“Partnership for the Goals” in South America

A partner in need, is a partner indeed.

On October 28 2023, news broke that China and the US had agreed for President’s Xi Jinping and Joe Biden to meet at the upcoming Asia-Pacific Economic Cooperation (APEC) summit in San Francisco. In ordinary times, this would be no news. Unfortunately, we are not living in ordinary times. With tensions rising between China and the US, there has been a lot of talk of a potential split between the “East” and “West”; what some analysts call the ‘great decoupling’.

Possibilities of military confrontations in the Pacific aside, many ordinary people are concerned about the resulting implications for the climate if the world’s two largest emitters of CO2 are not cooperating. On some level, these fears have already started to be realised. With tariffs being levied on finished products, trade restrictions on critical components and minerals, we are already seeing what the groundwork for future rifts could be.

It is with this political backdrop in mind that we find ourselves covering this Briefing for the 17^th Goal of “Partnerships for the Goals” and looking at mobilizing resources to improve domestic revenue collection in South America as measured by government revenue as a proportion of GDP.

For this briefing we focused primarily on the ability of the state to collect revenues domestically as opposed to international sources. While international aid, grants, and remittances are critical sources of funding, especially for lower-income countries, they are at the mercy of the good will of those outside of the country.

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If you want to go fast, go alone. If you want to go far, go together.

At the heart of the goal is the understanding that without considerable cooperation between and across countries, we will not have any shot at achieving any of the other 16 Goals. It is not just what you’re trying to achieve, but how you go about it. Diving a bit deeper, the Goal is broken down into a further 5 categories: finance, technology, capacity building, trade, and systemic issues; with finance being the only one relevant for our purposes today.

Unlike other briefings with a laundry list of big and small numbers, this briefing has only main one, 26% – the global average of government revenues as a proportion of GDP (minus grants). Behind this number are a few differences as illustrated in Figure 1.

In global terms, South Africa is not too far behind the pack at 21% and surprisingly ahead of North America. However, if it wants to reach European levels it has a long way to go before reaching 34%.

Money can’t buy happiness, but it can buy economic development, which is kind of the same thing.

This is why the goal to mobilise resources to improve domestic revenue collection is so important. When governments lack the ability to raise capital themselves both, they lack the means with which to invest in their own futures. This understanding, the centrality of domestic public resources in the pursuit of sustainable development, was formally recognized in 2015 at the Addis Ababa Action Agenda.

It’s a scary place out there.

In the past 4 years, governments the world over have been hit hard by a series of unfortunate events, what we at Holocene call the “4 Horsemen of the Modern Economy”. In these trying times, partnerships and international cooperation, though in short supply, are necessary now more than every.

Disease. The COVID-19 pandemic led to a double-whammy of depressed economic outputs as well as the need for governments to take out historic levels of borrowing to support struggling families while staying at home – for those fortunate enough to stay at home.
Inflation. In the depths of the pandemic and on the way out of it, through a combination of supply and demand shocks, the world has had to grapple with historic and sustained inflation. These higher costs have been especially crippling in emerging markets and felt even in the rich world with generational levels of interest rates meant to curb fears of runaway inflation.
Debt. With historic levels of debt accrued during the pandemic, a potentially more expensive future where interest rates may stay high for the decades to come, and a lack of political/diplomatic cooperation, the result is that the world now finds itself in a fiscally precarious situation. Even before the spend-thrift policies of the past few years, 37 of the world’s 69 poorest countries were in debt distress or at high risk of it. As for the rich world, levels of national debt are at their highest for some countries since the Napoleonic wars.
War. With the outbreak of Russia’s war in Ukraine, and now the Israel-Hamas war, governments are on especially higher alert. In Europe, much capital, both financial and in terms of military equipment, have already been expended in support of Ukraine. Whereas now, in the Middle East, there are concerns the war may escalate into a regional confrontation that would have cataclysmic impacts on the global economy.

Regional trends

The aforementioned “4 Horsemen of the Modern Economy” have partially spared South America. For example, while all countries are struggling with higher rates of inflation, much South America is a commodity powerhouse with their exports priced higher, partially offsetting the pinch of domestic inflation. Instead, we turn our attention to South America’s “4 Chronic Horsemen”: the informal economy; commodity curses; limited state capacity building, and; tax evasion.

First is the sheer size and the role of the informal economy in South America. While one of the benefits of informal economies is their relative flexibility, some of the associated downsides include lower levels of productivity, a dramatic drop in tax revenues, poor governance due to a lack of visibility, and high levels of both poverty and income inequality due to their precariousness. All things that might ring true for people following the ‘gig economy.’ In the South American continent, on the whole, it has a lot of room for improvement in bringing the informal economy into the formal economy and catching up with North America and Europe. However, on a continental level, there are great disparities between countries highlighted in Figure 2.

The second is the commodity curse, otherwise known as Dutch Disease. Often confused for the venereal sort, Dutch Disease is the economic concept for the rise or over-reliance and investment in a particular sector (for example, natural resources), often at the cost of another. In the South American context, this is visible through the continent’s over-reliance on natural commodities which leads to wild swings in fortunes.

In previous commodity booms, such as in the 2000s underpinned by China’s rapid growth and development, South America was in the ascendant. However, when the commodities bubble popped, government fortunes crashed because of the drop in prices and leaving massive budgetary shortfalls. One famous example of this was the case of oil-rich Venezuela. Once the region’s richest country, the country has famously experienced one of the world’s worst economic crises of all time due to a combination of gross industrial mismanagement, economic largesse and public handouts, and an over-reliance on oil.

The third is limited state capacity building. Without sufficient government infrastructure and a lack of investment in technology and training, revenue collection agencies are hamstrung in their ability to enforce necessary tax compliance. This leads to the fourth horseman of tax avoidance. When people are working in the informal sector earning in cash, and have limited faith in their governments, they will be less inclined to pay tax to which they do not believe they will see any benefits.

So what can be done to grow as well as stabilise the domestic revenue collection for South American governments?

We have identified two major priority areas.

Don’t chase the purple dragon.

The first priority area is not falling for the trappings or false promises of the commodity curse/Dutch Disease. Ideally, what would be in the best interests of South American governments would be to take steps today that would actively support their economies to diversify away from the commodities sector. That said, given the rush of money and political attention piling into natural resources, especially critical elements which are found in abundance on the continent, most countries may be less willing to not heavily invest in commodities, lest they miss out on the expected riches. In which case, for South America, the next best step would be to prioritise saving those future riches such as through the creation of sovereign wealth funds for those that do not already have them. Or for countries such as Chile and Peru that already have one, widening their remit to include future riches from critical elements should be the top priority.

Focus on the fundamentals.

The second is moderate investments in the tax ecosystem. While less exciting than a sovereign wealth fund, it would lead to many benefits. Politically, cleaning up and strengthening the domestic institutions that are responsible for the collection of taxes and distribution of its revenues would lead to increased visibility and accountability of the system as a whole. This in turn would encourage ordinary citizens to pay their fair share. While neither would serve as a silver bullet to fix the system, both would be great steps for short and long-term development of South America and its ability on a domestic level to collect revenues.

If you would like to get in touch with Holocene and learn more about our geopolitical risk capabilities and capital raising solutions, contact us at [email protected].