The tax reform: As unjust as ever

This analysis of the recently approved tax reform describes how the government and business elite conspired to change the country’s unjust tax system just enough that everything will stay the same. It also discusses the differences between economic growth and sustainable development, as well as the elements that are needed— and seemingly not on the agenda— to attain the latter.

José Luis Medal

Nicaragua is about to sign a new three-year agreement with the International Monetary Fund. In exchange, the IMF has imposed—or “suggested”—three elements, understood as conditions, for next year’s agenda: a tax reform, a social security reform and an “adjustment” to the electricity rates. What we don’t see anywhere is a national discussion about Nicaragua’s large and very serious long-term challenges: productivity, poverty and the institutional-political situation.

Nicaragua has had a series of agreements with the IMF since 1990 in which the Fund’s central requirement has always been that the Central Bank not print money, because doing so creates inflation. It argues that there are enough international reserves, but if necessary to avoid a huge fiscal deficit, the government must tighten its belt, not spend much more than its income. We mustn’t make the mistake of thinking that, because the IMF wants a tax reform, it cares about the details. It is only interested in assuring enough fiscal income to avoid a huge fiscal gap in public finances. It doesn’t care if our tax system continues to be regressive, or if the tax burden weighs more heavily on the middle classes and lowest income sectors. Although in theory the IMF says it’s against tax exonerations, in practice it favors them.

The tax reform was a
strictly corporative process

In my opinion, the economic and political situation in 2012 can be summarized as “more of the same.” Save unpredic¬table—but very possible—factors such as another world recession as a result of the European crisis, Nicaragua’s situation will remain the same in 2013, when the new agreement is signed with the IMF to permit a continuation of the relative macroeconomic stability that has existed since 1990.

We can already talk about the tax reform, which the government hammered out in secrecy over a number of months with the big business leaders from the umbrella organization called the Superior Council of Private Enterprise (COSEP), then sent to the National Assembly’s Economic Commission on November 23, still under wraps. Clearly taking no time to review anything, the commission passed it on to the Assembly plenary on Friday November 30, where it was approved in a matter of hours by the governing party’s absolute parliamentary majority.

The process that concluded with the passage of this tax reform in record time was neither transparent nor participatory. The text was known and agreed to by only the government, the business elite and pro-government union leaders. Consumers, the middle classes and professionals were not represented in the discussion of the reform. In fact, the text wasn’t even available to the public. While the general population played no role at all in the process, even the Assembly legislators’ role was only formal. It was a clear confirmation of the corporative nature of our political system. And its content ratified the strategic alliance between the government and the business elite grouped in COSEP.

It’s not that big capital has no right to lobby, but the excluded sectors should also have the right to participate and influence. Without putting too fine a point on it, corporativism, the alliance between the government and big capital, was a feature of fascism under Mussolini in Italy, Hitler in Germany and Franco in Spain. To say the very least, presenting the tax reform as a done deal with no informed public debate even though it affects absolutely everyone, then hastily pushing it through the legislative channels, isn’t exactly democratic.

Changing some things so nothing changes

The first thing I want to say is that the reform changes some things in a positive way, such as the regulation of the fixed quota and transfer prices—but essentially nothing changes. It’s more of the same.

The fundamental criticisms of this reform include the fact that it keeps the current income tax system, which is profoundly inequitable and discriminates against both salaried workers and the middle sectors. It establishes that the current uniform annual tax rate—a flat 10%—will still apply to capital gains. In contrast, the tax rate on salaried income will continue to be progressive, but the lowest rung will now be 15% instead of 10%, then will gradually drop back down by 1% annually starting in 2016, so that by 2020 it will get back down to the original minimum rate of 10%. Meanwhile, the highest rung will remain at 30% for now, dropping to 25% by the same year.

Why penalize salaried workers?

In short, we still have what we already had: salaried workers continue to be subject to a progressive tax rate—more salary means progressively more taxes—while income from capital in the form of interest and dividends is still charged a flat 10% capital gains rate no matter the volume of earnings. This means that anyone who has a Christmas savings account will pay the same 10% tax on the interest it earn as a wealthy person pays on the millions in dividends on stocks or interest on investments. It means that a poor single mother who tries to earn some income by renting out a room will pay the same flat 10% on her earnings as the millionaires pay on their huge capital investments. And even more gallingly, that 10% is between 50% and 300% less than the respective floor and ceiling of the progressive tax on income earned by salaried workers.

I find myself wondering, as I’m sure we all do, what the logic is behind hitting salaried workers with a progressive income tax that starts at 15% and goes up to 30% while taxing capital gains is a measly fixed 10%. Why would a government that calls itself socialist tax workers more than capital? Warren Buffett, a US multimillionaire with a social conscience, called it unfair that his secretary pays 30% of her salary while he pays much less for the earnings on his capital. Why did Enrique Bolaños’ neoliberal government increase the tax on business income from 25% to 30% in 2003 while a government that proclaims itself socialist is going to bring it back down and even maintain the ample exonerations that favor high income sectors? I admit to favoring lowering the rate to 25%, but only if the exonerations are substantially cut, because these exonerations have been the Nicaraguan tax system’s central problem. Yet that didn’t happen.

The schedular income system
vs. the overall income system

The United States, the European countries and others that respect the principle of vertical equity that must exist in any tax system—which means that those who earn more pay proportionately more taxes on their income—have what’s called an overall income system. It’s very different from our scheduler system, ratified again in the reform, which takes its name from payment schedules for different kinds of income.

In an overall income system, if someone receives a salary, earns interest on a savings account or has some capital gains, it all goes into a single bag and a single progressive tax rate is applied to the overall amount. Doesn’t that seem more equitable that our system, where a capitalist pays a low fixed rate on capital gains whereas salaried workers have to pay more if they earn more? Conclusion: while the reform tweaked some of the percentages, actually favoring capitalists more than workers, it didn’t really change one of the most inequitable aspects of our tax system. Could the reason capital gains are favored and salary income penalized perhaps have something to do with the strategic alliance between the government and the business elite in Nicaragua?

Some years ago, world renowned tax specialist Juan Carlos Gómez Sabaini recommended establishing the overall income system in Nicaragua. His suggestion was welcomed by various economists, myself among them. But this government decided to stick with the scheduler income system. Enrique Sáenz, the Sandinista Renovation Movement’s National Assembly representative, was spot on when he said this tax reform should be called the “Romney reform,” because the US Republican Party’s big-business presidential candidate this year also favored cutting taxes for the wealthy and making the middle sectors pay more, while President Obama argued that the wealthy should pay more and the middle and poor sectors should pay less. Paradoxically, our government’s tax system mirrors the political line of the most conservative US Republicans.

Which sectors get special treatment?

A second central aspect of the reform we strongly disagree with is that the system of exemptions, exonerations and special treatment for certain sectors of the economy has remained intact. The IMF has remarked for years that establishing a tax system in Nicaragua based on tax generality and neutrality would require dismantling or at least significantly reducing the broad system of exemptions and exonerations that erode the tax base. It has never, however, set it as a condition.

Tax exonerations have a long history in Nicaragua. In the 1960s and 70s, when there was a Central American Common Market, it was argued that the nascent industrial sector should be exonerated from taxes so it could compete with imports. Despite the fiscal incentives, however, that industrialization attempt failed. Now tourism, cooperatives, the media, the free trade zones and public transportation are exonerated from various taxes. Article 288 of the new tax reform mentions no fewer than 77 laws that grant exonerations and special fiscal treatment. It presents them as untouchable and insists they will remain in effect. Some might be justifiable, but not the majority.

And if that weren’t enough, investment funds are receiving other special treatments and free trade zones are getting increased fiscal benefits as they are now exonerated from taxes on purchases they make in Nicaragua. It’s often said that it’s a good thing the free trade zone assembly plants for re-export don’t have to pay taxes because they provide jobs to a hundred thousand people. But the micro-businesses scattered all over the country employ two million and they aren’t exonerated, at least not to the same degree as tourism or the free trade zones.

Deciding who gets to keep their exonerations and who doesn’t means “selecting winners,” which also implicitly means “selecting losers.” It isn’t just a technical problem; it’s a political problem and the result depends on the influence of the different power groups.

This is where the Nicaraguan saying that “The one with the bigger gullet drinks more pinol” gets played out. Discussing the issue of exonerations, Vito Tanzi, another world authority on tax issues, noted that one starts with the obvious and ends up exonerating almost everything. Should we exonerate the products in the basic market basket? Of course we should. Should we exonerate education? Obviously. Should we exonerate cooperatives? Absolutely. Should we exonerate the tourism sector? But what about the huge tourist projects, many of which are like enclave economies? Should we exonerate the “Bolívar’s Supreme Dream” refinery just because it’s an ALBA project? Should we exonerate the Tumarín hydroelectric project because it’s renewable energy?

Somebody has to pay for the exonerations

Someone has to pay taxes because without them the business of government would have to shut down… We often don’t understand that in economics nothing is free and Peter ends up paying the taxes that Paul doesn’t pay to cover the budget. All the rest of us end up paying for those who are exonerated. Although the income tax on salaried workers basically only affects the formal sectors, and then only those with medium and higher salaries, no one escapes the indirect taxes on sales, our water and electricity bill, etc. We pay when we buy fuel, which is heavily taxed, and when we pay the 15% value added tax (IVA) on goods. The high taxes we pay on fuels, which weren’t reduced in the reform, even affect the prices of the most basic foods, which have to be transported from one place to another. And those point-of-sale taxes, which are attractive to the government because they’re the easiest to collect, are the most regressive of all.

The losers of this reform are the economic sectors that don’t receive exonerations, among them the formal commercial sector and the manufacturing industry, both of which had exonerations in the sixties and seventies and no longer do. Why was the system of exonerations left virtually intact? It is said that exonerations are essential to promote investment and create examples. But if that’s true, why isn’t the manufacturing industry exonerated as well? Why not grant more exonerations to the micro, small and medium-sized businesses, which create over 80% of the country’s job posts?

A system that lends itself to favoritism

The reform mentions that in two years a few exemptions and exonerations granted to various sectors will end, most notably the exoneration from paying the IVA and selective consumption tax (ISC), the taxes on capital goods transfers and the taxes on spare parts and on certain products that big agricultural producers buy from small and micro industrial and fishing businesses. The reform states that those exonerations will be extended a further two years only to businesses that can show that they created jobs, increased their exports, raised their productivity, introduced innovations or presented new projects that demonstrate how they will do it. But given that the decision to extend these exonerations will be granted on a case by case basis and that thousands of both small and big businesses will surely apply for them, a bulky bureaucratic system is being created that’s wide open to corruption because it’s discretionary. In a country as accustomed to favoritism as this one, rubber stamping exonerations to a company with certain political tendencies, or one run by a buddy or a relative, or one that has slipped you an “incentive” under the table is how things often get done.

Fiscal systems must be simple and streamlined; they must be as unburdened by bureaucracy and complications as possible to avoid discretionality. Moreover, there’s no economic rationality to limiting fiscal benefits to agricultural producers and to medium and micro industrial and fishing businesses, when at the same time the exonerations granted for many years to other sectors such as tourism or the free trade zones remain intact.

The Agricultural Exchange:
An infamous case

The reform also ignored the privileged fiscal treatment received by the famous Agricultural Exchange (Bolsa Agropecuaria), benefited by a sui generis tax regime that runs roughshod over the principle that special fiscal regimes shouldn’t be based on the commercialization channel used. A business that sells its agricultural products through the Exchange only has to pay a 1.5% definitive net tax on the first 60 million córdobas (some US$2.5 million) of its yearly sales, or 2% if it’s a cattle business. The only change now is that the annual exonerated sales will gradually shrink from 60 to 40 million córdobas. Changing something to change nothing.

Daniel Artana, an international specialist on such issues, stated years ago in Nicaragua that it’s absurd to create an income tax system based on the commercialization channel involved. And the Agricultural Exchange is just that: a channel for buying and selling agricultural products and arranging contracts. Why should it have such special treatment, with its tiny definitive tax withholdings, in which definitive means that nothing further has to be paid on those earnings?

I have absolutely nothing against the agricultural sector, but it is inconsistent for the government to keep the Agricultural Exchange intact, modifying only its earnings ceiling. When the government presented its tax reform proposal months ago, it admitted that the Nicaraguan agricultural sector represents nearly 20% of the gross domestic product (GDP), but that the taxes it pays represent only 2-3% of the total collected by the government.

Given that inequity I’ve stated several times that if the Agricultural Exchange is going to be maintained, why not create a similar exchange for manufacturing industry? Why not a workers’ exchange, so they can arrange all their labor contracts through it and thus pay lower taxes? Or exchanges for professional services, industrial goods and formal commerce, in which the definitive withholding for everything transacted there is only 1.5% or 2%? It’s an obviously absurd idea, but no more so than the Agricultural Exchange, where the huge agricultural producers receive privileged benefits under the guise of benefiting small farmers.

This reform violates two principles

From the technical point of view, generality and neutrality have to be maintained in taxes. Taking this into account, two basic principles are being violated by this reform. The first is the principle of horizontal equity, which states that those who earn the same should pay the same. It’s being violated because people in the manufacturing industry or the formal commercial sector get no exoneration, while those in the tourism sector or the free trade zone, or those in the agricultural sector who trade through the Agricultural Exchange, have exonerations for the same level of earnings as the others, and even for much higher earnings.

The second principle violated is that of vertical equity, which states that those who earn more should pay proportionately more. This principle is being violated because if a millionaire earns US$2 million on capital gains he’s only going to pay 10% in taxes while a middle-class professional who earns 100,000 córdobas (a little over $4,000) a month will pay 22% on that salary. I ask again: Why should a salaried worker or a middle class professional pay over twice as much on his labor earnings as the millionaire pays on his capital gains? I have nothing against millionaires either. I’d love to see more of them in Nicaragua, but I’d like to see them paying the taxes that in all fairness they should pay. This isn’t some war on the wealthy I’m talking about; it’s a question of applying elementary principles of tax equity.

Where does COSEP fit in this game?

It’s important to point out that the COSEP directors say they’re defending private enterprise, but that’s not quite true. While the Government-COSEP alliance is framed by a market economy, COSEP isn’t defending a competitive free market system, but rather a system of “rent seekers,” as they’re called in economic literature. It’s defending the activities of coupon-clippers, whose income is the interest and dividends from bonds and investment stocks, and who love nothing more than receiving special treatment from the State. By taking care of “its own,” COSEP is jeopardizing thousands of business people who don’t get special fiscal treatment and who end up paying for what Peter doesn’t.

COSEP defends the politics of rightwing Republicans, but not that of Warren Buffett, who said millionaires should pay proportionately more taxes than the middle class. As Vito Tanzi also noted, defending exonerations and special fiscal treatment implies a lack of faith in the market economy. The theory of the optimum tax system in a competitive market economy holds that taxes should be as distortion-free as possible, which excludes exonerations and other special fiscal treatments. I’m in favor of a competitive market economy. A tax system must be broad-based so it can establish low rates, and that requires substantially reducing exonerations, but Nicaragua’s reform doesn’t do that. Regrettably, we just have more of what we had before: a tax system that favors the rent seekers.

COSEP also says it’s defending the exonerations because they are indispensible to promoting investment. That’s at best a half truth, because giving an incentive to the agricultural sector through the Agricultural Exchange, for example, discriminates against the industrial sector and hurts investments in manufacturing. It’s a curious thing: despite all the lip service to the concept of value added, the only way you benefit from the low tax withholding in the Agricultural Exchange is by transacting primary goods that aren’t industrially transformed. If a ton of tomatoes, for example, was made into tomato sauce and packaged, providing many more jobs and more value added, it would no longer get the tax break, so the implicit message is that industrializing is negative. So much for promoting investment! So this exoneration policy favors the agricultural sector, but doesn’t promote its industrialization.

The reform to taxes on salaries

The reform does raise the tax-exempt salary ceiling from 75,000 córdobas to 100,000 a year (roughly from $3,100 to $4,100), so those earning less than 100,000 córdobas a year pay no income tax. While this is positive, it doesn’t reflect either the increased prices of the basic basket or the inflation rate.

In 1997, when the Tax and Commercial Justice Law was passed, a tax exempt ceiling of 50,000 córdobas annually was set for workers’ salaries. In 2009 that ceiling was raised to 75,000 córdobas and now it has been raised to 100,000. But we’re talking about nominal córdobas here. The basic basket cost 1,403 córdobas in 1997 and now costs around 10,500 córdobas. In other words, the value of the basic basket of goods and services has increased sevenfold while the exoneration ceiling has only doubled. Meanwhile, prices in the consumer price index have increased 3.4 times between 1997 and 2012, which means that to maintain the tax exoneration value constant for workers, the ceiling should be 170,000 córdobas, not the 100,000 established in the reform.

The reform does establish a gradual adjustment of 5,000 córdobas a year—applicable starting in 2014—until it reaches 120,000 córdobas a year. But that automatic adjustment is less than the projected inflation rate. By not indexing the tax exoneration on low incomes to inflation, the workers will end up losers in a few more years. What the reform offers them now is only illusory because the thinking is based on córdobas of a constant value.

The fixed quota system will
now be a progressive system

It’s positive that the tax reform is regularizing the fixed quota system. Those who sell under 100,000 córdobas worth of merchandise or services a month will now pay a minimum tax rate, which could even be reduced further if they turn in invoices for their purchases. It’s also positive that small and even medium-sized businesses whose sales don’t exceed a million córdobas a month will pay a progressive tax and not the 30% uniform rate applied to large economic activities. That equal tax of 30% for everybody wasn’t correct. It was also a kind of deadly leap into space to move from the fixed quota system to the formal income tax system. But some of that has been corrected now.

A uniform income tax rate applicable to all business is inequitable. To be equitable it has to be progressive, according to the principle I mentioned earlier that those who earn more should pay more. Nicaragua’s structure of businesses has a very small number of monopolies and oligopolies at the top, with extraordinary earnings, then a multitude of small and medium businesses that barely survive with their tiny income. It’s a good thing that lower tax rates will be applied to these latter businesses.

The free trade zones and
the world rent system

The reform is definitely more of the same for the free trade zones, which are areas restricted to companies that import raw materials, use local cheap labor to assemble them into goods ranging from clothes to electronics, then re-export them. It ignored a suggestion various economists presented years ago: that Nicaragua should tax the income of the companies in those zones whose headquarters are under the world rent system. Such companies in the United States, Europe and Taiwan pay taxes on their profits in the country where their headquarters are located, independent of where those profits were obtained. But if a Taiwanese or US world rent company pays taxes on its income here in Nicaragua, it can deduct that payment there. There’s thus no logical reason not to tax their profits.

We’ve argued that until we’re blue, but this government doesn’t want to tax the free trade zone companies, which on the face of it indicates that it prefers to subsidize the US treasury and shortchange the Nicaraguan one. Naturally it doesn’t explicitly admit that, but it’s the consequence of the treatment the free trade zone companies are receiving in Nicaragua thanks to the government-COSEP alliance.

It doesn’t touch public spending distortions

This reform is also still more of the same because it’s exclusively about taxes without touching public spending distortions. Nicaragua needs a comprehensive fiscal reform that includes important reforms to public spending, which is badly oriented. In education, for example, it doesn’t prioritize primary education, technical education and vocational education, which would favor the poorest. Too much money is allocated to the public universities, which prepare professionals… for unemployment. The belief is that this is doing the thousands upon thousands of poor youths who go to university a favor, but it’s really doing them harm.

For some time now we have also been suggesting a Remunerative Law for the whole public sector, which has serious inequities in the public employee retribution system. It’s equally necessary to technify and depoliticize many state institutions, including the General Income Division and the General Customs Division.

This reform clearly has
big winners and losers

The winners are the sectors that will continue enjoying subsidies through special fiscal treatments for many years, because saying that it will only be for two years is an attempt to pull the wool over our eyes. Other winners are those who have significant capital gains, as well as major projects such as the Bolívar’s Supreme Dream refinery and the Tumarín hydroelectric project, not to mention the highly touted Interoceanic Grand Canal, which many doubt will ever be built. Very special fiscal incentives have been created for those mega-projects, even though there’s no study that demonstrates they wouldn’t be profitable without such incentives.

The losers include the middle-level employees in the formal labor sector, as they will continue paying more than those who have capital gains. They also include those in the lowest income brackets, as the system is still markedly regressive, with a predominance of indirect taxes, which means that the poor pay proportionally more in taxes than the rich. And consumers also come out losing, as IVA will begin to be charged on new products—chicken breasts, olive and corn oils, quality packaged rice—considered “luxury” items according to the declarations of one government official. And finally, sectors such as the manufacturing industry and formal commerce are losers, because they have no exonerations or special fiscal treatment.

Social security should have been on the table

The reform should have been comprehensive, but that would have required putting the reform to the social security system on the negotiating table at the same time. The IMF has already established a kind of conditionality for signing a new agreement with Nicaragua by “suggesting” that the social security system is currently unsustainable. The IMF’s auditing studies indicate that within the next nine years Social Security will end up without enough funds. So far the Nicaraguan Social Security Institute (INSS) has only presented a brief summary of the reform, proposing among other possible solutions to increase retirement age from 60 to 65 and to increase the number of weekly contributions needed to be eligible for a retirement pension from 750 to 1,500, which would mean a worker having to pay in for some 30 years to have the right to a complete pension. It also proposes slightly increasing the contribution of both the employer and the employee.

Yet another proposal is to increase the number of workers covered by social security. Right now it’s a small minority: of Nicaragua’s 3 million workers, only 650,000 (21%) are affiliated to social security. If the net is widened, how many could meet the 750 weeks required to get pension benefits? Very few, because our labor market is very informal, and is becoming even more so. One only has to check out the want ads: “Seeking graduate in business administration, age 25 to 35.” Those who are older and don’t have “connections” are being pushed out of the formal labor market and into informal work.

The majority of Nicaragua’s workers survive in the informal labor market, with no social security coverage. And if it’s already very hard for a worker in the formal labor market to rack up 750 weekly contributions, it will be impossible to double the number. Given the generalized informality, the Economic Commission for Latin America and the Caribbean (ECLAC) has said there would have to be some sort of social security system that would guarantee essential services to all workers. Even the IMF has said that a social security reform has to include some flexibility given the informality of our economy. If the informal sector isn’t taken into account when reforming social security, it will be ignoring nearly 80% of our labor force.

The social security reform studies are a kind of state secret, making it impossible to offer an informed opinion on the issue. If you go to the INSS web page you’ll see a summary of the proposals, but the studies themselves, by Troncoso and other consultants, aren’t available.

Nor are the special pension systems in various state institutions on the table. Although this is a delicate issue, the public budget is, by definition, public and should be transparent. Rumor has it that retiring Central Bank employees, for example, are receiving not only the pension guaranteed by social security, but also a lifelong pension paid by the Central Bank. Why don’t the employees of other state institutions have the same right? It’s common knowledge that the Military and National Police also have a pension system for their members. And it’s rumored that the brilliant judicial branch justices have decreed themselves special retirement pensions. What’s the difference between the pension of a Supreme Court justice or Army general and that of a public education teacher? Are these differences justified? If the social security pension system is going to be reformed, why not also discuss the special pensions that exist within the public sector?

Will the government-COSEP alliance also present us with a social security reform as a done deal? Or will the state break its secrecy, offering those affected a chance to voice their opinion?

Electricity rate hike coming up

Another issue that will be on the 2013 agenda is the increase in electricity rates, put there by the IMF as another condition for signing an agreement with the government. According to one study that appeared on the IMF web page, there are important losses in the distribution of electrical energy, due to both fraud and unresolved technical issues.

To avoid raising the rate, which is very unpopular, the government decided to subsidize it with ALBA funds for those who consume less than 150 kilowatt hours, which means that Nicaragua is indebting itself by using that loan money to subsidize a problem rather than fix it or invest in growth that will help pay back the loan. The discussion about whether the ALBA loan is public or private is interminable, but either way, the fact is that we’re indebting ourselves to avoid either increasing the electricity rate or cracking down on the freeloaders and fixing the technical problems. Nicaragua still depends on hydrocarbons for 70% of its energy generation because it hasn’t yet changed its energy matrix, although important investments are coming.

Where are we headed in the long term?

After mentioning the 2013 agenda items defined by the International Monetary Fund, I’d like to talk about long-term issues: Where are we headed? Can we achieve sustainable economic development? The reality is that ever since 1990 we’ve had the same neoliberal and IMF economic policies, and the bad thing about them is that our growth has been insufficient. There haven’t been in-depth changes and there won’t be in the coming years. The economy has continued along a path of inertia and will continue to do so. The same thing will happen with the deteriorated institutional situation, for which no solution is on the horizon.

In October the IMF reviewed its 2012 projections, predicting that the GDP growth rate would close this year at 3.7%. ECLAC was more optimistic, estimating it at 5%. The government’s own annual growth projection for the next four years is 4%. These aren’t insignificant rates, but they also aren’t sufficient. Various economists, myself included, have insisted that Nicaragua must have sustained economic growth of no less than 7% a year, as it did in the sixties, if it is to significantly reduce its poverty levels.

What do we need to increase growth?

When economists analyze GDP growth rates from a long-term perspective, they attribute average long-term growth to three main factors: an increase in capital, a bigger and more skilled formal labor force and a third factor they call “the total productivity of the factors,” which is basically an indicator of an economy’s overall productivity (the business climate, greater levels of investment per worker, innovation, technological transfer…).

Better ways to attract capital. Exonerations aren’t the key to development and world experts point out that even in the best of cases they play only a very marginal role in attracting investments. There are other better instruments to promote some sectors. If the government wants to promote tourism, for example, it should finish the famous coast highway, a project that has been around for over 20 years. Or investments could be made to ensure that electricity and drinking water services cover the whole of Nicaragua, particularly in the many potential tourist attractions. Also useful would be investments in health and in citizen security. The real way to attract tourism is to provide the right infrastructure: decent highways and quality services in the tourist centers. But those investments require public spending and that in turn requires fiscal income.

Attracting investment to all sectors in the country also requires an independent and transparent judicial system, not a politicized one. It requires a better business climate, eradicating corruption. And if we’re talking about fiscal incentives, the most neutral one is rapid depreciation, which should be granted to all sectors… something this reform doesn’t do.

Improving the quality of the work force. Increasing the potential growth of the GDP largely requires starting right now to make major investments in both human capital and infrastructure, which is not being seen anywhere. The budget for 2013 doesn’t include the necessary investment levels in either education or public infrastructure. Nor will the tax reform increase public spending, because it’s virtually neutral with respect to more tax collection. Any increased tax pressure would only have come from dismantling exonerations, and that didn’t happen.

The total productivity of the factors. I’ve said it before and I’ll say it again: the Nicaraguan economy’s “golden age” and the greatest growth rates in our history occurred during the Somoza family dictatorship. Is it possible to grow economically with a dictatorship? Yes it is, as we can see in the case of China, which has grown 9-10% annually, but we don’t need to look at China to demonstrate it. During Nicaragua’s “golden age” of economic growth, there were increases in the total productivity of the factors given the period of economic expansion after World War II. The greatest national productivity growth was due to a greater incorporation of lands and appropriate economic policies. The per-capita GDP of that period was the highest in our history. And during those years of economic growth the Somoza family fortune also grew, because the State has historically been used in Nicaragua, to quote Karl Marx, as a primitive method of capitalist accumulation. The concept of State as booty has always existed, both in the past and today.

Nicaragua’s yield per hectare of coffee or of maize is very low, despite 60 years of technological assistance in the countryside. And we’re still exporting the same products we exported a hundred years ago: coffee, sugar, cattle, bananas… Nicaragua hasn’t had an industrial revolution, or even an agro-industrial one for that matter. Its attempted industrial revolution in the sixties and seventies with the Central American Common Market failed.

As I mentioned, the only way to resolve Nicaragua’s acute poverty problem is to sustain 7% economic growth. It’s very possible to increase the 3% average annual growth we’ve had between 1990 and 2012 to the 4% projected by the IMF for the coming years, but that will only reduce poverty very slowly. We could have a burst of economic growth up to 7% for a short period if, for example, the ALBA refinery is finally completed and comes on line. But that won’t resolve things in the long term either, because it doesn’t deal with the productivity issue. If Nicaragua doesn’t significantly increase its productivity levels, we won’t achieve the GDP growth rates that will allow us to reduce poverty to any meaningful degree over the medium and long term.

Economic growth doesn’t
equal sustainable development

In engaging in this debate we also need to remember that economic growth isn’t synonymous with development, much less sustainable development. There was economic growth in the Somoza period, but not sustainable development, which involves social, environmental, institutional and political sustainability.

Social sustainability means an inclusive project but growth wasn’t socially inclusive in the Somoza period and still isn’t. There has been a slight improvement in the poverty figures, but a survey by Nicaragua’s International Foundation for the Global Economic Challenge (FIDEG) shows 44% of the country’s population still trying to survive on less than US$2 a day. Is a person who now has $2.10 no longer poor? Using different indicators, the UN’s Food and Agriculture Organization stated just a few days ago that 20% of Nicaraguans, some 1.2 million people, go to bed hungry, even after all the years of the Zero Hunger program.

As for environmental sustainability, the expansion of cotton certainly didn’t foster that during the Somoza period. The insecticides used to fumigate those 200,000 hectares of cotton are still being found in the underground water of León and Chinandega and are still having negative effects on the population’s health.

The Somoza dictatorship may have been the golden age of economic growth, but it certainly wasn’t the golden age of democracy and institutionality. And the consequences of that model followed by an authoritarian socialist model were that Nicaragua tanked economically in the eighties.

What’s so important about
democratic institutionality?

Above I referred to the three factors most often identified as necessary to assure long-term economic growth. But if we want to achieve long-term sustainable development in Nicaragua we have to add a fourth: quality institutions. Democratic institutionality isn’t an end in itself; it’s fundamental to long-term sustainable development. The authoritarianism we have today isn’t suitable to sustainable development because it’s only showing an interest in resolving the immediate needs of the poorest sectors, giving out sheet metal roofing and other resources. The real solution to poverty and hunger can only be achieved with greater growth rates, the application of socially inclusive policies and the creation of an institutional and political setting that’s sustainable over time. Handouts, however welcome they may be, don’t resolve long-term problems. We’re all familiar with the ancient Chinese proverb: Give a man a fish and you feed him for a day. Teach a man to fish and you feed him for a lifetime.

An IMF study concluded that if Nicaragua had institutions of the quality of Chile’s, our average annual growth would increase 3% a year. What is understood by quality institutions is a debatable issue, because when discussing what institutions we need, there’s a narrow vision and a broader vision. The narrow one proposes things like: new business permits should take 15 days rather than four months; institutions, starting with the traffic police, shouldn’t encourage bribes; there should be arbitration procedures to resolve business conflicts… Obviously those are aspects that should be corrected to improve the quality of institutions, but a broad vision involves much more. It insists on the need for the real independence of the branches of the State and respect for the Constitution and laws. This doesn’t exist today in Nicaragua, nor is there any real power factor that can pressure—or is even interested in pressuring any more—for a modification of the current institutional and political disorder. Worse yet, I can’t envision any change in Nicaragua’s precarious institutional and political system in the foreseeable future, which means serious long-term risks for everyone, including the business class.

What does all this mean for the future?

Today’s youth faces a huge challenge because Nicaragua has to do something it has never done before in its history. It has to achieve not only significant GDP growth, but also socially, environ¬mentally, institutionally and politically sustainable growth.

One group that has been thinking about these issues has defined—I think correctly—the three revolutions we need: an educational one, an ethical institutional one and an agro-industrial one. Another analyst has been arguing that the current government’s assistance programs at least resolve immediate needs, and concludes that what we have today is the best we’re going to get because the Nicaraguan economy has never been better. The strategic COSEP-government alliance is based on that thesis, which grows out of the theory—only they of course wouldn’t state it quite so baldly—that democratic institutionality is irrelevant, or at least secondary, for Nicaragua. It’s positive that there’s an agreement to continue fighting poverty, which the inter¬national agencies have promoted for many years now. But it’s not at all positive that institutionality and the rule of law are considered irrelevant, even if the rhetoric says the opposite.

Nicaragua is a country of false rhetoric

The rhetoric also says we’re socialists or have a socialist project. But what we really have is an implicit albeit no less effective agreement to continue following a capitalist free enterprise economic model.

Another example of false rhetoric is COSEP saying it’s in favor of democratic governance. Propaganda aside, we can see that its alliance with the government hasn’t translated into any move toward democratic governance in practice.

Still another example is the government’s assurance that Nicaragua is a secular State, when we are clearly seeing the conversion of religion into an instrument of power.
And a last example is that there are opposition parties, when what we have for the most part parties that cut deals.

Governmental power is
concentrated in few hands…

When a country is dependent on one or two people it not only has a serious immediate problem of institutionality, but also a serious problem of long-term stability, as we saw with Somoza. When Somoza fell, his party collapsed, the National Guard collapsed, everything collapsed. And the Somozas had a stronger opposition then than our President has today. The Conservatives used to rebel, at least until the Agüero period, when there was a massacre during a demonstration. Somoza was also opposed by the international Left.

Is the current “Ortega-centricism” opposed by some country? Not that I can see. It has the support of the ALBA group, the United States and the Europeans, although they say they don’t like Ortega and that Nicaragua’s recent elections have been “irregular.” The money the international financing institutions have directly put in Ortega’s hands—over $300 million a year—plus the bilateral money that gets freed up when the IMF gives its green light objectively strengthen the power structure, even though it isn’t their subjective intention.

This government has a concentration of power today the likes of which I never saw during the Somoza period. And barring any unpredictable factors, its political model will continue to function with the inertia displayed in recent years.

…and the political class is
dominated by the third age

And now that we’re talking about inertia and succession, we’re up against yet another serious challenge: the inevitable generational changeover. Without speaking ill of the third age, to which I belong, Nicaragua is governed by a gerontocracy and isn’t prepared to pass on the baton.

This problem isn’t exclusive to the government; it’s present in the whole political class. We need to start preparing to deal with this challenge right now. When all power is concentrated in a couple of people and the political class is dominated by the third age, it inevitably creates a serious institutional problem, whose negative effects could be magnified when the inescapable generational changeover finally takes place.

For Nicaragua’s own good, we need to avoid all these risks by beginning right now to build the kind of foundations the country has never had: a sustainable development that includes long-term institutional and political sustainability. Democratic institutionality and long-term stability simply aren’t compatible with the extreme concentration of power we see today. People come and go, but institutions remain. We need to start right away to build a government of laws and not of individuals.

But to end on an unfortunately pessimistic note, I don’t see anyone really interested in initiating that task.

José Luis Medal is an economist who specializes in fiscal issues.

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