansion of Central American trade and investment flows within the region, making the new face of our economies now “more Central American” than it was a few years ago. But this new face also has a hidden profile, created by the activities of drug traffickers, which have acquired financial and economic dimensions unimaginable even a few years ago. Although there are not yet any reliable estimates of their impact on the growth of the Central American economy, some Guatemalan economists consider that the expansion of drug trafficking has already played a key role in mitigating the effects of the global crisis in their country.

What accounts for the recovery?

The dependence on migration and remittances was behind the significant fears related to the course the Central American economy might take when the global crisis flared up. Given the degree of unemployment in the United States, people thought the reduction in job opportunities for our migrants would drastically shrink remittances and that this source of economic dynamism could even dry up in a few years. Reality has calmed those fears. Although what happened hasn’t yet been studied in depth, remittances are on the rise again, even though unemployment figures in the United States remain high. During the first six months of this year the money sent home to Central American countries by emigrants grew an average of around 5% compared to 2009, according to the region’s central banks.

The export sector’s recovery has also been rapid and energetic, with an improvement in the price of agricultural exports playing a key role. For example the price of coffee, traditionally Central America’s main export since the 19th century, has been at its highest in the last ten years. The demand for maquila products has also recovered, although it is still weak compared to recent years. Overall, Central American exports grew by an average of over 15% during the first half of 2010, an improvement even on the export levels before the crisis hit.

Persistent sluggish growth and
high unemployment predicted

Despite all this, the reactivation of the Central American economy is still incipient and uncertain as long as there’s no substantial improvement in the international economic context. The International Monetary Fund (IMF) and the region’s central banks are predicting sluggish growth for Central America for the next three years, meaning that high unemployment rates will persist in the immediate future.

In the global crisis unemployment most affected the youngest and those with a low educational level. According to the World Bank, full unemployment—a category that only includes those who haven’t even been able to take refuge in the huge informal sector where most of Central America’s population works—affected almost 18% of people between 18 and 25 years old, which means that one in five young people of employment age remained completely and utterly unemployed. With other age groups the situation wasn’t quite so critical: unemployment affected 6% of people between 26 and 55 years old and 4% of people older than 55. A differentiated impact could also be observed among different educational levels. Those who had finished high school or more experienced less than 4% unemployment, while the percentage for those who hadn’t completed their secondary education or only finished primary school or less was more than double, at 9%.

Education projections are dismal

As organizations that produce these figures, the question we must ask is: If we’re now out of the hole, are we on the road to development? The projections with which we can answer this question aren’t yet optimistic. Projections have been made as to the educational level of the Central American work force in 2015 if things continue as they are now. According to calculations of the Central American publication Estado de la Región (State of the Region), no less than 11% of our work force will be totally uneducated in 2015. If we add to this people who will only have finished part of their primary education or primary school only, we’re looking at over half of our region’s work force.

This dismal projection should open our eyes to the main challenge Central America faces in order to insert itself into the global economy; because a person who only has a primary education, if that, will have a hard time joining the computerized economy that today dominates all economic fields. How to invest in, educate and train people is the central challenge for the future of our region and our people.

Most of our exports are still low-tech

We know that achieving sustainable growth requires us to compete with new products and new services in new markets, developing competitive advantages that go beyond merely lowering production costs. It will be difficult to have a different Central America if we continue being a region with an economy that depends on sending its people abroad as migrants so that can send back remittances; and carry on being countries whose population majority can only get jobs in low paid and low productivity jobs in sweat shops or agroexports.

Central America’s export capacity is still concentrated in low-technology products, which only require an uneducated and unskilled work force. We export a very limited number of products that employ medium-level technology, and even fewer high-tech manufactured products. If we compare Central American exports in 2000 with those in 2008, we see that the region has experienced significant growth in the total volume of exports, but the low-tech products have grown the most. This means that instead of pushing further into the global economy with products that use more advanced technology, we’ve carried on doing what we’ve always done: export meat, coffee and the like, most of it with minimal or no processing, to the world market. Now we have trousers from the sweat shops, most of which import the raw materials that are sown together, and all of which re-export, tax free, both the finished goods and the profits.

Only Costa Rica stands out. It has started to diversify the products it exports and the markets to which it exports them. The evolution of Costa Rica’s exports has been progressive and an increasingly greater proportion of Costa Rican exports overall have been products with a high technological content. This doesn’t happen by chance. It has to do with Costa Rica investing in the education of its people over many years, which has helped it attract foreign investment to production sectors that use high technology. Despite this progress, however, Costa Rica still has far to go to reach countries such as China and India, which were underdeveloped only a short while ago but have evolved very quickly in this direction.

An educated workforce is
the key to real development

In order for countries in our region to develop within the new Knowledge Economy in the medium term, we urgently need to educate, certify and increase the skills of our work force. Nicaragua and the other Central American countries can only be incorporated into the 21st Century Economy if we make an enormous effort to turn our human capital into a qualified work force. We urgently need to invest in both higher education and technical education. Both are crucial if we want the whole of Central America to follow the example set by Costa Rica.

In Nicaragua we have a particularly unbalanced technical education. I remember that in a research study we did on the maquilas a couple of years ago, the president of the association of maquilas, someone from the United States, said to us: “I’ve got too many engineers, lots of engineers graduate from the UNI [Nicaragua’s National University of Engineering]. I pay them US$300 a month to supervise the factory workers for me. But I have to pay the mechanic who looks after the machines US$1,000 a month, because I can’t find good mechanics in Nicaragua.”

The limited access most Central American people have to education naturally influences their income. According to a World Bank study on Central America’s human capital, comparing the Costa Rican salary structure to the educational level of its work force reveals that the gap between the earnings of those with a university education and those who only completed their primary education is enormous: almost 1 to 8. We also see that the salaries of those with less education remain low more or less constantly throughout their lives, while those who have a better education gradually earn more, reaching their best salary level when they’re between 40 and 50 years old.

Better education is as
key as more education

In Central America everything about education has to improve: from the quality of basic education to university research. There are studies that compare the quality of basic and middle education in all countries of the world by means of standardized tests they give pupils in all countries. The differences between the scores of Latin American pupils and those from other parts of the world are enormous. Cuba leads the field among the Latin American countries, considerably ahead of the other countries in the region. The Dominican Republic appears at the bottom with the lowest score, just below the Central American countries. South Korea and Taiwan, which only developed in the second half of the 20th century, today lead the world in educational performance. If we compare the scores of Korean and Taiwanese primary and secondary pupils with their counterparts in El Salvador using the same tests, we see an average of 600 points for Korea and Taiwan against an average of 350 for El Salvador.

There are also gaps among the Central American countries in this field too, and again Costa Rica stands out. If we compare the scores of pupils in the four other countries of the region with those of the Costa Ricans, the gap in quality is huge. The average score of Nicaraguan primary and secondary students, for example, corresponds to the average score of the worst 20% of Costa Rican pupils at the same stage.

The problems of quality and the gaps between Costa Rica and the other Central American countries are widespread in university and higher education. In the other Central American countries the dropout rate is very high, teacher quality is limited because only a few teachers have graduate degrees and very few resources are dedicated to scientific research applied to resolving our countries’ problems.

This data confirms something we’ve known for a very long time. Central America’s fundamental problem, which is to transform its human capital to respond to the need to join the 21st Century’s Knowledge Economy, always revolves around education. In this respect, our States must guarantee their people’s ability to read and write and their access to quality primary, secondary, tertiary and technical education. This is indispensible if we want to substantially reduce poverty.

Resources are the heart of the problem
and taxes are the heart of resources

Here we get to the heart of the problem. If the challenge is to improve education, where will the resources come from to invest in education and make it a policy priority? In theory they should come out of an increase in the national budget. Is this possible? One way to increase revenue would be to achieve significant and sustained economic growth over the next few years. But we’ve already seen that the forecasts are predicting relatively weak growth instead.

The other way is to increase taxes. Figures on the tax burden as a percentage of the gross domestic product (GDP) in Central American countries show that it is extremely low, one of the lowest in Latin America. In Sweden the proportion is close to 40% and in Chile somewhere above 20%, but in Central American countries it varies between 11% in Guatemala and 18% in Nicaragua, according to data from the IMF and the Central American countries’ own treasury ministries. This means that those with the capacity to pay tax in Central America pay very little. This is one of the fundamental roots of Central America’s structural problem, of its inequalities, and in the end of the Central American States’ inability to invest in their people’s education.

A lot needs changing

It’s imperative to improve tax redistribution in all Central American countries, and a lot needs changing. Indirect taxes prevail over direct ones, income tax is a mere blip on the screen and disproportionate tax breaks and exemptions abound, favoring the wealthiest groups in our countries and making tax evasion even easier.

Indirect taxes are what we pay on the goods we buy and direct taxes are what we pay on the income we earn. In Central America the greatest volume of tax revenue comes from indirect taxes, especially the value added tax known as IVA (VAT), which people pay when they buy a pair of trousers, a shirt, liquor, cigarettes… In Guatemala the IVA is 12%, in El Salvador it’s 13%, and in Nicaragua 15%. In contrast with the volume indirect taxes represent in the tax burden, the volume of direct taxes is minimal.

While all of us pay indirect tax on what we purchase, those who have considerable earnings and income by being part of the corporate business sector hardly have to pay any direct income tax at all. Or they evade it. While someone who earns a salary receives their paycheck with the income tax already deducted, bank shareholders have a thousand tricks to avoid paying tax on their earnings. In Nicaragua it’s well documented how banks in the financial system evaded taxes for many years. According to a study by the Central American Institute of Fiscal Studies, the rate of income tax evasion is 63% in Guatemala and 45% in El Salvador.

The result of this regressive tax system is a great inequality: those with the lowest income pay proportionally more tax than those with the highest income. On average, the poorest fifth of the population in each of our countries proportionally pays far more tax than the wealthiest fifth. This injustice, the same in all Central American countries, has been pointed out by civil society organizations and political parties on the Left, and also been documented for years now by the multilateral financial institutions: the IMF, World Bank and Inter-American Development Bank (IDB).

The double root of inequality

Inequality in Central America thus has this double root: not only do States invest too little in their people’s education, they also deny people the right to education because those with more resources and higher incomes don’t pay their tax, evade taxes or benefit from lots of tax breaks or corruption. The consequence of this fiscal inequality is very low public expenditure—once again with the exception of Costa Rica. According to the IMF, overall public expenditure as a proportion of economic activity in Guatemala, El Salvador, Honduras and Nicaragua didn’t even reach 10% in 2009. In Costa Rica it’s 18%, practically double.

Differences in per-capita public expenditure are also significant elsewhere, according to a study by the Economic Commission for Latin America and the Caribbean (ECLAC). In order to compare per-capita public expenditure on education, health and social security in Latin America, the countries were divided into three groups. In the first are the countries that invest the most: Brazil, Argentina, Chile, Panama, Uruguay and Costa Rica, which invest an annual average of around US$1,102 per person. In the second group are Colombia, Mexico and Venezuela, which invest an average of US$638 per person per year. And in the third group appear Bolivia, Ecuador, Paraguay, Peru, the Dominican Republic and the four other Central American countries, with social investment of barely US$178 a year per person. There’s also a large gap with regard to the proportion of the population that draws pensions and benefits. The first group of countries, where we find Costa Rica, covers 64% of the population and the third group only 14%.

Central America also ranks
low in vulnerability aspects

The urgent need to increase tax revenue isn’t linked only to the need to invest in human capital. Central America also suffers from extreme vulnerability with regard to the effects of climate change and faces high levels of public insecurity. Out of 176 countries in the world, Honduras comes in third and Nicaragua fifth in terms of environmental vulnerability. These two poorest countries in Central America are also among the most vulnerable in the world to climate change. Guatemala and El Salvador are better off: in 24th and 37th place respectively. Costa Rica is in 61st place and Panama is in 101st. With regard to public risk, Honduras, Guatemala and El Salvador register daily homicide rates that are among the highest in Latin America, while drug trafficking networks are spreading throughout the whole region, including Costa Rica.

A closer look at Nicaragua

Faced with all these figures it’s indisputably obvious that a far-reaching fiscal reform is one of Central America’s greatest political challenges. Now, let’s concentrate on Nicaragua’s case, the one we’re most familiar with.

If we analyze the national budget produced and administered by the Ortega government these past five years, including the one inherited from President Bolaños in 2007 and the one recently presented for 2011, we see that there has been no fundamental change in terms of fiscal equity. The timid fiscal reform passed in 2009 was a Band-aid applied to cover the most pressing public expenditure needs, without altering the fiscal inequality we’ve experienced for so long, represented by the injustice of poor families paying proportionally more tax than the wealthiest families.

We’ve spent more than a year now talking about elections, parties and candidates. We have to pay special attention to what they say they intend to do about fiscal reform… or what they don’t say. We’ve heard that candidate Fabio Gadea’s priority will be education. Does he plan to back it up by a far-reaching fiscal reform? Responding to the challenge of educating Nicaragua’s people will necessarily entail such reform. Without more resources, no party, no candidate will be able to confront this challenge. While quality education isn’t just a matter of resources, it’s not possible even to talk about improving things without them. What do the candidates propose to do about the highly unfair tax system we have today? What would they do to fund an increase in public expenditure on education to reach the internationally suggested figure of 7% of GDP? Nicaragua currently assigns only 4% of its GDP to education.

The kind of fiscal reform we need in Nicaragua and Central America can’t result from an authoritarian decree, because those national groups privileged with abundant tax breaks have been very successful in protecting them and aren’t interested in any reform. A few years ago an IDB specialist calculated that tax breaks represent 4% of Nicaragua’s GDP. In other words what we would need to be able to dedicate 7% of the GDP to education is assigned to tax breaks that benefit powerful economic groups. If any presidential candidate promises that hundreds of schools will be opened and has set the target at getting children to complete the third year of secondary school or even further without backing this promise up with a reform that modifies the current unfair fiscal situation, we can consider it so much hot air. Without modifying the status quo, all promises to “save the country” will be no more than empty speeches.

Tax reform won’t happen without
national and international allies

Far-reaching fiscal reform in Nicaragua, indeed in Central America, requires a lot of negotiation and internal and external alliance-building to create a political coalition that can make it a reality. There is solid agreement among international cooperation agencies about the need for fiscal reform in the region. And there is total consensus in wanting to see Nicaragua increase its social spending, sustaining it by means of greater and fairer tax collection so that ten years down the road we’ll have a different country from the one we have today. Even the World Bank and the IMF, which internationally advocate tax reductions, want a wide-ranging fiscal reform in Nicaragua that eliminates tax breaks and facilitates collecting income tax from those with the highest earnings. A coalition working for such a fiscal reform would have the full support of the multilateral institutions, bi-lateral cooperation and NGOs who cooperate in Nicaragua’s development.

There have been innumerable attempts at fiscal reform in Central America and all have come to grief because the powerful groups are the least interested in going along with them and have always managed to block them in the parliaments. Last year we saw how the fiscal reform in Nicaragua was reduced to just a little Band-aid, that was even then fiddled to satisfy certain business interests. As a result, the business class got the changes it wanted, just as it also got a postponement until after the 2011 elections of the reform that will ensure the social security system’s sustainability, which involves increasing the employers’ contributions.

Does the Ortega government
have the political will?

Recent surveys have unquestionably reflected some improvement in Nicaragua’s poverty indicators, which is associated to a certain impact from some of the current government’s social programs. But it’s also true that the 2005 poverty measurement survey, taken during the Bolaños government, had already shown a number of Nicaraguans stepping out of extreme poverty and into poverty, which means going from surviving on one dollar a day to surviving on two.

The social programs designed by the Ortega government with Venezuelan resources have somewhat reduced poverty by allowing for a certain degree of immediate income redistribution. But this isn’t the sort of program that will finally get us out of poverty. The only thing that will do the job is a sustainable redistribution of resources that will allow the government to increase public expenditure, especially on education. The structural exit from poverty is through more and better education.

Is there the political will in today’s government to achieve a sustainable solution to the problem of poverty through major fiscal reform? If we base our answer to that question on what has happened in these past five years between Ortega’s government and big capital represented by the Superior Council of Private Enterprise (COSEP), the possibility of such a fiscal reform is less likely if Daniel Ortega is reelected. The relationship between him and national big business has been excellent so far. No other social group or trade or civil organization in Nicaragua has had such a regular and cordial dialogue with the government.

The Venezuelan aid has allowed
Ortega to avoid a real tax reform

When the FSLN took office in 2007 it was ideally placed to embark on a profound fiscal reform. It had the legitimacy of having just won the elections, the opposition was deeply divided, as it still is, and it could depend on full international consent in doing so. But it didn’t do it. Why not? What will have to change in the political coalition that backs Ortega to make it take this step in 2012? Would Ortega accept such a political risk? Seeing what has happened in recent years, it’s hard to imagine that he would. And Venezuela’s ALBA funds act as a disincentive to do so, allowing Ortega to provide some solutions to certain social needs without touching taxes.

When one looks at the projections of the Human Development Plan produced by this government, which reach beyond 2011, when Ortega hopes to be reelected, all one sees are the limited and insufficient percentages we’re already familiar with. There is no appreciable increase in public expenditure. The reality is that the government has been able to avoid dealing with the heart of the fiscal problem thanks to the Venezuelan aid.

It’s very difficult, almost impossible, to predict what could force Ortega’s government to enact the profound fiscal reform that Nicaragua needs. The social programs financed with Venezuelan aid have meant an immediate improvement in the population’s living conditions, but if Ortega continues to use it only for these short-term ends and continues what Nicaragua has been doing, our young people will look for solutions outside of our country. If we can’t insert ourselves into the 21st century economy, more young Nicaraguans will emigrate to wherever they can get a job with their low education levels, and send a little bit of the low salaries they earn to their families.

That’s what we can see on the horizon. We’ve been down that road and there’s no change ahead in the short term that would stop us continuing on down it. It’s pretty obvious that the solution is far greater investment in education and that the only way to get these investment resources is by making those who earn more, pay more, parti- cularly those who don’t pay now. If our politicians don’t see this reality, what do they see?

What’s the government afraid of?

It’s possible that what has stopped the Ortega government from getting involved in this reform—which necessarily involves confronting the business class—is the fear of provoking capital flight or some other situation that’s too difficult for the economy. Or perhaps this fear of confronting the business class simply has to do with the strong presence and representation of business interests inside the governing party and government itself.

The challenge is there, and we’ll have to see what the government’s political gamble will be if Ortega is reelected: either continue satisfying some immediate needs with ALBA funds without touching the business class or undertake a thoroughgoing fiscal reform without letting fear impose itself over and above the urgency of providing the education that will allow a quality future for the Nicaraguan people.

If fear does impose itself on this or any other government, Nicaragua, like Central America, will at least have emerged into the light from the hole in which the global crisis plunged it, just as the Chilean miners did. But that’s all; everything else will carry on just the same.

Arturo Grigsby is director of the Nitlapán Research Institute at Managua’s Central American University (UCA).

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