''--'T H E W O R L D B a N K . i - - A a * _ hi1 nE Il Marcelo M. Giugale Olivier Lafourcade o e c Connie Luff 25426 December 2002 Marcelo M. Giugale t' UTC"' - lve4aorae t-" -I I-- The Economic Foundation Editors Marcelo M. Giugale n2P0 Olivier LafourcadeOU P UU b Connie Luff THE WORLD BANK WASHINGTON, DC Copyright C) 2003 The International Bank for Reconstruction and Development / THE WORLD BANK 1818 H Street, N.W. Washington, D.C 20433, USA All tights reserved Manufactured in the United States of America First printing December 2002 1 2 3 4 03 02 The findings, interpretations, and conclusions expressed in this paper are entirely those of the authors and should not be attributed in any manner to the World Bank, to its affiliated organ- izations, or to members of its Board of Executive Directors or the countries they represent. 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Please contact the Copyright Clearance Center before photocopying items. For permission to reprint individual articles or chapters, please fax a request with com- plete information to the Republication Department, Copyright Clearance Center, fax 978- 750-4470 All other queries on rights and licenses should be addressed to the Office of the Publisher, World Bank, at the address above or faxed to 202-522-2422. The cover illustration is Nacimiento de los Andes (1961) by Alejandro Obreg6n, reproduced courtesy of his son, Diego Obreg6n, Santa Fe de Bogota, Colombia. ISBN 0-8213-5348-9 Library of Congress Cataloging-zn-Publication Data has been appliedfor Contents Acknowledgments ........................... xxxi Preface ......................................xxxiii Editor Biographies ........................... xxxv Acronyms ........................... xxxvii Synthesis ........................... 1 I. Rationale and Organization . .......................... ....... 1 11. Central Messages. ............ ........................ ...2 111. The Agenda's Diagnoses and Policies ........ ............ 4 Achieving Fast and Sustainable Growth ...... ... .............. 4 Sharing the Fruits of Growth ........ ....................... 19 Building a Government of Quality .................. ........ 25 IV A Path to a New Colombia ........... ...... ................ 29 Table 1. Colombia: A Possible Priontization of Policies for the New Presidential Administration .. . 31 Part I Thematic Notes 1. Violence, Sustainable Peace, and Development . .35 I. Introduction ....................... .... ............... 35 II Violence Trends and Characteristics ..... ........... 35 III. Sources of Violence and Conflict ............ ................ . 39 Armed Conflict ... .................... ................. 40 Social Conflict ................................... .... 41 Drug Trade ................ 43 IV. Costs of Violence and Conflict ......... . .. ........... ....... 44 Economic Costs of Violence . 44 Social Costs of Violence ......... . ............ .......... 47 Political Costs of Violence ....... . .. ..................... 48 Environmental Costs of Violence ......... 49 iii iV COLOMBIA. THE ECONOMIC FOUNDATION OF PEACE V. Toward Building Peace and Sustainable and Equitable Development ..... 49 Armed Conflict and Drug Trade ............................. 50 Underlying Social Conflicts ........1.. ..................... 51 Critical Elements of Strategic Approach ........................ 54 VI. Conclusion ..................................... 55 References ..........................5 ....................... 56 Figure 1. Murder Rate per 100,000 Population, 1993-94 . . 36 Figure 2. Murder Rate, 1946-98. ............. ................... 38 Figure 3. Cocaine Production, Homicide Rate, and Guerrilla Front ........ 43 2. Enabling Sustainable Growth ................................. 59 I. Introduction ............. ........ 59 II. Providing a Sustainable Macroeconomic and Fiscal Framework . ........ 60 Background ........................................ 60 Fiscal and Debt Sustainability ............................... 61 Debt Management ....................................... 61 Fiscal Adjustment Options ................................. 62 III. Ensuring a Healthy Financial System .......... .................. 65 IV. Creating a Business Environment to Foster Private Sector Development .............................................. 69 V. Improvement in Infrastructure and Public Services to Foster Competitiveness .............. 70 Energy Sector ........... ................ .............. 71 Telecommunications ...................................... 74 Transport .............................................. 76 Urban Development and Low-Income Housing .................. 78 Superintendency of Domestic Public Services ......... ........... 79 VI. Management of Natural Resources and Physical Environment .... ...... 81 Rural and Agricultural Development ................ .......... 81 Water Resources Management ............................... 83 Potable Water Supply, Sanitation and Wastewater Treatment .... ..... 84 Solid Waste Management .................................. 86 Disaster Management and Disaster Insurance Mechanisms .... ...... 86 VII. Conclusions .............................................. 88 3. Shared Growth, Poverty, and Inequality . ........................ 89 I. Introduction .............................................. 89 II. Colombla's Tradition of Economic and Social Progress ......... ...... 90 Economic Growth Was Instrumental to Poverty Reduction .......... 90 Persistent Social Progress ................................... 91 Generally Propoor Expansion of Social Expenditures in the 1990s ..... 92 III. Recent Setbacks ............................................ 94 Economic Recession ..................... ................ 94 CONTENTS V Increasing Macroeconomic Instability and Judicial Uncertainty .... . 95 The Growing Burden of Violence and Crime ......... ......... 96 Rising Income Inequality: Induced by Higher Wage Skill Premia and Eroding Potential Welfare Gains ...... ...... . .......... . 97 IV. Resulting Vulnerability ............................. ..... 100 V. Addressing the Emerging Challenges: Employment, the Efficient and Equitable Provision of Public Services, and Security ....... . ....... 102 Restore Economic Growth to Accelerate Job Creation and Reverse the Rise in Poverty ........... .... ................... 103 Improve the Equity and Efficiency of Public Social Services .105 Establish a Functional Social Safety Net .... ............. .. 109 VI. Conclusion ................................... ......... 111 Raising the Income of the Poor .............. .............. 111 Ensuring the Equitable and Efficient Provision of Basic Social Services ................ ..... ... 112 Reducing Exposure to Risk ................ ............ 112 Appendix ..... ....... .... .. 113 References ..................... ....... 128 Figure 1. Labor Earnings by Skill Level, Urban Colombia, 1999 . . 99 Figure 2. The Poverty Rate Under High and Low Growth Scenarios, 2001-10, Urban Colombia ..... ............ ...... 104 Figure 3. Share of Total Household Income Required to Close Poverty and Extreme Poverty Gaps ....................... .... 106 Table I Poverty and Inequality Indicators, Colombia 1978-99. .... .... 91 Table 2. Social Indicators, Urban Colombia 1978-99 . . 92 Table 3. Change in Social Service Coverage Rates, 1992-97 ......... 93 Table 4. Colombia's Volatility. ............... ................. 96 Table 5. Poverty Count for Different Subgroups of the Population, Urban Colombia 1978-99 (percent) ..................... 101 Table 6. Coverage and Expenditure for Social Services, Colombia 1992-97 (growth) .................. .............. 107 Table 7. Coverage Shortfalls and Targeting in Selected Social Programs . . 107 Table A. I Summary of Issues, Objectives, and Recommendations by Sectors ............... ........................ 113 Table A.2. Summary of Policy Handles that Impact Welfare in Three Dimensions: Income, Access to Social Service, and Risk Management .............................. 122 Table A.3. Definitions Associated with Table 1 . ............... 126 Table A.4. Inequality Decomposition, Urban Colombia ........... .... 127 4. The Demand for Governance and Quality of Government .... ...... 131 I Summary ............. .................... ............ 131 II. Background: A Dual Quality of Government ....... . ... ....... 132 vi COLOMBIA. THE ECONOMIC FOUNDATION OF PEACE III. The Problem with the Coexistence of Strong and Weak Governance .... 136 IV. Strategizing to Strengthen Governance: Selectivity and Gradualism in Building High-Quality Government . . 138 Box 1 Budget Implementation and Control .... ......... 133 Box 2. Efforts to Improve Quality of Government in the United States and Mexico ............. 139 Box 3. Targeting Reforms to Plug Loopholes ............. 140 Box 4. Steps to Ensure Good Governance in Colombia ............. 141 Box 5. Focalizing Reforms ..... . .. ......................... .. 142 Box 6. Singapore's Experience with Phased-In Governance Strengthening .... 142 Part II Achieving Fast and Sustainable Growth 5. Macroeconomic and Fiscal Frameworks . . .145 I. The 1990s: From Rapid Growth to Recession. ... 147 II. Policies for Adjustment . . . ................................. 152 III. Main Issues and Options .............................. 157 Fiscal Sustainability . . . 157 Expenditures . . ................. 159 Net Worth and Illusory Adjustment . . .164 Revenues . ......................................... .. 165 The Central Bank . . . 167 IV. Conclusions ............ ... ........ 168 References ............... ........ 170 Figure 1. Central Government Revenues and Expenditure .151 Figure 2. Central Government Current Savings .151 Figure 3. Growing Deficits .152 Figure 4. Growth of Expenditures .160 Figure 5. Composition of Expenditures .166 Figure 6. Major Tax Reforms, 1990-2000 .......................... 166 Table 1 Increased Volatility in Colombia in the 1990s ...... .......... 147 Table 2. Growth in Central Government Spending Due to Legal and Constitutional Changes, 1990-98 (percent of GDP) ..... .... 149 Table 3. Two Medium-Term Scenarios .......... .................. 158 6. The Tax System ..173 I. Introduction .173 II. Background ...................... ...................... 173 III. The Tax System: Issues and Policy Recommendations .178 National Taxes .179 Subnational Taxes .......... ............................ 184 CONTENTS Vil Tax Administration .................. .. ......... 186 Appendix A Summary of Previous Tax Reforms ...... .. ......... 188 References . . .. .......... ................ ..... 191 Table 1. Colombia-Structure of Taxes . .......... . 174 Table 2. Colombia-National Taxes .......... . ............. ... 175 Table 3 Colombia-Taxes Collected by Departments (1999) .......... 176 Table 4 Comparative Composition of Tax Revenue (Average 1995-97) . 177 Table 5. Colombia-Central Government-Earmarked Taxes (1999) ..... 180 Table 6. Colombia-Taxes Collected by Municipalities (1999). ... 185 7. Public Debt Sustainability and Management .193 1. Summary .. ... ............... ................ .... . 193 II. Background ... . .................. ........... ..... .. 193 III Issues, Diagnosis, and Policy Recommendations . . 201 The Primary Balance and Debt Sustainability. 201 Vulnerability and Management Risks in the Debt Structure . 206 Key Government Liabilities and Potential Impact on Debt Management ..... .................. 210 Policy, Legal, and Institutional Framework for Central Government Debt Management ...... ..................... ... . 212 Strengthening the Framework for Debt Management . .217 Estimated Fiscal Impact .. 225 Annex 1. Key Elements of Vulnerability of Central Government Debt. 227 Annex 11. Analytical Framework for Fiscal Sustainability ........... ... 234 Annex III. External Liquidity and Fiscal Vulnerability Issues in Colombia- A Contrast with the Argentine Case ............. ...... 238 Annex IV. Debt Management Strategy and Portfolio Benchmarking .247 Annex V. Development of Debt Markets .... .............. ... .. 251 Box 1. Legal Framework for Debt Management in Colombia ... .... 214 Box 2 Reform of the Legal Framework for the Debt Management Office in Brazil ................... ... ........ 218 Box 3. Risk Management in Brazil .220 Box 4. Building Benchmark Issues Through Reopening and Buyback Operations. ... .... 223 Box 5. Growth and Importance of Institutional Investors . .. ...... 223 Box 6. The Role of Secondary Market Windows . . 225 Box A.V. I The Spanish Experience with Specialized Investment Funds .. 253 Figure 1. Public Sector Balances ..194 Figure 2. Interest Payments of the Public Sector . ........ ... 196 Figure 3. Gross External and Domestic Debt of the Public Sector. . 197 Figure 4. Gross Public Debt by Debtor . . 198 Figure 5. Domestic Debt of the Central Government by Creditor.. 199 Figure 6. External Debt of the Central Government by Type of Creditor .. 200 ViII COLOMBIA THE ECONOMIC FOUNDATION OF PEACE Figure 7. Debt Structure of Sub-National Entities ..... ............... 201 Figure 8. Debt/GDP Ratio; Primary Balance Constant at 2001 Level ...... 203 Figure 9. Debt/GDP Ratio; Primary Balance Set to Keep Debt/GDP Ratio Constant .......... .......................... 204 Figure 10. Debt/GDP Ratio; Primary Balance Constant at 4 Percent of GDP Slow Growth Scenario ........................... 205 Figure 11. Domestic Real Interest Rate Volatility ... .................. 208 Figure 12. Average Coupon in Real Terms on Domestic Public Debt ....... 209 Figure 13. Public External Debt Ratios ....... ...................... 210 Figure A.I. 1. Domestic Central Government Debt by Type of Coupon, TES Bonds ...................................... 228 Figure A.I.2. Half Life and Duration of Domestic Central Government Debt . ....................................... 229 Figure A.I 3. Maturity of Domestic Central Government Debt ............ 229 Figure A.I.4. Currency Structure of External Public Debt ..... ........... 230 Figure A.I.5. Currency Structure of External Public Debt ................ 231 Figure A.I.6. External Central Government Debt by Type of Coupon .... ... 232 Figure A.1.7. Half Life and Duration of External Central Government Debt . .......................................... 232 Figure A.I.8. Maturity Structure of External Central Government Debt .......................................... 233 Figure A.III.1. International Reserves and Public External Debt Stocks ...... 239 Figure A.III.2. Total Exports and Public External Debt Stocks .... ........ 240 Figure A.III.3. Public External Debt Service and Total International Reserves ........................................ 241 Figure A.1II.4. Public External Debt Service and Total Exports .... ...... . 241 Figure A.II.5. Public Interest Payments and Tax Revenues ..... .......... 243 Figure A.III.6. Public Interest Payments and Total Revenues .............. 243 Figure A.III.7. Public Debt Stocks and Total Revenues ..... ............. 244 Figure A.III.8. Gross Public Debt and GDP ...... ................... 244 Figure A.III.9. Consolidated Public Sector Balances ..... ............... 245 Figure A.III. 10. Total Public Sector Revenues ......................... 245 Figure A.V. 1 Holders of Central Government Domestic Debt .... ...... 252 Table 1. Key Assumptions and Projections .202 Table 2. Permanent Primary Surplus: Sensitivity Analysis (percent) . 205 Table 3. Permanent Primary Surplus: Sensitivity Analysis (percent) . 206 Table 4. Short-Run Impact of Changes in Key Variables on Public Sector Debt Service .207 Table A.I. 1. Types of Domestic Treasury Bonds .......... ............. 227 8. The Financial Sector ............................... 255 I. Background ...................... ..................... 255 II. The Financial Crisis Management Strategy ............. ..... 257 CONTENTS ix III. Restructuring and Recapitalization of the State-Owned and Private Banks ..... ........................ 258 FOGAFIN's Crisis Response Instruments .259 The Development of Regulatory and Supervisory Strategies .261 IV. Fiscal and Economic Costs in Relation to Financial Sector Restructuring ......2.........6...... ... . .. 263 The Corporate Sector . ... 264 Pending Policy and Institutional Reforms-The Banking Sector . 266 V. Reform of Second-Tier Public Banking Institutions ......... .. .... 268 Characteristics of Government Banks in Relation to a Merger Proposal .. ...................................... 268 Pending Policy and Institutional Reforms-Second-Tier State Banks .270 VI. Capital Market Development and the Public Debt Market .271 VII Conclusion .277 Table 1. Financial System Return on Assets (percent) .... .. ..... . 256 Table 2. Capitalization Support Provided to State-Owned Banks, 1998-2001 . .............. ... .......... ....... 260 Table 3. Private Bank Capitalization (Credit Line) Program, 1998-2001 . .. 261 Table 4. FOGAFIN Balance Sheet as at end 2000 and end 2001 (Col$ billions) .262 Table 5 Total FOGAFIN Support to Financial Entities, 1998-2002 (C$ millions) ........... ... . 264 Table 6. Assets as Percent of GDP of Companies/Corporations in Distress (percent) ...... ...... ..................... 265 Table 7. Public Pension System Liabilities ..... 274 Table 8. Estimated Fiscal Funding of Territorial Pension Obligations (Col$ billions) . . ... . ........................... 275 9. Pension Reform ..279 1 Executive Summary ............ ........................... 279 II. Introduction ...... . ...................... ............. 281 III. Colombia's Pension System ........... ...................... 282 The 1993 Pension Reform .282 Law 100 of 1993 .............. ........................ 283 Current Structure of the Pension System ........ 286 Evolution of Coverage ............ . ............... ...... 286 Instituto de Seguros Sociales .287 Private Pension Fund Managers ..... .............. . .. . 290 Transition Regimes . .......... ... ................ 290 Exempted Regimes ... .............. ............... 292 Collective Agreements .............. ............. I ... 293 Pension Recognition Bonds ........... .............. 294 x COLOMBIA. THE ECONOMIC FOUNDATION OF PEACE IV. Fiscal Requirements of the Current System ....... I ............... 294 The Model ............................... 294 Pension Liabilities ........ ............................. 295 V. Reform Requirements ................ 298 Overall Strategy ................ 298 Reform Options ................ 299 Specific Reforms ................ 302 Fiscal Impact of Pension Reform .................... 305 Pension Reform in Draft Law .................... 305 VI. Conclusion ........... ......... 310 Figure 1. Payroll Taxes for Social Insurance and Health in Latin America, 1995 ... ................. ................... 285 Figure 2. Pension Benefit Recipients as Percentage of Elderly Population 1980-99 ... 288 Figure 3. Contributors to Publicly Mandated Social Security as Percentage of Economically Active Population, 1980-99 . 289 Figure 4. Current Deficit of the Pension System by Component (as percent of GDP) .297 Figure 5. Reserves in Millions of 1999 Pesos; Cohort of 1,000 Women and 1,000 Men Joining ISS .301 Figure 6. Total Current Deficit of the Pension System With and Without Reform, as a Percent of GDP .306 Table 1. Colombia: Total Labor Costs (as percent of wage) .284 Table 2. Labor Force Statistics as of January 2001. 287 Table 3. Exempted Regimes .292 Table 4. Contributions to Exempted Pension Regimes (as a percentage of salary) .293 Table 5. Pension Liabilities, by Regime .296 Table 6. National Government Pension Payments (as percent of GDP) .... 296 Table 7. Estimates of Implicit Pension Debt and General Government Debt, Selected OECD Countries (percent of GDP) .298 Table 8. Implicit Pension Debt Estimates, and Pension and Public Debt Data (percent of GDP) .299 Table 9. Impact of Individual Parameter Changes on the ISS Deficit . 302 10. Housing Finance ........................................ 313 1. Executive Summary ........................................ 313 11. Genesis and Evolution of a Crisis .............................. 313 111. Government Packages of Reforms .............................. 314 IV. Main Sectoral Issues ........................................ 315 A Contaminating Deterioration of the Mortgage Portfolio .... ..... 315 A Contracting Mortgage Stock and Production of New Loans ....... 317 Legal, Regulatory, and Institutional Environments ..... .......... 319 CON1IENTS xi Figure 1. Quality of the Residential Mortgage Portfolio ........ ...... 316 Figure 2. Nonperforming Mortgage Loans, Public and Private Banks ... 318 Table 1. Recent Evolution of Mortgage Lending ................ .... 319 ll. Urban Development ... 329 1. Urbanization in Colombia .................. .. .. ..... .. 330 11. The Legal and Institutional Framework ...... ..... ............ 332 111. Urban Poverty ............... .. ....................... 334 IV. Access to Public Services ....... ........... . . 336 Land and Housing ............. .......... 338 Water Supply, Sanitation, and Solid Waste Management .341 Urban Transport .. . . . ........ 350 V. Policy Recommendations .................. .. .. ..... .. 353 Urbanization ............ ................. ..... 353 Land and Housing ............... .................. . . 356 Water Supply and Sanitation ...... ......... 357 Urban Transport ......................... .. ... ..... 357 References .......... . .. .............. ...... ......... 358 Box 1 The Medellin Metro .............. .................. . 354 Box 2. The TransMilenio System in Bogot ................. ........ 354 Figure 1. Bid Rent for Land: Poor versus Nonpoor ............... ... 344 Table I Gross Annual Rates of Internal Migration to the Main Cities and Some Conurbations, 1982-2000 ... .......... 331 Table 2. Indicators of Unsatisfied Basic Needs by Zone, 1993-2000 ...... 335 Table 3. Poverty Indicators and Income Inequality, Urban Colombia, 1978-99 ....................................... 336 Table 4 Social Indicators, Urban Colombia, 1978-99 ........... ... 337 Table 5. Housing Deficit (National, Urban, and Rural), 1997-2000 ...... 342 Table 6. Coverage of Water Supply and Sewerage Services in Colombia (percent) ............. ................... 345 Table 7 Coverage of Water Supply, Sewerage, and Solid-Waste Collection in the Main Cities (percent), 2000 . ................ 346 Table 8 Coverage of Water Supply Services in Major Cities ..... ....... 346 Table 9 Water Supply and Sewerage Utilities: Total Expenses/Operational Income, 1999 and 2000 ... .......................... 348 Table 10 Solid Waste Companies: Total Expenses/Operational Income, 1999 and 2000 ................................... 349 Table 11. Unaccounted-For Water in Major Cities, Percentage .349 Table 12. Demand for Public Transportation in Major Cities ........ ... 350 Table 13. Public Transport Vehicles and Their Productivity in the Main Cities, 2000 ............................ .... 351 Table 14. Public Transport Fares in Several Cities, 2000 .......... .... 352 Table 15. Accident Rates in Colombia's Main Cities, 1999 .. . ....... 353 xii COLOMBIA THE ECONOMIC FOUNDATION OF PEACE 12. Transport ......... 363 I. Background ............................................ 363 II. Main Sector Issues and Strategies ........ ...................... 370 Armed Conflict Negatively Affects the Functioning of the Sector .... 370 Isolation of Areas Due to Lack of Transportation Infrastructure ...... 371 The Unfinished Development of the Institutional and Regulatory Framework ..................... ......... 371 Ensuring Adequate Resources to Address the Needs of the Transport Sector ...................... 374 Private Participation in the Development of the Sector's Infrastructure................ ..... 377 Difficulties in the Mobilization of Population within Urban Areas.... 380 II. Recommendations ...... ......... ......................... 381 Contributing to the Peace Process ........................... 381 Consolidation of the Institutional Reforms of the Transport Sector . .. 382 Decentralization of the Road System ....................... 383 In Search of Financial Sustainability for the Sector ...... ......... 384 References ... .. ...... 385 Annex ..... ............................................. 386 Figure 1. Transportation and Economy, GNP, Tons per Kilometer ........ 364 Figure 2. Transport Sector Investment ............. ................ 375 Table 1. Cargo Mobilization at National Level (thousand of tons per year) ......................................... 365 Table 2. Deterioration of Paved Road System Managed by INVIAS (percent) .... . ............................ 366 Table 3. Condition of Unpaved Roads (percent) ......... ............ 367 Table 4. Private Participation in the Transport Sector ...... ........... 369 Table 5. Transport Budget 1998-2001 (millions of pesos) ..... ......... 376 Table A. 1. Road Priority Projects-Vias para la Paz Program .... ......... 386 Table A.2. Transport Entity Roles ... ............................. 387 Table A.3 Port Indicators With and Without Reform ....... ........... 388 Table A.4. Anticipated Private Participation in Transport ...... .......... 389 13. Energy Sector Strategy .................................... 391 I. Background. .............. 391 Terrorism . .....391................ 391 Oil Subsector .392 Gas Subsector .395 Power Subsector ...................................... 397 Coal Subsector .400 Energy and the Environment .401 II. Achievements and Issues ....... ........... ................. 402 Issue 1: Oil and Gas Supply and Pricing ....................... 403 CONTENTI S xiii Issue 2: Regulating Generation and Distribution .... ... ....... 406 Issue 3: Unfinished Business-Further Privatization of State-Owned Companies ... 409 Issue 4: Reforming or Strengthening the Regulatory and Supervisory Institution ......... ..................... . 411 Issue 5: Energy, Poverty, and Peace ... . ..................... 414 III Summary of Recommendations and Next Steps .415 References . .. .... ............................. . .. . 419 Figure 1 Per Capita Energy Consumption (kg oil equivalent per year) . 392 Figure 2. Comparative Reserves (Mboe). ................... .394 14. Information and Communications Technology Sector .421 I. Background .................. .. .. 421 Information and Communicationis Technology and Development .... 421 Sector Reform and Liberalization . . 422 Privatization Attempts .. 425 II Sector Issues .. . . . 425 Low Private Sector Participation ....... ..... ... . . 425 Fragmentation of Regulatory Institutions ... . 426 Subsidies and Tariffs .. 426 Low Internet Penetration .................. 428 Reduced Role of Colombia in the Information Society and the Global Economy .... .. .... .. ......... 428 III Options for Solutions .......... ........... .429 Increased Private Sector Participation ...... . .. .... ..... 429 Tariff Reform ............. ...... ...... . .... 430 Consolidation of Regulatory Institutions . . . . .. 430 Incentives for Local Telephone Companies to Compete With Each Other and Flexibility to Merge .. ... . . ........ 430 IV Colombia in the Information Society .... ..... . .. ..... . . 431 Ministry of Information and Communication Technology .431 Telecom Fund . .432 Developing and Promoting the Use of ICT Applications .... ...... 432 Figure 1. ICTs Are the Basis of the Knowledge Economy ... 423 Figure 2. Teledensity in Selected Latin American Countries and Spain 424 Figure 3. Cell Phone Penetration in Selected Latin American Countries .... 425 Figure 4. Local Subscription Rates in Selected Latin American Countries . 427 Figure 5. Internet Penetration, Selected Latin American Countries and Spain .......................... ................ 429 Table 1. Finances of Colombia's Telecommunications Companies ... .... 428 15. Urban Water and Sanitation Sector .433 I Summary ......... ......... ...... 433 xiv COLOMBIA THE ECONOMIC FOUNDATION OF PEACE II. Background. Sector Status and Issues ........ ................... 435 Sector Context .......... ............... 435 Main Sector Issues ... .................................. 436 III. Water Sector Policy Recommendations for the Incoming Government ............ ............................... 442 Improving the Water Supply and Sanitation Services in Medium-Size Cities and Small Municipalities ..... ........... 442 Improving the Water Supply and Sanitation Services in the Rural Sector ................................... .... 443 Management and Disposal of Municipal Wastewater ... ......... 444 Guidance for Major Projects in Large Cities ............. ...... 447 Improving the Regulatory Framework of the Water Sector .... ..... 447 Annex I. Improving the Water Supply and Sanitation Services in Medium-Size Cities and Small Municipalities ..... ......... 452 Annex II. Examples of Government Guidance Regarding the Water and Sewerage Projects in Large Cities ...... ................. 458 Annex III. Intersectoral and International Context of the Problems Associated with the Regulatory Reform Proposed by the Water Regulatory Commission .......... ............... 461 Table 1. Coverage of Water and Sewerage in Colombia . .437 Table 2. Effective Water Coverage in Colombia as Indicator of Level of Service ................... ................... 438 Table 3. Regional Distribution of Water and Sewerage Coverage Rates in Colombia ................... 438 Table 4. Performance Indicators in Some Large- and Medium-Size Utilities Operated by the Private Sector ................... 441 16. Natural Disaster Management: Vulnerability Reduction & Insurance .......................... 463 Part A. Hazard Mitigation and the Institutional Framework ..... ......... 463 I. Background ......... ................................... 463 Risk and Vulnerability Assessments ...................... 464 Institutions ..... ....................... 466 Part B. Catastrophe Risk Exposure of Public Assets: An Analysis of Insurance Instruments for Smoothing Fiscal Volatility . 470 I. Insurance Contractual Arrangements and the use of Reinsurance . 471 The Quantification of the Natural Hazard Threat in Colombia 472 Inventory of Public Assets and Infrastructure .475 Loss Projections for Risk-Management Planning .476 Catastrophe Insurance Pricing and Risk-Load Factors .477 Comparison of Financial Instruments for Catastrophe Protection .... 478 Financial Parameters for Establishing a Risk-Management Strategy .... ................................ 479 CONTENTS xv Risk-Linked Securities and Catastrophe Bonds ................. 479 Risk Financing with Contingent Credit . 482 Role of the Domestic Insurance Sector ....... ........ . . ... 484 11. Recommendations for the Development of a Government Risk-Transfer Policy .............. ..... .. 484 Figure 1. Quantification of Natural Hazard Threat in Colombia .. .. . 473 Figure 2. Seismic Risk-Loss Distribution Function .................. . 476 Figure 3. Loss Probability Functions for Single and Cumulative Events . . . 478 Figure 4. Catastrophe Bond Financing Structure ............... ... 482 Figure 5. Potential Role of Domestic Insurers in Government Risk Transfer. 485 Table 1. Local Industry Reinsurance Arrangements .......... . . . 471 Table 2 Catastrophic Earthquake Frequency and Loss Intensity .. 474 Table 3. Roads Vulnerability Factors as a Multiple of Standard Damage Ratio of 1.00. . ..... ... . .. ....... 474 Table 4. Capital Stock-Earthquake Damage Ratios .................. 475 Table 5. Equivalence in Pricing Between Financial Market Bonds and Cat Bonds (percent) .......... . .. . .. ...... . 480 Table 6 Example of Parametric Loss Triggers for Cat Bond "Payment" . 481 Table 7. Insurance Structure Using Risk Transfer and Risk Financing Instruments . ... . .. . .. . 483 17. Agriculture and Rural Development .487 I Background . . .. . ............. 487 II Main Issues.. . .... ................. ... 492 Missed Opportunities for Growth ........................... 492 The Poor Functioning of Factor and Goods Markets .......... ... 493 Poverty and Inequality .................. .. . . .... 499 Institutional Breakdown ......... ............. ..... 502 LII. Options for the Future ...................... .. ..... . 505 Fostering Growth in the Rural Economy ............. .. 505 Poverty .. .. ... .. .. ... . 510 Institutions ......................................... 511 Natural Resources .......... .. ....... 513 References . . . ... . . ... .. 514 Box 1. PROCAMPO .......... ............ 507 Figure 1. Growth Rates ............................... ..... 488 Figure 2. Percent Change in Area Harvested Between 1988-90 and 1999-2000 .498 Figure 3. Income Per Capita-Sen Welfare Index. .. .. . .. 500 Table 1 Poverty and Inequality (in percent) .................. 489 18. Coffee .517 I Background ........... ...... .. .. .... ..... 517 xvi COLOMBIA THE ECONOMIC FOUNDATION OF PEACE Anatomy and Evolution of the Sector ......................... 517 Global Context and Trends ................................. 519 Production and Demand Trends ..... ........... ........... 520 Macro Trends in Established Consumer Markets ..... ........... 523 II. Main Sectoral Issues/Diagnostic ...... ............... ......... 525 Domestic Impact of Low Prices Trends and Volatility ..... ........ 526 Smallholders and Their Integration with the Process of Rural Development ..................................... 528 Policy Initiatives with Stabilization Funds and Subsidies ..... ...... 529 Institutions and Their Roles ........ ............... ....... 530 Credit ...................................... 532 Issues Across the Supply Chain ............. ................ 532 The Changing Nature of Demand and Adapting to Differentiated Markets .......................................... 536 III. Policy Recommendations . .................................... 538 Smallholders and the Rural Poor ......... ................... 538 Managing Transition: Options for Diversification ..... ........... 540 Risk Management and Safety Nets ........................... 543 Policies of Subsidy and Support .. ........................ . 545 Institutional Leadership .................... 546 Competitive Foci .................... 547 Annex I. The Nature and Characteristics of Differentiated Coffee Markets . .. 551 Annex II. Colombia's Coffee Subsector Public Supports .554 References ..555 Figure 1. Importer Demand for Exportable Production (percent) .521 Figure 2. Producer Price ($1998 = 100) and Production Volume .526 Figure 3. Key Policy Recommendations for the Coffee Sector .... ..... .. 539 Figure A.I. 1. Percent Rating Attributes as Important . .553 Table 1 The Increasing Concentration of the International Coffee Business .522 Table 2. Coffee Prices Volatility Index (Standard Deviation Percent) . 527 Table 3. Distribution of Coffee Plots (by size) .527 19. Land Policies .559 I. Executive Summary .559 II. Background and Challenges .560 The Extent of Inequality in Land Access and Reconcentration and Underlying Factors .561 The Consequence of Colombia's Skewed Land Distribution: Inappropriate Use of Natural Resources .563 Landownership Patterns and Administrative Decentralization . 564 Land Access and Landownership as Key Determinants of Household Welfare .565 CONTENTS XVii 111. Main Issues. .. . .................. ....... . .... .. 566 Security of Tenure and Mechanisms of Land Access. ........ 567 Land Titling ... . ..... ........... ......... ..... 572 Land Reform ....... . 573 IV. Policy Recommendations ........ .............. ....... ... 580 Systematic Titling .... ......... ...................... 580 Fiscal Policy and Land Taxation ............. ....... . . . 580 Ordenamiento Territorial and Sustainable Land Use .. ........... 581 Land Reform ...... ..................... . ........ 581 Annex ... ....... ....... ........................... 583 References ............ 585 Table 1. Structure of Landownership and Use in Colombia, 1984 and 1997 ......................... 562 Table 2 Actual and Potential Land Use in Colombia, 1985 and 1999 .. 564 Table 3. Means of Land Access, Colombia ................ ........ 568 Table 4. Ways of Land Acquisition in Different Periods, Colombia .. 569 Table 5. Producers' Rental and Sales Market Participation in Colombia, by Region ... .. ........................ ..... 570 Table 6 Probit Regression for Land Rental and Sales Market Participation .571 Table 7. Public Spending for Land Reform and Related Projects, Colombia Different Years (millions of current pesos) ... 576 Table 8. Cost Per Beneficiary Family for Different Modalities of Reform (millions of 1998 dollars) . ... .......... ......... . 577 Table 9. INCORA's Executed Budget, Total and by Component (millions of 1998 pesos) ...... 578 Table 10. Debt Burden of Different Farms Under Pilot and Nonpilot .... 579 Table A. 1. Determinants of Land Prices .. . . .. .583 20. Rural Finance ...... 587 1. Background .587 Overview. ....... ..... 587 Market Destruction and Distortion Due to Conflict and Violence .... .......................... ............ 589 Crisis and Reform in the Financial-Cooperatives Sector .589 The Public Sector .............. ........................ 590 Alternative Sources of Finance .................... ......... 591 11. Main Issues ........... ................................. 592 111. Policy Recommendations .... ............................. 595 The Role of the State- Banco Agrario, FINAGRO, and the Effectiveness of Public Interventions ... .............. .. 595 Modernizing Rural Risk Assessment and Risk Management . . ... 597 Enabling the Use of Nontraditional Collateral ....... .... 598 XVIII COLOMBIA. THE ECONOMIC FOUNDATION OF PEACE Annex I. The Cooperative Sector ........ ........................ 599 Annex II Public Sector Institutions and Programs in Rural Finance ........ 603 References .... ................. .......................... 607 Figure 1. Density of Retail Financial Outlets Supervised by the SuperBancaria ........... .......................... 588 Figure 2. Total Agricultural Sector Loan Disbursements-FINAGRO Discounted Funds and Own "Substitute" Funds .... ........ 593 Table 1. Cities and Towns with at Least One Bank Branch .... ......... 589 Table A.I.1. Financial Cooperatives and Commercial Banks, Balance Sheet Aggregates and Relative Comparison, US$ Millions as of 31 December of Each Year .. .... .......... 599 Table A.I.2. Number and Balance Sheet Aggregates of Cooperatives Supervised by the SES, US$ Millions as of December of Each Year ... ................................... 600 Table A.I.3. Number and Balance Sheet Aggregates for a Subset of Cooperatives Consistently Reporting to the SES, US$ Millions as of December of Each Year ..... ........... 601 Table A.II.1. Agricultural Sector Lending 1998-2001 (disbursements, US$ millions) ..... .............................. 604 Table A.II.2. Distribution of Financial System Loan Portfolio by Sector, 1996-98 ....... 605 Sharing the Fruits of Growth with Al Colombians 21. Education .................. 611 I. The Big Picture: Colombia's Education and Challenges .... .......... 611 II. Colombia's Education System: Organization and Recent Trends. ...... 613 Preschool Enrollment: Coverage is Low ...... ................. 614 Primary Enrollment Trends: High Coverage, But Stagnating With 12 Percent Still Out of School ...... ................. 615 Secondary Enrollment Trends: Coverage is Low Especially the Poor ... 615 Higher Education Trends: Very Low Coverage and Favors the Rich ... 616 III. Policy Issues and Options in the Education Sector .................. 617 IV. Government Strategy: Addressing Education Sector Issues .... ........ 629 Programs and Policies Responding to Issues of Educational Access and Equity ..................................... 629 Programs and Policies Responding to Problems of Quality and Sector Efficiency ...................................... 631 Programs Addressing Effectiveness of Decentralization .... ........ 632 V. Conclusions and Policy Recommendations ...... ................. 634 Annex I. Possible Activities to be Implemented by the New Administration to Respond to Critical Education Sector Issues .... ......... 637 CONTl-ENTS xix References ............. ....................... ........ 650 Box 1. Hogares de Bienestar Infantzl .......... . . .. ....... 614 Box 2. Colombia's Escuela Nueva A Tested Strategy for Reaching the Rural Poor and Improving Quality ........... .. ...... 633 Box AI.1. Applying the Community College Model to Colombia . ... 639 Box AI.2. Mexico's Telesecundaria: Increasing Access to Secondary Education for the Rural Poor ....... .. .......... 641 Figure 1. Impact of the 1998-99 Crisis on Primary Enrollment ..... 616 Figure 2. Higher Education Gross Enrollment in Selected Countries, 1980 and 1994 .......... .... 617 Figure 3. Fiscal Situation and Contributions, 1994-2000... .. 634 Table 1. Average Math Achievement Test Scores of Eighth Graders, Selected Countries ........ ... .. ............... 620 Table 2 Average Years of Education by Income Decile, 1991-97 . . . 623 Table 3. An Education Action Plan. Policy and Program Option Matrix . .. 636 Table A.1 Country Scores in 1998 UNESCO/OREALC-Assessment of Student Outcomes in Latin America and the Caribbean . 644 Table A.2. Distribution of Family Spending on Education, 1997 . . 645 Table A.3. Distribution of the Primary and Secondary Education Subsidy by Income Decile, (constant 1996 pesos) ........... . . 646 Table A 4 Per Capita Transfer for Education by Department, 1994-98 ... . 648 22. Health .. . 653 I Introduction ... . .. 653 11. Background ............. .... ... ................ 657 Before the Reform .................... ... ... ..... 657 The Reform: Law 100 of 1993 .................. ........ 658 Implementation of the Reform ....... .................... 661 Financing ....... .. .. ... 664 III Sector Issues . . ....... ...... .. . . .. 666 The Social Security Institute ..... ....................... 666 Public Hospitals ....... . . ............................. 670 Financing . . . .................... ... .. ... ... 675 Health Insurance Coverage and Targeting . . .680 Public Health: The Issue of Vaccination .. . . . .... 684 IV. Government Response and Current Reforms . . . 685 V Policy Alternatives and Recommendations . . .689 The Social Security Institute . . .690 Public Hospitals ..... . .... . .. ... . .. 693 Financing . . . .. ... ....... 694 VI. Conclusion ...... ... .............................. 699 Appendix . ... . ... . ..... ........... .. ....... 702 References . . ........... . .......... . . ... ...... . 706 XX COLOMBIA THE ECONOMIC FOUNDATION OF PEACE Box 1. The British Experience ............................ .... 674 Figure 1. Overall Health Performance and GNP Per Capita (PPP) .... 655 Figure 2. The Colombian Health System After the Reform of 1993 .... 660 Figure 3. Coverage Rates by Quintiles .................... ....... 663 Figure 4. Financing of the Health System .... 665 Figure 5. ISS Expenditures .............. .......... ........... 668 Figure 6. Balance Sheet, Consolidated EPS-IPS .. .................. 670 Figure 7. Income Statement, Consolidated EPS-IPS ........... ... 671 Figure 8. Public Hospital Financing, Millions of 1999 Pesos .673 Figure 9. Allocation of Resources-Law 60 ...... ................ .. 678 Figure 10. SISBEN Classification Document Affiliation and Health Care Copayments in the Subsidized Regime .682 Figure 11. Coverage Levels for Three Doses of DTP Among Children Younger Than 1 Year of Age, Andean Region, 1990-2000 . 685 Figure 12. Allocation of Resources-Law 715 .686 Table 1. Health Sector Indicators ....................... ..... 661 Table 2. Number of Affiliates, 1996-2000 ..... ................... 662 Table 3. Changing Patterns of Health Insurance, Percentage of Affiliates . . . 664 Table 4. Quality of Health Care, 1997 ...... .................... 664 Table 5. Waiting Time to Receive Treatment ....................... 665 Table 6. Transformation of the Fiscal Situation and the Transferred Rents, 1997-2000 ...................................... 666 Table 7. Distribution of Total Expenditure and Total Income of Public Hospitals of Levels I, II, and III, 1993 and 1998 ..... ....... 672 Table 8. Real Public Hospital Expenditures as Percentage of GDP .... .... 673 Table 9. Evasion in the Contributory Regime (millions of 2000 pesos) ..... 676 Table 10. FOSYGA: Annual Budget FY 2000 (pesos) ..... .......... .. 677 Table 11. Situado Fiscal Transformed into Demand Subsidies (millions of 1999 pesos) .............................. 679 Table 12. Number of New Affiliates in the Subsidized Regime by Type of Action ..................................... 681 Table Al. Option 1: ISS Health, Millions of US$ (in year 2000 dollars) .... 702 Table A2. Option 2: ISS Health, Millions of US$ (in year 2000 dollars, without including values of assets that could be sold) ......... 703 Table A3. Option 1: Timid Restructuring of Public Hospitals, Millions of US$ (in year 2000 dollars) . .......... ................ 704 Table A4. Option 2: Bold Restructuring of Public Hospitals, Millions of US$ (in year 2000 dollars) ............................ 705 23. The Social Safety Net .709 I. The Social Safety Net in Colombia .709 II. Role of Social Safety Nets and Recent Policy Initiatives .711 Colombia's Social Assistance Programs .711 CONTENTS Xxi Responding to the Recent Economic Crisis: The Social Support Network .. . . .. ................................ 714 III Main Sectoral Issues ......................... .. ...... ... 714 Issue 1: Sources of Vulnerability .. ....... .................. 715 Issue 2: Social Risk Management. ..... ... ... ... .... 719 Issue 3: Problems with Colombia's Social Safety Net .721 IV. Options and Recommendations for Reforming Colombia's Safety Net ... .. .. .. ............................... 723 Recommendation 1: Increase Resources for Social Assistance . 724 Recommendation 2. Focus on Streamlining the Existing System, not Creating Additional Programs .......... .. . 725 Recommendation 3: Establish a Countercyclical Element of the Safety Net ... .............................. .. .. 726 Recommendation 4 Addressing the Needs of the Internally Displaced Population .727 V Conclusions . 727 Annex . ..... ......................................... 729 References .. ........................................... 733 Table 1. Colombia's Main Social Assistance Programs . .... . ... 712 Table 2 Perceptions of Vulnerabilities by Socioeconomic Level . . 716 Table 3. Poverty Count for Different Subgroups of the Population, 1978-99 ... ................................. 718 Table 4. Social Risk Management Strategies . .720 Table A. Social Risks and Social Protection Programs in Colombia, 2000. . . 729 24. Higher Education .737 I Quality Expansion of Higher Education: Governance and Financing.... 737 II. Emerging Trends in Colombia's Higher Education .. ......... .... 737 1II A Strong But Underperforming Sector ...... ........ ........... 740 IV Policy Recommendations ........ .......... ......... 743 Ensure Clear and Progressive Governance ..... . .............. 743 Direct Public Resources to Its Core Responsibilities .. .. 744 Stimulate Demand in Public and Private Tertiary Education Through Student Aid ... ..... ... ....... ....... 745 Promote Strategic Levels of Education .... . .. ........ 746 Induce and Assure Quality . ... .... .................. 746 Figure 1. Expansion in Tertiary Enrollment Led by the Private Sector (Private and Public Enrolment, 1980-2000) ......... 739 Table 1. Urban Labor Market Indicators, by Level of Education (2000) ... . 740 Table 2. Public Spending on Education (1990-99) ... .. ......... 741 25. Science and Tchnology .749 1. Background on Science and Technology .. . 750 xxii COLOMBIA. THE ECONOMIC FOUNDATION OF PEACE II. Strengths and Weaknesses in Colombia's Science and Technology Sector ............. ......................... 751 III. Policy Recommendations ........ ..................... ..... 753 Figure 1. Strengths and Weaknesses in the Science and Technology Sector: Technology and Innovation Indicators ..... .............. 751 26. Enhancing Employment Opportunities Through the Labor Markets .......................................... 755 I Context for Reform ............... ........................ 755 II. Issues and Policy Options .................................... 757 The System of Social Security ........ ...................... 757 Labor Unions, Wages and Industrial Relations ..... ............. 759 The Labor Market, Informal Sector, and Small Firms ..... ........ 761 Insufficient Human Capital Accumulation ...... ............... 764 III. Key Policy Conclusions ............ ......................... 766 References ................................................. 766 Table 1: Total Wedge on Payroll (as percent of wages) ....... .......... 757 Table 2. Marginal Rates of Return on an Additional Year of Education (percent for urban males age 25 to 60) ..... ............. 764 27. Gender ............................................... 767 I. Introduction ............................................. 767 II. Advances Related to Gender .................................. 768 Demographics and General Health .......................... 768 Reproductive Health ..................................... 769 Education and Literacy ................ ............... 770 Labor Force Participation ............... 770 Wage Gaps ............... ............................ 771 Rural Development ............... 772 III. Gender Issues as They Relate to Colombia's Economic and Social Development ................. 772 Conflict and Violence ................. 772 Displacement ................. 774 Domestic Violence .............. ....................... 774 Drugs, Alcohol Abuse, and Violence . ....... ............. 775 Reproductive and Sexual Health .......... .................. 775 Male Dimensions of Reproductive and Sexual Health ..... ........ 777 Family Size and Poverty ................................... 778 Educational Attainment . .................................. 778 Household Structure ..................................... 779 IV. Conclusions and Policy Recommendations ....... ................ 780 Crime and Violence ..................................... 781 Reproductive and Sexual Health ......... ................... 782 CONITENTS XXIii Support to Female Single-Parent Families .... ........... .... 782 References ..... . 783 28. Indigenous Peoples and Afro-Colombian Communities . 787 I Colombia: A Pluriethnic and Multicultural Nation . ........... . 788 The Indigenous Population ................. .............. 788 The Afro-Colombian Population ................. ........ 788 Progress in Recognition of the Rights of Ethnic Groups .789 11. The Rights of Ethnic Groups in the Context of the Political Conflict and Economic Criss .............i............ .. ....... 790 Surveying and Consolidating the Territorial Rights of Ethnic Groups ............... .......................... 790 Natural Resources ....... . ........................... . 794 Territorial Pressure on the Indigenous Homelands and Collective Territories of the Afro-Colombian Communities .796 The Vision of the Future for Ethnic Groups ....... .. ........ 803 III Policy Recommendations ................. ..... 805 Respect for New Models for Living Together and Human Rights Protection for Ethnic Groups ..... . ... . .......... . 805 Protection of Social, Economic, and Cultural Rights of Ethnic Groups ........................................ 806 Conservation and Sustainable Use of Natural Resources of the Collective Territories and Indigenous Homelands ...... . ..... 808 Annex I Legal Advances in Colombia as Related to the Rights of Ethnic Groups ..... ......... ..... ............. 810 Annex II ..... .............................................. .814 Annex III ........... ........ ................. .......... 818 Annex IV. . .. ...... ...... ........ ....... ..... .. 821 References. ...... 823 Box 1. National Development Plan for the Afro-Colombian Population: Building a Pluriethnic Nation: Poverty and Human Development Indicators, 1998-2002 ..................... ..... .... 790 Table 1. Legal Situation of Indigenous Land Tenure in Colombia, December 2001 ......................... .... ..... 792 Table 2. Comparison of the Legal Situation of Indigenous Land Tenure in Colombia Between 1980 and 2001 .............. ....... 793 Table 3. Natural Parks that Overlap with Indigenous Territories . 795 Table A.II.1. Ethnic Groups and Indigenous Population by Department, 2001 ...................... ........ 814 Table A.II.2 Ethnic Groups of Colombia, Population and Area, 2001 . 815 Table A.III. 1 Some Basic Demographic Indicators in Four Indigenous Regions, Pifieros Marion, and Ruiz Magda, 1998 .. ..... 818 xxiv COLOMBIA: THE ECONOMIC FOUNDATION OF PEACE Table A.III.2 Colombia, Population and Indigenous Area and the Population and Total Extension by Department, December 2001 ...... 819 Table A.IV.1 ICN Resources Assigned to Homelands 1994-2001 (2001 pesos) ......... ............................ 821 Table A.IV.2 Distribution of Resources by Fiscal Sector Prioritized by Indigenous Authorities, 1994-99 ....... .. .......... 822 29. Forced Internal Displacement .............................. 825 I Summary .. .... .................................... 825 II. Background ......... 826 Causes of Displacement ............... 828 Responsible Parties .. ................................... 829 Estimation of the Magnitude of the Problem ........ ........... 829 Characteristics of the Displaced Population ......... ........... 832 Lost Property ..... .................... ...... .. .... 833 Areas Affected by Displacement .... . ....................... 833 Consequences of Displacement ......... ............ 834 The Government's Response ....... .............. 835 Other Institutions Working on the Issue .......... ............ 836 III. Main Issues ...... ...................................... 837 Issue 1: Lack of Priority to the Problem of Forced Displacement both Nationally and Internationally ... .................... 837 Issue 2: Lack of Preventive Measures to Reduce or Mitigate the Impact of the Armed Conflict, the Main Cause of Displacement . 838 Issue 3 Insufficient Understanding of the Size and Characteristics of the Internally Displaced Population ...................... 839 Issue 4: Little Success in Reestablishment and Socioeconomic Stabilization of the Population ......................... 840 IV. Recommendations ........... ............................. 841 Recommendation 1: Make the Problem of Forced Displacement a Priority and Cover the Displaced Population According to their Needs in the Governmental Programs ........ ............. 842 Recommendation 2: Prevent the Risks of Displacement by Implementing Effective Measures at the Local Level and Protecting the Assets of Displaced People ........... ........ 843 Recommendation 3: Adopt a Common Methodology Among Key Stakeholders for Estimating the Size and Characteristics of the Internally Displaced Population ....... .............. 843 Recommendation 4: Create Realistic Incentives and Opportunities for the Reestablishment-Return, Relocation, Integration-of the IDP ........................................... 844 References ..... 846 Figure 1. Urban-Rural Population ........................ 827 CONTEN1'S xxv Figure 2. Displaced Population Accumulated Between 1985-2000 ... 830 Figure 3. Plan of Action for the Prevention and Attention of the Displacement ... ... .. .. ............... 836 Table 1. Internally Displaced Population ............ .. . . 830 Table 2. Displaced Population by Country . .... ... ........... 831 30. Natural Resources and Global Commons: Capital for Sustainable Development ............................ 849 1. Background ................. .. ... 849 Contribution to Global Biodiversity . . . . 849 Contribution to Global Carbon Sinks . . . . 850 Contribution to CO2 Mitigation . . . . 850 Contribution to International Waters . . . ... 851 11. Past and Recent Policy Initiatives . . .852 Biodiversity Strategy . . .. .. 852 Regime for Land Conservation .. . . . . 854 National Strategy for Use of the Clean Development Mechanism (CDM) ........ .............. ... ... 855 III. Main Issues .. . ............ .... . ........... 856 Unsustainable Use of Biodiversity (Forced Extinction of Species and Habitats .. .......... .. . . . . ........... 857 Poor Understanding of Carbon Sequestration and Mitigation Potential .. ... . .. .... ... ... .. ... 859 Poor Linkage Between Global Issues and Local Development . .. 860 Social Conflict and Use of Natural Resources .... 861 IV. Policy Recommendations . . . . 862 Invest in Conservation and Sustainable Use of Natural Capital .... 862 References ..... 866 Figure 1. Gross Potential of Annual CER Exports from Colombia (excluding oil) ... .. ....................... 852 Building a Government of Quality 31. At the Crossroads of Decentralization, Recentralization, Federalization ..... 871 Introduction The Gap Between Objectives and Achievements ...... .. 871 I Colombia A Country Committed to Decentralization Groundbreaking Reforms, and a Precedent-Setting Decentralization Framework .... .. 872 Unsatisfactory Fiscal Results ...... . .. ............ ... 875 Insufficient Capacity Strengthening . . .. .......... .. 876 Decentralization Did Not Meet Democracy and Governance . 877 xxvi COLOMBIA. THE ECONOMIC FOUNDATION OF PEACE II. Factors that Account for Partial Failure of Decentralization in Colombia ............................................. 877 Fiscal Decentralization Factor ....... ....................... 877 Internal Conflict ........................................ 885 Weak Governance at the Central Level ........................ 887 III. Pros and Cons of Main Policy Courses ...... .................... 888 Option 1: Partial, Explicit Reversal of Decentralization ............ 889 Option 2: Streamlining and Reinvigorating Decentralization ........ 890 Option 3: Let Policies other than Decentralization Silently Operate the Reform of the Decentralization Process ............ 891 IV. Recommendations ......................................... 892 Recommendations Regarding Fiscal Decentralization Issues .... .... 892 Proceed with Market-Oriented Regulations for Subnational Borrowing .................. ....................... 893 Recommendations Regarding Administrative Decentralization Issues .............................................. 894 Recommendations Regarding Political Decentralization Issues ....... 894 Recommendations Regarding Context Factors for Decentralization in Colombia ......................................... 895 32. The Judiciary ........................................... 897 I. Background .............................................. 897 II. Enhancing the Constitutional Framework ...... ................. 899 III. Issues Related to the New Constitutional Framework ..... .......... 902 Increased Juridical Insecurity ..... ......................... 902 The Growing Governance Quagmire ........................ 903 Managing the Inefficiencies of Success: The Protection Action ...... 903 Reducing Impunity ...................................... 905 Increasing Efficiency, Quality, and Integrity ..... ............... 913 IV. Conclusions and Recommendations ....... ..................... 926 References ................................................. 928 Figure 1. Labor Justice Demand (1994-99) ........... .............. 904 Figure 2. Protection Actions on Labor Matters (1995-99) ..... ......... 904 Figure 3. Budgetary Appropriations (1992-2000) ........ ............ 906 Figure 4. Workload of Preliminary Investigations ....... ............. 908 Figure 5. Output at the Criminal Instruction Phase ........ ........... 908 Figure 6. Criminal Justice Demand ............................... 909 Figure 7. Evolution of the Homicide Rate in Colombia, 1993-99 ........ 909 Figure 8. International Comparison on Homicide Rates, 1998- .... ....... 911 Figure 9. Recurrent Expenditure of the Judiciary, 1992-98 . .......... 914 Figure 10. Investment Expenditures of the Judiciary, 1992-98 .... ........ 914 Figure 11. Institutional Capacity, 1998 ............. ................ 915 Figure 12. Comparison of Caseloads in Andean Countries, 1992-98 ....... 916 CONTENTS xxvii Figure 13. Judiciary's Budgetary Allocations, 1998 ..... . ........ 916 Figure 14. Workload Evolution Ordinary Jurisdiction, 1993-99 .917 Figure 15. Average Process Duration Civil Procedures .918 Figure 16. Critical Factors Affecting the Quality of Justice .. . .. ..... . 919 Figure 17. Critical Factors Affecting the Quality of Justice .. . 920 Figure 18. Changes in Stock of Civil Cases (by type of proceedings), 1992-98 ... .................................. 921 Figure 19. Public Perceptions on the Independence of the Judiciary .. . ...922 Figure 20. Entrepreneur Perceptions on the Independence of the Judiciary . . . 923 Figure 21 Evolution of Judicial Branch's Expenditure .. . . 924 Table 1. Judicial Human Resources (1985-95) .907 33. Corruption, Institutional Performance, and Governance: Developing an Anticorruption Strategy for Colombia .931 I Background ........................... ... ... ....... 931 11. Main Conclusions of the Empirical Study. ....... ............... 932 State Capture and Governance .............................. 933 Moderate Incidence of Administrative Corruption ..... ....... 941 The Purchase of Public Administration Posts ..... .. ... 941 The Perception of Institutional Performance .... . . . 941 Institutional Performance .............................. 944 Presence of Corrpution at the Regional Level ......... .......... 946 Judicial Power and Corruption ... 946 Greater Impact of Administrative Corruption on the Poor ..... .... 948 III. An International Comparison of Governance ... ..... .......... 948 IV. A Strategy for Integrity .. .. .. . 950 References .......... . .. ....... 955 Figure 1. Corruption: Comparison of Colombia, Ecuador, Honduras, and Peru. ....... 934 Figure 2. Level of State Capture/Undue Ability of Elites to Influence High-Level Decisions of Authorities in Colombia, Honduras, and Peru (according to companies, 2001) .935 Figure 3. How Much Ability Do the Following Actors Have To Use Bribes To Influence the Decisions of High-Level State Authorities? . . 936 Figure 4. Meritocracy versus Presence of Corruption (Central Level) . 938 Figure 5. Level of Politicization versus Presence of Corruption . 939 Figure 6. Restrictions on Competition for Public Contracts .... . ..... 940 Figure 7 Quality and Presence of Corruption in Public Services .942 Figure 8 Quality and Presence of Corruption in Public Services . . 943 Figure 9. The Ten Most-Honest Public Institutions: How Dishonest/ Honest Is Each of the Following Institutions? .944 Figure 10. The Ten Least-Honest Public Institutions: How Dishonest/ Honest Is Each of the Following Institutions? .... ...... 945 xxv;Ii COLOMBIA THE ECONOMIC FOUNDATON OF PEACE Figure 11. Evaluation of the Judicial Sector .........................4947 Figure 12. Indicators of Governance in Colombia: 1998-2001 (based on more than 175 countries) ................ .... 949 Figure 13. Governance Indicators for 2001 (based on a study of 175 countries) .. 950 Table 1. Strengths and Weaknesses of Public Institutions, Colombia . 946 Table 2 Corruption and Level of Government .......... 947 34. Reform of Public Administration and of the State in Colombia . 957 I. Background to Current Challenges.957 II. Government Proposal for a New Public Sector Reform .............. 961 Strategic Options .................................... ..... 961 Concept of Reform .. .. ................. 965 Objectives, Strategy, and Goals of the Reform Agenda .. ......... 966 Choice of Instruments, Risks, and Costs ............ 967 Stages of Reform ............. ......................... 974 Formulation Unit and Management Unit for the Reform .975 Monitoring, Evaluation, Dissemination .976 III. Synthesis of Recommendations .......................... ... 979 Table 1. Examples of Objective and Goal Definition ... ........... ... 968 Table 2. Tools, Projects, and Actions Regarding the Transversal Reforms of the Colombian Public Administration (with multilateral financing) .973 35. Budgetary Institutions .981 I. Introduction ............................................. 981 II. Budgets and Fiscal Balance .............................. 982 The Issue ...... ................................... .. 982 Ongoing Actions ....................................... 983 Recommendations ............... ....................... 983 III. Control of the Budget . . 984 The Issue ................. 984 Ongoing Actions ................. 985 Recommendations ......... ........... ................. 985 IV The Planning and Budgetary Process ... 986 The Issue ......... .. . . .. ............ .... 986 Ongoing Actions ........................................ 987 Recommendations ............... ....................... 987 V. Budgetary Inflexibility ...... . .. ........................... 988 The Issue ............ ............................... 988 Ongoing Actions . 988 Recommendations ......................... ... ... 989 VI. Organizational Adjustment ................. ................ 990 CONTENTS XXIX The Issue ... .... .............. ........ 990 Ongoing Actions. ......... ........... ......... ... 990 Recommendations ... ........ .. .... 991 VII Information Management and Use . ........ ........ 992 The Issue ....... . ......... . . ........ .. ...... 992 Ongoing Actions ...... ........ ..... ... 992 Recommendations .. ........ ................ 993 References ................. ............ ........... . ... 993 Table 1. National Budget Arrears, 1990-2002 ....... . ....... ... 982 Table 2. Budgetary Inflexibilities ... . ......... ........... .. 989 Acknowledgments This volume is the result of a team effort and, as such, it has benefited from an array of invaluable contributions. Our thanks are therefore due to a large number of peo- ple. First, the chapters' authors, who have provided not just material of outstanding technical quality but a remarkable commitment to enriching the policy debate in Colombia. We consider ourselves fortunate to share this book with these principle authors-Jairo Arboleda, Adolfo Brizzi, Krishna Challa, Loic Chiquier, Alberto Chucca Mora, Vivian Foster, Vicente Fretes Cibils, Eleoterio Codato, Elena Correa, Maria Correia, Mauricio Cuellar, Carlos E. Cuevas, Mario Adolfo Cuevas, Shelton Davis, Klaus Deininger, Clemente Luis Del Valle, Marfa-Luisa Escobar, Eduardo Fernandez (consultant), Christina Garcia, Elsie Garfield, Jose Gil-Diaz (consultant), Daniele Glovannucci (consultant), Natalia Gomez, Lauritz Holm-Nielsen, Isabel Lavadenz, Menahem Libhaber, Matthew McMahon, Alexandra Ortiz, Panagiota Panopoulou (consultant), Vicente Paqueo, Zeinab Partow, Thakoor Persaud, John Pollner, Juanita Riafio (consultant), Laura Rawlings, Fernando Rojas, Juan Pablo Ruiz, Felipe Saez, Enrique Sanchez (consultant), Mario F. Sangines, Lisa Taber, Car- los Eduardo Velez, Eduardo Velez Bustillo, Walter Vergara, Eloy Vidal, Hermann von Gersdorff, Steven B. Webb, and Eduardo Zolezzi. All authors are affiliated with the World Bank Group unless otherwise indicated Other contributors to individual chapters are recognized in the credits of each specific chapter. While this book reflects the authors' own views (and not necessarily the views of the World Bank, its Board of Executive Directors or its member countries), its pro- duction was institutionally housed at the World Bank We thus benefited enor- mously from the general guidance of Guillermo Perry (Chief Economist for the Latin America and Caribbean Region), and from the auspices of the office of David de Ferranti (Vice-President for Latin America and the Caribbean Region). We also recognize the importance of and thank the participants at the workshop held on July 27, 2002 in Bogota. This workshop not only brought together a major- ity of the authors under one roof for a day of candid discussions but also, and more importantly included Colombian officials of both the outgoing and incoming administrations. Of the Colombian officials at the workshop, we especially wish to thank: Maria Consuelo Araijo, Carolina Barco, Jorge Humberto Botero, Carlos Gustavo Cano S., Alberto Carrasquilla, Luis Ernesto Mejia Castro, Andres Uriel Gallego Henao, Alejandro Gaviria, Gustavo Gaviria, Roberto Junguito, Fernando Londofno Hoyos, Beatriz Londofio, Juan Luis Londofio, Santiago Montenegro, Juan xxxi XXXii COLOMBIA. THE ECONOMIC FOUNDATION OF PEACE Ricardo Ortega, Martha Pinto de De Hart, Jaime Ruiz Llano, Martha Lucia Ramirez, Cecilia Rodriguez Gonzalez-Rubio, Francisco Santos, Sandra Suarez, Miguel Urrutia, Alberto Velasquez, and Cecilia Maria Velez. Their comments, sug- gestions, and inputs along with those from the many others who attended this work- shop added greatly to this volume. Finally, we are especially grateful to Michael Geller, who so ably managed the production and support team-from initial conception and planning to final lay- out, type-setting, and dehvery. At various stages, that team included: Cristiam Rodriguez and Christopher Humphrey, who assisted in the actual preparation of various chapters; Liliana Wiesner, who organized the initial two-day country team meeting in Washington on February 25-26, 2002; Maria Teresa de Henao, who at various times before, during, and after the course of this project gave much time and energy to support its successful completion; Cristina CGfuentes, Jenner Guzman, Daniel Reyna, Julieth Rodriguez, and Adriana Salazar-all of the World Banks Bogota office-who gave many hours particularly on July 27, 2002 to create the proper environment for discussions between the Colombian officials and the Bank staff; Vinh H. Nguyen, who acted as our budget advisor; Diane Stamm, the princi- pal language editor; Santiago Pombo-Bejarano, Brenda Mejia and Thaisa Ysonde Tiglao, who spearheaded the printing efforts in English and Spanish; Richard Creighton, Brenda Waugh, Judy Gibson and the staff of the Magazine Group, who created the design and layout of the volume; and Maria Victoria de Robayo and Natalia Bonilla Maldonado of Museo Nacional de Colombia in Bogota and Ana Escallon of the OAS Museum of the Americas in Washington, D.C. who greatly assisted in contacting Diego Obreg6n to secure the art of his father, Alejandro Obreg6n, for use on the cover of this volume. Our thanks to all of them. Marcelo M. Giugale, Olivier Lafourcade, and Connie Luff Washington D.C. and Mexico City October 2002 Preface Colombia faces a future of challenge-and of opportunity. Long besieged by con- flict, it has been unable to free itself from the shackles of poverty Rich in human and natural endowments, the country has yet to become a prosperous, equitable nation. The scourge of violence has repeatedly tested the resilient effort of its peo- ple Even its impressive record of economic growth seems less remarkable when one sees the poor, the homeless, and the refugees. It need not be like that. And the time has come to leave the past behind. The resounding election victory of President Uribe on May 26, 2002 and his underlying mandate for change have opened the door for Colombians to think beyond war -to articulate a shared vision and a path toward it Economic devel- opment will be an integral part of that path. Jobs, education, and a clean environ- ment need to be as much a foundation of peace as security and political agreement. The World Bank was thus honored by the new authorities' invitation to publish this set of policy notes which, from an independent point of view, provides an account of Colombia's development agenda-the problems, many of the reasons behind those problems, and some options to address them. The analysis here does not pro- vide definite answers. Rather, the intention is to contribute to the national debate, to Colombians' own search for solutions. The required reforms would be difficult for any government. For a government trying at the same time to end a decades-old war, they are even harder. Current regional and international conditions are not facilitating matters, and are unlikely to facilitate them in the near future. The financial crisis in Argentina is restricting access to external funding for other emerging market countries, including Colom- bia. Sagging global growth is dampening Colombia's exports. Prospects of military action in the Middle East have heightened the volatility of oil prices. Terrorism and its financing have fostered the illegal drugs trade. Yet, the cost of inaction seems unbearably high- without reform, the Colombian economy risks spiraling into a cycle of recession, increasing poverty, and intensifying conflict. The government of President Uribe is determined to address, head on, the dou- ble challenge of peace and reform. In the few months since taking office, the new administration has rallied support for some major changes in policy direction-for example, in the fiscal area. We at the World Bank stand ready to support the gov- ernment's efforts. This is central to our institution's mission of poverry reduction. And, more personally, it is central to our staff's desire to see Colombia succeed. xxxiii xxxiv COLOMBIA THE ECONOMIC FOUNDATION OF PEACE Finally, I wish to express our gratitude to the Colombian authorities for giving us the privilege of being part of their country's quest for development, and to the edi- tors, authors and producers of this book. David de Ferranti Vice President Latin-America and Caribbean Region Washington, D.C. October 2002 Editor Biographies MARCELO GIUGALE, an Argentine/Italian national, holds a PhD and a MSc in Eco- nomics from The London School of Economics, and a B. A. in Economics from Universidad Catolica Argentina. After a spell in academia, he joined the World Bank in 1989 as an economist in its financial research department. From 1990 to 1994, he was a Senior Economist in the Middle East Operations Vice-presidency, super- vising Egypt's structural adjustment program and leading the Bank's reconstruction work in post-war Lebanon. From 1994 to 1998, Mr. Giugale was a Principal Econ- omist in the Eastern Europe and Central Asia Region, responsible for the Bank's lending and analytical economic work in Lithuania and Kazakhstan. In September 1998, he became the Lead Economist for the Colombia-Mexico-Venezuela Depart- ment. He is currently the Director of the Bank's Andean countries Department. He held teaching positions at the London School of Economics and the American Uni- versity in Cairo, and has published in the areas of applied econometrics, finance, business economics and economic development. OLIVIER LAFOURCADE, a French nationial, is Director of the Colombia-Mexico- Venezuela Country Management Unit of the World Bank, located in Mexico City. Mr. Lafourcade joined the World Bank in 1973. A graduate of Ecole Nationale Superieure Agronomique of Rennes (France), and holding MSc and Ph.D degrees in Agricultural Economics from the University of Maryland (U S.A), he started a career in the Bank working largely on agriculture and rural development projects in Bolivia, Mexico, Brazil, Cameroon. From 1980 to 1982, he was Personal Assistant to two successive Bank presidents (Robert McNamara and Tom Clausen). He then was responsible for the Bank's agricultural programs for several African countries (Zaire, Rwanda, Burundi) before taking charge of the agricultural program for India. He became Director of the European Office of the World Bank in Paris in 1988. In 1992, he moved back to Washingtoni to become Director of the West Cen- tral Africa Department (Benin, Burkina Faso, Cote d'Ivoire, Ghana, Niger, Nigeria and Togo), before taking his assignment in Mexico in September 1997. Before join- ing the Bank, Mr. Lafourcade worked in Argentina for two years as a researcher in the Argentine National Agricultural Research Institute CONNIE LUFF, a United States national, is a Senior Operations Officer in the Colombia-Mexico-Venezuela Country Management Unit, located in Mexico City. xxxv xxxvi COLOMBIA THE ECONOMIC FOUNDATION OF PEACE Since joining the World Bank in 1988, she has spent most of her time managing projects and working on operational activities such as developing country assistance strategies, enhancing project quality enhancement and managing project portfolios. She has worked extensively in Latin American and Africa. She has an MBA from ESADE in Barcelona, Spain and a BA from Michigan University. Acronyms and Abbreviations ACODAL Asociaci6n Colombiana de Ingenierfa Sanitaria y Amblental ACOLGEN Asociaci6n Colomblana de Generadores, Syndicate of Colombian Electricity Generators ACP Asociaci6n Colombiana de Petroleo, Association of Oil and Gas Companies ACPM p. 14 of Taxation Note ADBs Agricultural Development Bonds ADT Average daily traffic AFP Administradora de Fondos de Pensiones, Pension Fund Managers AGD Accountant General's Department AGO Attorney General's Office ALM Asset and Liability Management ALMACAFE Almacenes Generales de Dep6sito de Cafe S.A. APU Agricultural Production Unit ARP Administradoras de Riesgos Profesionales, Administrators of Professional Risks ARS Administradora de Regimen Subsidiado, Administrator of the Subsidized Regime ASOCODIS Asociaci6n Colombiana de Distribuidores, Colombian Distribution Companies Association AVSC Association for Voluntary Surgical Contraception BANCAFE Commercial Bank in Colombia BANCOLDEX Banco de Comercio Exterior de Colombia, S.A. (the export bank) BANRURAL Banco Nacional de Credito Rural (Mexico) BaR Budget-at-risk BCH Banco Credito Hipotecario BIBOR Bogoti Inter-Bank Operations Rate BOD Biochemical Oxygen Demand BOMT Build, operate, maintain, and transfer contracts BOT Build-Operate-Transfer BRI Bogota River Interceptor xxxvii xxxviii COLOMBIA: THE ECONOMIC FOUNDATION OF PEACE BSE Bovine spongiform encephalopathy ("mad cow" disease) B2B Business-to-business CAA Centro de Atenci6n Ambulatoria, Centre for Ambulatory Care CAF Corporaci6n Andina de Fomento CAIPs Centros de Atencion Integral al Preescolar CAJANAL Caja Nacional de Previsi6n Social, Government Employees Pension Fund CAMEL Capital/Assets/Management/Earnings/Liquidity (an international prudential and regulatory diagnostic tool for assessing financial soundness of banks) CAN Comunidad Andina CAPRECOM Caja de Previsi6n Social de Comunicaciones CARBOCOL Carbones de Colombia CARs Corporaciones Autonomas Regionales, Autonomous Regional Corporations CAS Country Assistance Strategy CASA Corporaci6n Casa de la Mujer CASEN/93 Encuesta Nacional de Caracterizaci6n Socioeocon6mica 1993, National Survey of Socio-economic Characteristics 1993 CAV Corporaciones de Ahorro y Vivienda, Housing Savings and Loan Associations CC Cajas de Compensaci6n, Compensation Associations CCF Caja de Compensaci6n Familiar, Family Compensation Fund CCI Corporaci6n Colombia Internacional CDM Greenhouse gas mitigation CEDAW United Nations Committee on the Elimination of Discrimination Against Women CEGA Centro de Estudios Ganaderos y Agricolas CEJ Corporaci6n Excelencia en la Justicia CENCOA Central de Cooperativa Agraria, Central Agrarian Cooperative CENICAFE Colombian Coffee Research Center CEPAL Comision Econ6mica para America Latina y el Caribe CER Carbon emission reductions CESU Consejo Nacional de Educact6n Superior CGR Comptroller General CIGADE A UNDP database CISA Central de Inversiones, S.A. CMO Collateralized Mortgage Obligation ACRONYMS AND ABBRENIATIONS xxxix CNA Consejo Nacional de Acreditaci6n CNDM Comision Nacional de Doctorados y Maestrias CNSSS Consejo Nacional de Seguridad Social en Salud, National Council of Social Security in Health CODENSA The Bogoti distribution company CODHES Consultorfa para los Derechos Humanos y el Desplazamiento, Bureau on Human Rights and Displacement COLCIENCIAS Fundaci6n Colombiana Francisco Jose de Caldas para el Fomento de las Ciencias CONFECOOP Confederaci6n de Cooperativas CONFIS Consejo Superior de Politica Fiscal CONPES Comisi6n Nacional de Politica, Econ6mica y Social, National Commission for Economic and Social Policy COP Colombian pesos CORPOICA Corporaci6n Colombiana de Investigaci6n Agropecuaria CPI Consumer price index CPS Caja de Previsi6n Social, Social Health Insurance Fund CRA Comisi6n Reguladora de Agua Potable y Saneamiento Basico, Water Regulatory Commission CRE Comisi6n de Regulaci6n de Electricidad CRECE Centro Regional de Estudios Cafeteros y Empresariales CRLP Center for Reproductive Law and Policy CRT Telecommunications Regulatory Commisslon CREG Comisi6n de Regulaci6n de Energia y Gas DANE Departamento Nacional de Estadisticas, National Department of Statistics DANSOCIAL Departamento Administrativo Nacional del Sector Social DAPS Potable Water and Sanitation Directorate DAS Departamento Administrativo de Seguridad DB Defined benefit DC Defined contribution DDT Direcci6n de Desarrollo Territorial del Departamento Nacional de Planeaci6n, Ministry of Territorial Development of the National Department of Planning DESEPAZ Program Programa Desarrollo, Salud y Paz DGCP Direcci6n General de Cr6dito Publico, General Directorate for Public Credit DGPAD Direcci6n General para la Prevenci6n y Atenci6n y de Desastres DHS Demographic Health Survey DIAN Direcci6n de Impuestos y Aduanas Nacionales, National Tax and Customs Administration xI COLOMBIA THE ECONOMIC FOUNDATION OF PEACE DNP Departamento Nacional de Planeaci6n, Department of National Planning DNPAD National Department of Prevention and Attention of Disasters DRI Desarrollo Rural Integral DTF Colombia's benchmark interest rate DTP3 Diphteria-Tetanus-Pertussis Vaccine EAAB Empresa de Acueducto y Alcantarillado de Bogota EAP Economically active population EC European Community ECAT Traffic Accidents and Catastrophic and Terrorist Events ECD Early childhood development ECHO European Union Humanitarian Aid Office ECOGAS Empresa Colombiana de Gas, a public gas transmission enterprise ECOPETROL Empresa Colombiana de Petr6leos, State oil company ECOSALUD Empresa Colombiana de Recursos para la Salud ECV Encuesta de Calidad de Vida, Survey of Living Conditions EDA Enfermedad Diarreica Aguda, Acute Diarrhea Disease EDUSAT Mexico's Educational Broadcast System EEB Empresa de Energia de Bogota (Bogota electricity holding company-controls EMGESA and CODENSA) ELN National Liberation Army EMAs Environmental Management Agencies EMCALI Empresas Municipales de Cali (Cali water, electricity and telephone distribution municipal company) EMGESA Generation company under EEB EN Escuela Nueva ENCV/97 Encuesta Nacional de Calidad de Vida 1997, National Survey of Quality of Life 1997 ENH Encuesta Nacional de Hogares, National Household Survey ENH/2000 Encuesta Nacional de Hogares 2000, National Household Survey 2000 EPL Expected loss EPM Empresas Piblicas de Medellin EPSs Empresas Promotoras de Salud, Entities of Health Promotion ESE Empresas Sociales del Estado ESMAP Energy Sector Management Assistance Program ESP Autonomous public service enterprises ACRONYMS AND ABBREVIATIONS xli ESS Empresa Solidaria de Salud, Health Solidarity Entity ESTA Energy Sector Technical Assistance project ETB Empresa de Telecomuniaciones de Bogoti ETIS Entidad Territorial Indigena, Territorial Indigenous Entity EU European Union FAEP Petroleum Stabilization Fund, Fondo de Ahorro y Estabilizaci6n Petrolera FAG Fondo Agropecuario de Garantfas FAO Food and Agriculture Organization of the United Nations FAOSTAT Food and Agricultural Organization Statistics FARC Fuerzas Armadas Revolucionarias de Colombia FEC Fondo de Cr6dito Educativo FEN Financiera Energetica Nacional (the energy sector bank) FES Fundaci6n para la Educaci6n Superior, Financiera (a finance company for educational funding) FINAGRO Fondo para el Financiamiento del Sector Agropecuario FINDETER Financiera de Desarrollo Territorial FIRA Fideicomiso Instituido en Relacion con la Agricultura (en el Banco de Mexico) FNC Fondo Nacional de Cafe, National Coffee Fund FNC Fondo Nacional de Calamidades FNUAP Fondo de Poblacion de las Naciones Unid FODESEP Fondo de Desarrollo de Educaci6n Superior FOGAFIN Fondo de Garantfas de Instituciones Financieras, Financial Institutions Guarantee Fund FONADER Fondo Nacional para el Desarrollo Rural FONCOLPUERTOS Pension fund of port workers FONECAFE Costa Rica National Fund for Coffee Stabilization FONPET Fondo de Pensiones Territoriales, National Fund for Regional Pensions FONPRECON The pension fund for members of Congress FOPEP Fonde de Pensiones Publicas FOREC Fondo para la Reconstruccion y el Desarrollo Social del Eje Cafetero FOSIT Programa Para el Fortalecimiento del Sistema de Informaci6n Financiera Territorial, Territorial Financial Information System FOSYGA Fondo de Solidaridad y de Garantfa, Solidarity Fund FRECH Fondo de Estabilizacion de la Cartera Hipotecaria FSAP Financial Sector Assessment FSL Fiscal Strengthening Loan Matrix xiii COLOMBIA. THE ECONOMIC FOUNDATION OF PEACE FSOPEN Fund for Pension Solidarity FSP Pension Solidarity Fund GDP Gross domestic product GEF Global environment facllbty GNP Gross national product GPS Global Positioning System GWh Gigawatt-hour HBI Hogares de Bienestar Infantil HCBs Hogares Comunitarios de Bienestar IAvH Instituto de Investigaciones Alexander von Humboldt ICA Impuesto de Industrias y Comercio ICA International Coffee Agreement ICBF Instituto Colombiano de Bienestar Familiar, Colombian Family Welfare Institute ICETEX Instituto Colombiano de Credito Educativo y Estudios Tecnicos en el Exterior, The National Scholarship Institute ICFES Instituto Colombiano de Fomento para la Educaci6n Superior ICO International Coffee Organization ICR Incentivo a la Capitalhzaci6n Rural ICRC International Committee of the Red Cross ICT Information and communication technologies ICVs Indices de Calidad de Vida, Quality of Life Indicators IDB Inter-American Development Bank IDEAM Instituto de Mercadeo Agropecuario, National Hydrology, Meteorology and Environmental Studies Institute IDEMA Instituto de Mercadeo Agropecuario IDP Internally displaced population IEA International Association for the Evaluation of Education IFI Instituto de Fomento Industrial (the State Industrial Development Bank) (the national development bank) IGAC Instituto Geografico Agustin Codazzi, Geographic Institute 11 Information infrastructures IICA Instituto Interamericano de Cooperaci6n Agricola IIED International Institute for Environment and Development ILO International Labour Organization IMF International Monetary Fund INAS Instituto Nacional de Salud ACRONYMS AND ABBREVIATIONS Xliii INAr Instituto Nacional de Adecuaci6n de Tierras INCORA Instituto Nacional Colombiano de la Reforma Agraria, National Colombian Institute of Agrarian Reform INDEMUN Indice de Desarrollo Municipal, Municipal Development Index INDERENA Instituto Nacional de Recursos Naturales Renovables y Medio Ambiente, National Institute of Natural Renewable Resources and Environment INGEOMINAS Instituto de Geociencias y Minas INS Instituto Nacional de Salud, National Institute of Health INURBE Instituto Nacional para la Vivienda de Interes Social y la Reforma, Urbana; National Institute of Social Interest, Housing, and Urban Reform INVIAS Instituto Nacional de Vias, National Highway Institute IOM International Organization for Migrations IPC Consumer price index IPD Implicit pension debt IPPF International Planned Parenthood Federation IPR Intellectual property rights IPS Instituciones Prestadoras de Salud IRA Infecci6n Respiratoria Aguda, Acute Respiratory Infection ISA Interconexi6n Electrica S A. ISAGEN ISA Generaci6n, a major, state-owned, power producer ISS Instituto de Seguro Sociales, Institute of Social Security IUD Intrauterinie device kbpd Thousands of barrels per day kWh kilowatt-hour LAC Latin America and the Caribbean LFR Law of Fiscal Responsibility LIBOR London Inter-Bank Operations Rate LPG Liquified petroleum gas MADR Ministry of Agriculture and Rural Development MAFP2 Proyecto de Modernicaci6n de la Administraci6n Financiera del Sector Piblica 11 Mbbl Millions of barrels MBS Mortgage-backed securities Mcfd Millioni cubic feet per day MDE Ministerio de Desarrollo Econ6mico MED Ministry of Economic Development MEN Ministerio de Educaci6n, Ministry of Education MHz Megahertz xliv COLOMBIA. THE ECONOMIC FOUNDATION OF PEACE MISs Management Information Systems MMA Ministerio de Medso Ambiente, Environment Ministry MME Ministry of Mines and Energy MOE Ministry of the Environment MOFPC Ministry of Finance and Public Credit MOH Ministerio de Salud, Ministry of Health MT Metric tons MT Ministry of Transport MW Megawatts NBI Indice de Necesidades Basicas Insatisfechas, Index of Unsatisfied Basic Needs NBPTS U.S. National Board for Professional Teaching Standards NPR National Performance Review NCF National Coffee Fund NFCG National Federation of Coffee Growers NFPS Nonfinancial public sector NGO Nongovernmental organization NIS National Innovation System O&M Operation and maintenance OAPF Old Age Poor Fund OECD Organization for Economic Cooperation and Development OLADE Organizaci6n Latino Americana de Energia OMA Displaced Pop OMS Organizaci6n Mundial de la Salud, World Health Organization ONAD Oficina Nacional para la Prevenci6n y Atenci6n de Desastres OREALC Oficina Regional de Educaci6n para America Latina y el Caribe PAC Plan Anual de Caja PAC Plan de Atenci6n Complementaria, Complementary Health Plan PACES Programa de Ampliaci6n de la Cobertura y Mejoramiento de la Calidad de la Educaci6n Secundaria y Media, Program to Improve Access and Quality in Lower and Upper Secondary Education PAHO Pan-American Health Organization PAI Programa Ampiado de Inmunizaciones, Expanded Programme on Immunization PAYG Pay as you go PCBs Polychlorinated Biphenyls PCS Personal Communication Service ACRONYMS AND ABBREVIAT IONS xlv PCMH Por cada cien mil habitantes, for each hundred thousand inhabitants PDS Planes de Desarrollo y Expansi6n Sectoroal PDs Primary Dealers PDT Planes de Desarrollo Territorial PEIs Proyectos Educativos Institucionales, Institutional Education Projects PFMP Public Financial Management Project PICN Participacion en los Ingresos Corrientes de la Nacion, Participations of Current National Income PLANTE Plan Nacional de Desarrollo Alternativo, Alternative Development Plan PMP Plan de Medicina Prepagada, Prepaid Medicine Plan PNPAD Plan Nacional para la Prevenci6n y Atenci6n de Desastres PNR Plan Nacional de Rehabihtaci6n POAT Environmental zoning plan POI Programa de Obras e Inversiones, Works and Investment Program POS Plan Obligatorio de Salud, Mandatory Health Plan POSS Plan Obligatorio de Salud Subsidiado, Subsidized Mandatory Health Plan POTs Planes de Ordenamiento Territorial, Territorial Land Use Plans (Land Zoning Plans) PRAN Programa Nacional de Reactivaci6n Agropecuaria PRI Programa de Desarrollo Institucional PROAGRO Programa de Oferta Agropecuaria PRONATTA Programa Nacional de Transferencia de Tecnologfa Agropecuaria PSP Private sector participation R&D Research and development RAS Red de Apoyo Social, Social Support Network RED Red de Solidaridad Social R/P Reserves to Production ratio RRPSC Civil Society Reserves System RRSC Civil Society Reserves Network RSS Red de Solidaridad Social, Social Solidarity Network RUT Colombian Bishops Conference's Information System on Displaced Population SABER National Evaluation System for the Quality of Education xIvi COLOMBIA THE ECONOMIC FOUNDATION OF PEACE SAT Sistema de Aprendizaje Tutorial, Tutorial Learning System S&T Science and technology SCAA Specialty Coffee Association of America SCD SISBEN Classification Document SCJ Superior Council of the Judicature SDS Secretaria Distrital de la Salud, District Health Secretary SECAB Secretaria Ejecutiva del Convenio Andres Bello, Executive Secretariat of the Andres Bello Agreement SECF Sistema de Estimaci6n de Desplazamiento Forzado por Fuentes Contrastadas, System to Estimate Forced Displacement through Compared Sources SENA Servicio Nacional de Aprendizaje, National Training Service SF Subsidio Familiar SFAL Structural Fiscal Adjustment Loan SGP Sistema General de Participaciones SIIF Sistema Integrado de Informaci6n Financiera, Integrated System of Financial Information SINA National Environmental System SINAP Sistema Nacional de Areas Protegidas, National Protected Areas System SINERGIA Sistema Nacional de Evaluaci6n de Resultados, Evaluation System for Public Management SINTAP Sistema Nacional de Tecnologia Agropecuaria SIRAP Regional Protected Area System SISBEN Sistema de Selecci6n de Beneficiarios para Programas Sociales, Selection System of Beneficiaries for Social Programs SISDES Sistema de Identificaci6n de Desplazados SNCTA Sistema Nacional de Ciencia y Tecnologia Agroindustrial SNCyT Sistema Nacional de Ciencia y Tecnologia SNPAD National System for the Prevention and Attention of Disasters SNSSS Sistema Nacional de Seguridad Social en Salud, National System of Social Security in Health SPI Comprehensive Production Systems SPNN National Natural Parks System SS Suspended Solids SSAL Social Sector Adjustment Loan SSPD Superintendencia de Servicios Publicos Domiciliarios, Superintendency of Domiciliary Public Services ACRONYMS AND ABBREVIATIONS XIVii SUIFP Sistema Unificado de Inversi6n y Finanzas Plblicas, Integrated Public Investment System SV Superintendencia de Valores TA Technical Assistance Tcf Tera (1012) cubic feet TES Treasury bonds TIMSS Third International Math and Science Study TM TransMilenio UAESPNN National Park System Special Administrative Unit UAFs Unidad Agricola Familiars UASB Upflow Anaerobic Sludge Blanket reactor UFW Unaccounted-for water UMARCO Unidad de Analisis Macro-Economico en el Departamento Nacional de Planeaci6n UMATA Unidad Municipal de Asistencia Tecnica Agropecuaria UN United Nations UNAIDS Joint United Nations Programme on HIV/AIDS UNDP United Nations Development Programme UNESCO United Nations Educational, Scientific and Cultural Organization UNHCR United Nations High Commissioner for Refugees UNICEF United Nations Children's Fund UNSO United Nations Statistical Office UPAC Constant Purchasing Power Unit UPC Unidad de Pago por Capacitaci6n, Capitation Payment Unit UPME Unidad de Planeamiento Minero-Energ6tica URC Unified Registry of Contributors USAID United States Agency for International Development USCR United States Committee for Refugees UTC Unidad T&nica Con)unta, Joint Technical Unit UVR Unidad de Valor Real, Constant Value Unit VaR Value-at-Risk VAT Value added tax VIS Vivienda de Interes Social, Social Interest Housing WAP Working-age population WB World Bank WDI World Development Indicators WFP World Food Program WHO World Health Organization WTO World Trade Organization WS&S Water supply and sanitation services WWF World Wildlife Fund xlviii COLOMBIA: THE ECONOMIC FOUNDATION OF PEACE XL Excess of loss ZNIs Zonas No Interconectadas (non-interconnected zones) ZRCs Zonas de Reserva Campesinas Colombia The Economic Foundation of Peace Synthesis This Chapter was written by Marcelo M Giugale. I. Rationale and Organization It is the practice and the privilege of the World Bank to provide incoming Presi- dential Administrations in its client countries with a comprehensive diagnosis of their development position-and with independent policy recommendations to advance it. That practice appears particularly pertinent for Colombia today. Presi- dent Uribe is to lead a nation of immensely talented people and with abundant nat- ural resources that, for far too long, has been trapped in a deepening circle of vio- lence, destruction, and poverty. There is now an opportunity to break that circle, and this volume is meant to help the new authorities seize that opportunity. This chapter delivers a summarized account-a synthesis-of the development challenges that the incoming President is likely to face, and of the possible policy responses to address them. It distills the four thematic chapters that make up Part I of this book. Those chapters are, in turn, based on 31 sector-specific chapters con- tained in Part II. While the findings and analysis presented here respond to the country's current realities, they have been enriched by five decades of development partnership-the first World Bank mission to visit Colombia took place in 1948, opening the way for some 150 projects and over a thousand pieces of analytical work spanning the entire development spectrum. Yet, the intentioni is not to provide definitive, foreign answers but, rather, to trigger and support policy debate in the country. Below, the central messages in Colombia's development agenda are presented, followed by the diagnoses and policy recommendations that make up that agenda The chapter closes with a suggested path for the prioritization of actions. This book was finalized in August 2002, policy actions that may have taken place after that time are not reflected 2 COLOMBIA THE ECONOMIC FOUNDATION OF PEACE II. Central Messages There is no doubt that the long-standing armed conflict is the most Important issue facing Colombia as a nation, let alone as an economy. The cost of violence is diffi- cult to overestimate.' Since 1980, some 100,000 people have died directly as a result of the conflict, and two million desplazados have lost their jobs, homes and, increas- ingly, hope, and are now lingering at the fringe of society. Another million, perhaps the most educated million, left the country altogether. By some calculations, the conflict dampens GDP growth each year by two full percentage points-in other words, had the war stopped, say, 20 years ago, the income of the average Colombian would now be 50 percent higher, and an estimated 2.5 million more children would be above the poverty line. More fundamentally, the conflict has bred gross underal- locations and misallocatons of resources: frightened by violence, private investment has, over the last 30 years, rarely surpassed one tenth of GDP, and just the lost rev- enue due to sabotaged oil pipelines (some US$500 million per year) would be enough to double the country's annual budget for social assistance. And, behind these costs, lies a less quantifiable but even more disturbing consequence of the con- flict-the dilution of Colombia's "social capital," that is, its citizens' basic trust in societal contracts and institutions that make nations function. It is indeed a tribute to the resilience and ingenuity of the Colombian people that, in spite of so long a conflict, they managed, until 1998, to keep their econ- omy growing every single year for the previous seven decades. While other coun- tries in the region stumbled (notably in the early 1980s), Colombia achieved income, education, and health standards that made it stand out in the developing world. As recently as three years ago, the country whose image had been so tar- nished by drugs-fostered violence, still inspired investment-grade confidence among international financiers. A disturbing message is, however, embedded in that economic resilience-material prosperity alone has not and will not stop the war. But impoverishment may spin it out of control. When the economy collapsed in 1999, the country found itself unable to cater for its people, three million of whom fell into poverty and one in 10 into unemployment, and the many efforts at peacemaking faltered. It is therefore argued here that economic development will be a necessary, but not a sufficient, condition for peace-it will be one of the foundations, perhaps a cornerstone, on which an eventual settlement (and national reconciliation) will stand and from which a new nation will be built. This brings us to the cen- tral question of this book: Given its quest for peace, what is the development agenda that the new administration should follow? The answer has three main components. I Not all violence in Colombia is, however, due to the armed conflict, and much of it is driven by common criminal activities (especially drug-related) SYN I HESIS 3 * Achieve fast and sustainable growth * Share the fruits of growth with all Colombians * Build a government of quality The first priority is indeed to reach fast and sustainable growth. Growth has been Colombia's best and most effective social safety net; on average, each per- centage point increase in per capita GDP, reduces poverty by 0.6 percent (or, at present, a quarter million people). Given the historical, geographical, and military fragmentation of the country, and the related weakness of the state, the possibility of earning income within a growing economy has held the nation together. That order came to an end in 1999, wiping out within a year the previous decade of decline in poverty levels. Putting the economy back on a rapid, sustainable growth path will not be easy, but it is feasible It requires action on five fronts. First, and foremost, a more con- ducive macroeconomic framework (which Colombia once had) is necessary and, in particular, redressing the large financial imbalance in the public sector and the asso- ciated, rapid debt accumulation problem. The key will be to spend less and tax more, but without slowing down the economy. The ensuing adjustment will need to be "locked in" through a stabilizing fiscal responsibility law and a professionalized debt management function. Second, the reform of the financial sector needs to be completed, if the sector is to become an engine for growth rather than another lia- bility for the state-both the conclusion of the bank-restructuring program and the fiscally all-important pension reform are pending. Third, the institutional, regula- tory, and cross-subsidization arrangements in infrastructure provision should be adjusted for further private participation to materialize and, at the same time, for service coverage to reach the poor (the state cannot afford the cost of replenishing the country's much depreciated physical capital). Fourth, a rebirth of the rural econ- omy is difficult but possible, even despite the armed conflict, the illegal crops, and the coffee crisis, if public policy is credibly reoriented toward facilitating, rather than resisting, market signals-policies and programs that shield producers from inter- national commodity prices, distribute subsidies that are not farm-size neutral, dis- tort the land market, or perpetuate institutional arrangements that, although tradi- tional, have outlived their usefulness, should be abandoned. Finally, the intrinsic synergies between growth and environmental protection remain unexploited, both at the local and global level (notably, Colombia's potential in the carbon emissions market remains untapped). Growth will mean little to the 27 million Colombians that live in poverty if they are not given the tools to share In that growth. For most of them, better human capital formation mechanisms, and better markets in which to sell that capital, will be the answer. Both the public education and health systems need to be freed of the vested interests that now resist reform and accountability In both systems, the gov- ernment is paying too much, and getting poor and deteriorating quality. At the same time, the legal and regulatory framework of the labor market, where the poor 4 COLOMBIA. THE ECONOMIC FOUNDATION OF PEACE should be able to exploit their human capital, is out of tune with a modern econ- omy and effectively shuts out one in three workers. A comprehensive labor reform is much overdue. But flexible labor markets and enhanced human capital will not be the answer for all Colombians-certainly not for those that cannot cope with systemic shocks, have been displaced by the conflict, or still face race- and gender- based discrimination. Colombia does not yet have a proper social safety net, and badly needs one. Finally, the new government's capacity will be challenged by the breadth of the attendant policy agenda and, at the same time, handicapped by the gradual but, by now, profound loss of credibility of the state. A reform of the state itself is thus critical, but this should not be about changes in bureaucratic organigrams (much as some of these may be needed) but about improving the way the state discharges its main functions-how it budgets, procures, audits, evaluates, regulates, super- vises, and reports. Moreover, the context in which those functions are performed should be the subject of reform too, on three fronts First, the decentralization of responsibilities is on an unsustainable path, and a new incentive framework is nec- essary if departments and municipalities are to raise the quality of their public services and maintain fiscal discipline. Second, the mechanisms to fight corrup- tion need strengthening, especially because corruption in Colombia takes the per- verse form of state capture. And, third, the judicial system is caught between its pre-1991-Constitution culture and its post-1991 mandate and, thus, delivers serv- ices of poor quality and insufficient quantity. A few, but critical, reforms can cor- rect that problem (like the introduction of fee-for-services or the circumscription of the Tutela). III. The Agenda's Diagnoses and Policies a) Achieving Fast and Sustainable Growth Reaching a higher growth plateau will be a multidimensional task. Both macro and micro interventions will be necessary-adjusting the fiscal position, completing the reform of the financial sector, fostering private participation in infrastructure, diver- sifying the rural economy, and protecting the environment. Many of those inter- ventions are urgent, and none is simple. However, in no case is the "do-nothing" sce- nario really an option, let alone a preferred option. i. A Foretold Macro-Fiscal Adjustment Recovering from the crisis of 1998-99 in effect dictated the macroeconomic poli- cies of President Pastrana. Protecting that recovery will dictate President Uribe's. More specifically, during the past four years, Colombia's macroeconomic policy had to focus, and rightly so, on redressing the imbalance in the public purse. In the context of a three-year IMF Extended Fund Facility, the growth of territorial SYNTI'HFSIS 5 transfers was delinked from the central government's revenues (through the Acto Legzslatzvo),2 fiscal discipline among subnational governments was fostered (through Law 617/2000, Law 715/2001, and new regulations for municipal bor- rowing), public investment was further curtailed (regrettably, to a mere 1 percent of GDP), civil servants' real wages were reduced (a measure later reversed by the Constitutional Court), the base of the value-added tax (VAT) was widened, fuel taxes were increased, and a financial transactions tax was introduced. The Central Bank's independence was enhanced and its mandate to fight inflation was strengthened. Undoubtedly, those were all critical achievements, and perhaps all that could be done given the political space for reform. But they fell short of cor- recting the financial imbalance of the public sector-the deficit did not fall enough and still hovers at around three percent of GDP. As a consequence, the country's sovereign debt position deteriorated: total nonfinancial public sector debt as a proportion of GDP increased by half (to 45 percent) in the four years of the outgoing administration And, today, Colombia spends more on interest pay- ments than on education. The main macroeconomic task of the incoming administration will therefore be to complete the fiscal adjustment that its predecessor initiated and put the accumu- lation of public debt on a sustainable path. More specifically, even under optimistic assumptions in terms of growth, interest rates, oil prices, and Central Bank senior- age, the new authorities will have to immediately reach and maintain a primary sur- plus in the nonfinancial public sector of at least four percent of GDP per year just to keep debt accumulation on a manageable trend (that is, reaching about 52 per- cent of GDP by the end of the Presidential tenure in 2006). At present, that surplus stands at only one percent of GDP. What can be done to achieve that three-percentage-point adjustment in the pri- mary balance? A combination of three factors is in order-a major reduction in the size of the state, a growth-friendly tax reform, and better debt management. The Colombian government, at its various levels, consumes a third of what the country produces. One million people, or about five percent of the labor force, work for the state. In relative terms, these staffing figures are not particularly large; and, yet, the salaries and benefits to those employees (not to mention their pensions) amount to almost eight percent of GDP. The areas for potential contraction are many-linking subnational expenditure decisions to the political cost of having to raise local taxes to pay for them, reversing the exploding cost of servicing pension obligations, rationalizing the health branch of the Instituto del Seguro Social, eliminating over- 2 While de-linking transfers from revenues and consolidating all transfers into one budget item were its major achievements, the Acto Legislatnvo also established specific annual rates of real growth for those transfers over the next ten years, something that could increase their relative burden on the central government's budget should the economy not grow fast enough 6 COLOMBIA THE ECONOMIC FOUNDATION OF PEAcr lapping agencies, and so on.3 These structural reforms to the fiscal accounts, which are discussed in more detail later, will mean that the Colombian state will spend less. A parallel effort should also be put in place for the state to spend better. This implies upgrading the budgeting, procurement, financial management and, critically, evalu- ation and accountability mechanisms. Lower expenditure will, however, not suffice-it will need to be accompanied by higher tax collection. The six partial reforms implemented over the last decade, all triggered by immediate revenue needs, left Colombia's tax code riddled with loop- holes, inequities, and distortions, and cumbersome to administer. This facilitates the rampant evasion of the two most important taxes-the income tax and the VAT, which together represent about 80 percent of the total tax collected. On average, about a quarter of every peso due on taxes is evaded. The current problems with the tax system are, however, also an opportunity-there is room to both increase rev- enue and make taxation fairer by removing the array of exemptions that plague it and without overrelying on hikes in tax rates. Specifically, in the corporate income tax, industry-, firm-, and location-based exemptions should all be eliminated (the list is long: public service enterprises, livestock funds, funds organized by financial institutions, firms with operations in the Paez River, publishing houses, lotteries, liquor producers, and cooperatives); presumptive income taxation should be based on gross assets (not net worth); and inventory valuations should be adjusted for inflation. Similar rationalizations should also be applied to the personal income tax-the flat exemption of 30 percent of the wage should be eliminated, the general exemp- tion should be set at three times the per-capita income (from its current three min- imum wages), and the three rates should be scaled down to 15, 25, and 35 percent (from 20, 29, and 35). Finally, the VAT should be recovered as the broad-based tax it was supposed to be-a single rate of 16 percent should apply to all goods and serv- ices, instead of multiple rates and multiple exemptions. This will extend the 16 per- cent VAT to among others, food and medicines (currently at zero rate), capital goods (currently at 10 percent), and all previously exempted transactions (like those involving paper, printing, beer and tobacco, personal services, transportation and construction); it will also discontinue the "implicit" VAT, exempt exports, and make the VAT creditable against the VAT itself (not other taxes). At the same time, a flat- rate, national excise tax on luxury goods should be introduced. Those reforms to the tax code, taken together, would not only make the system fairer and simpler to administer, but would also generate a much needed three to four percent of GDP in additional revenue. This will allow for compensating the poor for the impact of extending the VAT to food and medicines-even doubling the size of the total social assistance budget to make cash transfers to the poor will 3 It should be noted that some of those "reforms of the state," while necessary, would reduce fiscal costs only in the medium- and long-term (and may increase them in the short-run, for example, because of related severance payments) SYNTHESIS 7 only cost some 0 7 percent of GDP.4 But a word of caution is called for if too much of a "tax shock" is applied, the risk that the fragile growth recovery will evaporate (or even turn into recession) is high. This could put the economy on a downward spi- ral-tax pressure reduces growth, which increases the need for a larger primary sur- plus, which calls for further tax pressure, and so on. The spiral would soon make the debt burden unbearable, especially in terms of access to refinancing (a regrettable example of this phenomenon is Argentina 1999-2002) That is why Colombia's tax reform should be more about tax rationalization and simplification than about higher or new taxes. The adjustment in public finances will be politically costly, and pressLire to undo it will not diminish. Thus, mechanisms to "lock in" the adjustment will need to be institutionalized. Two such mechanisms stand out. First, the currently proposed "fis- cal responsibility law," which sets up a primary balance goal and regulates contin- gencies, arrears, tax expenditures, forward allocations (vzgenczasfiuturas), and other accounting tools that might weaken fiscal discipline, should be expanded to include mechanisms for aggregate revenue stabilization (for both budgeting and reserve accu- mulation purposes) and automatic expenditure reduction rules in case of revenue shortfalls. Second, the public debt management function needs to be professionalized and made directly accountable to the taxpayers for its performance; this will strengthen the incenitive against the unwarranted assumption by the central govern- ment of liabilities from the parts of the public sector that refuse to reform (the con- tingent liability of the central government for the debts of subnatiolals governments, banks, pensions, and toll roads already amounts to several times the size of GDP) ii. Completing the Reform of the Financial Sector Much as the macroeconomic policy of the new Presidential Administration will be dictated by the need to complete what its predecessor initiated, policy in the finan- cial sector, the second key element in achieving fast and sustainable growth, will also be about completing and consolidating reforms With decisive action and sheer ingenuity, the outgoing government managed to avert a systemic banking collapse in 1999. That action was, however, not without costs-the fiscal liability arising from rescuing, to varying degrees, borrowers, depositors, and bankers is so far esti- mated at about 8 percent of GDP. And the cleanup is far from over. While the let- ter of the legal and regulatory environment for banking operations is now up to interniationally accepted standards, the government's deposit insurance and resolu- tion agency (FOGAFIN) is still in the midst of supporting (through credit lines to their shareholders) a number of private banks and housing finance institutionis that 4 Still, the extension of VAT to food and medicines may be politically and, in some cases (like primary agricultural products), administratively infeasible In this case, a second-best reform package could maintain the exemption for food and medicine, reduce the thresh- old of minimum non-taxable personal income to twice (rather than thrice) the per capita income, and generate a total additional revenue of 1 5 to two percent of GDP 8 COLOMBIA: THE ECONOMIC FOUNDATION OF PEACE have not yet been fully capitalized or restructured; disposing of two large, failed, and rapidly deteriorating banks (Bancafe, Granahorrar); articulating a suitable strategy for an array of second-tier, state-owned lending institutions (IFI, FINDETER, FEN, FINAGRO, BANCOLDEX) that have a quarter of the industry's assets, an outdated mandate and a weak balance sheet; and instilling needed expediency in its asset disposition subsidiary (CISA). In other words, Colombia's banking system will over the next four years need to undergo a second, and perhaps larger, round of reform. The key will be to facilitate that reform without incurring further fiscal costs (which the government can Ill afford anyway) or interrupting, and optimally foster- ing, the flow of bank lending to the private sector (which, as a percentage of GDP, has been continuously falling and is still only two thirds of what it was in 1999) Two sections of the banking industry merit a closer look, because of both the fragile financial position of their main actors and the social role they are supposed to play-housing and rural finance. The mortgage industry has not yet been restored to soundness, following its virtual collapsed in 1999 (when one in every five mortgaged properties had to be repossessed). A quarter of its loans are still nonper- forming (and the rate is rising); various rulings by the Constitutional Court (cap- ping interest rates, forbidding out-of-court foreclosures, and so forth) have fostered a spreading culture of nonpayment; the legally mandated inflation indexing mech- anism (the WVR) makes payments highly volatile; and the mortgage-backed securi- ties and mortgage bond market has been slow to take-off (the passing of the enabling legal framework-Housing Law 546/1999-has not yet been fully matched by investor interest). Not surprisingly, the financial sector's portfolio of housing loans has shrunk every single month since 1999.5 This hints at a difficult reality: apart from technical improvements that can be achieved by amending various regulations (for instance, in basing the UVR on a moving average of, rather than on a previous month's, inflation), a rapid revival of housing finance in Colombia may, for the time being, be beyond the reach of policymaking. This is a particularly distressing reality, because Colombia is estimated to have a deficit of one million new housing units, and two million in need of repair. A similar situation exists in rural finance. Some 2,300 financial cooperatives, with primary focus in rural markets, spawned unregulated in the two decades to 1999; at their peak, they controlled one tenth of the financial system's deposits. When the crisis took place, most of them went bankrupt, saddling the government (through FOGAFIN) with assuming responsibility for the largest among them. The government's own rural banks, which as a group provided one quarter of all agri- cultural credit, fared no better (notably, Caja Agraria had to be reorganized into Banco Agrarto). While arguments about the efficiency (that is, cost) and effectiveness (that is, impact on poverty) of the government's continuing supply of rural funding (through Banco Agraro, FINAGRO, FONADER, and the like) are debatable, the 5. Although the stock of housing credit remains flat, the flow of new housing loans has recently restarted SYNTI HESIS 9 likelihood that private banks may be attracted back into rural finance, especially for small and medium borrowers, is marginal as long as the armed conflict rages While there may be room for divesting from Banco Agrarto and FINAGRO and using the released resources to subsidize private mobile rural banking, part-time branches, and risk-assessment tools that lessen the reliance on collateralization, the fact remains that, until peace returns to the rural areas, private banks will not venture in any sig- nificant way to provide additional services there-let alone services that cater for the poorer segments of the population. The banking industry is not the only component of the financial sector the reform of which remains incomplete and poses a major contingent liability to the fiscal accounts-a more complex reform and larger liability are pending in thepen- sion system. The consolidated pension system for public sector workers is technically insolvent, the total actuarial value of its liability (the "implicit pension debt") is twice the size of GDP, and the annual fiscal transfers required to cover its cash deficit is now some 2.5 percent of GDP-that is, equivalent to the total health budget of the nation. This is a worrisome position for a country that is still demographically young and whose pension system only covers a third of the labor force Moreover, partly because of the rich political debate that it has generated, pension reform has become an icon of the Colombian governmenit's resolve to address deep-rooted structural imbalances in its fiscal accounts-and international financial markets are pricing Colombia's country risk accordingly How did Colombia reach this point, and what can it do now to correct the situation? Until 1993, Colombia had a large series of pension institutions for the public sec- tor (the largest of which-CAJANAL-serving central government workers) and one for private workers (administered by the Instituto de Seguro Social, ISS). All of them were in practice unfunded, pay-as-you-go schemes with unsustainably gener- ous benefits and high-levels of evasion. That year, a major reform was implemented, with five main components. First, the central government assumed explicit respon- sibility for all accrued pension tights. Second, the array of pension regimes was con- solidated into one (with the exception of the staff of ECOPETROL, teachers, armed forces, and Congress) and its benefits package was curtailed by an increase in retire- ment ages and a tightening of eligibility conditions This reduction in the benefit package would, however, be introduced only gradually through 2014, that is, a 20- year "transition" period was built in. Third, all public and private workers were given the choice to contribute to the pay-as-you-go regime (still administered by ISS) or to a defined-contribution system of individual accounts administered by new private fund managers but with a minimum pension guarantee. Workers were, however, given the option to switch back and forth between the two systems every three years Fourth, the contribution rates were raised for all workers, in whichever regime. Fifth, workers above a certain salary level were forced to contribute toward a new nonicontributory pension scheme for the poor (the so-called Solidarity Tax). In retrospect, while the 1993 reform was important in introducing new concepts (lower benefits, defined contributLion, private fund managers, and the like), it had 10 COLOMBIA THE ECONOMIC FOUNDAnON OF PEACE too long a transition period and too many exceptions. While the increase in contri- butions and the gradual reduction in the benefit package reduced the implicit pen- sion debt of the government (by some 37 percent of GDP), it did not correct the structural imbalance in the system-between effective benefits that are still too gen- erous and the contributions made by the workers. In its current form, the system is not sustainable, because the necessary fiscal transfers to cover its annual deficits will continuously grow, up to six percent of GDP in 2020. There is therefore no question that a new round of pension reform is urgently needed. At the same time, contribution rates (13.5 percent for all concepts) are already too high and discourage participation in the formal labor market. Further reforms should thus primarily focus on a reduction of the benefits package and, crit- ically, in how fast that reduction is introduced (to avoid yet another long-lingering "transition"). The guiding principle should be that, at the very least, the marginal worker entering the system after the reform, should not increase the implicit pen- sion debt of the government. This can be achieved with many combinations of changes in the system's parameters (retirement ages, replacement rate, and so on).6 However, this type of reform will not bring fiscal relief soon. For that, it is also imperative to accelerate the "transition" of public sector workers out of the pre-1993 regime-that is, to actually implement the 1993 reform.7 Taken together, the acceleration of the 1993 transition and a new reform to the current regime could reduce the implicit pension debt by some 40 to 50 percent of GDP. It should be mentioned that complementary amendments will also be needed to armor the new system thereafter-like the reform of the currently exempted regimes, a predictable and sustainable mechanism to index the minimum pension guarantee, a provisioning mechanisms for regimes arising from collective bargaining agreements of public enterprises, and the discontinuation of the "switching" option between defined-contribution and defined-benefit regimes. Finally, banking and pension reforms would be much facilitated if Colombia could count on a deeper, more liquid capital market. Today, financial intermediation is vastly dominated by banks, since not even creditworthy corporations venture much into the private bond markets. Similarly, administrators of the newly created private pension funds do not find many private debt securities into which they could diversify, especially out of the dominant Treasury bills. The capitalization of the country's stock market (equivalent to about 13 percent of GDP) is one of the low- est in the region. Fortunately, much activity is planned to develop Colombia's capi- 6 As an exarmple, one possible option is to introduce retirement ages of 60 for women and 65 for men, a replacement rate of 50 percent after 1,300 weeks of contribution, and an increase in contribution rates of one percentage point 7 Again as an example, that acceleration could take the form of leaving untouched the regime for men and women that in 1994 were 50 and 45, respectively, or older; acceler- ating the transition for those that at that time were between 42 and 49, and 36 and 44, respectively; and bringing all other workers into the full effect of the 1993 reform SYNTHESIS 11 tal markets. a proposed draft securities law currently in Congress would reduce obstacles for private issuance and wotld standardize mortgage instruments; a new securitization firm is now operating; market-making has been institutionalized for government bonds; and, critically, an almost complete range of Treasury bill matu- rities are now available as risk-free benchmarks. The new government should see these various reforms through, and prepare the relevant supervisory institutions to implement them (specifically, the Superintendency of Securities). iii. Infrastructure: Making Private Participation Work for All An adequate provision of physical infrastructure will be the third key element in returning Colombia to a path of fast and sustainable growth This is particularly rel- evant for a country where armed groups systematically target and destroy bridges, transmission pylons, and pipelines-and kidnap those that could help rebuild them. It is therefore not surprising that private investment has been very low But even at those low levels, Colombia has been unusually successful in attracting private par- ticipation into the provision of infrastructure services-with the exception of telecommunications, the private sector has a major role in all subsectors (oil, gas, coal, power, water, and the like). The problem is that those infrastructure services are both insufficient to support a higher growth plateau, seldom reach the poor, and there is no fiscal space to complement them with additional public investment. Thus, the policy dilemma for the next administration is how to make private infra- structure investment more appealing in the context of the conflict, increase the cov- erage for those that cannot pay for infrastructure services, and protect the fiscal accounts, all at the same time. The answer lies in removing the remaining institu- tional and regulatory constraints that prevent further private participation and in adjusting the mechanisms for subsidization across users. More specifically, in energy, while the government has been extremely successful in adjusting the rewards of oil exploration to the heightened security risks (in the so- called contratos de asociacidn), the process of environmental licensing has become unduly cumbersome-and needs institutionial resources to upgrade it Similarly, wellhead gas prices are regulated rather than market determined, precluding the nec- essary investments to tap even larger fields (especially Cusiana) or explore for new ones. Price regulation is also an impediment to entrants in the downstream oil industry-the ex-refinery prices for gasoline and diesel are still set by the Ministry of Mines and Energy (and then taxed at the pump) rather than by the market. Reg- ular disputes over the "capacity charge" for thermal power plants (a surcharge on the regulated price meant to ensure a minimum income in a primarily hydro system) and over the allowed return-on-assets for transmission and distribution services have cooled private appetite for further investment in electricity after the initial round of privatizations. Most important, the government still holds ownership of one major power generator (ISAGEN) and some 20 distribution companies (electrificadoras). The privatization of the former was delayed in light of anti-trust concerns, whereas the privatization of the latter is proving elusive because of their already-fragile finan- 12 COLOMBIA THE ECONOMIC FOUNDATION OF PEACE cial health and governance problems-an uncomfortable position, because they serve about half of the country's electricity consumers. Beyond regulation, pricing, and ownership problems, the institutional frame- work of the energy sector needs reform, as well. On one hand, the Superintendencia de Servicios Pi;blzcos Domiciliarios (SSDS) is an ombudsman for consumers, a work- out unit for distressed companies, and an asset manager for the corporations that the state decides to keep. Naturally, it struggles to handle such diverse roles and to fence off political interference in its management. On the other hand, the Comzsidn de Regulacidn de Energiay Gas, supposedly an independent regulatory commission, sees many of its functions overtaken by the line ministry (for example, in oil price set- ting) and, partly as a result, its professional capacity diminished. Similar impediments to private participation exist in water and sanitation, although, in this area, the investment gap is even bigger. While coverage is high by Latin American standards, only half of all drinking water and less than eight percent of municipal wastewater receive any treatment. The Comisidn Reguladora del Agua (CRA), who deals with an atomized group of 1,700 operators, is not isolated from local political pressure and, thus, tends to set tariffs that do not cover costs-even if they did, the tariff-setting process is based on reported costs rather than perform- ance benchmarks and quality standards, allowing for the cost of inefficient manage- ment to be transferred to consumers. Almost all providers in small and medium-size cities exhibit operational deficits that call for fiscal support. In many of those cities, and especially in rural areas, the consumer base is not affluent enough to pay for the investment and operation of the service, and public funding is indeed required. CRA's relative role vis-a-vis the policy-setting line ministry (the Ministry of Eco- nomic Development) and the consumer-protecting SSDS is not well defined, gen- erating further uncertainty for private participants. And environmental standards for wastewater, as currently specified in the regulations, are so high as to be self- defeating; to meet nationwide the absolute level of minimum removal of biochem- ical oxygen and suspended solids (80 percent) would require an additional invest- ment of about five percent of GDP-so the standard is ignored. A standard more endogenous to the use of the receiving water body may be more suitable. The private sector has also participated in a major way in transport (especially toll roads, railroads, maritime terminals, and main airports). Given its dominant role in cargo, its absorption of 70 percent of public investment in transport, and its rapidly deteriorating physical status, the road subsector is perhaps the one in most urgent need of policy attention. The institutional setup is similar to other sectors: a line ministry establishes policy (Ministry of Transport), an independent commission reg- ulates (Comisidn Reguladora de Transporte), national and local institutions actually manage the roads (national INVIAS being the largest), and a supervisory authority controls and enforces (Superintendencia de Transporte). In practice, the division of responsibilities is less clear-cut: those institutions overlap in their activities, are not mutually independent, and engender uncertainty. This institutional weakness is par- ticularly unfortunate in the context of the armed conflict-the government SYNTHESIS 13 (national or local) can neither reach certain areas to perform road maintenance nor protect cargo from hijacking This all but smothers interest in further road conces- sions; the first generation of those concessions have demanded, and have called on, a minimum revenue guarantee or complementary public funding absorbing about one third of the central government's budget for roads. Like other infrastructure sectors, and also following the mandate of the 1991 Constitution, the telecommunications service was opened to private participation- but with less success. Less than four percent of telephone lines are in the hands of private companies, compared to 85 percent for Latin America as a whole. There are onily two cellular providers in Colombia, with high prices and low quality of serv- ice. Private providers did enter BOT arrangements with public enterprises to pro- vide local services, and the long-distance and international business was opened to competition. But this put financial pressure on the national carrier (Telecom, which, because of labor opposition, was not privatized) and forced the government to default on the terms of the BOTs. The ensuing legal battles have stiffened further private interest (notably in the otherwise profitable cellular service), already weak- ened by the imposition of a hefty 16 percent tax on long-distance service and a pro- posed 5 percent tax on the operators' gross revenues. To make matters worse, the overlapping of regulatory functions seen in other infrastructure sectors is present here as well-a tariff-setting Comisidn Reguladora de Telecomunicaciones, a policy- setting Ministry of Comunicaciones, and an enforcing SSPD. The above suggests that the uncertainties associated with the armed conflict and with the entanglement of institutional functions hampers all infrastructure sectors alike. There is, however, a third, equally binding impediment for all sectors-cross- subsidization. The Public Services Law classifies residential users of natural gas, elec- tricity, water, sanitation, and telephones in six strata and forces the fifth, the sixth, and commercial to pay a surcharge (up to 20 percent of service cost) in order to pro- vide subsidized service primarily to the first and second (that is, the poorest). While the system is ingenious and has politically facilitated the opening of the various infrastructure sectors to private entrance, its application has been complicated by the fact that not all companies have a balance between rich and poor consumers (call- ing for support from the government) and the strata certification process is less than accurate (it is based primarily on residence characteristics-neighborhood's overall quality and house size-that are in practice misleading predictors of well-being). In some municipalities, the entire population has been classified as poor, pushing, for example, telephone operators into bankruptcy. This hints at two policy alternatives: either the stratification system is improved to include better means-detection and means-testing tools (not just housing quality); or a government-funded connection and bare-minimum level of service is provided to all consumers, above which marginal tariffs grow steeply to recover the initial investment. The problems with the various infrastructure sectors also have a common geo- graphical point of convergence-urban centers Two-thirds of Colombians live in urban areas, of which more than half live in poverty The armed conflict feeds the 14 COLOMBIA THE ECONOMic FOUNDATION OF PEACE migration flow to cities, giving birth to peripheral towns burgeoning around already-congested metropolises (for example, Soacha on the outskirts of Bogoti). As will be explained later, those cities now operate within more binding budget con- straints (a consequence of various laws and policies putting order into the decen- tralization process). This limits their capacity to support the arriving poor with cash, while suboptimal regulations (like minimum floor-to-area ratios and maximum con- struction densities) limit the support they can give through land allocations. Not surprisingly, it is estimated that one fifth of all urban land developed each year is developed in informal settlements, where the subsequent provision of basic services is not only more expensive but also, under current legislation, technically illegal. In principle, local governments are compelled by law to produce Planes de Orde- namlento Territorial, nine-year land-development plans that are supposed to direct the new settlements toward efficient locations, but because of lack of resources, few municipalities do. iv. Facilitating the Rebirth of the Rural Economy The opening of the Colombian economy in 1991 brought about major reforms to the country's rural economy and, in particular, its agriculture. Protection against imports, subsidized credit, price supports, marketing monopolies, and the like were all to be abandoned as part of a change in development strategy domestically called the apertura. This was expected to foster productivity increases, a diversification away from traditional products, and eventually an export boom. It did not happen. The reason is simple: the apertura never really occurred. Marketing boards returned in 1992 (until 1997). Price bands, stabilization funds, and import barriers were rein- stated on and off for certain crops, for certain periods of time. Although many of those interventions were relaxed in recent years, the ensuing uncertainty about pol- icy direction left the sector's performance essentially unchanged-its productivity has not increased, its flagship product (coffee) is on the brink of collapse, and the one product that proves profitable and skews market incentives is illegal (coca leaf). More profoundly, 80 percent of the rural population remains poor and subject to the trauma of an armed conflict whose tactical epicenter Is the control of land In that inauspicious context, what, if anything, can pohcymakers do now to unlock the otherwise rich potential of Colombia's rural economy? The answer lies in a combi- nation of market-based diversification and direct social assistance; the former is addressed below, while the latter is addressed in the next section. The diversification, and through it, the revival of the rural economy, calls for four main policy reforms. First, the new authorities need to make an early, credible, and consistent statement about the direction of their sector policy-signaling their intention to put the sector permanently on a path of open markets and private- sector-led efficiency. One powerful signal will be a reduction in the dispersion and average level of agricultural import tariffs (which vary widely across crops) and a relaxation of nontariff barriers, both of which are perceived as volatile and captured by special interest groups SYN1i IESIS 1 5 Second, all public interventions in the sector should be made farm-size neutral. At present, only two percent of small farmers have ever managed to access the govern- ment's matching grant facility for investmiienit financing (Incentwvo a la Capitalhzacidn Rural). Even the state-owned institutions that remain engaged in rural finance (Banco Agrarzo, Fondo Emprender, anid FINAGRO) require collateralization levels that, in practice, exclude small farmers and crops not linked to commodity markets. Those farmers increasingly find the municipality-based technology extension services (so- called UMATAs) not as relevant as they could be for the needs of small farming units. Much of this is a natural market response-between the uncertainty of ever-shifting sectoral policies and the insecurity of the armed conflict, a few standardized agricul- tural products turned out by large commercial establishments with export reach hold the best chance to survive and, thus, attract the bulk of the available support. The key is then to link those larger establishments to the rest of the sector without causing fur- ther distortions-this is the objective of the existing Acuerdos de Competitrvziad, whereby the government provides demand-driven support (financial, informational, trade representation) to local, private associations of producers that risk their own capital to exploit synergies among local participants of all sizes. Peso for peso, these Acuerdos are perhaps the most efficient use of public money in the sector Third, distortions to the land market should be removed. Colombia has one of the most concentrated land ownership structures in the World (with a land Gini of 0.86), and is getting still more concentrated. More than half of the land is consid- ered "large farms," and only two thirds of plots-mostly the largest two thirds- have titles Money laundering by the illegal drugs industry fuels the concentration of land Limited cadastre coverage, market-insensitive valuation mechanisms, and weak collection capacities keep municipalities from exploiting the land tax (thepre- dia), exacerbating the regressivity of land ownership. Limited cost recovery for irri- gation favors low-margin crops and pasture, activities more suitable for large plots. And, most of all, the insecurity associated with the armed conflict pushes those that have no alternative means of living (typically small farmers) to cash out, and those that can retain their land (typically commercial ventures and richer absentee owners) to refrain from difficult-to-reverse investmenit. All these factors combine to produce a worsening mismatch between the natural vocation of the soil and its actual use: livestock uses double the land that would be technically appropriate, while agricul- ture uses a third of what is suitable for it Policymakers in Colombia have been trying since 1961 to correct the concentra- tion problem through a land reform program (last adjusted by Law 160 of 1994). On the whole, the program has failed to redistribute land, has grossly distorted the land markets, and should IIow be shut down or, at a minimum, overhauled. In its current form, the program provides funding for beneficiaries to buy farming units; 80 percent of the funding is a grant, while the rest is a loan from a state-owned bank (Banco Agrarzo). TIhis absorbs about one fifth of the central government's budget for agriculture. However, lacking working capital, the prototypical beneficiaries cannot set up business, defaults on its loan (virtually all loans have been defaulted on), and 16 COLOMBIA THIE ECONOMIC FOUNDATION OF PEACE abandons the land. Moreover, the public institution that administers the program (INCORA) spends two thirds of the program's budget on its own administrative costs and, predictably, has not been free of political influence and rent-seeking. Clos- ing down the land reform program would free resources that could be better employed in direct social assistance, a faster titling mechanism, the provision of title safekeeping services, or defraying the cost to municipalities of improving the collec- tion of the predial tax. If closure were politically infeasible in the short-term, a series of program modifications, currently being piloted, hold some promise for enhanced effectiveness-decentralization of decisions to local participants, delinking the grant from the purchase of land itself, and permitting the purchase of smaller than full- farm units. Finally, the diversification of Colombia's rural economy will be spearheaded by the structural transformation of the coffee industry. This transformation is already underway, and the best policy response is to facilitate it-rather than resist it. In Colombia, the income of one in every five rural households, and one in every four agricultural jobs, depend on coffee. Coffee accounts for just under 5 percent of GDP and 6 percent of exports. The country controls one tenth of the world's cof- fee market, and a highly valuable brand name. But formidable external forces are changing the business of coffee-the international prices are at their lowest point in almost 200 years (and are unlikely to recover, given the increase in tree planting worldwide), the concentration of international roasters, traders, and retailers has squeezed the share of earnings going to producers; consumer preferences have shifted toward specialty coffees, and an international regulatory structure has effec- tively emerged (through the WTO's phytosanitary standards, global environmental agreements, and so on). Those forces have hit Colombia's coffee hard. Low earnings are trapping the domestic growers in a vicious circle-low profitability pushes them to cut back on production costs, which reduces quality, leading to lower earnings, and to low profitability. By now, the domestic price stabilization fund has run out of money, forcing the government, for the first time in history, to launch a rescue package in 2001. That package, which is supposed to be a temporary three-year arrangement, is meant to support a certain price level, the renewal of coffee trees, technical assistance, and debt refinancing. It costs some US$100 million per year. While the rescue package is supposed to end in 2003, political realities will likely prevail and force a continuation. The key will then be to convert further support into direct income transfers to poor households in the coffee-producing areas. This will give them the choice to stay in the industry under the new market conditions (and use the cash to invest accordingly) or diversify away from it. Part of the funds could also be used to provide technical assistance for diversification into specialty coffees, rather than more production of the same type. Most of all, using the lever- age of its financial support, the government will want to elicit a fundamental reform of the industry's institutional framework-of the semipublic, policy-setting National Coffee Committee and of its regulatory arm, the National Federation of Coffee Growers. In the new reality, the Federation will need better governance, SYNTHESIS 17 enhanced public accountability, a separation of its role as regulator and market par- ticipant, more partnership with new local associations, and an end to its exclusive right to broker coffee exports. Will this transformation mean the demise of Colombian coffe& It need not. There may well be lower production volume of the traditional single type-but there will be better earnings thani at present. The new industry will likely be better serving the domestic market (as Brazil has done); exploiting Geographic Indications of Origin (as Jamaica and Antigua have done), integrating vertically to sell its own brand directly in the retail markets of consumer countries (at least in part); and developing niche coffees (organic, fair-trade, and so forth) Some growers, especially medium-size ones, will phase out and move onto other parts of the rural economy. The transformation, and the government's support for it, will be crucial for Colom- bia in one other respect-if the authorities signal their commitment to efficiency- enhancing transformation in coffee, the leading and most traditional agricultural product in the country, there will be no doubt about, and less resistance to, its sim- ilar intentions in other parts of the rural economy. v. Exploiting the Synergies Between Growth and Natural Resource Protection Colombia is the third-most biodiverse country in the world. It has 65 different types of ecosystems and 18 ecoregions. The diversity of its birds, amphibians, and vascu- lar plants is unparalleled on the planet. With close to a thousand permanent rivers, its water supply is the fourth largest; the country is also home to headwaters of large tributaries to the Amazon and Orinoco Basins. Much of this natural wealth is being rapidly destroyed, by three main factors. First, and foremost, the armed conflict pro- tects and fosters illicit crops. These take place in primary forest in fragile areas with no consideration for long-term soil preservatiol, discharge chemical residues from coca laboratories, and attract chemical fumigation-which pushes them further into new virgin areas to clear. Second, much of Colombia's growth (and badly needed fis- cal resources) is increasingly dependent on extractive industries (like oil, gas, and coal). Extractive industries, even if well regulated, can have a substantial negative impact on the surrounding environment where they operate, especially amid the sensitive ecosystems of the western Amazon. Third, as described earlier, perverse incentives in agriculture have caused a major gap between the natural vocation of the land and its actual use. Successive governments have over the last decade tried to address the degradation of the country's natural resources (for example, through Law 99/1993 which established the ministry of the environment; the National Strategy for the Conservation of Biodiversity of 1997; the creation of various protected areas; the ratification of the Kyoto Protocol; the signing of the Stockholm convention; and the membership in the Montreal Protocol). These initial steps have, however, brought little success. This evokes the question: Given the country's war, poverty, and fiscal realities, can growth be made compatible with environmental protection? This book argues that, in Colombia, growth and environmental protection not only can be compatible but also are mutually reinforcing-that is, they are intrinsi- 18 COLOMBIA. THE ECONOMIC FOUNDATION OF PEACE cally synergistic. Two types of policies-local and global-can help exploit those synergies. On one hand, the central government should use its (shrinking) environ- mental budget (about half a percent of the central government's total expenditures) to support, technically and financially, the municipalities' effort to conclude their legally mandated Planes de Ordenamiento Territorial (Territorial Development Plans), and in particular the environmental components of the plans. These plans will highlight concrete areas where protector-producer reserves are most urgently needed (in effect, the reserves are individual contracts with landowners in environ- mentally fragile areas whereby the owner agrees to a set of protective local activities in exchange for some form of compensation). At the same time, the central and municipal governments should further foment and recruit local associations to help enforce existing regulations and reserves. On the other hand, untapped opportunities remain at the global level. First, Colombia is not yet fully profiting from the carbon emission trade.8 A first, pio- neering deal for carbon mitigation was recently completed, but vast amounts of car- bon credits are still possible in the "cleaning" of the power sector and industry, and in switching to renewable sources of energy. While still globally less developed, an eventual market in carbon sequestration (both through reforestation and forest con- servation) would also carry large potential for Colombia, a country with some 300,000 square kilometers of largely pristine rainforest and, thus, an important car- bon "sink."9 If well developed, total exports of carbon emission credits could gener- ate an estimated 0.5 percent of GDP per year-that is, about three times the size of the current environment-related expenditure in the national budget. [Channeling part of those resources back to the local communities that host the sequestration and, more generally, the environmental protection efforts would enhance the sus- tainability of the initiative.] The government, with active private participation, should hence take the lead in organizing this market domestically-strengthening the institutional capacity of the recently established Office for Optimal Use of Clean Development Mechanisms, funding methodologies for project preparation and cer- tification, disseminating information on external opportunities, and assembling a portfolio of carbon trade projects. Most critically, standardized risk-management mechanisms need to be articulated for carbon emission credits of Colombian origin to be globally valuable. Second, Colombia is not exploiting its enormous potential for biocommerce (oils, medicine plants, ornamental plants and flowers, exotic tropic fruits, natural dyes, and the like). Very small public investments in bringing foreign market information and technological know-how to local communities could help spur this industry. Third, 8 Under the Kyoto Protocol, an international market for carbon credits was created to assist overall global reductions in carbon emissions. The carbon trade enables parties (including industrial firms) in developed nations to meet their greenhouse gas reduction targets through purchases of carbon credits in developing nations. 9 Carbon "sinks" are areas that can absorb the C02 that would otherwise feed global warming. SYN I'HESIS 19 the country has not taken full advantage of nature-for-debt swaps, whereby foreign sovereign debt is written off in exchange for the preservation of natural reserves, indigenous areas, or commitments to set aside areas for future generations. Finally, much as the environment needs to be protected from growth, growth also needs to be "protected" from the environment. Colombia is a country of prevalent natural disasters. In the last quarter century, it has experienced six major earthquakes, three volcanic eruptions, three landslides, and three avalanches, all at a tremendous cost to the human and physical capital of the country These disasters have taught important lessons and, through legal, regulatory, and institutional action over the last decade, the country is now better prepared to deal with them. It essentially oper- ates a decentralized system (the Sistema Nacional para la Prevencuin y Atencion de Desastres Naturales) where local commissions are responsible for mitigating risk and dealing with the ex-post consequences of disasters (for which they can access a National Calamity Fund). The system is, however, weak on two critical fronts, both of which call for policy action by the central government With very few exceptions like the city of Bogota, local governments lack financial and technical capacity to invest in future risk identification, mitigation, and prevention (as menitioned earlier, most of them have not yet completed their Planes de Ordenamiento Territorial, which are supposed to take into account the probability of natural disasters). And insur- ance instruments (be they the pooling and reinsurance of risks, the issuance of catas- trophe bonds, or other financial tools) that could smooth the fiscal volatility that natural disasters entail have not yet been developed; this is of concern, as the asset value in the balance sheet of the state that is at risk from natural disasters is estimated at around 20 percent of GDP. b) Sharing the Fruits of Growth Colombian society is highly unequal. While in the past three decades, sustained growth brought about marked reductions in poverty, inequality continued to increase This not only affects the distribution of income but also of assets and of access to infrastructure-the two top deciles control 60 percent of income, while the bottom two accrue less than five percent; the measure of land concentration is one of the largest in the world (Gmi 0.86); and the coverage of electricity, water, sewerage, and other public services mostly stop at the door of fast-growing informal settlements where most of the urban poor live. Moreover, inequality seems resilient to public pol- icy-it has not been significantly dented by 40 years of land redistribution efforts, low-income housing programs, and schemes for cross-subsidization among users of infrastructure. In fact, many of those policy efforts were not only ineffective in reduc- ing inequality but also hurtful to growth (as the ensuing market distortions damp- ened investment). This is an inauspicious position to be in because, in Colombia, inequality has been shown to be an important determinant of violence The new government is therefore faced with this question What can policymak- ing do to spread the fruits of the growth process without )eopardizing it? This book 20 COLOMBLA THE ECONOMIC FOUNDATION OF PEACE suggests two strategic lines of response: break the lock that interest groups have on the public systems of human capital formation (education, health, labor markets), and attend directly to the needs of those for whom markets will not cater (those that need a "safety net" to cope with systemic shocks, the displaced, and those discrimi- nated against on the basis of race or gender). i. Recovering the Mechanisms for Human Capital Formation Colombia's public education can show remarkable achievements. Those achieve- ments, however, mask serious inequities. The richest 10 percent of the population have more than double the education of the poorest 10 percent. At the current rates of relative educational attainment, the rural sector is 30 years behind the urban areas. Some two million, primarily poor, school-age children and youth are out of school, a worrisome fact since reaching nine years of education in Colombia has been found to reduce the risk of poverty by one third. The large majority of higher education students come from the upper two quintiles of the income distribution- and 40 percent of those go to free public institutions. Those inequities are exacerbated by problems with the quality of public educa- tion, in turn brought about by outdated teacher training (still mostly based on frontal, teacher-centered models), weak teacher supervision (both technical-peda- gogical and administrative), inflexible curriculums (that put emphasis on memoriz- ing information) and, most important, weak accountability mechanisms (standard- ized tests results are not published and do not cover all departments; parent participation is limited). Interestingly, Colombia has experimented in poor rural areas with a different education model, the so-called Escuela Nueva, which puts emphasis on student-centered learning of critical thinking and communication skills in an accountable, community-based environment. By all standards, the model has produced excellent results; however, it has not spread, least of all to the urban areas. The sharp inequity and the stagnant quality of the public education system is not due to lack of resources-over the last three decades public education expenditures quadrupled in real terms, while the school-age population grew by less than one third. The problem is rather that the resources are captured by the vested interest of teachers unions which, on one hand, are reluctant to reform the teaching status quo (especially if it means recruiting fewer teachers, or putting them under heightened accountability) and, on the other hand, find it relatively easy to press politically the subnational entities (departamentos and large cities) to which the responsibility for public education was decentralized in the early 1 990s The subnationals themselves, fearing that their future education transfers could be curtailed if they cut costs and reallocate resources away from teachers, have had no incentive to negotiate reforms with the unions (a few progressive mayors-like Bogota's-did, with good results). It is thus clear that, in the current setup, additional resources will not improve edu- cation coverage or quality; if anything, Colombians are overpaying for the public education they now get. This points to the policy priorities for the new government in regards to education: to link subnational transfers to the number of students SYN IlHESIS 21 rather than teachers (the failed intention of Law 60/1994 and, when actually applied, the main objective of the recent Law 715/2001), and to elicit public accountability for the results obtained with those transfers (for example, linking part of the transfers to the evolution of published, standardized test results). A similar problem of capture by special interests affects the performance of the health sector as a tool for human capital formation-and is bringing major parts of it to the brink of financial collapse. In 1993, Colombia implemented a sweeping, pionecring reform of its health system (though Law 100/1993). The new arrange- ment would ensure efficient, effective, and universal coverage. It was based on sep- arating the funding of health services from the provision-health "promoters" would compete to Insure clients who would then use their insurance benefits to con- tract health services from competing public and private suppliers. People would pay for that insuranice according to their means, with the poor being subsidized by the government and by a portion of the premium for the nonpoor. Public funding would thus go to "subsidize the demand" by the poor, rather than the "supply" by public health providers. The initial results of the reform were impressive-total cov- erage more than doubled, rural coverage increased sevenfold, and coverage among the poorest decile rose tenfold. The World Health Organization now ranks the over- all performance of Colombia's health system as the best in Latin America, and 22nd in the world. Those achievements, however, are currently jeopardized by two main factors First, the state-owned InstitUto de Seguro Social-Salud (ISS-Health), the largest insurer and provider in the market, has not adapted to the new market rules simply because it has been unable to reduce the bloated cost of its 30,000-strong labor force and, thus, to compete with other providers This has called for successive financial rescues from the government (some financed by FOSYGA, the fund that is sup- posed to administer the cross-subsidies for the poor) that, in turn, have perpetuated inefficienit management practices, disregard for service quality, and ballooning arrears wilth other parts of the system Second, similar labor cost rigidities have pre- vented public hlospitals from competing for business and, as a consequence, have all but stopped the transformation of public funding for "supply" subsidies to "demand" subsidies-only some 60 percent have so far been transformed, putting the whole concept of the reform on hold. In fact, public resources for public hospi- tals more than doubled in real terms since the reform began, but two thirds of the increase went to pay for a larger wage bill. What is the appropriate policy response to these problems? As with education, in health there is a need for additional reform, not for additional money The outgoing government attempted, with partial but positive results, to negotiate the reform of ISS-Health and to restructure 27 of some 170 public hospitals. Both initiatives need to be deepened by the new authorities. In particular, two options should now be con- sidered for ISS-Health (both its insurer and provider arms): a complete closedown, or a closedown and reopening on commercial terms (splitting the insurer and the provider into separate companies, and rehiring workers according to competence and 22 COLOMBLA THE ECONOMIC FOUNDATION OF PEACE need). The estimated total net saving to the fiscal accounts from each option would be 1.2 and 2.4 percent of GDP, respectively, compared to the do-nothing-further sce- nario. On the public hospitals front, all of them should now be put under restruc- turing; this will call for an up-front cash injection of about US$500 million but, depending on how deep costs can be cut (the initial restructurings achieved only a five percent reduction) that investment can be recovered in four to seven years. Improving the two main mechanisms for human capital formation-education and health-will mean little in terms of inequality reduction if the poor cannot count on functioning labor markets in which to convert that capital into employ- ment. However, Colombia's formal labor markets are excessively rigid. High and binding minimum wages, a perceived weak link between hefty social security con- tributions and benefits, and powerful unions that are primarily concerned with maintaining real wages result in a so-called "natural" rate of unemployment that is extremely high (about 11 percent), while actual unemployment is even higher (17 percent in mid-2002). The "wedge" between the cost of labor to the employer and the compensation received by the employee is worth about 50 percent of the wage bill (compared to 39, 31, 19 percent in France, Mexico, and the United States, respectively). Not surprisingly, 60 percent of the workforce operate in the informal sector; in contrast, only one in 10 Colombian workers belongs to a union. This calls for a major overhaul of the legal and regulatory framework in which the labor markets function. In particular, contributions for which the individual worker sees no direct benefit (parafiscales) should be eliminated and the correspon- ding programs (like training and family welfare) should be funded out of general tax revenues."° The minimum wage should be nonbinding and should not apply to apprenticeships, temporary workers, or public workfare programs. Collective bar- gaining should be done at the firm level, not at the industry level. Legal provisions extending equal benefits to all workers in an "economic entity" (principal firm, sub- sidiaries, and affiliates); those imparting seniority-based promotions, compensation and training; and those mandating indefinite rollovers of fixed-term contracts, should be abolished ii. Helping Those for Whom Markets Will Not Work While strong human capital and functioning labor markets will be an effective means for many Colombians to share in the fruits of growth, there will be others for whom market-based solutions will simply not work and for whom direct govern- ment support will be necessary-those that cannot cope with systemic crisis, those that have been displaced, and those that are discriminated against on the basis of race or gender. I0 The elimination of all parafiscales may not be politically feasible, especially those associ- ated with family welfare. A second-best solution would be to keep those that fund the most sensitive, best-targeted social programs and, for these, to separate financing from provision (opening the provision to competition by public and private suppliers). SYNTIHESIS 23 Colombia never really had a formal social safety net, something that became painfully clear during the unprecedented macroeconomic crisis of 1999. Existing social programs (like the Servicio Nacional de Aprendizaje, SENA; the Caja de Com- pensaczdn; and the Instztuto Colombiano de Bienestar Familiar, ICBF) are paid out of payroll taxes and only cater to formal workers. The sweeping reforms that accom- panied the enactment of the 1991 Constitution brought about neither a strategy for social assistance nor additional funding for it Thus, in response to that crisis, a tem- porary five-year Social Support Network (Red de Apoyo Social) was created to fund temporary employment (Empleo en Accu5n), conditional cash transfers to poor fam- ilies (Familias en Accid5n), and firm-based apprenticeship grants for youth (Jovenes en Accidn). The network, which took two years to unfold fully, has several loopholes, but one is particularly worrisome-it does not sufficiently protect children and ado- lescents at risk. About 70 percent of urban children under the age of seven are poor, a proportion that reaches almost 90 percent in rural areas. Roughly half of all chil- dren have not been vaccinated against basic communicable diseases. And the armed conflict limits the effective reach of the government's safety net in certain rural areas, precisely where the youth are being recruited (mostly by force) into combat. All this is both a challenge and an opportunity for the new administration. Based on the lessons that the completion of the RAS will bring in 2004, it should proceed to establish a permanent and comprehensive Social Risk Management System. This need not mean new budget appropriations; rather, it should absorb the funding cur- rently going to the SENA, the Caja de Compensaczo'n, and the ICBF This should be accompanied by an overhaul of the means-testing mechanisms (the SISBEN), some- thing that could also improve the targeting of subsidies in infrastructuie services (discussed earlier). Overall, the incominig government will have to decide whether Colombia, which at the moment spends a low 0.7 percent of GDP on social assis- tance, will have a standing safety net arrangement and, if so, what would be its prod- ucts and its countercyclical features. Even a properly functioning social safety net would, however, need to be adapted to cater to the urgent needs of Colombia's displaced population. Unofficial estimates put the number of desplazados at some two million people (about five percent of the population) They have been traumatized out of their rural homes by the armed conflict; have lost jobs and assets (and, in most cases, even the titles to their assets); can no longer access formal education or health services; and are lingering in slums at the outsklrts of large cities. The ma)ority are women, about half are under 18 years old, and one fifth is either Afro-Colombian or Indigenous. Virtually all are poor. Most distLrbinigly, they are stigmatized and isolated in the receiving localities, something that, until very recently, made them invisible as a political and policy pri- ority. It is difficult to see how Colombia will attain a functioning level of social cohe- sion if the plight of the desplazados is not attended to, a plight that will not go away and will get worse if unresolved. It was not, however, until 1997 that a legal framework (Law 387/1997) was enacted providing for "the integral care" of the displaced, and a single institution 24 COLOMBIA THE ECONOMIC FOUNDATION OF PEACE (the Red de Solidaridad Social) was designated to implement it. The RSS, in coop- eration with the Interniational commUiuity, issued a corresponding action plan in late 1999. So far, some US$50 million have been invested in that plan, and only an esti- mated 17 percent of the desplazados have been reached. The new government needs to bring the aid program for the desplazados to a much higher plateau. To this end, there are five priorities. First is to give them means of political representation, including mobile voter registration services-this would ensure sustained policy attention. Second, support mechanisms should move from mere humanitarian aid to schemes for return, relocation, or integration, as the case may be, and adequate budget resources should be made available (a strong, well-articulated commitment by the Colombian government is likely to attract substantial donor funding). Third, the operating rules of all existing social assistance programs, including those that are based on means tests through the SISBEN, should be modified to allow for priority consideration of displaced cases. Fourth, local governments should be co-opted to take the lead in preventive action in high-risk regions, for which additional resource transfers from the central government will be needed. Fifth, a uniform methodology to track, classify and, ultimately, understand the displaced populations should be pursued. Finally, race- and gender-based discrimination still distorts the way many Colombians can profit from the growth process. Colombia is pluriethnic nation with some 800,000 indigenous peoples (belonging to 82 different groups) and over one million Afro-Colombians. The country has a strong tradition of recognizing ethnic rights (cultural institutions, communal properties, political participation) and enshrined them in the 1991 Constitution. However, several factors have now combined to weaken those populations' ownership of one of their defining assets- their land-and, thus, their capacity for market-based development. Some of those factors are technical in nature and within reach of public policy (like more precise surveying, adequate collective titles, better rules for assessing public services and pro- grams); others are more difficult to address (the colonization process, illicit crops, and, critically, the internal conflict). Contrary to common observations elsewhere, in Colombia the ascription of gender-based roles is more harmful for men than women. Girls have higher school enrollment levels than boys, women's fertility and maternal mortality have decreased, women's labor market participation rates have increased, and gender gaps in wages have narrowed. Not only do boys perform worse in education, but also males are more affected by HIV/AIDS-, alcohol-, and drug-consumption-related diseases. More critically, males are the disproportional victims of violent death because of both the armed conflict and crime. Available research explains this pat- tern as low-income, unemployed males seeking to fulfill through violence a socially expected identity as family providers, a role they have failed to play through pro- ductive work. School curriculums and learning materials that refrain from gender stereotypes and teach conflict resolution skills; media-based campaigns that provide nonviolent role models; and community-based programs that seek to identify and SYNTHESIS 25 prevent local sources of violence (like the government's Convzvenczay Seguridad Cmu- dadana) are the best ways to address gender-driven social issues for males c) Building a Government of Quality Reaching a path of fast and sustainable growth, and giving people the tools to share in the fruits of that growth, is a difficult policy agenda for any government. In today's Colombia, it will be a formidable challenge, for the armed conflict, the ille- gal drug industry, and the capture of policymaking by interest groups have all but paralyzed the effective authority of the state. The new administration will thus need to rebuild early on the government's management credentials in front of its citi- zens-in other words, they will have to enhance the quality of the government func- tion. There are, of course, very many ways in which the quality of government can be improved, and prioritization will be crucial. This section argues for five areas of immediate focus-reform of the state's functions, decentralizationi, budgetary insti- tutiols, corruption, and justice. Colombian governments have for decades exhibited a dichotomic performance in discharging their functions. On one hand, a technically competent, domestically independent, and internationally accountable set of institutions (among others, the Central Bank, the Ministry of Finance, the Departemento Nacional de Planeaczon) consistently watched for and delivered solid macroeconomic policy. On the other hand, the array of sector institutions administering microeconomic policies and pro- grams have had less success, and have been regularly perceived as captured by their own bureaucracies and by the surrounding sectoral interest groups. This perception covers a large array of such institutions operating in many fields-from the Cajas de Compensacidn Familiar and the ICBF (operating family welfare programs); to INCORA, INVIAS, the SSPD (in land, roads, and residential public services); to labor unions (stifling decentralization efforts in education and health). This background of macro-competence and micro-capture hints at three basic principles that should guide a meaningful reform of the state in Colombia. First, while some organigramic reorganization will be necessary, and redtindant and duplicative agencies will have to be merged or closed (notably in agriculture), the reform should be about fixing critical "functions" within the state, not about reordering reporting lines and shifting personnel among ministries and institutions. Those ftinctions include much-enihanced accountabiliry in decentralization transfers (see below); an initial shift toward results-based investment budgeting in the central budget (also discussed below); a major overhaul of procurement systems (with trans- parency as the guiding principle); much stronger internal and external auditing of the central government (especially, the Contraloria General de la Repablica, which is the external auditor of the Executive); currently-missing tools for evaluating public expenditure (in terms of their impact and beneficiaries, not Just their procedural propriery); more efficient and more independent regulation in infrastructure (espe- cially in roads, water, electricity, and gas), and better mechanisms to detect, report, 26 COLOMBIA. THE ECONOMIC FOUNDATION OF PEACE and punish abuse of power and rent-seeklng (notably, through capacity upgrading at the Procuraduria General). Second, given the entrenchment of special interests, early reform successes in a few focal functions (and in their related institutions) will be preferable over sweeping, across-the-board undertakings that are likely to run out of political steam very quickly (Colombia has tried time and again to pass and implement comprehensive public sec- tor reforms-most recently in 1992-93 and 1998-99-but was soon derailed by the political resistance of vested interests). Third, some of the functional reforms will, at times, trigger changes in major agencies; support at the highest level of government will then be necessary to proceed and, thus, set Important precedents for lesser insti- tutions For example, better evaluation of public expenditures and better procurement systems may have implications for, respectively, the ISS and ECOPETROL; reform of these, would send a clear signal to the rest of the administration. Focusing on state functions will naturally lead to the second key priority in upgrading the quality of government in Colombia-decentralization. Since the mid- 1980s, the country led Latin America in embracing the principle of bringing poli- cymaking closer to its beneficiaries (partly as a tool to address the causes of the armed conflict), enshrined it in the Constitution of 1991, and implemented it almost at once. The results have fallen well short of expectations, and have threat- ened not only the efficiency of sectoral expenditures but also the fiscal pillar of macroeconomic stability. This presents a strategic question to the new administra- tion: Should Colombia further decentralize, should it recentralize, or should it pro- ceed with an all-out federalization? It is argued here that decentralization remains the best option, but major adjustments to the process are needed to deal with its main weaknesses-lack of incentives to rely on local taxation, to enhance efficiency in service delivery, and to maintain fiscal discipline. First, while the constitutional amendment Acto Legislativo of 2001 brings all transfers into one single fund and fixes its growth, there is still no mechanism to evaluate, and hold subnationals accountable for, the results they achieve with those transfers. Nor has Law 715/2001, which clearly shifted responsibility for core social services to the subna- tionals, established delivery standards (this is naturally worrisome, because subna- tionals now handle almost half of all public sector revenues-about 15 percent of GDP). Further legislative action to that end is necessary, especially in education, to make the very transfer of responsibility conditional on performance."1 Second, the volume of transfers (like those meant to cover teacher payrolls) should not be based on historical supply cost, but rather, on need-and-effort (like cost per student or "capitation"); the above-mentioned Law 715/2001 calls for that. However, for the transformation to be at all possible in practice, teacher salaries (the largest decentralized expenditure) and employment policies can no longer be deter- mined by national negotiations with the unions, but at the subnational level. Third, 11. Law 751/2001 provides enough flexibility to instrument performance agreements (acuer- dos de desempeno) with the sub-nationals SYNTHESIS 27 subnational governments, especially large municipalities like Bogota and Medellin, should be allowed to surcharge and fiscalize the income tax and the VAT (the draft law on Taxation Territorial currently in Congress is a good step in that general direc- tion). Fourth, subnational borrowing regulation, currently based on certification by the central government-semaforos-and clauses in past bailout agreements-under Law 617/2000-need to become market based. For this, the current, essentially vol- untary banking regulations linking capitalization requirements for loans to subna- tional borrowers to published credit ratings, must become compulsory Fifth, while in theory a rearrangement of political divisions and levels of government could bring improvements to Colombia's decentralization process (that is, a so-called Reorde- namiento Territorial, regrouping current departments into regions or provinces), the country's political and fiscal reality advises against it at the moment. Finally, central government resources should be invested in developing a common budgeting, accounting, and reporting framework at all levels of the state, as well as common procurement standards. Both the reform of the state's functions and the adjustment of the decentraliza- tion process will be mutually reinforcing with the third key element in improving the overall quality of government-better budgetary institutions. In recent years, Colombia has made significant progress in this area, notably with the establishment of a single treasury account for its central government (Cuenta Onica del Tesoro). This technical improvement has, however, not been matched by better policies in designing and operating the budget itself Several areas for policy action stand out. The National Development Plan should become a strategic, indicative roadmap, rather than a bloated, legally binding list of wished-for projects the execution of which is then controlled discretionally through cash management. International accounting standards (like the IMF's Government Finance Statistics Manual) should replace the rather loose definitions currently applied in Colombia's budget (for example, in regards to investment outlays). The array of legal entitlements and earmarks accumulated over the years should be reviewed and their costs and benefits put out for public consideration Congress and the public should be given reading access to the government's financial infor- mation system (Sistema Integrado de Informaci4n Financiera) and to the currently- under-construction results assessment system (SINERGIA). The split responsibility for the "operational budget" (current expenditure) under the ministry of finance, and the "investment budget" under the Department of Planning should be unified, and only one of those institutions made responsible for the whole budget, some- thing that will avoid funding investment projects without adequate maintenance allocations in subsequent years. More broadly, public sector budget information should be "regulated" and clear responsibilities assigned; at present, several institu- tions collect and publish (sometimes inconsistent) data on the same matter, an obvi- ously inefficient and confusing use of resources. The fourth pillar in raising the quality of government in Colombia is the fight against corruption. As with other aspects of the country's social life, the 1991 Consti- 28 COLOMBIA THE ECONOMIC FOUNDATION OF PEACE tution set out a framework to reduce corrupt practices in public office (by, for exam- ple, establishing the officc of the Attorney Gencral), but had little impact on the per- ceived integrity of the government function. Surveys indicate that Colombians see corruption as a rampant problem in their society. The traditional indicators of integrity (in licensing, tax administration, customs, and the like) are, however, much better than the average, certainly the average in Latin America. The reason is that, in Colombia, corruption takes a particular form-"state capture"-that is, high-level government officials affecting, for their own financial, social, or reputational benefit, the rules that govern the relationship between interest groups and the state This is an especially perverse form of corruption, because it goes well beyond specific transac- tions and puts a cloud of illegitimacy over the continuum of government dictums. As such, the solution lies not as much in improving administrative processes (although some of these need reform), but in the reforms of the party and electoral systems. Many of those reforms, like changes to the campaign finance laws, fall outside the purview of this book. But others are a matter of development policy: a profes- sionalized civil service, top-level management appointments that are done on the basis of public competitions run by outsourced human resource agencies, and com- pensation and job stability that are based on performance; a procurement system that is online and open to public scrutiny; enhanced independence for key regula- tory institutions (not surprisingly, the above-mentioned surveys show the constitu- tionally independent Central Bank to be among the least corrupt and the most com- petent institutions in the nation); the establishment of a single institution in charge of fighting corruption that reports directly to Congress; and, as discussed below, a much more effective judicial system. A better-functioningjudicialsystem is, indeed, critical to abate the problem of cor- ruption and, more generally, is a core priority to improve government quality in Colombia. The system was one of the main targets of the 1991 Constitution-a new constitutional control jurisdiction was created in the form of a Constitutional Court (over and above the existing Supreme Court and State Council); a new arrangement for criminal justice was set up, headed by the new office of the Attorney General; a new legal figure (the Tutela) was instituted giving citizens the right to stop and dis- pute at any judicial level any action that may hurt their constitutional rights (which, in turn, were widely defined, like the "right to life"); the administration of the judi- cial apparatus was given to a new Superior Council of the Judicature; and a new juris- diction of community-based justice was opened (the so-called Justices for Peace). The new justice function was then given a major increase in its resources (the judicial sec- tor's budget has tripled in real terms since 1991). The overall objective was to raise the judicial system's performance, especially in terms of congestion, quality, and chronic corruption. The results have been disappointing; if anything, access and res- olution rates deteriorated (some 4 million cases, one for every 10 Colombians, await disposition). Why, and what can now be done to fix it? The new Constitutional Court has pro-actively, and distortingly, intervened in matters of economic policy (like reversing a freeze in public sector wages and cap- SYN rHFSIS 29 ping interest rates for mortgages); the roles of the Constitutional Court and the Supreme Court are in practice overlapping, causing a great deal of judicial uncer- tainty, and the Tutela has become a much-abused way to dispute contracts (notably, labor contracts) and has clogged the courts. Optimally, such structures should be changed. Political support for reversing some of the mandates of the 1991 Consti- tution is, however, highly unlikely to materialize. Adapting the old judicial appara- tus to the new reality is, therefore, the best reform strategy in the sector This can be achieved through a combinationi of six main actions. First, justice services can no longer be completely free in all branches and for all cases, if not to generate revenue at least to restrain superfluous use of the system. Dur- ing the last decade, 80 percent of the cases in the civil jurisdictioni were related to commercial payments collection; these should pay for all or part of their adjudica- tion, even if it is on a means-tested basis. Second, procedural rules and their associ- ated logistical arrangements should be adapted to deal with Tutelas through swift, oral proceedings. Third, the governance of the administrative Superior Council of the Judicature should be made more accountable to the system's users, its board should be dominated by stakeholders outside the judiciary itself Fourth, additional resources within the overall judicial budget should be reallocated to the criminal justice branch (where the demand for )ustice services far outstrips the installed capaciry) but, in par- allel, the Attorney General's Office should be made publicly accountable for an agreed set of socially relevant performance indicators (like serious-crime resolution rates). Fifth, the union-driveni rigidities in retraining and reassigning (let alone dis- missing) judicial personnel to functions more compatible with the new reality should be overcome (a telling example- there is no need for a lawyer to play the role of court secretary). Finally, a sizable investment in improving the physical infrastructure through a computerized case-management system seems long overdue. IV. A Path to a New Colombia The development policy agenda described above calls on the new governmenit to reach a higher and more sustainable growth plateau, to give all Colombians a chance to share in that growth, and to make the state itself an icon of quality. Even in nor- mal circumstances, this would be a formidable challenge. For a country dealing with an armed conflict and pent-up social demands, the agenda is nothing but over- whelming. But it is also feasible. Colombia can still marshal the talent and resilience of its people, the wealth of natural riches on its land, and the deserved support of the international community to create a new economic pillar on which to build peace. The presidential elections of 2002 brought about a clear mandate and a unique opportunity to construct that pillar. The tasks ahead are many, and the ability of the government to implement reforms is necessarily limited by the capacity of the state's institutions and the polit- ical realities of the country. Prioritization will thus be crucial, and a clear imple- 30 COLOMBIA THE ECONOMIC FOUNDATION OF PEACE mentation map will be necessary. Table 1 presents an example-and only an exam- ple-of such a map. Determining what is possible when remains, however, the sole prerogative of the new authorities. It will be up to them to assess their preferred sequence of policy actions according to their own strategic objectives and the avail- able consensus. Not all policy initiatives will succeed. In some cases, reaching agree- ment among stakeholders will prove elusive, as is rightly expected in a vibrant democracy like Colombia. In other cases, first-best solutions will simply have to give way to more practical arrangements. Most of all, not everything that needs to be done can be done within a single presidential term. So, what kind of country would Colombia be, four years from now, if a policy agenda along the lines of Table 1 were implemented? It may not be rid of the inter- nal conflict. It would certainly not be free of all its economic problems. There would be a lot more jobs, but many people would still be jobless. The painful emigration flow and its associated brain drain would have slowed down, but not reversed. Colombia would not even be a "rich" country. But it would be a country on a fast path of construction, where development would give hope and opportunity to all. Table 1. Colombia: A Possible Prioritization of Policies for the New Presidential Administration From the very beginning... Protect the macroeconomic framework Send early, confidence-building signals Make human capital development an * Launch a growth-friendly tax reform (with * Pass a comprehensive pension reform explicit priority compensatory programs for the poor) * Put specific privatization efforts on the * Commit to quantifiable improvements in * Announce reform of the state agenda (for example, telecommunications) the quality of education * Pass a strengthened "Fiscal Responsibility * Fill senior positions in the civil service * Commit to freeing the health system from Law" through open competition vested interests * Reach out to the Desplazados After thefirst 100 days... Take first steps toward higher growth Gather consensus for reforms in human Bring governance to the forefront of the * Launch the reform of the coffee sector capital formation agenda * Press on with the commercial banking . Begin publishing the disaggregated results * Announce a detailed plan to combat sector's consolidation and reform of existing standardized tests corruption * Enhance regulatory independence in Launch participatory evaluation (cost and * Put the government's procurement and infrastructure beneficiaries) of all social programs financial management systems on-line Eliminate all parafiscales * Launch reforms in the judicial system After thefirstyear... Focus on enhancing long-term growth Begin reforms in human capital formation Begin to exploit the synergies between * Overhaul the SSDS and make all sector * Link all education transfers to cost per growth and environmental protection regulatory commissions truly independent student and performance agreements . Bring Colombia to the international car- * Reform cross-subsidization mechanisms in * Close or reengineer ISS bon trade market infrastructure * Put all public hospitals under restructur- * Fund the completion of all Planes de * Close the land redistribution program, ing plans Ordenamiento Territorial and covert it into cash subsidies for the * Multiply local producer-protector reserves rural poor (continues on next page) Table 1. (continued) By mid-administration... Consolidate the higher growth plateau Complete and Consolidate Reforms in Bring government quality to the local level o Articulate an exit strategy for all second- Human Capital Formation . Give municipalities larger taxation powers tier state-owned banks * Convert all health subsidies into Link all transfers to open performance o Complete privatization in electricity and "demand" subsidies standards in service provision telecommunications o Launch labor reform o Put market-discipline in sub-national * Open agriculture to international o Create a permanent "Social Risk borrowing competition (a true apertura) Management System" And leave behind at the end of the presidential term... An economy that is growing A stronger human capital A "greener" Colombia And a state that is respected for fast and is sustainable * The poverty headcount has * Where deforestation has been its improved efficiency * Real long-term growth is at fallen by at least ten percent- stabilized * With institutional capacity at least five percent per year, and age points since 2000, and a . Extractive industries do not the central, department and unemployment is below 10 permanent social safety net is systematically damage the municipal levels percent in place environment * A judicial system of quality, * The fiscal accounts are in The education system begins Blodiversity is preserved, speed, and access surplus and inflation is to turn out skillful, critical celebrated, and profitable . And internationally acclaimed rn comparable to that of the thinkers transparency 0 G7 countries Basic health coverage is * External and public debt efficient, universal and positions are comfortable financially sustainable '11 0 z 0 Part I Thematic Notes 1 Violence, Sustainable Peace, and Development This Chapter was written by Elsie Garfield andJairo Arboleda. I. Introduction There is a clear consensus among Colombian citizens of all walks of life that the current state of insecurity and violence that prevails in most of the country is unacceptable. It has resulted in a poor quality of life, and has created a poor investment climate, a serious obstacle to economic growth and employment gen- eration, and, many would argue, a threat to the social fabric and very survival of Colombia as a nation. In a poll taken in February 2002 following an upsurge of violent acts related to the end of negotiations with the Fuerzas Armadas Revolu- cionarias de Colombia (FARC), 92 percent of Colombians ranked violence as the problem with the most perverse effect on them and their families, far above any other social or economic issue. As was the case in 1996-97 when the World Bank was developing with Colombia its Country Assistance Strategy (CAS), there still seems to be widespread agreement that a top priority in Colombia's development agenda is peace. II. Violence Trends and Characteristics Colombia is a country with a long history of violence going back to the war of One Thousand Days in 1899, which left 100,000 dead, to La Violencia in the late 1940s and early ]950s. Since the 1980s, the multidimensional problem of vio- lence has become more widespread and is exacting an increasing economic and social toll This thematic chapter draws heavily on Alberto Chueca Mora's research on the sub)ect 35 36 COLOMBLA THE ECONOMIC FOUNDATION OF PEACE TRENDS IN VIOLENCE HAVE WORSENED AND ARE SOME OF THE HIGHEST IN THE WORLD. Using the homicide rate as a proxy for violence levels, official figures increased from 15 to 92 per 100,000 inhabitants between 1974 and 1995, with levels growing dramatically in the post-1985 period. The homicide rate is one of the highest in the world: three times higher than in particularly violent countries such as Jamaica or Russia, seven times higher than in the United States, and 50 times higher than in a typical European country (see Figure 1). In some cities murder took on almost epidemic proportions in the early 1990s Medellin Figure 1. Murder Rate per 100,000 Population, 1993-94 C olom bia - _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ Jamaica Russia Estonia Ecuador Scotland Nicaragua Bulgaria Israel I Costa Rica Uruguay Kuwait Northern Ireland Italy India Jordan 3 Sudan Ungria I Finland - Greece `I France- - , Chile---| Slovenia -! Canada-I Sweden -|i Malaysia - 1 Singapore - Australia -- Hong Kong -- Denmark Korea Belgium Austria 3 Cyprus -i Indonesia I Spain i Japan Egypt _I I II I 0 20 40 60 80 Source Global Report on Crime and justice. United Nations VIOLENCE, SUSTAINABLE P'EACE, AND DEVELOPMENT 37 recorded a rate of over 400 per 100,000 population. The rate of homicides attrib- utable to internal armed conflict has also risen in the last 20 years and reached lev- els experienced during the period of La Vtolencia (see Figure 2). In terms of dura- tion and loss of life, Colombia's armed conflict (1948-62 and 1984 to the present) is among the five longest and most intense in the world, comparable only to coun- tries like Afghanistan, Angola, Rwanda, and the Sudan (Echeverry, Salazar, and Navas 2001). All types of crime-including extortion, kidnapping, car theft, and armed rob- bery-flourished in the 1980s and continued to rise significantly during the 1990s. Further, the crime boom was geographically concentrated, such that the offenses grew tenfold in some places, while in others it remained almost unchanged Between 1985 and 1998, the number of reported kidnappings rose from about 9 per million persons to about 80 per million persons, with the majority of victims being civilians (Mejia 2000); this was an important source of revenue for some armed groups. An upsurge in crime in urban areas is linked to the upsurge in drug trafficking, partic- ularly in Cali and Medellin, and to unemployment and poverty, and to precipitators such as availability of arms and consumption of alcohol. INSURGENT ARMED CONFLICT Is MORE ENTRENCHED AND WIDESPREAD THAN AT ANY POINT IN THE PAST THREE DECADES AND AREAS WITH AN ACTIVE STATE PRES- ENCE HAVE DECLINED. During the past five decades, the number of actors involved in the armed conflict has expanded from the guerrilla and armed forces to include drug cartels and right-wing armed paramilitary groups. This has been accompanied by increasing density-both spatially and in terms of interdependent reciprocal net- works between different actors. The internal armed conflict has become a struggle to control territory with many areas of the country, particularly rural, under active dispute between guerrilla and right-wing armed groups. Municipalities with some type of guerrilla presence increased from 17 percent in 1985 to 58 percent in 1995. If areas experiencing paramilitary, drug, and armed forces activity are added, approx- imately 75 percent of the country is experiencing some level of armed conflict. The Colombian military and police have been unable to ensure the security of its citi- zens, and impunity is widespread in the face of increasing human rights violations of all kinds. As a result there has been a loss of sovereignty of municipal adminis- trations and a growing number of displaced persons. VIOLENCE ESCALAT'ED WITH TIHE UPSURGE IN THE DRUG INDUSTRY IN THE 1980S. Numerous studies have shown that Colombia's involvement in the illegal drug trade is a key factor explaining the dramatic increase in violence, particularly homicides, over the last two decades. The drug trade has exacerbated levels of violence related to organized crime around drug production and processing, the militarization of the fight against drugs, and disorganized violence around distribution and consump- tion It has also fueled violence by providing a steady source of funding for several of the key illegal armed groups. Figure 2. Murder Rate, 1946-98 130- 120 Deaths attributable to Deaths today _ "La Violencia" 100 __________ 90 C) 80- 70 70 F- __ ___ ____ 40~~~~~~~~~~~~~~~~~~~~~~~~~~~~ v~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~ C. - ~~~~~~~~~~~~~~~~~~~~~~~~~~~0 1 0 - - - - - - - - - . .. . . . . 0 z~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~I. I ~~~~~~~~~~~~~~~~0 2 0Source National P e-I Source Nauional Police VIOLENCE, SUSTAINABLE PEACE, AND DEVELOPMENT 39 VIOLENCE INCREASINGLY AFFECTS SOME GROUPS DISPROPORTIONATELY. All Colom- bians have been terribly affected by violence. However, the rural population in gen- eral, youth, and ethnic minorities have been most affected, particularly by the armed conflict. Younger, lower-income, and less educated men are more likely to be both perpetrators and victims of homicide. The homicide rate for men thus multiplied by 13.5 between 1980 and 1995, with shifts throughout this period toward younger men. The number of internally displaced people has increased over the last decade and is still growing. According to a 1995 study, 600,000 people were forced to leave rural areas during the previous decade (Meertens and Segura-Escobar 1996). The Presidential Council for Human Rights estimates that the current number of dis- placed people has reached 1 million, about 2.5 percent of Colombia's population. Women and their dependent children living in rural areas are the group most affected by displacement due to the armed conflict' 58 percent of the displaced pop- ulation are female, and 75 percent are under 25 years old (Conferencia... 1994). Indigenous communities have been disproportionately affected by armed conflict throughout the country. III. Sources of Violence and Conflict While there is broad agreement that the current state of insecurity and violence is unacceptable, there are significanit differences within Colombian society, among academic and other analysts of Colombia, and within the international community about the causes of the situation, and the appropriate strategy for progressing on a path to peace and development The many excellent studies and analyses of violence in Colombia, particularly of the last two decades of the 20th century, reflect these differences. It is our contention that no single analysis or perspective has sufficient explanatory power, but that taken together they provide important insights that are useful (Moser 2000). This is due to the multidimensional and interrelated nature of the sources of violence in Colombia, the importance of looking at its evolution over time, and the rapidly changing dynamics particularly at the local level. This section discusses the sources of violence and conflict,' and Section IV discusses the costs as a basis for drawing some preliminary conclusions about a path to sustainable peace and development. A somewhat stylized, simplistic presentation of the principal explanations of the current situation are that (a) the driving force for the escalation of violence in the 1980s is the illegal drug trade which has fueled criminal activity and financed the armed groups, which are motivated primarily by greed, tending to lead to a conclu- sion that punitive actions involving force are the solution; and (b) the latest phase I This discussion does not touch on interpersonal and domestic violence, which is a serious problem in Colombia These are discussed in more depth in Moser (2000) and Moser and Mcllwaine (2000) 40 COLOMBIA: THE ECONOMIC FOUNDATION OF PEACE of the armed conflict is rooted in long-standing social conflicts related to an exclu- sionary political, economic, and social system, and has been aggravated and perpet- uated by funding obtained by the armed groups through the drug trade, tending to lead to a conclusion that achieving sustainable peace requires structural changes involving a redistribution of power and assets within Colombian society. As indicated above, we consider each of these stylized explanations to have valid- ity, particularly if one enriches them by looking at the situation of the last two decades from the perspective of Colombia's long history of violence. We will briefly examine the sources of the complex phenomenon of violence in Colombia by mak- ing a distinction among: • The armed conflict (often referred to by many Colombian analysts as "politi- cal" violence) of the more recent period involving the guerrilla forces (FARC, National Liberation Army (ELN), and so forth), peasant self-defense move- ments, paramilitary groups, and the Colombian military and police * The long-standing, underlying social conflicts at the local, regional, and national levels, which have also manifest themselves in violent ways and which are claimed by various armed groups as a motive and justification for their actions o The illegal drug trade and related criminal activities (arms trade, money laun- dering, kidnapping, and so forth), which have interacted with and con- tributed to the worsening of both the armed conflict (with the drug cartels becoming an armed actor) and social conflict in complex ways that are diffi- cult to disentangle. a) Armed Conflict Colombia has a long history of violence: confrontations between liberals and con- servatives in the 19th century, the period of La Violencia in the mid-20th century, and the escalation of armed conflict and crime since the 1980s. In the past decade, the scale and intensity of the internal armed conflict has changed from one confined to certain rural areas to a generalized violence that dominates the daily lives of most citizens. As remote guerrilla activity has turned into a conflict that includes new armed actors including paramilitary groups and drug cartels, and a steady source of funding, the nature of the conflict has been transformed and its negative impact on Colombian life has become enormous. A distinguished analyst of Colombia's situation over the last two decades describes the current armed conflict as a "war against society" where a generalized state of violence prevails and the majority of citizens are in effect held hostage by the various armed groups. Domination of people and territory appears to be the core military strategy of each of the principal illegal armed groups; the original social jus- tice concerns that motivated the founding of the guerrilla groups seem to be of less importance (Pecaut 2001). Many areas of the country are either dominated by one VIOLENCE, SUSTAINABLE PEACE, AND DEVELOPMENT 41 group or are under active dispute The inability of the State, through the military and police, to exercise a monopoly of force and protect people and property has per- mitted the illegal armed actors to move into these areas and exercise authority The municipality has become a key arena for the armed struggle, making it nearly impos- sible in many parts of Colombia for citizens to exercise their rights and for local gov- ernments to carry out their responsibilities. The pervasive impact of this situation is discussed further in Section IV. There have been many peace initiatives in Colombia since 1982, with a small measure of success. The faltering of the peace process initiated by the Pastrana gov- ernment in August 1998 and the roller-coaster nature of the negotiations process with the principal guerrilla group, FARC, coupled with the many brutal acts com- mitted by each armed group against people and property, have led many Colom- bians to lose confidence and hope for a negotiated settlement of the armed conflict. Yet, as noted above, it would be too simplistic to reduce the discussion of violence and peace in Colombia to the armed conflict. b) Social Conflict A variety of studies indicate that Colombia's violence and armed conflict stem from a complex interaction of economic, social, historical, and political factors at the local, regional, and national levels (L6pez and Garcia 2000). International evidence also supports the importance of these factors. POVERrY. While Colombia made significanit progress in reducing the poverty rate (measured in terms of per capital income) between 1978 and 1988, a serious rever- sal in the second half of the 1990s brought these rates back to their 1988 levels. Growth has nor reduced the large gap between the incomes and well-being of rural and urban residents: the level of extreme poverty in rural areas is three times that of urban areas. Although it may not be possible to establish a direct causal relationship between poverty and the armed conflict, the relationship appears to be dual: poverty favors the appearance of violent conflict, and the conflict itself is a major cause of poverty as evidenced by the large number of persons and families from humble rural origins who have been forced to flee to poor outlying areas of cities leaving behind their land and other possessions which they have little hope of recovering. There is no doubt that the poor are the main victims of violence, whether in rural or urban settings Both in the regular armed forces and in the illegal armed groups, young men from poor families are on the frontline of the armed conflict. Likewise, lack of access to jobs, good education, and health services, the basic amenities of life, and opportunities offered by the drug trade are undoubtedly linked to an upsurge in crime in urban areas INEQUALITY The increase in violence over the last 20 years has occurred simultane- ously with an increase in economic disparities. The growth of the guerrilla move- 42 COLOMBIA THE ECONOMIC FOUNDATION OF PEACE ment has run parallel to the deterioration in all income distribution indicators. The number of guerrilla fronts has risen from 14 in 1980 to 102 in the mid-1990s; simultaneously, between 1982 and 1999 the share of the poorest 20 percent of the population in income fell 30 percent (from 4.9 percent to 3.4 percent of total income, according to the National Household Survey). At the same time, the top 10 percent earners have increased their share by 5 percent (up from 37.1 percent to 43.6 percent). In the last 20 years, it is not only the gap between rich and poor that has grown, but also the gap between the cities and rural areas. In 1975, an urban family earned 1.5 times more than a rural family, but 20 years later it earns 4.5 times more. A study comparing municipalities during 1985-96 found that the group of municipalities with an increasing rate of violence had a higher level of inequality measured in terms of the Quality of Life Index, and lower rates of political partici- pation and level of education (Sarmiento 1998). A recent study of 39 countries found a positive relationship between high levels of violence (measured by homicide and robbery rates) and income inequality (Fajnzylber, Lederman, and Loayza 2002). Colombia shares with other Latin American countries a turbulent and often vio- lent history of land relations. Access to land is a major source of political and social conflict, in addition to being a key determinant of the productivity of the rural economy. Land ownership is highly concentrated, particularly in certain regions. From 1984 to 1997, there was a clear tendency of increasing concentration of land ownership, which is explained in part by drug monies being invested in land; the physical area of large farms showed a marked increase-from 32 percent to 45 per- cent of the total farming area. Colombian experts have shown that regions with a history of a high concentration of land ownership and conflict over land are those with a high presence of illegal armed groups and purchases of large farms with drug monies resulting in increased inequality in land distribution (Reyes Posada 1998). Many experts and journalists have also discussed the financing of paramilitaries by larger landholders to provide a measure of protection for life and assets. POLITICAL EXCLUSION, POOR GOVERNANCE, AND CORRUPTION. Many analysts point to the concentration of political power in the hands of an elite and the exclu- sion of new actors-particularly during the power-sharing arrangement between the two traditional parties during the National Front period (1958-74)-as a source of conflict and discontent (L6pez and Garcfa 2000) A recent survey about corruption in Colombia revealed that the perception and experience of public servants and business people is that legislation and special privileges are negotiated at the top among business concerns, politicians, and the executive branch. The survey revealed a generalized lack of credibility and legitimacy of public institutions, which are not thought to serve the public interest. HIGH LEVELS OF IMPUNITY WITHIN THE JUSTICE SYSTEM. The Colombian State has proved unable to effectively serve as the arbiter of conflict among citizens, though either formal or informal institutions. The perception is that the more powerful pre- VIOLENCE, SUSIAINABLE PEACE, AND DEVELOPNIENT 43 vail, especially by use of influence or force. This, in turn, sends the signal that con- flicts need to be resolved by private means because the State is unable to do so, which creates lawlessness and a climate conducive to more use of force by various actors. This situation is examined in more detail in the Chapters on The Judiciary and Corruption c) Drug Trade It is widely agreed that the emergence of drug trafficking has been one of the most important developments in Colombia's recent history. Cocaine production has grown from less than 100 tons in 1980 to more than 500 million tons in 1999. The 500 percent growth in production and the 700 percent increase in growing areas have made Colombia the world's largest cocaine supplier. This has had serious neg- ative consequences: a sharp rise in crime and violence, corruption, weakening of institutions, health and social impacts, displacement of legal crops, and environ- mental degradation. Recent analysis suggests that the long-term sustainability of guerilla activity since the early 1980s and the rise of the paramilitary are closely asso- ciated with increasing involvement with the drug industry. These relationships are shown in Figure 3. An empirical analysis of the determinants of violence, measured by the homicide rate, found that in the seven main cities the main explanation for the increase in vio- lence in the 1980s was drug trafficking and, to a lesser extent, the collapse of the judicial system. Evidence for 700 municipalities showed that high homicide rates in the 1990s were primarily explained by the presence of armed actors (paramilitary, guerrillas), intensity of drug trafficking, inefficiency of the judicial system, and interaction between armed actors and drug trafficking; socioeconomic variables such Figure 3. Cocaine Production, Homicide Rate, and Guerrilla Front 120 - -800 Guerrilla Fronts v C, I600 uc 80 - _ _ 5 ° 80- Cocaine Production in Tons 60 - ---------- --.-- -----,,-- - -400 o o 40- Homicide Rate 200 E 20- - - 0 -1 I I I I I -0 1958 1964 1970 1976 1982 1988 1994 2000 Source Cardenas (2001) 44 COLOMBIA: THE ECONOMIC FOUNDATION OF PEACE as poverty and Inequality also contributed, but to a much smaller degree (Sanchez and Nunez 2000). There are two very different views expressed by Colombian analysts concerning the current relationship between the drug trade and the armed conflict: (a) some argue that the existence of the armed conflict and its increasing intensity (that is, need for funds to finance the war) is the reason for the expansion of illegal crops and drug traf- ficking, implying that finding a settlement to the conflict is key to stopping this process; and (b) others argue that illegal crops and drug trafficking are financing the armed conflict, and have become ends in themselves for the armed actors, and there- fore should be directly attacked in order to end the conflict. Irrespective of which view one adopts, it is evident that there are no easy solutions to either of these problems. As indicated earlier, the drug trade also relates in complex ways with underlying social conflicts. For example, much evidence indicates that money laundering and profits from the drug trade went into extensive land acquisition in rural areas, with negative impacts on employment, equity, and security (Reyes Posada 1998). Another example is the lack of viable economic alternatives to offer small farmers growing coca, who are concerned about the high social costs to them and their families of being involved in this activity. These are just a few examples of the interrelated issues of armed conflict, social conflict, and the drug trade as sources of violence. IV. Costs of Violence and Conflict The impact of violence and conflict on the well-being of the Colombian people is enormous, resulting in a pervasive sense of uncertainty and vulnerability. For pur- poses of this discussion, these will be divided into economic, social, political, and environmental costs, though these are, of course, interrelated. Although much important analysis has been done on this subject, these costs remain difficult to measure in quantitative terms.2 a) Economic Costs of Violence Discussion of the economic costs of violence and conflict must be seen in the con- text of the prevailing interpretation that between 1950 and 1980 the armed conflict and violence did not significantly affect Colombia's economic growth and develop- ment. Throughout that period, Colombia avoided significant macroeconomic imbalances, maintained a respectable record of economic growth, and made signif- icant improvements in key social indicators, though progress in rural areas contin- ued to lag behind urban areas. This situation began to change in the 1990s; Colom- 2 See Moser (2000) for a more in-depth discussion of these costs, which synthesizes the work of Colombian experts and instirutions like the Departamento Nacional de Planeactdn on this subject. Also see DNP (1998), and Ca-macho Guizado and Leal Buitrago (2000). VIOLENCE, SUSTAINABLE PEACE, AND DEVELOPMENT 45 bia's macroeconomic imbalances, particularly fiscal deficits, started to build up, and internal and external debt steadily increased. At the same time, the armed conflict expanded and intensified, and an increasing area of Colombia's territory was under active dispute or controlled by the armed groups. In the second half of the 1990s, as the armed conflict and violence were dramatically increasing, economic growth slowed down, and toward the end of the decade there was a serious recession. ECONOMIC COSTS MEASURED IN TERMS OF GROSS DOMESTIC PRODUCT. While there are various interpretations as to the relationship of these phenomena, it is clear that the economic costs of violence and conflict are high. DNP's comprehensive study on violence, La paz el desafio para el desarrollo, brings together and builds on the growing number of studies on the economic costs of violence in Colombia. It concludes that during 1991-96, the cost of violence, that is, the cost to the victims, referred to as "gross cost") was COP17.2 billon (1995), equivalent to 25.3 percent of GDP, or an annual average of 4.2 percent.3 The cost to the economy as a whole (that is, the macroeconomic cost, referred to as the "net cost," which does not include transfers) was estimated to be COP12.5 billon (1995), equivalent to 18.5 percent of GDP, or an annual average of 3.1 percent (Rubio 1998) Loss of life accounted for 43 percent of the amount, "excess" military expenditures 30 percent, other security expenditures 23 percent, terrorist acts such as blowing up the oil pipeline 3 percent, and health costs 1 percent (DNP 1998). Another way of look- ing at this is the effect on the Human Development Index (HDI)4 a broader meas- ure of development that includes, in addition to per capita income, variables such as life expectancy, and educational level. In 1998 it was estimated that the fall in life expectancy in Colombia results in an economic loss equivalent to between 2.7 per- cent and 3.6 percent of GDP (Sarmiento 1998b). DECLINE IN INVESTMENT. Common sense dictates that the current situation in Colombia is unfavorable to investment: risks are high due to insecurity, including targeting of violent acts such as kidnapping, and destruction of costly assets; pro- duction costs are high due to security costs, extortion, and disruption of trans- portation and electricity supply; and legal recourses are limited. The situation is par- 3 The "gross cost" includes the cost of robbery, extortion, and kidnapping, which are not included in the "net cost," because for the econonmy as a whole these are transfers. Thus, the distribution of costs looks different for the two measures In the case of cost to the vic- tims, loss of life accounted for 31 percent of the amount; "excess" military expenditures 22 percent, other security expenditures 17 percent; crimes against patrimony (delitos pat- rzmoniales) 15 percent, kidnapping, extortion, and robbery 12 percent, and terrorist acts such as blowing up the oil pipeline, 2 percent. 4 HDI is calculated based on life expectancy, individuals' educational level, and income level. This Index is a reply to the general criticism made of measuring the development of a country based only on the GDP because it reflects the income distributlon. 46 COLOMBIA THE ECONOMIC FOUNDATION OF PEACE ticularly dramatic in rural areas. A quantitative analysis shows that when indicators for human capital and homicide rates are factored into the traditional equations for calculating inflation and the capital costs of investment, violence had a negative and significant impact on investment in Colombia. One study found that each percent- age point of increase in the murder rate reduces the rate of private investment by 0.66 percent (Parra 1998). The decline in the rate of domestic and foreign invest- ment, from 19 percent of GDP in 1995 to 5 percent in 2001, is now attributed by many to the increase in violence: In Colombia today, in addition to the constant changes in regulations, the main factor discouraging investment is the armed conflict and its conse- quences in terms of loss of life, forced displacement and indiscriminate attacks on production infrastructure. From this point of view, the armed conflict is undoubtedly the main obstacle to the distribution of the benefits of growth in our society as a whole (Segundo parlamento de paz 2000). DESTRUCTION OF PHYSICAL CAPITAL AND Loss OF PRODUCTWVE ASSETS. Violence has eroded physical capital (also known as man-made or produced capital) by reduc- ing the stock of plant, equipment, infrastructure, and other productive resources owned by individuals, the business sectors, and the government. Costs associated with violent attacks on infrastructure-especially petroleum and electrical installa- tions, roads, and airports-are mounting dramatically in Colombia. The petroleum, coal, and electrical power industry have been particularly hard hit. The costs of pro- tecting and repairing this infrastructure, not to mention the foregone sales and other indirect impacts, are high. The impact of the armed conflict on rural areas has been dramatic. Many landowners do not have physical access to their land or are unable to make full use of its productive potential. Others, mainly poor, peasant farmers have been forcibly evicted by the competing interests of guerrillas, paramilitaries, and drug traffickers, or have voluntarily fled to escape death threats. According to a recent study in Cali, for instance, 53 percent of the rural displaced had land ownership rights that they relinquished upon migrating, and 83 percent of them were landowners (CODHES 1997; Angarita Canas and Osorio Moreno 1998). Since many peasants do not hold legal title to their land, if they abandon it, they lose their legal rights to ownership. Even those who have legal title to land do not necessarily have recourse to judicial processes to regain their land or claim compensation. IMI'ACT ON GROWTH. Colombia's annual GDP growth fell from an average of 5 per- cent between 1950 and 1980 to 3 percent between 1980 and 2000. A recent study found that the decline in the growth rate is fully explained by a fall in productivity. It concludes that "the implosion of productivity is related to the four-fold increase in criminality. The existing literature has already shown that the explosion of crime was the result of the rapid expansion of drug-trafficking activities and the intensifi- VIOLENCE, SUSTAINABLE PFACE, AN) DEVELOPMENT 47 cation of the internal armed conflict (fueled by the rents from the drug trade)." The study concludes by indicating that "the period between 1980 and 2000 can be char- acterized by a vicious circle of high crime, negative productivity gains, low growth, and increasing concentration" of income, reversing the positive pattern of the earlier period (Cardenas 2001). Analysis of the rural sector indicates that the armed con- flict and drug monies are associated with the increased concentration of some of Colombia's highest potential land for crop production and its use for livestock pro- duction; this is not economically efficient and represents a significanit social and environmental problem. International evidence supports the idea that high crime rates and high concentrations of income are linked, and that countries with those characteristics suffer from low productivity and low growth Conversely, GDP growth has a significant impact on the reduction of violence when it is accompanied by a distribution of income, which reduces poverty (Fajnzylber, Lederman, and Loayza 2002). b) Social Costs of Violence Colombia's social fabric has been seriously weakened by violence and conflict, basic human rights are not being met, and the quality of life for all has declined in the cli- mate of intimidation and uncertainty that prevails, particularly in rural areas and poor urban neighborhoods. The cost to Indigenous and Afro-Colombian peoples has been particularly high. Violence has eroded human capital by limiting access to education and health care by both users and providers. For examnple, death threats and assassinations of rural teachers and health workers by armed groups have led to the abandonment of many rural facilities across the country (Parra 1997). It has also created an added burden for the health care sector, with trauma care consuming an important pro- portion of health resources This includes not only physical injuries and disability caused by violence, but also the psychological consequences of victimization or wit- nessing violence among adults The social costs of forced displacement, both in terms of those displaced and the recipient areas, is also high. Those displaced usually flee to the periphery of urban centers where housing and work are difficult to obtain, and often lose access to health and social services. A 1995 study of pre- and post-displacement unemploy- ment rates showed male rates increasing from 6.2 percent (when most worked in rural agriculture) to 34 percent (when they had relocated on the urban periphery) In Medellin, where the situation is particularly acute, the municipal government has struggled to cope: displaced persons have been evicted from the city on the grounds that their presence was a risk to public order and could cause a natural disaster due to their settlements being in geologically unstable areas (Angarita Canas and Osorio Moreno 1998). Violence has also eroded household relations as an asset by reducing the capacity of many households to function effectively as a unit. In rural conflict zones, where 48 COLOMBIA. THE ECONOMIC FOUNDAnON OF PEACE many men have joined illegal armed groups, family life is seriously disrupted by high stress levels. In poor urban communities, many women have identified a direct link between male unemployment, alcohol abuse, and increased domestic violence. In the case of internally displaced populations, research shows that women are more vulnerable than men at the moment of eviction, when they are exposed to unex- pected widowhood, threats, clandestine action, flight, and separation from their homes. Men, in contrast, seem better equipped to cope at such times, but the reverse is true when displaced households restructure their lives. Then the impact is greater on men, who become unemployed and experience a loss of status as breadwinners and a rupture of their sense of masculine identity. Gang involvement is an example of the negative social cost: young people, bereft of strong family and community support, form mutually reinforcing groups. Violence has eroded social capital5 by reducing trust and cooperation within for- mal and informal social organizations and among their members. The importance of social capital relates to its recognized contribution to sustainable development and the evidence that the size and density of social networks and institutions, and the nature of interpersonal interactions, significantly affect the efficiency and sus- tainability of development processes (Putnam 1993). A 2001 cross-country study (Fajnzylber, Lederman, and Loayza 2002) provides empirical evidence showing a strong negative relationship between violent crime and social capital. Evidence for Colombia is consistent with this, showing higher levels of participation in commu- nity action groups in less violent areas and lower levels in more violent areas (Cuel- lar de Martinez 1997) This is not surprising as the capacity for community-level organizations to function depends on their cohesiveness and personal safety, and the ability to meet locally. Sustained conflict, arbitrary killings by armed groups of sus- pected sympathizers of their opponents, and widespread death threats have system- atically reduced trust between neighbors and communities across the country. c) Political Costs of Violence Important progress was made toward opening up the political system in the late 1980s and early 1990s, most notably with the election of local and regional author- ities, and the adoption of the 1991 Constitution, which recognized citizens' basic rights, provided mechanisms for citizen participation and oversight of public affairs, and recognized Colombia as a multiethnic nation. However, this progress has been seriously eroded by the inability of the Colombian State to guarantee its citizens basic rights such as security, and to prevent the domination of many areas of the country by armed groups. The decentralization process and exercise of democracy under such conditions is precarious. 5 Social capital is the rules, norms, obligations, reciprocity, and trust embedded in social relations, social structures, and societies' institutional arrangements, which enable its members to achieve their individual and community objectives. VIOLENCE, SUST-AINABLE PEACE, AND DEVELOPMENT 49 Violence has severely eroded faith in the relevance and effectiveness of many social institutions as a consequence of both human rights violations and a reported 98 per- cent impunity rate. The growing concern that Judicial, educational, health, media, and security institutions are no longer viable is testing the institution of democracy. The effect of drug trafficking on the judicial system is a primary example of the impact of violent crime on institutions. Furthermore, as Colombia's police and judi- cial institutions weaken, the privatization of security is a growing phenomenon in both rural and urban areas: in 1980, Colombia had 2.5 policemen for every private security agent, by 1995, this ratio had dropped to 1 to I (Ospina 1997). Systematic threats and attacks against the communications media have been meant to alter media behavior and information content, thus affecting a key channel of information necessary to an informed, democratic civil society. More generally, continued violence has created a climate of fear, anxiety, and mutual distrust, which tends to suppress the "voice" of civil society institutions to participate effectively and peacefully in political decisions at community and national levels (Quintero and Jimeno 1993) d) Environmental Costs of Violence Colombia is rich in natural resources and is recognized as being one of the most bio- diverse countries in the world, with nearly all the world's ecosystems represented. Environmental degradation has only recently been recognized as a significant cost of violence, particularly the armed conflict and drug-related activities. One of the most dramatic examples is damage due to oil spills resulting from regular attacks on the pipeline. Environmental degradation in and around urban areas has been exacer- bated by the influx of displaced populations, worsening the problems of solid waste disposal and water contamination. In rural areas, land degradation and inappropri- ate land use have been exacerbated by the armed conflict. The presence of armed groups in and around many of the national parks and other protected areas (many of which overlap with Indigenous reserves and Afro-Colombian community prop- erty) has been a major obstacle to effective conservation and protection of these pre- cious ecosystems. Finally, drug-related activities result in contamination of soil and groundwater due to aerial spraying of illicit crops and chemicals used to process coca, and increased deforestation rates and destruction of fragile ecosystems for coca and heroin poppy cultivation. V. Toward Building Peace and Sustainable and Equitable Development It is apparent that Colombia is enduring a crisis of terrible proportions, with enor- mous economic, social, political, and environmental costs. Building conditions for peace and tackling the sources of violence and conflict are goals that will address the basic development problems of the country. International experience in the post- 50 COLOMBIA THE ECONOMIC FOUNDATION OF PEACE cold-war era with peace processes that mark the transition from violent conflict to development, make it clear that building peace requires a process of reinforcing mutual confidence and financial support to lay the foundation for a more open and inclusive State (Colleta and others 2000). There is also growing recognition that development must continue even when all or part of a country is in conflict. Posi- tive incentives for peace, security, and development must prevail over perverse incentives for violence, fear, and destruction (World Bank 1999b). The goals of achieving peace and securing equitable economic and social development comple- ment and reinforce each other. In Colombia, an agenda to build peace and tackle the sources of violence in order to create conditions for equitable development must address simultaneously (a) the armed conflict, (b) the drug trade, and (c) the underlying factors of social conflict. The first two aspects need military and political measures and a hemispheric approach to deal with them; the third one demands an integrated social and eco- nomic policy based on broad consensus. The key issues to address are (a) land, (b) access to justice, (c) security of life and property, and (d) fighting corruption. The best way to deal with these issues is through a region-based approach, for example, peace and development programs in critical regions; and a population-based approach, for example, priority on youth. Finally, the formulation and implementa- tion of policy and programs must follow a partnership approach between govern- ment, private business, and civil society organizations. a) Armed Conflict and Drug Trade The first two elements of the agenda will encounter formidable opponents in the armed groups (both guerrilla and paramilitary) and in the drug cartels, which fuel the conflict by financing the armed groups in exchange for the protection of their business. The reasons for this opposition are based on the following facts. First, these extralegal armed groups pose a direct challenge to the sovereignty of the State, both in a territorial sense and in an administrative and legal one. They, in essence, sub- stitute for the State and provide basic services, including administering justice, edu- cation, and social services. Lately, they have even forced the exile of legitimate local authorities. Second, they have an efficient economic base based on drug money and other illegal and inhumane methods such as extortion, kidnapping, and forced con- tribution. Third, they have declared a de facto war on the civilian population and the State through acts of terrorism and the violation of fundamental human rights. The illegal drug industry and armed groups have created a lawless environment that threatens not only Colombia, but the neighboring countries. To the extent that the drug trade, the violation of human rights, and the acts of terrorism are matters of international concern and consequence, dealing with these elements of the agenda demands a hemispheric approach. The aim of a plan of action is to regain control and sovereignty of the State over the entire territory of the nation, and increase the security of citizens. VIOLENCE, SUSTAINABLE PEACE, AND DEVELOPMENT 5 1 b) Underlying Social Conflicts Even If the armed conflict and the drug trade are handled through a variety of mil- itary and political measures, including a negotiation process with the armed groups, several structural elements associated with violence and the violent conflict will remain unresolved, unless there is a plan with the objective of attacking the struc- tural problems of violence and social conflict. Addressing this element of the agenda should not be dominated by the negotia- tion themes proposed by the various armed groups, even if there is a new dialogue for peace. This aspect of the agenda needs to be constructed, independently of their willingness to start a peace process, through an integrated economic and social pol- icy which is formulated on the basis of a broad social consensus on content and pri- ority, and carried out in a partnership between civil society, the private sector busi- ness community, and government at various levels. Evidence from other countries indicates that while the specific context of violent conflict varies, the exclusion of some groups and the alienation of citizens have always been major factors. Most important, dealing with such structural factors is necessary, regardless of the exis- tence of an armed conflict, because of their implication for the reduction of poverty and inequality in Colombia Such integrated economic and social policy must deal with at least the following unresolved issues: access to land and productive assets, reduction of impunity, pro- tection of life and property, and fighting corruption. i. Land and Productive Assets Access to land has been a major source of political and social conflict in addition to being a key determinant factor of the productivity of the rural economy. Displace- ment of population from rural areas has been associated with the conflict over land, and the demand for access to land and other productive assets a permanent cause of peasant movements. Measures toward the removal of land-related conflict factors may include: * Facilitating the integration of land purchase with productive investments and financial services within a broader context of local development. This will remove impediments for the integration of smallholders into a more equitable development process and thus a source of wealth, employment, and growth. The emphasis of this measure is on gaining access by smallholders to existing mechanisms for public support to the agricultural sector (Incentivo a la Cap- ztalrzaczSn Rural [ICR], credit, Fondo de Garantias) to improve livelihoods and avoid their capture by the largest producers. * The availability of working capital is an option that might have considerable positive impact on improved livelihood as well as preventing the involvement of small producers in the production of coca or finding alternative crops for those already involved. In effect, a major element that sets the production 52 COLOMBIA. THE ECONOMIC FOUNDATION OF PEACE process apart from other crops grown by small farmers is the easy availability of working capital to produce coca. It is common that downstream agents in the coca "value-chain" prefinance working capital needs of small coca pro- ducers for the entire season. This contrasts sharply with the widespread lack of access to credit by small farmers in Colombia for the cultivation of other crops. Increased efforts to ensure access to rural credit by small farmers could well be one of the elements of a more active policy to simultaneously provide economic opportunities to the rural poor and combat drug production. ii. Reduction of Impunity Security and justice are essential elements for renewed trust in the capacity of the State to protect citizens. However, the Colombian State has proved unable to effec- tively serve as the arbiter of conflict among citizens, either though formal or infor- mal institutions or to exercise control over criminal behavior. The recent survey on Corrnpczdn, Desempefio Insitutucional y Gobernabilidad (March 2002) shows that most of those interviewed think that justice in Colombia is unfair, favors those with power and influence, and that the judicial system is not independent from the exec- utive or from politicians. Consequently, gradual reduction of impunity and establishing the rule of law on an equal footing for all citizens in all regions of the country must be a priority of the new administration in order to increase the credibility of the State and to increase the security of citizens. The State must regain the monopoly of justice and its coer- cive capacity on individuals. In particular, the judicial system must increase its capacity to apprehend those involved in serious criminal activity. In the past, the reform efforts were geared toward governance issues within the judiciary, the change of codes, or the increase in penalties. The challenge now is to break the cycle of impunity, which reinforces the idea that crime pays because the probability of being apprehended is small. This cycle, some argue, may also generate a demonstration effect particularly among youth who will give social value to the attitudes and possessions of delinquents. Toward the reduction of impunity, the criminal system must become highly selective and strate- gic to be socially relevant in the middle of an acute structural imbalance between criminal activity and investigative resources. This would imply that the criminal sys- tem should aim at dealing effectively with those criminal problems that are most dis- turbing to Colombian society, such as a drastic reduction in the number of homi- cides by organized crime. iii. Security of Life and Property Colombia's social fabric has been seriously weakened by violence and conflict, basic human rights are not being respected, and the quality of life for all has declined in the climate of intimidation and uncertainty that prevails particularly in rural areas and poor urban neighborhoods. The cost to indigenous and Afro-Colombian peo- ples has been particularly high. VIOLENCE, SUSTAINABLE PEACE, AND DEVELOPMENT 53 In this context, the protection of the lives and property of citizens becomes a pri- ority for the government, State agencies, and all other social actors. This is bolstered by international experience that indicates that the degree of security enjoyed by cit- izens affects the amount of time peace will last. Measures toward this end may include (a) increasing the presence of the State, particularly in the territories with low or no presence, (b) promoting a culture of respect for human rights, and (c) securing the rights of land and assets. * The increased presence of the State should have three dimensions (a) the pro- vision of basic services and the special protection of vulnerable groups, (b) the presence of institutions to intermediate or serve as arbiter to resolve conflicts among citizens; and (c) the presence of an agent that can exercise the monop- oly of force as representative of the State. * Bolster the voices of ordinary citizens that have decided to stand up before the armed actors to claim their fundamental human rights. In particular, reinforce with economic and security resources the organized Indigenous communities and small municipalities of the emerging movement of civilian resistance to counterbalance the domination exercised through terror by armed actors, both guerrilla and paramilitary. Recognizing the weakness of the State, pro- mote among private business, civil society organizations, and the international community their contribution to this local effort from the strength of their own specialty. This action is very likely to be successful because there is a growing number of citizens from all walks of life tired of being actual or potential victims of the same violations of their human rights and willing to make an effective contribution. The burgeoning culture of respect for human rights and citizenship and a growing conviction of the urgent need for political solutions-reached through a negotiated settlement, rather than military solutions-means that today a social movement around peace is developing. * Securing rights to land and assets in rural and urban settings, as a factor of production, as a source of livelihood, and as asset endowment for the market. A massive land titling and securing of assets program would be of particular importance for rural populations at high risk of displacement (as a preventive measure) and for urban dwellers that could secure their property and acquire a market value. iv. Fighting Corruption The capture of the State-understood as the capacity of interest groups to influ- ence through corrupt practices the high levels of decisionmaking of the State- appears to be one of the most predominant forms of corruption in Colombia. About 70 percent of respondents among business people and civil servants indi- cate that this is a significant pattern in the high levels of the business environment in Colombia. 54 COLOMBIA. THE ECONOMIC FOUNDATION OF PEACE This high level of agreement around the incidence of the capture of the State poses a significant challenge regarding the framework of governance in Colombia. Based on the analysis of the results of this large survey, the following measures to reduce this level of corruption are proposed: * Increase political competitiveness by reforming the financing rules of political campaigns * Reduce clientelistic practices inside public administration, particularly between the executive branch and Congress * Introduce meritocracy in public institutions to discourage corrupt practices in government and state agencies * Establish social accountability mechanisms to oversee budget and investments of public resources at all levels of public administration, and municipal, departmental, and national agencies. c) Critical Elements of Strategic Approach i. Community-Based Regional Development Given that roots of unresolved social conflicts are within regions and local contexts, the main issues of access to land and productive assets, reduction of impunity, secu- rity of life and property, and fighting corruption must be addressed at those levels. This emphasis, however, should be complemented with outside political and eco- nomic support by parties not embroiled in the conflict themselves. Therefore, the intervention of civil society groups, the private sector, commu- nities, and producer organizations should be emphasized so that they can better participate in local planning, definition of local priorities, and implementation. The local and regional development approach will integrate rural-urban popula- tions in terms of on-farm and off-farm opportunities. This approach promotes better integration of communities and rural producers, integration with the sup- ply chain, development of labor and financial markets, provision of basic infra- structure and services, and sustainable management of natural resources. The regional space becomes the main scenario where social cohesion can be rebuilt and participation in the decisionmaking process becomes the basis for consensus building and ownership of the local development process. The Program for Development and Peace in the Magdalena Medio region shows the enormous potential of this approach. Community-driven development will increase the stake of the population in peace and their willingness to resist the pressure from armed actors. The economic and social opportunities will facilitate the productive occupation of the territory. This occupation supported by the State and government agencies will also con- tribute to regaining the control and sovereignty of a more legitimate State that sup- ports and receives the support of its citizens. VIOLENCE, SUSTAINABLE PEACE, AND DEVELOPMENT 55 ii. Targeting Regions and Youth Poverty, inequality, and conflict vary gready throughout Colombia. This is not surpris- ing given Colombia's incredible physical, cultural, social, and economic diversity, history of strong regional identities, and important rural-urban differences. These differences need to be kept in mind in the formulation of policies and programs to deal with the underlying factors of violence and conflict. Being poor or discriminated against in the Pacific region or in the southern departments of Colombia is quite different from being poor or discriminated against in Bogota or the Central region. The Pacific region, for example, has social indicators similar to those that Colombia as a whole had 20 years ago. To make matters worse, much of the Pacific region, along with much of Colombia outside of Bogota, are territories under active dispute among contending armed parties for the control of resources and people. As a result, the poor-the majority of people in such territories-are subject to the devastating, combined effects of unemployment, lack of basic services, poor infrastructure, and the threat of forced displacement. Forced dis- placement, mainly as a result of the social and armed conflict, is the most serious humnan- itarian and social problem in Colombia today. It causes uprooting of people and disrup- tion of family life; loss of human, social, and physical capital; generalized impoverishment, and high costs for the families and for the State. Therefore, a special effort must be made to identify the crintcal regions most affected by poverty, mequality, and social and armed conflict, and target them for government programns of the kind described above. In these regions, access to safety nets, education and health services, infrastructure, and new economic opportunities are essential, as are measures to reduce or mitigate the armed conflict, the main cause of displacement. Youth, on the other hand, is the population group most affected by violence, unem- ployment, and lack of educational opportunities. They are also subject to voluntary or forced recruitment by armed groups or drug lords and to the contamination effect of ille- gal and criminal activities that go unpunished. Young men and women should receive priority attention in the design of local or regional peace and development programs, and special opportunities in urban programs in intermediate and large cities. Particularly important are opportunities for postprimary education, job training, and employment. In countnes affected by conflict, job creation is a central instrument to pro- vide alternatives to youth and adults, and thus to prevent armed fighting This is an area where the involvement of the private sector and specialized nongovernmental organiza- tions is promising. In effect, the use of special trust funds to finance job training, offer microcredit, and increase livelihood chances have proved effective. The creation of new jobs is good not only for economic development but also for security. VI. Conclusion Colombia is a country with an enormous base of human and natural resources, a good geographic location for international trade and foreign investment, and a 56 COLOMBIA. THE ECONOMIC FOUNDATION OF PEACE valuable democratic and cultural tradition. The Colombian people have demon- strated enormous courage and creativity in coping with and trying to address the long-standing issues that are a threat to their well-being and that of their nation. There are an enormous number of positive experiences and achievements through- out Colombia to build on, from the National Rehabilitation Program, to the Pro- grama Desarrollo, Saludy Paz (DESEPAZ Program) in Cali, to the pioneering Pro- gram for Development and Peace in the Magdalena Medio region. While the obstacles are enormous and sacrifices will need to be made by all, there is great hope that Colombia's many assets and strengths, particularly the courage and determi- nation of its people, will be sufficient to build a sustainable peace and achieve equi- table development. References Angarita Canas, P. E., and C. A. Osorio Moreno. 1998. "Analysis of Displaced Pop- ulations in Colombia." Washington, D.C.: World Bank. Camacho Guizado, A., and E Leal Buitrago. (Compiladores). 2000. Armar la Paz es Desarmar la Guerra. Bogota, Colombia: Ciro Editores. Cardenas, M. 2001. Economic Growth in Colombia- A Reversal of Fortune? Center for International Development, Harvard University, Working Paper No. 83, December. CODHES (Consultoria para los Derechos Humanos y el Desplazamiento). 1997. Desplazamiento rural: violenctaypobres. Bogota: CODHES. Colleta, N., M. Kostner, P. Cleves, and J. Mendelson. 2000. "Toward an Architec- ture for Sustainable Peace and Development: Lessons from the World Bank's Experience." In A. Solimano, ed., COLOMBIA Essays on Conflict, Peace and Development. Washington, D.C.: World Bank, pp. 159-93. Conferencia Episcopal Colombiana. 1994. "Secci6n de movilidad humana." Mimeo. Conferencia Episcopal Colombiano, Bogota. Cuellar de Martinez, M. 1997. "Valores y capital social en Colombia " Coporaci6n Porvenir and Universidad Externado de Colombia, Santa Fe de Bogoti. Mimeo. DNP (Departamento Nacional de Planeaci6n). 1998. La paz: El desaflo para el desarrollo Bogota: Tercer Mundo Editores. Echeverry, J. C., N. Salazar, y V. Navas. 2001. "Si nos parecemos al resto del mundo? El Conflicro colombiano en el marco internacional." Seminario de Economia de la Catedra Colombiana, Bogoti. Fajnzylber, P., D. Lederman, and N. Loayza. 2002. "Inequality and Violent Crime." Journal of Law and Economics, Vol. XLV, April: 1-40. L6pez, C., and A. Garcia. 2000. "The Hidden Costs of Peace in Colombia." In A. Solimano, ed., COLOMBIA: Essays on Conflict, Peace and Development. Wash- ington, D.C.: World Bank, pp. 78-158. Meertens, D., and N. Segura-Escobar. 1996. "Gender, Violence and Displacement in Colombia." Singapore Journal of Tropical Geography, 17 (2):165-78. VIOLENCE, SUSTAINABLE PEACE, AND DEVELOPMIENT 57 Me)ia, D. 2000. "El secuestro en Colombia: una aproximaci6n econ6mica, en un marco de teorfa de juegos." Coyuntura Econ6mzca, Vol. XXX, No. 2, Junio. Moser, C. 2000. "Violence in Colombia: Building Sustainable Peace and Social Capital." In A. Solimano, ed., COLOMBIA Essays on Conflict, Peace and Devel- opment. Washington, D.C.. World Bank, pp. 9-77. Moser, C., and C. Mcllwaine. 2000. Urban Poor Perceptions of Violence and Exclu- sion in Colombia. Washington, D.C.: World Bank and the Swedish International Development Agency. Ospina, J. 1997. "Hacia una nueva estrategia de manejo del orden publico." In Par- tido Conservador Colombiano, ed., Inseguridad e impunidad en Colombia. Bogota Partido Conservador Colombiano. Parra, C. 1998. "Determinante de la Inversi6n en Colombia: evidencia sobre el cap- ital humano y la violencia." DNP, Archivos de Macroeconomia, Doc. 84, June. Pecaut, D. 2001. Guerra Contra la Sociedad. Bogota: Editorial Planeta Colomblana. Putnam, R. D 1993. Making Democracy Work. Civic Traditions in Modern Italy. Princeton, N.J.: Princeton University Press. Quintero, M., and R. Jimeno. 1993 "Los medios de comunicaci6n y la violencia." CINEP-APEP, Bogata. Mimeo Reyes Posada, A 1997 "Compra de Tierras por Narcotraficantes." In Franciso E. Thoumi, ed., Drogas ilicitas en Colombia: Su impacto econcimico, politico y social Bogota Ariel Ciencia Polinca. Reyes Posada, A. 1998. "La Cuesti6n Agraria en la Guerra y la Paz" In Departa- mento Nacional de Planeaci6n, La paz- El desaffo para el desarrollo. Bogota: Ter- cer Mundo Editores, pp 205-26. Rubio, M. 1998 "Los Costos de la violencia en Colombia: El estado del debate." Washington, D.C. World Bank. Mimeo. Sanchez, F., and J. Niunez. 2000. "Determinantes del crimen violento en un pais altamente violento : el caso de Colombia." Mimeo. Universidad de los Andes, Bogota. Sarmienro, A. 1998a. "Violencia y Equldad." In Departamento Nacional de Planeaci6n, La paz. El desaflo para el desarrollo. Bogoti: Tercer Mundo Editores, pp. 227-61. . 1998b. Informe de Desarrollo Humano para Colombia, 1998. DNP-UNDP, Tercer Mundo Editores, pp. 122-25. Segundo Parlamento de Paz. 2000. "Desarrollo Econ6mico y Social." Camino de Conciliaci6n Nacional. Instituto de Derechos Humanos y Relaciones Interna- cionales. Universidad Javeriana. Bogota, March Solimano, A., con F. Saez, C. Moser, and C. L6pez, Editores. 1999. Ensayos sobre la Paz y Desarrollo. El caso de Colombia y la experiencia internacional World Bank, Bogota: Tercer Mundo Editores. Solimano, A., ed 2000. COLOMBIA Essays on Conflict, Peace and Development. Washington, D.C.: World Bank. English version of Ensayos sobre la Paz y Des- arrollo, 2000. 58 COLOMBIA THE ECONOMIC FOUNDATION OF PEACE World Bank and the Carter Center. 1997. "From Civil War to Civil Society: The Transition from War to Peace in Guatemala and Liberia." Workshop Report, July. Washington, D.C. and Atlanta, GA. . 1999a. Violence in Colombia: Building Sustainable Peace and Social CapitaL Washington, D.C . 1999b. Security, Poverty Reduction & Sustainable Development: Challengesfor the New Millennium. Washington, D.C., September, p. 9. . 2001. World Development Report 2000/2001 Attacking Poverty. New York: Oxford University Press. 2 Enabling Sustainable Growth This Chapter was written by Krishna Challa. I. Introduction Despite the major problems Colombia is facing in the areas of security and violence, it continues to have considerable growth potential. The most important reason for this is the country's impressive human capital, which has kept the country on a growth path for all but one year over the past five decades. Through a tradition of prudent macroeconomic management, Colombia has so far managed to avoid the major cycles of macroeconomic instability that have plagued a majority of countries in the Latin America region in recent decades. There is a good probability that Colombia will foster a sustainable growth path in the coming years, provided that the security situation does not worsen significantly, prudent macroeconomic man- agement continues, and that certain enabling conditions are maintained for a good business environment and responsible management of natural resources. Overall, the economic record of Colombia in the last three or four decades is one of quite impressive progress, and can be characterized as very good performance under duress and against significant odds However, there remains a substantial unfinished agenda. Requirements for a sustainable growth path in Colombia, apart from a security situation that does not worsen significantly and development of well-qualified human capital via improved human development policies (areas addressed in the other accompanying notes), include: * Prudent macroeconomic management, including sustainable fiscal policies and management. * A well-functioning finanicial system that can provide adequate services to all seg- ments of the productive sector and the population at large, including a healthy and sustainable banking, housing finance, pension, and insurance systems. 59 60 COLOMBIA THE ECONOMIC FOUNDATION OF PEACE * A business environment that would release the potential of the private sector, including adequate regulatory and competition frameworks, and administra- tive procedures governing the establishment and operation of firms that are not excessively cumbersome. o Efficient, effective, and well-managed infrastructure sectors that facilitate competitiveness of the Colombian productive sector vis-a-vis international markets (for example, through reductions in transport, communications, and logistics costs of firms and workers) and adequate access to good-quality basic infrastructure services for all parts of the society. o Responsible management of natural resources and the physical environment (land, water and wastewater, forest and agricultural resources, urban air qual- ity, waste and hazardous waste management) to ensure their sustainability and positive contribution towards the long term economic growth objectives. II. Providing a Sustainable Macroeconomic and Fiscal Framework a) Background Colombia's recent path could lead to an unsustainable increase in deficits and debt, along with poor prospects for GDP growth and high unemployment. The rapid expansion of the public sector over the previous decade, from spending one-fourth of GDP in 1990 to over one third of GDP by the end of the decade, combined with growing liabilities, particularly on the pensions front, have led to significant and per- sistent structural deficits. The private sector, on the other hand, languishes: while government consumption grew by two-thirds between 1994 and 2001, that of house- hold remained basically unchanged, and private investment fell by over 37 percent. The weakness of the private sector is at the center of Colombia's current economic woes. Private GDP has grown little since the mid-1990s, and private investment has deteriorated from its peak of near 12 percent of GDP in 1994 to under eight percent today. Total investment now stands at about 15 percent of GDP, incompatible with the resumption of significant growth. Public sector consumption has in effect dis- placed the private sector as the major contributor to domestic demand. As public spending rapidly outstripped the sector's revenue generating capacity, much of the fiscal deficit, particularly since the mid-1990s, has been financed with debt, both domestic and external. Today, net public sector debt in Colombia stands at about 46 percent of GDP. In 1997, prior to the onset of the recession and to the rapidly deteriorating fiscal balances of 1998 and 1999, public debt stood at 27 per- cent of GDP. Spending on interest payments to service public debt now stands at near five percent of GDP, constituting approximately a quarter of the central gov- ernment's expenditures and more than twice its investment budget. Colombia now faces the combined challenges of reducing its debt levels to ensure sustainabihty and achieving growth rates that are sufficient to reduce poverty levels ENABLING SUSTAINABLE GROWFH 61 and increase employment. Continued fiscal adjustment is unavoidable if debt sus- tainability is to be attained; just as important, the quality of the adjustment is key for a return to growth rates in the four to five percent range. b) Fiscal and Debt Sustainability To avert an explosion of the debt-to-GDP ratio, the combined public sector has to generate a permanent primary surplus of about four percent of GDP.' This calcula- tion incorporates the present value of all net public sector liabilities, including pub- lic pension payments (of the implicit liabilities) under a no-reform scenario, the sce- nario also assumes long-term GDP growth rates of 3.5 percent. In 2001, the public sector primary balance stood at 1.4 percent of GDP. In other words, to achieve fis- cal sustainability, the Colombian public sector will have to generate 2.6 percentage points of GDP in additional savings on a permanent basis. If the pension system were fully reformed along the lines recommended in this report, the required pri- mary surplus would be reduced to 1.5 percent by 2010, a much more feasible tar- get. This estimate does not take into account the incoming administration's program from significantly increasing military and social expenditures over the coming years. Even under the scenario of maintaining a primary surplus of four percent of GDP for the coming decade, it is estimated that the total net debt of the public sec- tor would nevertheless continue increasing, reaching about 57 percent of GDP by 2010. To further illustrate the vulnerability of Colombia's fiscal path in the absence of comprehensive reforms, one can project the path of public sector debt under the assumption that the primary balance is kept constant at its 2001 ratio with respect to GDP (1.4 percent). Under this scenario, debt would rise from about 46 percent of GDP in 2001 to about 80 percent in 2010 (assuming an annual real GDP growth rate of 3.5 percent). On the other hand, to maintain the debt-to-GDP ratio at today's level of 46 percent of GDP, primary surpluses between five and six percent of GDP would have to be maintained over the next decade. The magnitude of the required adjustment means that significant measures on both the expenditure and revenue fronts are needed. Before addressing the options for fiscal adjustment, however, a brief review debt management is presented below. c) Debt Management Colombia's public debt management is hampered by the absence of a comprehen- sive and coherent conceptual and legal framework for debt management, and the existence of overlapping responsibilities among various institutions. Colombia also needs to strengthen its debt management capacity to increase the efficiency and effectiveness of managing a vulnerable and complex portfolio. To date, debt policy has been largely driven by the need to finance the fiscal deficit. Consequently, debt 1. See the Public Debt Susrainabiliiy and Management Chapter for details. 62 COLOMBIA THE ECONOMIC FOUNDATION OF PEACE decisions have been taken with limited systematic analysis of risks, and without a strategic framework for debt management. The rapid growth of the debt stock over recent years has also led to a deterioration in the structure of the portfolio, whose management has been constrained due to shallow and incomplete domestic markets, limited access to international markets, and weak debt management capacity More- over, Colombia's debt portfolio is vulnerable to unexpected changes in both real interest and exchange rates. Strengthening the framework for debt management would involve attention to a number of areas. First is the creation of a legal and governance framework for debt management operations, consolidating all legal and regulatory instruments of debt management. Specifically, the new framework should provide for a separation of policy formulation, implementation, and evaluation functions, the clear definition of responsibilities and accountabilities of the various government entities, as well as clear objectives including risk tradeoff issues as a central dimension of debt man- agement. Second, specific steps can be taken to improve debt management strategy and portfolio structure. This should include improved monitoring of the govern- ment's contingent liabilities, the systematic use of active operations (such as swaps, exchanges, buybacks, etc.) to modify existing debt stocks, as well as the integration of long-run fiscal and debt sustainability analysis into portfolio and funding strate- gies. Third, capacity may be strengthened by centralizing operations in a single debt office with the necessary resources and skills, and sufficient administrative flexibility to respond to changes and opportunities in financial markets. Finally, public debt management would be facilitated by deeper domestic debt markets. In this regard, important steps would include the simplification of the benchmarks for the mini- mum rate of return of pension funds, the identification and removal of main con- straints to increasing the efficiency of collective investment vehicles and mutual funds, and an assessment of the suitability of the Interest Rate Index (DTF) as a market reference rate for secondary market activities. d) FiscalAdjustment Options The magnitude of the primary surplus required to avoid unsustainable debt expansion means that continued fiscal adjustment is unavoidable, and that it will need to include measure to both reduce spending and increase revenues. Nevertheless, international evidence has shown that adjustments based on expenditure reduction are more favor- able to growth than those based largely on increased tax revenues. As such, expendi- ture reduction and substitution will need to play a central role in government policy. i. Rationalization of Expenditures Expenditure adjustment has often been inefficient and inequitable, as it has relied on short-term measures with relatively low political costs, such as de facto invest- ment cuts, payroll freezes, and wage increases below inflation. This approach is unsustainable in the longer term, and creates an illusory fiscal adjustment as assets ENABLING S(JSTAINABLE GRO\TrH 63 of the state deteriorate, undermining future growth. Implementing significant spending cuts is a difficult challenge in Colombia, given large, inflexible expendi- tures such as debt service payments, territorial transfers, pensions and public sector salaries Together these categories constituted nearly 75 percent of the central gov- ernment's expenditures, and 112 percent of its tax revenues in 2001. This points to the importance of carrying out the necessary reform in order to inject greater flexi- bility into public sector spending. A ntimber of policy options have been under consideration in Colombia to address these challenges. Primary among these is addressing pension transfers through a cut in the transition period between regimes. It is difficult to expect rationalizing public sector employment and salaries without a review of expendi- tures, and their efficiency and effectiveness, in the justice and defense sectors, which currently account for fully 70 percent of the central government's personnel and goods and services outlays. Territorial transfers constitute the other main area of expenditure inflexibility for the central government, while at the same time formlig the bulk of the country's spending on social sectors. The recently approved constitutional amendment on territorial transfers guarantees that unless growth performance improves substantially, territorial transfers will continue to pose a bur- den on expenditures. In effect the amendment created a contingent liability in the event that real growth of the economy falls short of 2-2.5 percent by guaranteeing a lower threshold below which transfers will not decline even if growth, and rev- enties, fall short. Given recent evidence regarding the ineffectiveness of continued increases in expenditures on health and education as a means of delivering improved coverage and quality, the question arises of the appropriateness of real increases on the order of 2-2.5 percent in the level of territorial transfers during a period of fiscal austerity and low growth. A temporary transfer freeze, in real terms, would generate substantial fis- cal savings. If local governments are simultaneously empowered to manage central transfers and to raise own revenues, this should not result in any weakening of Colombia's drive towards decentralization. Currently, local governments have little incentive to responsibly manage resources whose assignation and management in effect remain under the control of the central government. The enhancement of serv- ice delivery, one of the main justifications for decentralization, is not merely a func- tion of more resources, but of their appropriate assignment and distribution. ii. Raising Revenues New ways to increase revenues should focus on comprehensive reforms that make the tax structure less complex and more efficient. However, the margin for increas- ing revenues significantly in the short term, without affecting growth prospects, is likely to be small. Moreover, passage of a tax bill that relies mostly on rate increases but does not correct the deficiencies of the current regime will only necessitate, as it has in the past, further rate increase within a year or two as "tax fatigue" sets in fol- lowing a temporary rise in revenues. 64 COLOMBIA THE ECONOMIC FOUNDATION OF PEACE Changes introduced over the last decade in the tax structure have boosted collec- tion, but they also introduced distortions into the system. Five major tax reforms were approved in the 1990s. The later reforms in particular were largely aimed at collecting more revenues in order to close widening fiscal gaps, rather than improving the archi- tecture of the system. The incremental approach has resulted in an excessively complex tax structure characterized by comparatively high rates and narrow base. Tax reform should be based on the principle of enhancing the quality of adjust- ment and incentives for growth. For example, caution should be exercised in con- sidering increased levies on the use of capital, since they will raise the cost of under- taking private investment projects and thereby reduce investment. Emphasis in tax reform must be placed on expanding the tax base and removing exemptions and exceptional regimes (which tend to promote evasion and inequalities), rather than increasing tax rates per se beyond a threshold. Specifically, the two most important taxes in Colombia, the VAT and the income tax, both suffer from significant distortions: their bases have been successively eroded by the reforms of the 1990s, and evasion rates are high, estimated at 20 per- cent for the income tax and 28 percent for the VAT. Regarding the income tax, major issues are the distortions of the corporate income tax and exemptions granted for personal income tax. For the corporate income tax, the categories of exempted firms and exempted sources of income largely explain the difference between actual and potential collection. It is therefore recommended that exemptions, such as those for firms operating in the Paez river area, for publishing firms, lotteries, coopera- tives, and itcoreras, be eliminated. The tax base should be widened to include cur- rently exempted public services enterprises, livestock funds, and funds established by financial institutions. Moreover, the corporate income tax creates a number of dis- torting incentives. In this regard, the adjustment for inflation, particularly with respect to inventories, should be reintroduced, as should the presumptive tax on gross assets. A presumptive tax on net wealth creates a bias in favor of contracting large debts, a problem which should be addressed when reintroducing the tax. For the personal income tax, the large number of potential taxpayers who fall outside the scope of the tax is an important constraint to expanding collection: more than 90 percent of wage earners are exempt from paying income taxes. Individuals with an income below three times the average per capita income are currently exempt; other wage earners enjoy an exemption of 30 percent, paying income tax on only 70 percent of their income. Suggested changes include the reduction of the general exemption for individuals to twice the per capita income, elimination of the 30 percent exemption for wage earners, and the introduction of new rates of 15, 25, and 35 percent (versus current rates of 20, 29, and 35 percent.) Similar problems have caused a low yield from VAT, with the ratio of collection to GDP below a third of the VAT rate. Exemptions are high, numerous rates make the tax complex, and further intractability results from the implicit VAT (aimed at protecting domestic activities) and complex procedure for VAT on capital goods. A reform with the objective of widening the base and eliminating preferential rates in ENABLING SUSTAINABLE GROWrH 65 the VAT should include a unification of rates, increasing the preferential 10 percent rate to the general rate of 16 percent; a widening of the base to include paper prod- ucts and printing, beer and tobacco, personal services, transportation and construc- tion; an elimination of the implicit VAT; and an introduction of a VAT on capital goods as a credit against the VAT. Multiple exemptions have also created difficulties for VAT administration, and the VAT on capital goods has added further complexities. In recent years, the Colombian tax administration (DIAN) has undertaken a number of programs to improve compliance and reduce evasion. DIAN's strategy incorporates measures to improve performance in the areas of collection, control, cashing, and efficiency. Clear indicators for tax administration, such as the recovery of overdue taxes, dead- lines for administrative actions and efficiency ratios, should be established and mon- itored. There is also scope to enhance controls on tax returns and for improvements in cross-checking of VAT-related data. III. Ensuring a Healthy Financial System Colombia managed to prevent the severe economic downturn in 1999-2000 from triggering a systemic financial sector crisis. The unprecedented economic contrac- tion of this period came on top of a combination of many other major challenges affecting the health of the financial system. Among the most prominent ones are: (a) the steadily deteriorating security conditions in the country; (b) the adverse effects of the large drug-related financial transactions on the financial system, such as money laundering and large financial transactions taking place outside the for- mal financial system in the shadow economy, which nevertheless had important effects on the real economy; (c) the resulting major political uncertainties and weak political leadership; (d) a prior history of sustained high real interest rates, which together with the recession had substantially weakened the finances of the corporate sector and consequently the portfolios of banking institutions; (e) the important setbacks suffered by housing finance institutions as a result of unex- pected Constitutional Court rulings declaring null and void certain features of the Constant Purchasing Power Unit (UPAC) indexing system for housing finance and requiring the establishment of a new indexing system (which had both a direct and indirect negative effect on the quality of loan portfolios of most hous- ing institutions, with a perverse effect on the willingness to pay of even borrowers with good payment records); (f) the social problems associated with the failure of the nonbank financial institutions in the cooperatives sector and homeowners who no longer had the economic capacity to service their loans; (g) the need to restructure, close and/or privatize several major public or "officialized"2 banks 2 "Officialized" banks are those that were originaly private institutions, but were intervened and taken over by the government 66 COLOMBIA THE ECONOMIC FOUNDATION OF PEACE facing financial problems; and (h) the negative effects of all these developments on the overall fiscal situation of the economy. During various stages of the crisis, the percentage of non-performing loans (NPL) in the overall banking system reached 12-15 percent, with certain acutely affected segments such as the public and officialized banks, housing finance institu- tions and cooperatives showing much worse ratios of NPL. The situation was also aggravated by a non-payment culture in some parts of the system (stemming from the uncertainties created by the Constitutional Court rulings regarding the legality of some of the prevailing rules), expectations of debt relief, and absence of clear supervisory and enforcement rules in some areas. By putting in place a balanced set of carefully chosen corrective actions, the gov- ernment managed to avert the onset of a financial sector crisis of major proportions. Over the last three years, the government has had to delicately balance the need to provide relief to some of the most severely affected borrowers in the system (for example, low-income homeowners, depositors into the failed cooperatives system), the legal requirement to abide by the Constitutional Court rulings, and the need to put in place a resolution process for failed financial institutions. It was important that the financial sector resolution process minimize the perverse incentives and neg- ative consequences that could stem from debt or debt service relief to borrowers and/or financial institutions facing problems. To respond to the crisis, the government secured passage of major financial sec- tor reform legislation (in 1999) and a series of associated regulatory and adminis- trative measures Among the most notable measures were to: (a) increase the mini- mum capital rules for financial institutions, strengthen loan classification, provisioning policy, and procedures for prompt correction actions by the Superin- tendency of Banks when problems arise, and strengthening the powers and financial capacity of the Fondo de Garantza de las Instituciones Financieras (Financial Institu- tions Guarantee Fund, FOGAFIN, the deposit insurance and bank resolution agency) to expedite mergers and other financial restructuring solutions as needed; (b) close, restructure, and/or sell to the private sector several publicly owned finan- cial institutions; and (c) overhauling the housing finance sector in terms satisfactory to the Constitutional Court, involving the establishment of a new housing finance indexing system (Unidad de Valor Real, Constant Value Unit, UVR) that corrects past problems while avoiding excessive interest capitalization in housing loans, and including a carefully circumscribed debt or debt service relief for housing loan recip- ients acting in good faith but with the least capacity to pay. Additional actions included: (a) substantially revamping bank supervisory author- ity and putting in place clear, streamlined rules to deal with loan classification to address different categories of risks facing Colombian financial institutions and con- trol illicit financial transactions; (b) providing long-term loans, subject to strict guide- lines and limits via special recapitalization programs of FOGAFIN, to banks and housing finance institutions that have clearly evidenced their commitment to a full recapitalization of their enuties using sufficient quantities of their own funds and risk ENABLING SUSTAINABLE GROWTH 67 capital; (c) strengthening guidelines to control money laundering; (d) overhauling the financial cooperatives segment, accompanied by a newly established supervisory and deposit insurance system; and (e) upgrading the Superintendency's comprehensive risk-management system. Overall, the government spent more than US$4 billion during 1999-2001 on financial sector emergency measures and to close, downsize, restructure, or otherwise resolve problems associated with financial institutions Due to a number of financial sector reforms, the institutional landscape for pub- lic and private financial institutions operating in Colombia's rural sector has shifted dramatically in recent years. With the closure of Caja Agrarta in 1999, the govern- ment has taken significant steps toward eliminating distortions in rural financial markets and rationalizing government support to agricultural and other rural enter- prises. In addition, changes in the legal and regulatory framework have led to the massive restructuring of bank and nonbank financial intermediaries in Colombia, with mergers and liquidations drastically reducing the number of banks, coopera- tives, and other financing companies operating in the country. Banco Agrario, Fondo Emprender, and several guarantee and titling programs administered mostly through the Fondo para el Financiamiento del SectorAgropecuarzo (FINAGRO), are still oper- ating in the rural sector. While the actions noted above did help avert a systemwide crisis, a substantial further agenda of actions remains if a healthy financial system providing the requi- site services to the population and productive sector is to be assured. The agenda of further actions to put the financial system on a sound footing for the future should include: * Wind up, restructuring, and/or privatizing the public and officialized finan- cial institutions (most important, BANCAFE and Granahorrar) as early as possible to avoid further fiscal drain and erosion of the value of these entities. * Review and overhaul policies, procedures, and action plans being followed by CISA, the subsidiary of FOGAFIN responsible for the management and dis- position of assets transferred from the bad loan portfolios as part of the process of the resolution of problem banks, in order to achieve more rapid and efficient disposition of the corresponding assets. * Review the operations of the various second-tier financial institutions cur- rently under state control (Instituto de Fomento Industrial, State Industrial Development Bank, IFI; Financiera de Desarrollo Territorial, FINDETER; Financiera Energe'tica Nacional, FEN; FINAGRO, and BANCOLDEX), with a view to rationalizing and consolidating their operations and thereby increas- ing the efficiency and effectiveness of second-tier bankung, ideally via the operation of only one or two second-tier agencies with clear rules that would be applied consistently across different sectors. * Reform the pension and social securiry system (see the Pension Reform Chap- ter). The main elements of a reformed system should include (a) establishing a fully capitalized, actuarially sound, defined contribution pension system at 68 COLOMBIA. THE ECONOMIC FOUNDATION OF PEACE the national level for public and private employees with parameters related to eligibility rules, benefit accumulation rates, retirement age, and maximum benefit rules, adjusted to ensure its long-term financial viability; and (b) har- monizing the system across the different employee populations by moving Instituto de Seguro Social (Institute of Social Security, ISS) and the various spe- cial and "excepted" public employee pension regimes toward such a system as early as possible and by clearly specifying a transition phase to the extent that an immediate switch to such a new system is not politically or legally feasible; and (c) reforming the various sub-national level public employee pension schemes by implementing essentially the same principles for pension reform at the decentralized levels of government. * Review and reform judicial system procedures as they affect credit and finan- cial system operations. Most important, reduce the extremely long delays imposed in exercising guarantees and foreclosure of properties provided as col- lateral for credit transactions, which places a major burden on creditors and imposes, in effect, a high risk premium in all credit transactions in the econ- omy. Specific attention should be given to continued strengthening of effec- tive commercial arbitration and extrajudicial methods to reduce the economic burden of these legal and judicial processes. * Develop a comprehensive strategy to foster capital markets development. This strategy should include completion of the work started under the proposed new capital markets and securities legislation that established clear disclosure and transparency rules and strengthened the legal framework supervisory guidelines for entities and instruments to facilitate housing mortgage securiti- zation. Streamline regulations for efficient securities issuance procedures, to increase the capacity of the Superintendency of Securities (for example, to detect and investigate cases of market fraud, manipulation, and insider trad- ing), and to deepen the primary and secondary markets for fixed-income secu- rities issued by the Treasury By establishing the appropriate anchor for interest rates and a yield curve in the market, a government securities market could provide the necessary platform to further develop capital markets operations in other segments. The new securities legislation should be passed without delay. * Overhaul the insurance sector and the regulatory framework guiding it, given the relatively weak information systems and database in this area and an underdeveloped regulatory system that could threaten the heath of the sector, as important products such as those covering natural disaster insurance and crop- and weather-related insurance are developed in the future (see section on Disaster Management and Disaster Insurance Mechanisms). • Review problems of access to finance reportedly experienced by medium-size, small, and microenterprises throughout the economy, and rural enterprises. The progressive withdrawal of public banks and the consolidation of private sector institutions may have set the stage for the growth of more competitive and stable financial intermediaries. However, their impact on the availability ENABLING SUSTAINABLE GROWIH 69 and terms of services for different strata of rural households has not yet been compensated by a growth in credit flows from the financial system to small/ micro enterprises and the rural sector In the case of agriculture sector, the cur- rent agricultural credit scheme, which is anchored in the Banco Agrario and FINAGRO, needs to be reviewed with the objective of shifting the role of the state from retail lending to an institutional development role with more par- ticipation of private sector and nonbank intermediaries. Incentives and tech- nical assistance for intermediary capacity building should be provided to pro- mote expanded services in rural areas by sustainable bank and nonblank institutions. Instruments adapted to cater to the special needs of the rural pro- ducer in terms of savings mobilization, insurance schemes, contract farming, investment funds, and facilitation for the use of collaterals will therefore need to be developed. Innovations that reduce transaction costs and spread risks more effectively, such as index-based insurance and commodity price hedging, also ought to be considered for wider adoption IV. Creating a Business Environment to Foster Private Sector Development Although Colombia has produced notable private initiatives and penetration of new markets (for example, development of export markets for flowers and educational material; and private participation in water, electricity, and road concessions), the overall trends in small and medium-size enterprise development, export growth, investment rates, direct foreign investment, and overall factor productivity have not been promising. A recent reform of the corporate governance and bankruptcy legis- lation has brought some essential reforms to prevent creditors from pushing trou- bled companies into liquidation prematurely. However, it may need some further adjustments to streamline and modernize the rules for extrajudicial debt restructur- ing agreements (Acuerdos de Reestructuracuin under Law 550) and to ensure efficient closing or bankruptcy procedures where needed. Regulatory and competition frame- works have been improved in several infrastructure areas (see below). The performance of small and medium-size businesses and microenterprises, a segment critical to employment generation in the economy, has been poor. Colom- bia has had a strong historical tradition of innovative private sector and philan- thropy-based schemes to support small business and micro-enterprise development, and this needs to be revived, with government support, if necessary, in the areas of technical assistance, business advisory and information technology services, and cat- alytic financial assistance where appropriate. A major obstacle to fluid private sector operation is the large administrative bur- den (tramitologia) imposed on enterprises by federal, departmental, and municipal government authorities in the form of a myriad of administrative and license requirements, slow processing of required authorizations, and special fees or mone- 70 COLOMBIA: THE ECONOMIC FOUNDATION OF PEACE tary compensation that officials may demand. The impact of the administrative bur- dens imposed by these procedures, fees, and required authorizations is dispropor- tionately high on the smaller businesses and microenterprises because they represent fixed costs applied to a very small scale of business, and because in many cases the entrepreneur, head of the enterprise, or the senior-most official often have to devote substantial amounts of their own time to these chores, which is time away from managing the firm's productive operations, looking for new areas of business, and developing a customer base The government should commission a special study of the current requirements and their adverse impact on productive operations of dif- ferent sizes and in different sectors, and develop an agenda of reforms to ensure more streamlined and less costly procedures. Effort to develop nontraditional exports should be given high priority. With the spread of free trade arrangements and the gradual coming into force of World Trade Organization provisions, export development becomes an important ingredient of Colombia's economic growth strategy. A combination of assistance to budding exporters in the areas of market identification, product development, information and business advisory services, improved access to financing, and other technical assistance sources would help accelerate the development of export potential by Colombian entrepreneurs. Given the critical importance of private sector led growth and employment gener- anon, developing a consensus view across the different areas of the government (e.g., planning, finance and trade ministries, and departmental/municipal authorities) on a specific integrated set of actions that should be taken in these areas is a matter of urgent priority. This is best done via a quick comprehensive review that would help develop more detailed options and actionable recommendations in each of these areas for early consideration by the Consejo Nacional de Politicas Econ6micas y Sociales (National Council on Economic and Social Policies, COMPES) and rhe President. V. Improvement in Infrastructure and Public Services to Foster Competitiveness Adequate physical infrastructure can play a major role in enabling economic growth and competitiveness. Econometric studies using data from a large number of devel- oping and developed countries show that as much as one third of economic growth can be directly linked to the availability of adequate infrastructure, and Colombia is no exception. Poor logistics alone have been estimated in some economies to lead to a 15 to 20 percent increase in the total cost of production in some sectors. Indeed the role of infrastructure in enabling growth may actually be even greater now in Colombia, given the significant erosion of physical infrastructure facilities that took place in recent years as a result of both inadequate maintenance budgets, and vio- lence that includes periodic sabotage of highways, bridges, power transfer stations, distribution towers, and other facilities. ENABIING SUSTAINABLE GROWrH 71 Despite very challenging circumstances, Colombia has made major efforts over the last decade to improve the organization and efficiency of infrastructure services, and has implemented several thoughtful initiatives. Although the nature of the efforts and their relative success varied greatly across different infrastructure sectors, there has been progress in most sectors. In general, these efforts paid off in terms of serv- ice improvement and greater amounts of foreign and domestic investment in many of the infrastructure sectors, even while hindered in specific sectors by the problems created directly or indirectly by the security situation (such as problems in road trans- port concession projects and privatization proposals in electricity generation and dis- tribution companies). In the last three years, foreign and domestic investment rates have turned downward sharply, reflecting the difficult macroeconomic and security conditions, the need for fiscal austerity, and the volatility and uncertainty that has characterized the financial markets and Colombia's credit rating in international mar- kets. Given the limited public resources available for investment in these sectors, unless private sector investment picks up substantially, Colombia will fall short of the minimum infrastructure investments needed to ensure adequate maintenance, replacement, and expansion of the services to keep up with the demands of the grow- ing population and to fuel the requisite economic growth. a) Energy Sector Over the last decade Colombia has been a pioneer in implementing far-reaching structural and regulatory reforms in the electricity sector. The current structure pro- vides for an unbundled electricity sector structure (between generation, transmis- sion, distribution, and marketing) that is conducive to competition and private sec- tor participation in electricity generation and distribution. A well-functioning wholesale electricity market has been established and has already demonstrated sig- nificant gains in overall efficiency, cost reduction, and quality of service (number of service interruptionis, loss and access indicators) and maintenance of relatively stable electricity prices to consumers since the inception of the wholesale market. The state-owned generation and transmission company (Interconexidn ElMctrica S.A., ISA) continues to be one of the most efficiently run public sector companies in Colombia, and has even shown an institutional capacity to cope with the traumatic events related to guerilla violence without major systemic breakdowns. Guerilla-related violence and threats have, however, caused major damage to power and oil transmission and distribution facilities, typically causing major inter- ruptions in service through the blowing up of towers and other facilities. The con- templated privatization of ISA (which was to be unbundled and sold) had to be sig- nificantly delayed as a result, but a proceeding more gradually via public share offerings in the market. Privatization of ISAGEN and several regional distribution companies was also delayed as a result of an anti-trust dispute (ISAGEN) and cer- tain financial and governance issues (distribution companies). Efforts are under way to complete the process with some innovative shareholder structures to offset the 72 COLOMBIA: THE ECONOMIC FOUNDATION OF PEACE uncertainties posed by guerilla activities, including the very successful offering of a significant block of ISA shares to the public at large via rhe stock market. The sec- tor regulatory agency, the Comiszdn de Regulaczdn de Electricidad (CRE), developed good institutional capacity and had been instrumental in the healthy development of the electricity wholesale market. However, over the last two years, some impor- tant questions have been raised by private sector participants as to whether CRE's interpretation of the regulations in imposing certain price restraints in the operation of the wholesale market was sound and whether CREG is becoming excessively short term oriented. Key concerns relate to the way the recovery of capacity charge is dealt with under the rules of operation of the wholesale market. There may well be some legal challenges to the jurisdictional authority of CRE or the manner in which it is being implemented. If not resolved in a manner amicable to all parties, doubts about such interpretations may have a negative effect on the attraction of fur- ther private sector investment into the sector. Colombia is a country with major coal reserves. The government has been largely successful in privatizing the coal industry and thereby developing an export-ori- ented, private-sector-led industry. The logistics of the transport of coal and arrange- ments for sharing transport and railway facilities among firms under clear rules are important issues in this sector. The government has generally been successful in arranging for reasonable sharing, although this may need some additional work. The government, through the Empresa Colombiana de Petrdleos (ECOPETROL), has been fairly successful in maintaining the interest of oil companies in exploration, primarily by adjusting the parameters of the association contracts and pricing to be in line with the evolving international scenario and the local reservoir characteris- tics. Oil exploration and production are conducted mainly under "association con- tracts" between ECOPETROL and private companies. Work is also under way to strengthen the regulatory structure governing natural gas transmission and distribu- tion throughout Colombia. The strategy is to strengthen the sector institutions in implementing the regulations, and to promote more effective use of natural gas through an expansion of the gas pipeline network and distribution stations through- out the country. In part to make up for the adverse developments in the investments stemming from the deteriorating security situation, the terms of the standard joint venture contract among ECOPETROL and oil and gas companies were modified during 1994-2000. The 1999 and 2000 reforms included royalty relief and a reduc- tion in ECOPETROLs participation requirement from 50 percent to 30 percent. There are, however, potential opportunities to improve incentives and move towards further deregulation in the natural gas and oil sectors. A special effort is needed to improve access to electricity and other energy sources in the rural and isolated areas. A focus in developing off-grid electricity supply based on renewable energy sources such as wind, geothermal energy or mini-hydro plants would seem a promising avenue to correct the deficiencies in access. In this connec- tion, Colombia should aim to take advantage of the incentives for renewable energy production offered under the Kyoto Protocol and the Prototype Carbon Fund. ENABLING SUSIAINABLE GROWTH 73 ENERGY/ENVRONMENT ISSUES. Oil exports have decreased in recent years, from 810,000 bbl/d in 1999 to 630,000 bbl/d in 2001. This decline is partially due to more than 180 bombings of the Cano Limon-Covenas, Transandino, and Ocensa pipelines in 2000 and 2001. Oil spills due to these bombings have had a significant negative environmental impact. Given the regulatory uncertainty caused by the current envi- ronmental licensing system, has led to regulatory uncertainty. There is an urgent need to reform the regulations on environmental licensing for oil and gas projects (Decree 1753/1994). The government has strengthened the capacity to monitor the environ- mental impact of energy-related policies and projects e.g., to monitor the environ- mental impact of the use of fossil fuels in the transport sector. Work is also under way to strengthen both the regulatory structure governing natural gas transmission and dis- tribution throughout Colombia and the sector institutions implementing the regula- tions, and to promote more effective use of natural gas through an expansion of the gas pipeline network and distribution stations throughout the country. Among the key strategic issues to be addressed by the new Administrationi in the energy sector are: * Adequacy of the incentives for petroleum exploration and development (including tax policies, royalties, sharing agreements, etc.) in light of the cur- rent security situation and how these may need to be adapted as security con- ditions in Colombia improve or deteriorate. * Appropriate division of roles between the public and private sector; including in particular ECOPETROL's dual role as a producer and as the entity with which all other producing companies have to enter into association contracts. * Possible further deregulation of the natural gas, in respect of well head prices, downstream operations and prevailing restrictions and exports. * Best strategies and options for proceeding with the privatization of ISA, ISAGEN and the distribution companies which are still in public sector hands. * A full review of the performance of CREG, required institutional improve- ments in CREG, and improving the clarity of the nature of its regulatory role and scope of functions, while preserving its autonomy from the line ministries. * Improving the capacity, operations and performance of SSPD. * Putting in place a holistic strategy to improve access to electricity/energy to rural and isolated areas via public-private solutions to energy services. * Taking advantage of opportunities offered by the Kyoto Protocol and the Pro- totype Carbon Fund (PCF) to finance off-grid solutions (e.g., wind, small hydro plant). * Reexamining the efficacy of the cross-subsidization scheme on electricity prices currently based on classification of customer by income strata. Consid- eration of options that may be available to make the system simpler and easier to operate-for example one in which the basic minimum level of services is offered at a subsidized price for all customers, with higher (and possibly esca- lating) prices for additional blocks of service. 74 COLOMBiA THE ECONOMIC FOUNDATION OF PEACE Further enhancement of institutional capacities to monitor and minimize adverse environmental impact of energy operations. b) Telecommunications Over the last five to 10 years Colombia has taken steps to open up the cellular tele- phone market, conduct spectrum auctions and, more recently, redesign the ongoing Personal Communication Service (PCS) concessions to make them viable. The fixed-wire telephone services are, however, lagging behind in terms of reforms, and are still dominated by government-owned local and long-distance telephone capac- ity (the Bogota telephone company and TELECOM, respectively). The telecommunications sector in Colombia faces several issues: * Low Private Sector Participation. Only 3.4 percent of Colombia's telephone lines are in the hands of private companies today, compared to 85 percent for Latin America as a whole. In general, telecommunications is considered to be a private sector business throughout the region, with the exception of Colom- bia and only a few other countries. * Fragmentation of Regulatory Institutions. Colombia's regulatory institutions are fragmented: (a) the Commission for Television Services oversees the television subsector; (b) the Ministry of Communications manages the Radio Frequency Spectrum, assigns frequencies for different use, and controls the radio subsector; (c) the Telecommunications Regulatory Commission dictates the fundamental technical plans and manages other scarce resources for the telecommunication operators; (d) the Superintendency of Industry and Commerce regulates the operators' anticompetitive behavior; and (e) the Superintendency of Public Domiciliary Services supervises the relations between customers and operators. * Subsidies and Tariffi. Compared with other countries and the rest of Latin America, Colombian tariffs are below the average, and in some cases, below the cost of providing the service, causing financial problems for electricity companies and contributing to government fiscal imbalance. o Low Internet Penetration. Colombia had only 0.54 Internet hosts per 1,000 inhabitants, well below countries of similar GDP per capita, and below Argentina, Brazil, and Mexico. * Reduced Role of Colombia in the Information Society and the Global Economy. Even though the Pastrana administration's "Connectivity Agenda"3 has made an impressive contribution to bring Colombia into the Information Society, much remains to be done. There are still too few computers in Colombia, fewer con- nections to the Internet than in other Latin American countries, and lower use of information and communication technologies (ICTs) for development. 3. "Agenda de Conectividad," Departamento Nacional de Planeaci6n, Bogota, 9 February 2000, Documento COMPES, 3072. ENABLING SUSTAINABLE GROWTH 75 In addressing these issues, the government should give serious attention to the following specific actions: * Increased Private Sector Participation The current scenario of public sector controlled companies playing a dominant role in providing telecommunica- tion services should yield way to significantly increased private sector partici- pation via a proactive restructuring and privatization program. To facilitate that, several other measures listed below need to be taken simultaneously to guarantee a vibrant and competitive sector. * Tariff Reform Local telephone tariffs need to be liberalized within the framework of a price cap-based regulatory system to stimulate investments in local service. Such a system would allow companies freedom to set their own tariffs as long as they comply with the price cap, which would be set at a level high enough to guarantee a reasonable rate of return to companies that invest in networks to provide new telephone lines. An international benchmarking system could be used to set and periodically adjust the price cap. To ensure access to minimum basic service to the poorest and least priv- ileged segments of the population, a "lifeline service" operated via public phones or a prepaid access cards system should be considered. This would replace the current system of stratification of subscribers for tariff purposes which has not been effective or economically efficient. In order to harmo- nize better with international rates and avoid adverse incentives for compa- nies and consumers, the government should also consider replacing the taxes imposed on long-distance calls with a general tax on telecommunica- tions company profits and setting the new proposed levy for universal serv- ice at a more moderate level.4 * Consolidation of Regulatory Institutions. The current system requires telecommunications enterprises to submit informationi and a multitude of reports to satisfy the requirements of diverse regulatory institutionls. More- over, given the overlapping jurisdictions, it is difficult to have clarity on with regulatory entity should have the ultimate say on a specific issue The creation of a single regulatory entity for the telecom sector covering tariffs, service licensing as well as spectrum control would be desirable. The gov- ernment, through the Ministry of Communications, should in any case retain the responsibility for formulating and implementing overall sector strategy and policies. * Incentivesfor Local Telephone Companies to CompeteAgainst Each Other and the Flexibility to Merge To provide incentives for the private sector to invest in local telephone companies, they should be allowed to also offer mobile services (cel- lular and PCS services) which is the segment of the industry that has higher growth potential for the future and needs large investments in line with the 4 In Latin America the fee is usually one percent of gross revenues 76 COLOMBLA THE ECONOMIC FOUNDATION OF PEACE oncoming third generation of mobile services.5 In addition to the 1900 MHz band (the North American Standard) already open, the government should also make available the 1800 MHz band (the European Standard) to operators. Telecommunication assets, concessions and frequency bands for mobile serv- ices should be auctioned via open public offerings to facilitate structured com- petition in the sector, efficiency enhancing mergers where appropriate. Colombia and the Information Society. The government should increase efforts to insert Colombia into the new Information Society. A key measure would be to assign consolidated responsibility for developing and implementing an integrated information and communication technology (ICT) strategy. Work- ing closely other ministries, it would help develop and implement new ICT applications to improve the efficiency and effectiveness in these other eco- nomic and social areas, and insert Colombia firmly into the rapidly evolving world knowledge economy. The government should also consider all or part of the revenues mobilized from the telecommunications companies to fund ICT applications for development purposes, outsourcing the actual provision of ICT-based services to the private sector as much as possible. c) Transport Colombia had been a pioneer in the private sector-driven development of ports, which handle 98 percent of exports flowing out of Colombia, with a large portion of it through specialized private terminals (coffee, bananas, and oil). The opening up of these sectors for private sector participation has on the whole been very success- ful and has yielded positive results in terms of increases in productivity and effi- ciency of port operations, reduction in total costs and shipping times, and corre- sponding reduction in rates. In the civil aviation sector, three hub airports and the second Bogota airport terminal have been given under concession contracts, and the independent regulatory authority (Aerocivdl) established earlier continues to func- tion satisfactorily. In railroads, two networks (Pacifico and Atl4ntico) and the rolling stock were recently devolved to the private sector under two concessions. Although these initiatives are also expected to yield productivity, efficiency, and quality-of- service gains, the ultimate effects cannot yet be assessed. In the area of highway development, Colombia had been innovative as well, lay- ing out a strategy that explicitly considered ways to maximize private sector partici- pation via different types and "generations" of toll road concessions, together with methodologies for prioritizing budget allocations among federal and departmentally funded highways and secondary and tertiary roads. The Instituto Nacional de Vias (National Highway Institute, INVIAS), the government agency responsible for managing the national highway program, was actively pursuing innovative methods 5 The third generation usually refers to mobile telephone systems that provide fast Internet access for data, voice, and video ENABLING SUSTAINABLE GRO\vTH 77 to achieve this objective, such as providing certain types of assurances regarding traf- fic demand, and "negativc concessions" where concessionaires bid for the minimum present value of the toll road revenue they will retain. Colombia has a long experi- ence of contracting maintenance through microenterprises, achieving substantial improvement in the condition of the road network by the end of the 1990s The government also took action to reduce accidents and hijackings, and introduced monitoring of vehicles in transit via Global Positioning Systems (GPS). Recently, however, all parts of implementation of the highways program have experienced severe setbacks. Security concerns have made it extremely difficult to reach agreements with the private sector on new concession arrangements, especially where the size of the transaction or technical capacity requires the participation of foreign investors and concessionaires. Severely constrained budget resources com- bined with an increasing incidence of sabotage have limited new work on even nationally or departmentally sponsored roads. Local communities that depend on access roads for education and health facilities and trade links to the rest of the Colombian economy have suffered severely. Management of road concessions has also suffered from weaknesses in the institutional capacity to follow up, control, and supervise the concession contracts, and from the lack of an overarching framework linking the concessions program to the functioning of the transportation system as a whole. Given that the availability of good quality roads is typically a key factor in the ability of the population (especially the poorest families) to access basic education and health service facilities and to participate in economic activity and the productive labor force, it is critical to quickly correct these deficiencies. One bright spot has been the development of the urban transport system in Bogota, with a clear and consistent policy anchored in the development of the highly successful transmilento and improved attention to road safety, service improvement, and reduction in adverse environmental effects of vehicular emissions (for example, through the introduction of the pico yplaca system which requires all cars to be off the roads one day a week). Given the uncertainties and lack of a sector strategy that can be effectively imple- mented, INVIAS and the Ministry of Transport have also suffered the loss of key staff and decreased motivation among those who remain in the agencies. The con- sequent erosion of institutional capacity in these agencies is an important problem that needs to be addressed. It is also critical to establish and build the capacity of a transport regulatory agency to provide clear guidelines for sector activities, and to build the capacity of agencies responsible for road building and maintenance at the departmental and local levels. Looking ahead, it is critical to * Rebuild and strengthen the institutional capacity of (a) the Ministry of Trans- port, to enable it to better perform its role as policymaker and ensure the devel- opment of a good master plan for transport; (b) INVIAS in its role as the entity with responsibility for detailed road planning and design and execution of road concessions; and (c) a well-functioning transport regulatory commission. 78 COLOMBIA: THE ECONOMIC FOUNDATION OF PEACE * Clarify the division of responsibilities between the federal and decentralized levels of the government, and build appropriate institutional capacities at the decentralized (department and municipal) levels of government. * Overhaul the highway concessions program to adapt it to the reality of the Colombian security situation, if necessary incorporating appropriate transi- tion and contingency management strategies, ensure longer-term financial and environmental sustainability of the system. Should the security condi- tions improve, be prepared to revert to a viable longer-term strategy. * Develop innovative methods for building and maintaining rural and regional roads that fully incorporate the participation of the local communities and promote a concept of integrated regional development; features could include contributions (in klnd or in cash) of the local communities in road construc- tion and/or maintenance, links to tertiary roads and nonmotorized transport methods where appropriate, and promoting participation of local microenter- prises in the work and in housing and community facilities development. d) Urban Development and Low-Income Housing In Colombia, 31 million people reside in urban areas, compared to about 12 mil- lion in rural areas. Indications are that there will be an even greater shift of popula- tion toward urban areas in the future. Among the problems faced by Colombia's growing urban population are (a) lack of systematic urban land management; (b) poorly developed land-titling systems and land markets; (c) congestion and trans- portation bottlenecks in the large urban centers; (d) large slum areas surrounding major cities that suffer from lack of access to basic infrastructure services such as piped water, electricity, community roads, and telephones; and (e) inadequate access roads to link the poorer neighborhoods to the main city centers. The problems tend to accumulate and worsen over time because of inadequate institutional capacity of the municipalities and departments to develop strategies to correct these problems. Given the limitation of three-year, nonrenewable terms for mayors of municipallties, there is also typically very little incentive for city administrations to take corrective actions that are strategically thought through. Also, notwithstanding specific provi- sions under Law 134 of 1994 to strengthen citizen participation in local decision- making, there is often less-than-sufficient consultation with and participation of local communities in designing and implementing urban development solutions. Despite some overall improvement in aggregate urban poverty indicators, there are large localities in metropolitan areas that are clearly suffering from acute poverty, overcrowding, unhealthy environmental and social conditions, lack of basic services such as water supply and sanitation, and extremely poor-quality housing with haz- ardous conditions. The history of inadequate shelter options and the lack of an effective targeted subsidy system for the lowest-income stratum has led to disorderly growth of slum areas. These areas are characterized by informal settlements typically initiated through illegal but organized "invasions" of public lands and accelerated by ENABLING SUSTAINABLE GROWTH 79 pirate developers. Since the settlers in these areas almost never receive legal property titles to the land they are occupying, there are few incentives for them to improve the land and the services thereof unless the government takes specific action to facil- itate an orderly transformation of these areas. To address these problems Colombia must focus on: * Progressive upgrading via community-based development, together with practical solutions for problems of land tenure and property titling, and effi- cient mechanisms to help the poor help themselves. * Other effective measures to expand the shelter supply to the poor that, among other things, could stem the tide of informal settlements and "invasions" of public lands. * More effective ways of addressing the problems of access to basic services such as water, sanitation, electricity, community roads, and other amenities, within the framework of actions advocated in the individual sectors as described in the preceding sections * Improved functioning and capacity of the environmental management agen- cies (EMAs) or the equivalent units operating through the autonomous regional agencies to ensure environmentally responsible development of these areas, removing the current overlapping responsibilities among the local, regional, and central level agencies. Also of high priority are measures to improve the operation of the land markets by removing or relaxing the excessively cumbersome rules and regulations that govern land acquisition, titling, and transfer. Programs to upgrade land, roads, and housing in slum areas surrounding the main cities of Colombia and to improve access of basic services to those areas could go far in improving the quality of life in urban slums. The experi- ence of other countries in Latin America and elsewhere (Brazil, Thailand, Venezuela) indicates that a systematic approach to upgrading slums will help integrate them into the cities and ensure access to basic services for the population living in those areas, and will instill in them a greater sense of community, ownership, and social capital. A well- designed subsidy system, with clear targeting of the subsidies to the lowest-income seg- ments of the population and with incentives built in for development of "progressive housing" (that is, gradual improvements in the housing units maklng use of household savings) could play an important role in improving the lot of these less-privileged com- munities and integrating them into the main urban areas. It would be important to combine and closely link these measures to initiatives to increase the supply of shelter, specifically to accommodate the needs of the poorest of the poor e) Superintendency of Domestic Public Services The Colombian institutional structure includes a unique mechanism for ensuring that public services provided to households by municipal or other public or private 80 COLOMBIA. THE ECONOMIC FOUNDATION OF PEACE service providers abide by certain basic rules and regulations. These supervision functions are preformed by the Superintendency of Domestic Public Services (SSPD). The SSPD complements the functions performed by the individual sectoral regulatory agencies such as the CRE, the Comisidn Reguladora de Agua Potable y Saneamiento Bdszco (Water Regulatory Commission, CRA), and others. Among its important functions are to ensure that the entities providing public services to citi- zens are being run effectively and in a financially responsible and sustainable way, that service quality is being respected, and in the case of specific concessions, that the rules agreed upon under the concession agreement are being respected. The SSPD has the authority to take over the management and control of a public utility under its jurisdiction if it finds that the utility is in violation of the rules and that its operation is deemed unsustainable financially or otherwise. In general, this means that if the SSPD intervenes in the operation of a utility, it will have to take over the operation of that utility and maintain satisfactory service provision during an interim period, until an appropriate restructuring and transfer of the utility to a new ownership and/or management can be achieved. While this rather unique structure offers the advantage of a clear separation between the roles of sector policy and tariff regulation and the supervision and con- trol of the operations of the specific entities providing services, in practice, this statute has given rise to a number of problems. Most important, it has been difficult for the SSPD to acquire the requisite institutional skills to interpret and enforce the regulations applying to the broad array of domestic services over which it has juris- diction (water, sanitation, solid waste disposal, electricity and natural gas distribu- tion, telecommunications, and so forth). There have also been gray areas as to its jurisdiction vis-a-vis the individual sector regulatory bodies (CRA, CRE, and so forth). Finally, while the SSPD is entrusted with the authority to intervene in the operation of a utility that is performing less than satisfactorily and poses the risk of defaulting financially or in the discharge of its responsibilities, it generally lacks the technical, administrative, or other capacity (or the incentives structure) to operate these public utilities effectively even during an interim period, let alone to shepherd a rational restructuring of the entity. The functions of intervention, restructuring, and spinning off the operations of public utilities require very advanced technical, administrative, and financial engineering skills that the SSPD lacks. This has become quite clear from the way the SSPD tried to manage the interventions of a number of electricity distribution companies and water supply and sanitation com- panies over the past two years. For the SSPD to be able to discharge its responsibil- ities effectively will require, at a minimum, highly focused efforts to precisely define the rules of operation governing SSPD interventions, the scope of authority and responsibilities of the SSPD during the period of intervention, and creation within the SSPD of the requisite advanced level of institutional capacity and sophistication. If this is considered untenable in the long term, the government may need to search for other more appropriate institutional mechanisms, including a possible reorder- ing of the entire supervisory apparatus for basic public services. ENABLING SUSTAINABLE GROwrH 81 VI. Management of Natural Resources and Physical Environment In pursuing growth, productivity, and employment objectives, it is critical that the government preserves and protects the rich natural resource endowment of Colom- bia. Clearly, growth achieved at the expense of damage to physical environment or poor management of natural resources will not be sustainable and cannot assure long term improvement of the quality of life for Colombians. Worldwide experience has shown that correcting environmental degradation will almost always prove to be much more expensive than prevention through prudent natural resource manage- ment policies based on appropriate incentives. The following sections examine five critical areas related to natural resources management and environmental protec- tion: (a) agriculture and land resources management; (b) water resources protection and management; (c) potable water supply, sanitation and wastewater treatment; (d) solid waste management; and (e) management of natural disasters. a) Rural and Agricultural Development Skewed incentives and lack of appropriate technologies, compounded by the expan- sion of illicit crops, are taking a toll on Colombia's natural resources, and its remark- able environmental capital is being rapidly degraded. Colombia has amongst the richest biodiversity resources but also faces major soil degradation and water pollu- tion problems which are having a detrimental effect on many watersheds and on the contamination of the hydrological systems.6 In the Orinioquia and Amazonia regions, the impact comes from recent colonization, but it is already showing in the Guanfa, Guaviare, Putumayo, Caqueta, and Meta departments, where more than half of the area has already been deforested. The gap between the natural vocation of the land and its actual use points to a distorted incentive structure and inappro- priate use of resources. It is estimated that the agriculture/livestock frontier advances at a rate of 200,000 hectares per year.7 AGRICULTURE The agriculture sector is of major importance in the Colombian economy accounting for 14 percent of GDP, 23 percent of the labor force, and 28 percent of total exports. In the aggregate, it shows relatively high labor productivity and a remarkable development potential thanks to the extraordinarily rich natural resource endowment and the quality of its human capital. However, recent produc- tion trends suggest that the natural resource base is not being used efficiently. There has been a sharp decrease in the area sown with annual crops during the nineties, 6 The volume of sediment transported by the Magdalena River to the sea (130 million tons) is equivalent to 40 percent of the total sediment carried by the entire fluvial network of the country (IDEAM 1998, "El Medio Ambiente en Colombia") 7 "Estudio sobre cobertura y uso actual de la tierra en Colombia," (IGAC-CORPOICA 2001). 82 COLOMBIA THE ECONOMIC FOUNDATION OF PEACE resulting in an estimated decrease of one million hectares to a level of 1.6 million hectares. This decrease in annual crops has been only partially offset by an increase in permanent crops. Most of the land taken out of crops has been converted into extensive livestock farming of low productivity. Almost all of the livestock farming is based on the latfijndios with about 38 percent of the production based in 3.5 per- cent of the farms and much of the expansion in permanent crops is also in the large- holder sector. The gap between the natural vocation of the soil and its productive use suggests an inefficient allocation of resources stemming from biased incentives in agriculture, land, rural finance, etc. This is evident even in the irrigation sector where the absence of rigorous cost recovery in public irrigation schemes and skewed incentives helps explain why most of the land is under low-margin crops and pasture. More- over, the insecurity generated by violence reduces the incentive to invest in agricul- ture and biases the pattern of investment toward non-intensive farm activities. At the prevailing low coffee prices, marginal coffee producing areas (especially small- holder farms), which have so far managed to remain relatively insulated, are now likely to be tempted to move towards illicit crops. Given the critical role of the coffee sector in the rural agricultural areas, avoiding a rural poverty crisis will require strong action to help improve productivity in the coffee sector. One strategy should be to help Colombian coffee producers move toward the country's comparative advantage, e g niche markets for high quality cof- fee. This requires targeted promotion and marketing effort and strengthening of public and private institutions to help implement such a strategy. A diversification strategy will be key to increasing productivity. Effective diversi- fication will require improvements in rural infrastructure, contract farming, mar- keting aliances, access to land and credit, and innovation strategies for small farm- ers. Some coffee producing farms and areas may have to get out of coffee. This will have large social implications and the issue of social safety nets and social compen- sation will have to be confronted while taking into account the fiscal costs of such strategies. The government, which has played a minor role in the coffee industry in Colombia up to now, should probably become more proactive in helping to imple- ment a multi-pronged approach along the above lines. FOREST LAND MANAGEMENT. Growing crops to produce illicit drugs contributes to deforestation. At the same time, spraying drug crops to destroy them contributes to environmental contamination and to the deterioration of natural resources, and is also affecting the health of the population living in these areas. In addition, coca cultivation is extremely destructive to forests in fragile areas. The recent expansion of the fumigation of coca fields has accelerated the itinerant characteristic of illicit crop growers in the search for new land to be cleared. In addition, chemical residues from coca laboratories are contaminating water flows and aquifers. The conflict will continue to pose a serious limitation on any attempt to manage natural resources in a sustainable way because violence is particularly acute in the richly endowed areas. ENABLING SUSIAINABLE GROwrWH 83 HAPHAZARD INFRASTRUCTURE DEVELOPMENT. Rural infrastructure work, espe- cially building roads, has also accelerated the natural ecosystem transformation process. Despite progress on the regulatory and institutional front, there has been little implementation of the Planes de Ordenamiento Territorial (Territor- ial Land Use Plans, POTs) contemplated in Law 388 of 1997, nor diligent application of environmental assessments to infrastructure development. ENHANCING COMMUNITY PARTICII'ATION. Efforts to restore natural resource man- agement practices need to be built from the local level up. Communities need to reestablish a certain level of social cohesion to enable them to make appropriate trade-offs among agriculture, livestock, and the sustainable use of natural resources at the local level. Unfortunately, the indigenous reserves and the communal land rights granted to Afro-Colombians have also been affected by decreasing social cohe- sion, as well as the disorder caused by the armed conflict b) Water Resources Management WATER QUALITY PROTECTION The ambiguities in the regulatory framework regarding pollution standards, environmental licensing, and pollution charges related to water resource management pose potential risks to the protection and conservation of this crucial resource as well as potential for private sector mivest- ment in this area The case of pollution charges illustrates the instability of the regulatory environment In 1993 Colombia became a regional leader in the development and implementation of economic instruments to mitigate and control environmental pollution. Under Law 99/93, Congress established pol- lution charges (tasas retributivas), and Decree 901 of 1997 established the actual implementation mechanism for wastewater charges. However, the ambiguity and other weaknesses of the system have allowed only few regional environ- mental authorities (Corporaciones AutSnomas Regionales) to fully implement the wastewater pollution charges. Even in those cases, the rules of the game are not completely clear. The regional environmental authorities determine the locally appropriate level of organic load and suspended solids in the water and set the pollution charges in a discretionary way. The wastewater charges could increase several times, in short periods of time, until the water quality goal is achieved. In light of this, and certain technical issues of water and sanitation regulation, it has become apparent that the system's regulatory methodology needs improve- ment. For example, it would be necessary to: (a) move away from the organic and total suspended solids loads for which the dischargers have to pay now, toward the actual water quality parameters that have a more significant effect on human health, such as heavy metals and toxic organic compounds; and (b) revise the actual charges such that they are less discretionary and more consis- tent across the country, ensuring clear "rules of the game" for industry and also for PSP in water utilities. 84 COLOMBIA: THE ECONOMIC FOUNDATION OF PEACE DECENTRALIZED WATER BASIN MANAGEMENT. The system of Corporaciones Autdno- mas Regionales (Autonomous Regional Corporations, CARs) has a mandate to oversee allocation of from individual water basins, act as regional environmental regulatory agencies, and to develop large infrastructure projects, water resources projects, basic sanitation, and other public works. There is a conflict of interest in the responsibilities of these authorities, since they act as regulators and at the same time implement irri- gation, drainage, water reservoirs, wastewater treatment plans, landfills, forestry, and other projects. The mandates of these authorities to implement large infrastructure development projects also overlaps with the mandates of national agencies, depart- ments, and municipalities. A reform of these 34 CARs that exist in Colombia is nec- essary to strengthen the environmental regulatory responsibilities and to overcome the conflict of interest and the overlapping of responsibilities mentioned above. c) Potable Water Supply, Sanitation, and Wastewater Treatment Given that water supply, sanitation, and wastewater treatment responsibilities fall mostly under local jurisdiction, the role of the central government is primarily to guide the overall policies and set the regulatory and tariff principles. As part of the provisions of the general law governing the economic management of all public serv- ices (Law 142 of 1994), water supply and sewerage charges levied on consumers (like most other public services) are required to be set at levels that ensure at least full recovery of operation and maintenance costs and the long-term financial sustain- ability of the utilities concerned. The law allows a scheme of cross-subsidization under which the commercial and industrial sectors and the two highest strata of res- idents could be required to pay up to 20 percent more than the value of their con- sumption to help finance the basic consumption of lower strata. Working within this framework, local governments can set the detailed tariff structures and decide on any explicit subsidies or cross-subsidies they are willing to provide from their own budget resources for the poorer segments of the population. This system of checks and balances is beginning to function, although there is still much to be learned as full implementation of the system proceeds. Most water and sewerage systems providing service to the major urban centers of Colombia are operated directly by the respective municipalities or enterprises fully owned by the municipal government. Although the major urban centers of Colom- bia have had operating water and sewerage systems for a long time, most of them suffer from problems of low operational efficiency, high water wastage, poorly main- tained pipelines, limited (if any) access of piped water to the poorer neighborhoods, and water and sewerage charges that are inadequate to allow a financially sustainable operation by the utility. Wastewater discharges into bodies of water are also required to fully abide by the applicable environmental regulations and charges. However, in reality, few municipalities in Colombia (including major cities) have satisfactory wastewater treatment facilities to treat the water prior to discharging it into bodies of water. Thus few of them manage to comply with the applicable environmental ENABLINCG SUSTAINABLE GROWTH 85 regulations on such discharges. This is a problem that needs urgent attention and appropriate corrective measures, because some of the major bodies of water in Colombia are already severely contaminated and pose significant health and envi- ronmental risks. The government recently launched a nationwide program to help small and medium-size water supply and sewerage systems improve the efficiency and quality of their services and ensure adequate water access to the poorer neighborhoods. The local communities themselves would have a major role in developing the available options to improve the quality and access of water service and choosing one that best fits their needs. It 1s anticipated that a majority of the communities will choose a pri- vate sector concessionaire, manager, or operator to run the services. The government initiative aims to attract the largest possible amount of private investment resources into the sector and to catalyze improved efficiency, reduced wastage, and good cost recovery The program is aimed at learning from the initial experience with water supply concessions and management and operating agreements, and then applying what is learned to the operation of a large number of water and sewerage systems throughout Colombia. This program of gradually extending private sector partici- pation and adapting the specific mode of private participation to the characteristics and size of the local water and sanitation system is highly commendable. To tackle the major issues facing the sector, Colombia must: * Focus on improving water supply and sanitation services in small and medium-size municipalities while improving the efficiency of operation, qual- ity of service, and access provided by them through the progressive applica- tion of economic efficiency principles and innovative methods to increase engagement of private sector participation in investments and operations. * Improve the operation, efficiency, quality, and access to water and sanitation systems in the large metropolitan areas, where there are even greater opportu- nities to move toward and increase the private sector role in all aspects of investment and operations. Pilot schemes to test alternative solutions should be tried in the near term in this area. * Develop and implement a policy for increasing the coverage and level of serv- ice in the rural sector, which has steadily deteriorated over the last 15 years. * Improve management and disposal of municipal wastewater throughout Colombia by (a) harmonizing environmental legislation and guidelines related to water and sanitation to ensure public health and to prevent further environmental deterioration, in general, and of the quality of drinking water sources, in particular; and (b) identifying municipalities of high priority in terms of the need for wastewater treatment to prevent public health risks and degradation of water resources. * Implement a simple but effective water sector regulatory framework under the authority of the Water Regulatory Commission (CRA) to address the prob- lems identified above. 86 COLOMBIA THE ECONOMIC FOUNDATION OF PEACE * Develop innovative options to finance the above activities by creating frame- works to attract increasing investment and financial resources from the private sector. * Reform the CARs to strengthen their institutional capacity to discharge their responsibilities and overcome the conflict of interest and overlapping respon- sibilities mentioned above. d) Solid Waste Management More than 21,000 tons per day of municipal solid waste are improperly disposed of in urban centers in Colombia. There is an urgent need to address this problem. The national government has developed policies and a methodology for the man- agement of solid waste in the country. However, the implementation of these poli- cies falls almost entirely in the hands of the municipal governments, and their record is very mixed. Although a number of municipalities have well organized col- lection systems, and with support from the Fondo de Regalias, have been investing in building landfills for the adequate final disposal of municipal waste, much remains to be done in this sector. For example, the regulatory framework needs to be revised, the technical assistance to municipal governments must be strength- ened, and additional resources for investments for solid waste management would have to be made available. e) Disaster Management and Disaster Insurance Mechanisms Colombia also confronts a variety of challenges related to natural disasters such as floods, droughts, and earthquakes. A separate section that follows identifies the key issues that bear consideration in achieving rational management of the impact of the potential natural disasters. Specific attention is paid to strategies to prevent or min- imize the disaster related damages and methods to anticipate the contingencies and financial costs and plan for them in a way that does not disrupt Colombia's long term economic development. Among other things, rational use of disaster insurance mechanisms and other contingent financial instruments should help mitigate and smooth the fiscal and financial costs of natural disasters. Colombia has historically been affected by a variety of natural disasters including earthquakes, hurricanes, floods, and droughts. Shifts in weather patterns make agri- cultural crop production particularly vulnerable. A systematic approach to antici- pating and putting in place appropriate safeguards could go a long way in reducing the human and economic costs of natural disasters. Specification and enforcement of better building codes at the national and local levels (tailored to the natural phe- nomena that characterize a particular geographical area), promotion of earthquake- proof construction methods, strengthening of information systems, a systematic approach to risk and vulnerability assessments, closer coordination amongst the dif- ferent institutions involved, and putting in place tighter standards for public infra- ENABLING SUSrAINABLE GROWTH 87 structure in disaster-prone areas could play an important role in minimizing dam- age and losses caused by natural disasters. Good contingency planning and innovative disaster insurance techniques should be used to help smooth the costs over time of coping with disasters, and minimize the trauma caused to the society by major catastrophes. Statistical and actuarial models have been applied successfully in other countries to derive probabilistic estimates of the types and frequency of the occurrence of disasters in a particular region. This information can in turn be used to design insurance schemes that achieve risk diver- sification across regions and risk smoothing over time. This will require develop- ment of appropriate statistical models, cost estimates, and design of progressive risk coverage, with different layers of risk being covered by different sources of funding. However, a government insurance scheme for public infrastructure could benefit from a substantial portfolio size to achieve pricing efficiencies and negotiating lever- age in terms of external reinsurance funding. Sources of funding to cover the risks could also include, progressively or in par- allel, insurance premiums and deductibles paid by the property owners, interna- tionally available insurance or reinsurance schemes, issuance of catastrophe insur- ance bonds to institutional investors or reinsurers, public funding of certain basic minimum costs in cases of the poorest segments of affected population and, possi- bly, contingency public funds that are especially set aside to cover catastrophic losses exceeding certain limits. The government has made a welcome initiative in strengthening contingency planning in order to increase its state of readiness to deal with disasters physically, logistically, and financially (for example, through the creation of a pooled contingency fund). Much more work is needed, however, to build a fully developed contingency planning and appropriate disaster management and insurance framework. The additional effort is well worth supporting in the coming years Parametric weather insurance instruments can also be very effective in helping farmers hedge against the risks of crop losses because of adverse shifts in climate. Other countries have initiated interesting pilot programs in this area that could be very relevant to Colombia, given its diverse agricultural climatic variations. Although commodity price-hedging markets already exist to manage world price fluctuations, even in stable pricing environments, unexpected weather developments can spell losses for sectors impacted by flood, drought, or freezes. The compilation of the historical record of such contracts and the development of financial hedging instruments (for example, options) to provide compensation against such events can be viable, particularly when counter parties might be available to take the "other side" of the risk, such as energy companies that actually benefit from weather extremes by providing more heating during colder weather. The benefit of using weather-based contracts, however, rests with the mechanism for contract triggering, that is, the use of degree measurements as the contract driver, without the need for on-site assessment of crop damage by area, which would otherwise significantly raise the costs and moral hazard risks of such contracts. 88 COLOMBIA THE ECONOMIC FOUNDATION OF PEACE VII. Conclusions Sustainable growth is obviously key to the realization of the dreams of any society of achieving better standards of living and quality of life for all segments of the popu- lation. A thoughtful and responsible approach towards achieving sustainable growth will be one that provides a platform not only for achieving positive economic results in the short and medium term, but for a long term growth trajectory that avoids undue economic and financial volatility and its associated social and economic development disruptions, and unleashes the dynamism, energy, and innovation of the country's private sector. Moreover, it does this while fomenting the talents of Colombia's human resources and allowing the nation's considerable natural resources to be conserved and if possible bettered. A well conceived sustainable growth strategy should in the process also help bring down the high incidence of poverty and unemployment currently witnessed in Colombia. Achieving true finan- cial, fiscal, environmental, and social sustainability is a complex challenge that can be dealt with successfully only if the policy and institutional frameworks in the var- ious areas discussed above are designed to be mutually reinforcing, and the govern- ment is able to apply a strong determination to pursue and sustain the needed reforms, and good )udgement in striking a balance between competing considera- tions where needed. 3 Shared Growth, Poverty, and Inequality This Chapter was written by Carlos Eduardo Velez, Laura Rawlings, Vic Paqueo and Juanita Riafio. I. Introduction The equitable distribution of the fruits of economic growth is the most powerful tool available for fostering economic development. Until 1996, Colombia enjoyed high, sustained, and very stable growth that allowed for substantial achievements in poverty reduction and social progress. Between 1978 and 1995 the share of Colom- bians living in extreme poverty fell from 45 percent to 21 percent, while impressive gains were achieved in primary and secondary school completion, health insurance coverage, access to basic infrastructure, child labor, infant mortality, and life expectancy. In the second half of the 1990s, the most severe economic crisis to hit Colombia since the 1930s erased over a decade of progress in poverty reduction, and under- mined Colombia's ambitious social agenda. Macroeconomic performance deterio- rated significantly, growth rates plummeted, and unemployment escalated to almost 20 percent. Simultaneously, risk indicators worsened, mostly due to increasing eco- nomic volatility and financial sector fragility, and persistently high levels of crime and violence. Moreover, de facto authoritarian regimes enforced by paramilitaries and local guerrilla warlords took hold in some isolated rural areas, fueled by profits from the drug trade Today, Colombia faces the triple challenge of securing peace, restoring robust economic growth, and ensuring that the benefits of growth are shared within Colombian society. Under present circumstances, economic growth of 4 percent over the next decade is required in order to reduce poverty to its 1995 prerecession level. Yet greater gains can and should be achieved by focusing on enhancing equity, efficiency, and security to ensure that the poor, in particular, are able to benefit from restored growth This Thematic Chapter focuses on how to improve equity and effi- 89 90 COLOMBIA THE ECONOMIC FOUNDATION OF PEACE ciency in the use of resources and application of public policy to ensure that the ben- efits of restored growth are optimally applied to reduce poverty and inequality. This Chapter has two objectives. First, it provides a brief diagnosis of the chal- lenges of poverty and inequality facing Colombia. After summarizing Colombia's historical progress and recent shocks, the Note considers three areas critical to improving the welfare of poor: (a) enhancing their levels of income and consump- tion, (b) ensuring their equitable access to basic social services, and (c) reducing their exposure to risk. In each of these areas, the Note identifies key issues and policy options that should be addressed in order to establish an equitable and efficient foundation for shared growth. Second, this Chapter synthesizes the key themes presented in the eight papers on education, the social safety net, health, labor, pensions, housing, the internally dis- placed population, gender, and Indigenous peoples and Afro-Colombians. Those Chapters provide an in-depth diagnosis and explicit policy recommendations in each of those areas. This Chapter concludes by summarizing a short-term and long-term agenda for reform, drawing on the ample agenda for reform in each of these areas, recognizing that priorities must be established in the face of a constrained budget. The Appendix at the end of this Chapter provides a summary in table form. II. Colombia's Tradition of Economic and Social Progress During the 1980s and early 1990s, when much of Latin America was suffering for its "lost decade" of growth, Colombia's strong economic performance allowed it to achieve remarkable success in poverty reduction and social progress. a) Economic Growth Was Instrumental to Poverty Reduction From 1978 to 1995, a period of rapid poverty reduction and social progress in Colombia, economic growth rates averaged over 4 percent, mean income per capita almost doubled, and unemployment remained below 10 percent.' From 1978 to 1995, the percentage of Colombians living below the poverty line fell by 20 per- centage points, from 80 percent to 60 percent. Extreme poverty declined even more rapidly, falling by more than half, from 45 percent to 21 percent. Although rural poverty is much worse than urban poverty, rural and urban areas made similar sub- stantial progress in reducing poverty from 1978 to 1988. However, between 1988 and 1995 rural rates saw a decline of only 1 percentage point in poverty, while poverty in urban areas dropped by almost 4 percentage points (see Table 1). Stable economic growth was instrumental to poverty reduction during the 1980s and early 1990s. Recent economic analysis conducted for the "Colombian Poverty Report" indicates that that economic growth explained, almost totally, the 22-percentage- I Unemployment rates exceeded 10 percent briefly from 1983 to 1985 SHARED GROWTH, POVERTY, AND INEQUALITY 91 Table 1. Poverty and Inequality Indicators, Colombia 1978-99 1978 1988 1995 1999 Poverty indicators National Poverty rate' 80% 65% 60% 64% Poverty Gap2 46% 32% 29% 34% Extreme poverty rate 45% 29% 21% 23% Mean income per capita3 112 183 216 210 Urban Poverty rate 70% 55% 48% 55% Extreme poverty rate 27% 17% 10% 14% Rural Poverty rate 94% 80% 79% 79% Extreme poverty rate 68% 48% 37% 37% Inequality indicators National Gmi Coefficient 0.53 0.54 0 56 0 57 Quintiles (Top/Bottom) 17.2 17.6 17 2 20 2 Inequality Urban-Rural Decomposition (Theil) Total 0.54 0.60 0 70 0.68 Within 0 42 0.50 0 59 0.58 Between 0.12 0 10 0.11 0 09 I Poverty rate Percentage of populationi under poverty line 2 The poverty gap describes the average distance to the poverty line 3 Thousand 1999 pesos per month 4 See other definitions in the appendix Source Colombia Poverty Report (2002) point reduction in urban poverty during this time frame (Velez and others 2002)." Much of this progress was made possible through the steady accumulation of human and physical capital, resulting in high productivity and employment. Moreover, thanks to this solid foundation of economic growth, today Colombia has a great deal more resources to tackle poverty b) Persistent Social Progress Colombia has also achieved clear social development gains during the last two decades. Table 2 shows that in education, completion rates for primary and second- ary schooling showed substantial improvement, reaching 90 percent and 59 percent, respectively. However, school enrollment rates progressed somewhat slowly and suf- fered a small reversal during the recent economic downturn. Illiteracy rates had a similar evolution. In health, life expectancy increased 20 years during the last four decades, with more than proportional gains for females. Equally important, child 92 COLOMBIA. THE ECONOMIC FOUNDATON OF PEACE Table 2. Social Indicators, Urban Colombia' 1978-99 1978 1988 1995 1999 Average education > 18 years 6.2 7.7 8.4 8.9 Illiteracy rate2 5.3% 3.3% 2 8% 2.6% School enrollment Ages 7 to 11 91.8% 94.8% 96.5% 95.3% Ages 12 to 17 76 9% 80.5% 84.4% 82.2% Ages 18 to 22 31 2% 35.8% 41.0% 363% Complete primary school (ages 12 to 17) 67 0% 78.7% 77.7% 89.8% Complete high school (ages 18 to 22) 21.6% 35 3% 48.7% 59 2% Child labor Ages 12 to 16 12.0% 11 5% 9.9% 9.5% Ages 12 to 14 5.8% 5.0% 5 2% 3 7% Child Malnutrition3 Stunting, low height for age 16 8% 10.1% 8.4% 6 7% Wasting, low weight for height 22.4% 16 6% 15 0% 13.5% Low weight for age 4.9% 2.9% 1.4% 0.8% Crime4 Homicides (Per 100,000 pop.) 26 62 65 59* Access to public utilities Electricity NA 99 3% 99 6% 99.4% Water NA 97.4% 97 7% 99 0% Telephone NA 62 2% 71.0% 84.2% Sewerage NA 94 8% 96 0% 97.3% 1 Urban Colombia represents 67 percent of Colombia urban area Barranquilla, Bucaramanga, Bogota, Cali, Manizales, Medellin anid Pasto 2 For population 12 years old & older 3 For population under 5 years old; represents national data for 1977, 1986, 1995, and 2000 4 Levitt and Rubio, 2000 * 1998 figure Sources Authors' calculations based on Encuesta Nacional de Hogares; Profamilia, and Encuesta Nacionial de Demograffa y Salud. malnutrition and infant mortality were significantly reduced. Despite being pro- cyclical-as in other Latin American countries-child labor has had a decreasing trend. Finally, basic infrastructure showed progressive gains. Most of the growth in coverage of water, sewerage, electricity, and telephone results from catch up by cities least covered in 1978 and the progressive extension of coverage to the poorer deciles. Sewerage and telephone connections still lag behind. The missing percentages mask thousands of individuals, concentrated in regional pockets of poverty, where these basic needs are not yet met. c) Generally Propoor Expansion of Social Expenditures in the 1990s Much of the social progress achieved in Colombia can be attributed to progressive social policies applied during the last three decades. Colombia's strong economic SHARED GROwTH, POVERTY, AND INEQUALITY 93 performance allowed for a dramatic expansion of social expenditures during the 1990s, many of which were of substantial benefit to the poor. Driven by mandates in the 1991 Constitution and a series of related legislation, the level of public social expenditure (defined as expenditure on health, education, housing, public services, and social security) doubled in Colombia between 1992 and 1997, raising its share of gross domestic product (GDP) from 8 percent to 15 percent, and its share of overall public expenditure from 30 percent to 35 percent. The new Constitution and accompanying laws also translated into major changes in the composition and administration the health, education, and public service sectors, notably because of the decentralization of power to departmental and municipal levels of government. The result of this expansion of expenditure and introduction of decentralization reforms was a rapid expansion of social service coverage, particularly among the poor. With the exception of childcare and primary education, all services showed much faster rates of expansion among the lower income quintiles (see Table 3). This is particularly striking in the case of health insurance and treatment, and public util- ities. Owing to increases in the underlying target population, the growth in cover- age rates understates the true expansion of services in all cases. A better indication can be obtained by looking at the growth in the total number of people served. While health insurance succeeded in doubling the number of beneficiaries during the five-year period, in the utility sectors, the modest growth in coverage entailed a substantial increase of around 35 percent in the number of household connections. Finally, in the case of childcare, we can appreciate that the drop in the coverage rate was larger than the drop in the number of beneficiaries. Against this generally positive scenario, pension obligations raise a note of con- cern. Social security accounts for the largest share of pubic social expenditures (40 percent), with negligible benefits for the poor. Due to the generosity of its design, the pension system is technically insolvent and government pension subsidies end up being clearly regressive-highly paid individuals receive larger subsidies. Public Table 3. Change in Social Service Coverage Rates, 1992-97 Education ChoLdcarm Health Utzihes Income quntile Primary Secondary Ternary Insurance Treatment Eletr. Water Sewerage Change in Coverage (percentage points) Quintile 1 9 13 3 -5 35 14 9 14 15 Quintile 2 7 7 2 -7 31 0 1 1 3 Quintile 3 9 14 5 -9 28 0 0 -2 -2 Quintle 4 5 12 6 -9 21 0 0 -1 I Quintile 5 12 13 17 -17 15 -3 1 1 -2 Total 8 12 6 -7 27 3 2 3 3 Growth rate of the number of beneficiaries (percent) Total 4 15 99 -4 116 19 35 36 38 94 COLOMBIA: THE ECONOMIC FOUNDATION OF PEACE pension payments have been growing at an explosive annual rate of 7 percent during the last decade. According to government estimates, the present value of the opera- tional deficit of pension payments is worth two times the GDP (Acosta 2000). This rate of growth raises serious concerns about the fiscal sustainability of these obliga- tions, placing pension reform as a key policy issue on the agenda for reform. These concerns are compounded by the distributional characteristics of the pension regime for public workers: in addition to subsidizing the nonpoor with taxpayer funds-vio- lating vertical equity principle-the multiple pension regimes for government work- ers discriminate among Colombians-violating horizontal equity principle.2 In addition to these problems of vertical and horizontal inequity, the payments under the current pension system impose a high opportunity cost on the use of pub- lic funds, a high efficiency cost on taxation, and labor market inefficiencies. In terms of the opportunity cost, the public funds demanded for pensions could be used for alternative public investment in human assets with higher economic return, notably education. The taxation and labor market problems are related in that the additional taxes being levied to finance the pension bill raise even further the tax burden on the Colombian economy, and induce labor market distortions. III. Recent Setbacks During the last decade Colombia has faced simultaneous setbacks in three areas: a severe economic recession that erased the poverty gains of the previous decade, ris- ing macroeconomic instability that raised the exposure of households and businesses to economic risk, and increasing violence. The impact of these shocks was exacer- bated by two structural issues: increasing economic inequality and inefficiency in public social expenditures. a) Economic Recession Since 1997, after two decades of positive and sustained growth, economic activity in Colombia plummeted to the point of reaching negative figures in 1999. Until the early 1990s, prudent management of the Colombian economy allowed for low gov- ernment debt levels that, together with low inflation rates by Latin American stan- dards, led to steady-although moderate-growth rates. However, public spending rose from 24 to 36 percent of GDP between 1990 and 1998. Fiscal imbalances helped pushed Colombia toward a slowdown after 1996, and into recession in 1998-99. The fiscal position continued to deteriorate as the economic slowdown adversely affected tax revenues. 2 According to Gomez-Buendia (2002), teacher pensions cost 1.7 times the average cost for an ISS affiliate, police pensions cost 1.9 times, Caja Agraria 2.3 times, ISS employees 3.9 times, and for members of Congress and court magistrates 22 times. SHiARED GROWrH, POVERTY, AND INEQUALITY 95 The recession of the late 1990s reversed the long-term poverty trend previously en)oyed by the Colombian economy, and raised the national poverty rate to 64 per- cent in 1999, a return to its 1988 level, reversing a decade of progress. However, the impact on extreme poverty was less severe, with rates rising to 23 percent, still well below 1988 levels. On the social front, the historical rate of unemployment doubled, and the reces- sion contributed to the deterioration of several key human development indicators that has left some groups in a highly vulnerable situation, notably young children, adolescents, and the internally displaced population. Finally, the recession placed severe fiscal constraints on the government's ability to address those vulnerabilities, and on households' ability to successfully manage the economic impact of the recession. b) Increasing Macroeconomic Instability and Judicial Uncertainty After being considered one of the most stable economies in the region, recent per- formance has shown greater volatility.3 The Colombian business cycle has suffered dramatic change. Cycle duration is now much shorter and much more volatile. Before 1996 the Colombian economy experienced relatively long business cycles of six to eight years in duration. However, the last cycle's duration was less than five years; not only the duration changed, but the amplitude of the last cycle was 50 per- cent larger than the amplitude of cycles experienced between the late 1970s and early 1990s 4 Moreover, according to Partow (2002), volatility of the Colombian economy during the 1990s increased relative to the two previous decades. Volatility nearly doubled for a number of macroeconomic and fiscal variables, with the exception of the terms of trade (Table 4). This went against the Latin American trend. A num- ber of authors-among them Gavin and others (1996), Herrera, Perry, and Quin- tero (1999), and IDB (1997)-have pointed out that domestic volatility in many countries of the region declined during the 1990s. Judicial uncertainty is leading to unpredictability in key policy areas, thus rein- forcing market uncertainty. A number of recent Constitutional Court rulings cre- ated increasing uncertainty about the "rules of the game" in several key economic markets, such as labor, mortgage credit, and the private provision of education. In 3. Rodrik (1999) estimates the probabilities of entering episodes of high volatility for vari- ous countries, and shows that Colombia faced a probability very close to zero for the last 30 years 4 See Echeverry, Santamarfa, and Escobar (2002) According to this article the main cause behind the change suffered by the Colombian business cycle is the Central Bank reform of the early 1990s Countries with monetary policy set by an independent body are sup- posed to experience greater volatility but lower resulting inflation, which is supposed to bring greater economic growth. 96 COLOMBIA THE ECONOMIC FOUNDATION OF PEACE Table 4. Colombia!s Volatility 1970s 1980s 1990s 1990s: 1980s* GDP Volatility 1.8 1.5 2 7 81% Fiscal Volatility 1.3 1.4 2 7 91% Exchange Rate Volatility 1.1 1.5 2.4 57% Monetary Volatility 6.8 3.5 3.7 56% Terms of Trade Volatility 13 0 10.4 5 8 -44% '1990s 1980s indicates the change in volatility in the 1990s relative to the 1980s Note Data represent the standard deviation, in percentage terms, of changes in GDP, in the fiscal bal- ance/GDP, in the real exchange rate index, In MI growth, and in the terms of trade index Source Partow (2002). addition, constitutional rulings on pensions rights have cast doubts about the con- tingent liabilities of the public sector.5 As a result, the ability of political mecha- nisms to solve the fiscal crisis has been weakened. For example, it is uncertain whether the pension reforms eventually passed by the elected legislative branch will become a public mandate, since the reforms may be overturned by the Constitu- tional Court. These combined factors led to the recent downgrading of the risk-based ratings given to the Colombian economy, increasing the cost of external borrowing. Finan- cial sector performance has deteriorated and has become more fragile, with signifi- cant bailout costs (Partow 2002; Acosta 2000). c) The Growing Burden of Violence and Crime Whereas most of the social indicators in education, health, and infrastructure show substantial and persistent long-term improvements over the last two decades, the simultaneous escalation of violence over this period has caused a deterioration in liv- ing conditions, imposed a considerable economic burden on the State and house- holds, undermined investor confidence, and presented itself as one of the preemi- nent challenges facing the incoming presidential administration. Empirical evidence indicates that the drug trade and the presence of illegal armed groups linked to this trade are the main factors fueling this rise in violence and crime. Colombia has the highest homicide rate in the world and, except for El Salvador, the highest crime rate in Latin America. Homicide rates almost tripled between the early 1970s and late 1980s, reaching their peak in 1991 when close 1 in every 1,000 Colombians was murdered. Although homicide rates fell in the 1990s, the incidence of extortion, car theft, armed robbery, and other crimes grew dramatically during this period, bringing the rate of victimization to more than 35 percent of households in 1997. 5. See, for example, "Colombia Poverry Report" (2002), Box 4, about mortgage credit. SHARED GROWTH, POVERTY, AND INEQUALITY 97 The poor are more likely to be victims of homicide, and the nonpoor are more likely to be victims of property crime, extortion, and kidnapping (Gaviria and Velez 2001). Domestic violence is also concentrated among the poor, with uneducated women and spouses of uneducated men bearing a disproportionate share of domes- tic violence. In Colombia, young men face an extremely high risk of being mur- dered. According to Velez and others (2002), men age 15 to 35 are 15 times more likely to be homicide victims than women the same age, and rwice as likely as men over age 45. Due to this phenomenon, gender differences in life expectancy have nearly doubled during the last five decades.6 This situation imposes a psychological and economic burden on victims and their relatives, and increases victims' chances of suffering from enduring pathological and dysfunctional behavior. The concentra- tion of these problems among children and youngsters ultimately erodes socioeco- nomic mobility and contributes to the perpetuation of poverty. Due to the escalating civil war an increasing proportion of Colombians have been forced to leave their homes. This internally displaced population (IDP) constitutes one of the most serious social problems in Colombia. The growing numbers of IDP and the limited absorptive capacity of the urban sector, especially in the context of the recession, are placing a growing number of vulnerable groups at increasing risks. The IDP faces major economic losses, tremendous psychological hardship, family disintegration, a loss of assets, and barriers to access to social services. These com- bined vulnerabilities put them at risk of falling into a vicious circle of extreme poverty. The well-being of children of IDP households, present and future, is par- ticularly jeopardized by the problem IDP households have with food security, and by shrinking opportunities for school enrollment in the overburdened receptor municipalities. Colombia's judicial system is stretched to its limits, and in remote areas the rule of law is tenuous at best. Almost every type of crime and violence-political, drug related, domestic, and normal street crime-remains rampant.7 The widespread practice of extortion and kidnapping, which pervades all strata of society, is increas- ingly weakening property rights over physical assets and thereby undermining the market economy. Moreover, de facto paramilitary or guerrilla authoritarian regimes enforced by local warlords effectively rule some rural areas and are making incur- sions into urban areas, as well. d) Rising Income Inequality: Induced by Higher Wage Skill Premia and Eroding Potential Welfare Gains Colombia's high levels of inequality need to be addressed to ensure that the benefits of restored growth are shared equitably. Colombia's income inequality is extreme in the 6 The gender gap in life expectancy reached 8 3 years in 1995 and tends to be larger in more prosperous regions of the country (see "Colombia Poverty Report" 2002, p 32) 7 Homicide rates are roughly 59 per 100,000. 98 COLOMBIA: THE ECONOMIC FOUNDATION OF PEACE international context but relatively moderate in Latin America, a region of relatively high income inequality, where it ranks just above the median.' Rising inequality reduced welfare gains made during Colombia's period of strong economic growth up to 1995, and exacerbated the impact of the recent recession on the poor. Average income increased by 88 percent between 1978 and 1995, then leveled off and decreased during the second half of the 1990s. But the Gini Coefficient jumped 7 percentage points between 1978 and 1999, reaching 0.57 in 1999. Had inequality remained constant during the last two decades, the poor would have benefited more from growth. The Sen welfare index estimates income correcting for inequalities by randomly selecting two individuals and assessing the expected welfare of the worse off of the two individuals. Had inequality remained constant, the income of the "second best" Colombian would have been 18 percent higher in 1995, and 23 percent higher in 1999. The two main factors behind changes in income inequality-skill-wage differen- tials and differences in educational attainment-operate in opposite directions. While growing skill-wage differentials between wealthier and poorer Colombians raised income inequality in the 1990s, the increasing equalization of schooling had the opposite effect. Between 1978 and 1999, skill-wage differentials explain nearly 150 percent of the 6.8-percentage-point increase in the urban Gini Coefficient. This negative effect of rising skill-wage differentials dominates the progressive impact of education endowment equalization that accounted for a 6.6-percentage-point reduction in the Gini Coefficient.9 Colombia's high wage-skill premia are illustrated in Figure 1 which shows that, on average, the labor earning of individuals with postsecondary education are 4.3 times those of individuals with incomplete primary education. The Colombian dif- ferential is nearly twice the differential in the United States (2.5), and well above Mexico (3.3) and Brazil (3O7).iO Why are wage skill premia high in Colombia, and contributing factors to income inequality) Is it because the supply of education is insufficient or regressive, or is it because the demand for high-skilled workers has grown above available supply? Edu- cational attainment shows a growing, progressive trend in the last 25 years: Colom- bian school-age cohorts have persistently reached higher educational attainment with less inequity.'1 But this trend has been present mainly in basic education, and 8. Out of 17 countries listed in the World Bank data for 1999, Colombia ranks seventh after Nicaragua, Brazil, Honduras, Bolivia, Paraguay, and Chile (see "Colombia Poverty Report" 2002). 9 See Table A.4 in the Appendix 10. Those differences are even higher when compared to high school graduates. In this case, Colombia leads with 2.4, followed by Brazll (2.0), Mexico (1.9), and the United States (1 6) 11. On average, the number of years of education that the 1975 cohort attained by 1995 was approximately 10 years, 4 years greater than achieved by the cohort born 40 years earlier. Furthermore, the inequality of education within each cohort (measured by the coefficient of variation) fell by more than half during the same period, from 0.75 to 0.33. SHARED GROxrrH, POVERTY, AND INEQUALI VY 99 Figure 1. Labor Earnings by Skill Level, Urban Colombia, 1999 4.5 4.0 - Brazil Mexico - C.Z I* _ 6 25 _-_____ ____ 10 _--- Us a Colombia ~0 5 partlall 1 atbto 4 5 toh 6l s 7upl tof hig9-toiend wokes oitpotsecondary education. The public policy problem underlying income inequality iS Colombia's bottleneck In postsecondary education. Colombian data show that, despite significant improve- ments in equity and effiacincy in finishing all levels of basic education-particularly in finishing secondary school-there is still a bottleneck at the entrance to postsec- ondary education, with increasing frustration for the lower-middle class and the poor. Similarly, while improvements in equity are substantial for high school graduates, they are nonexistent for students beginning their postsecondary education. From this perspective, the substantial Improvements in equity and efficiency in basic and secondary education in the 1990s are a mixed blessing on one hand they have provided an abundant pool of candidates for the potential expansion of post- secondary education, but on the other, these high school graduates face an inequitable bottleneck in accessing postsecondaty education. Those same high school graduates could move readily into postsecondary education if they were offered credit or some demand subsidy. In sum, despite propoor gains in secondary school attainment, access to postsec- ondary education has become a bottleneck and a source of inequality. Public policy should search for the most cost-effircient way of increasing the supply of postsec- 100 COLOMBiA: THE ECONOMIC FOUNDATION OF PEACE ondary education graduates in order to reduce the excessive level of skill wage dif- ferentials. This could be addressed through the provision of education credits for the poor, and demand subsidies for the middle class. Unless this trend is reversed, one would expect an increasing deterioration of inequality in the medium term. During the current period of internal conflict, another emerging important inequality is the socioeconomic bias of the military draft. Estimates from Velez and Riafio (2002) show that Colombian boys and girls do not enjoy equality of oppor- tunities with respect to military service. In Colombia, eligibility for full military service-including combat participation-is reserved for the Colombian young men-not women-without a high school degree. As a result, young men belong- ing to the poorest 20 percent of the population face 11 times more chances of being eligible for the military draft than those belonging to the richest 20 percent. IV. Resulting Vulnerability The combined result of the economic recession, increased macroeconomic instabil- ity, the rise in violence, and growing inequality has seen a marked rise in vulnera- bility. Those most vulnerablc to poverty today include children; young, low- and mid-skilled household heads; recent migrants; and non-homeowners. These groups are clearly worse off than pensioners, the college educated, the elderly, and non- recent migrants. As illustrated in Table 5: o Children under age 18 consistently present higher poverty rates than the gen- eral population, with an increasing proportion of infants and preschoolers in poverty. o Homeownership clearly provides protection against poverty. o Migrants used to fare better or similar to the overall population until 1995, but recent migrants are more likely to fall into poverty in the recession years. This must be partially associated with a shift from voluntary to forced migra- tion, and underscores the high vulnerability of the internally displaced popu- lation due to the armed conflict. o The disabled have remained consistently poorer than the rest of the urban population since 1988, although incidence rates are decreasing for this group. o Contrary to what could be expected, pensioners and the elderly do far better than the rest of the population, and their relative standing seems to be improving over time. Today, as throughout the 1990s, the likelihood of escaping poverty is increasingly dependent upon having fewer children, more working-age family members with postsecondary education, and access to employment for members other than the household head. SHARED GROWTH, POVERTY, AND INEQUALITY 101 Table 5: Poverty Count for Different Subgroups of the Population, Urban Colombia 1978-99 (percent) Share of population 1978 1988 1995 1999 in 1999 Urban Colombia 70 55 48 55 100 Children under 2 yrs 80 71 63 72 3 8 From 2 to 6 yrs 81 70 63 69 10 0 From 7 to 13 yrs 80 70 62 69 13.3 From 14 to 17 yrs 73 61 55 64 7 7 Migrants/Just moved' NA 50 50 64 1 1 Non home owners 77 64 57 63 51 0 Disabled 69 68 60 60 0.6 Migrants < 52 NA 51 46 60 1.2 Women 69 55 48 55 53.4 Migrants < 103 NA 49 43 54 1.7 Home owners 62 46 40 47 49.0 Migrants < 254 NA 50 42 44 3.8 Over 65 years old 52 42 35 37 4.7 Pensioners 37 32 20 24 1.9 1 Migrants/)ustmoved refers to people who have lived less than I percent of their lives at the current city 2 Migrants < s percent refers to people who have lived less than 5 percent of their lives at the current city 3 Migrants < 10 percent. refers to people who have lived less than 10 percent of their lives at the current city 4 Migrants < 25 percent refers to people who have lived less than 25 percent of their lives at the current city. Source Columbia Poverty Report (2002) Three specific groups call for special attention in the crafting of public social pol- icy because of their high levels of vulnerability: children, adolescents, and the inter- nally displaced population. * First, since children are the demographic group most exposed to poverty, pro- grams are needed to prevent irreversible losses of human capital investments that carry with them perverse effects on social mobility. Increasing the cover- age of nutrition, childcare, and preschool education will benefit not only the children at risk but will give many poor families the opportunity to increase the labor force participation of female spouses and improve the odds of escap- ing poverty. The dramatic decline in vaccination coverage rates among chil- dren must also be addressed. * Second, the vulnerability of adolescents needs attention. Young high school graduates face a disproportionate share of unemployment. Labor skill devel- 102 COLOMBIA THE ECONOMIC FOUNDATION OF PEACE opment through technical training and special exemptions from payroll taxa- tion could help improve the employment opportunities and improve their odds of escaping poverty. Moreover, the enormous exposure of young males to homicide, with documented post-traumatic effects on the survivors and witnesses, )ustifies specific preventive action for this population through the application of both judiciary and family welfare policies. Finally, the increas- ing risk of unwanted pregnancy among poor, young females, with negative effects on social mobility, justifies the expansion of reproductive health and counseling programs to this demographic group. Third, the internally displaced population, a result of Colombia's internal con- flict, constitutes another critically vulnerable group. The drug-related economic and military strength of the guerrillas and paramilitaries has led to a dramatic increase in violence, deaths, kidnappings, extortion, and displacement, especially among the rural civilian population. This population has been evicted from areas where they have been engaged in productive economic activities and relocated in urban slums where employment prospects are limited, access to social services is constrained, and violence and crime are rampant. Available data suggest that most of the displaced are women (56 percent) and children (55 percent are under 18), with limited skills and education. In their migration from rural to urban areas, they have abandoned their main asset-their land-and face barriers to accessing jobs and social services. Their concentrations in a few cities in Colom- bia has placed an added strain on limited municipal budgets, a situation com- pounded by a severe lack of financing for Colombia's main national strategy for the internally displaced population during the height of the recession. Finally, looking beyond the vulnerabilities of specific groups to focus on households underscores the critical role of the labor market in determining vulnerability. Those households experiencing the largest increase in poverty during the recent recession were those with only self-employed workers or only nonlabor income, whereas house- holds composed entirely of wage earners experienced the smallest increase in poverty. Of particular note, unemployment of the household head is catastrophic for poverty risks; in urban areas poverty is 25 percentage points higher if the head used to work and is presently unemployed (Velez and others 2002). Paralleling the findings from the survey data, participants in both rural and urban areas in focus groups conducted for the recently completed social safety net study ranked economic insecurity as their prin- cipal source of risk, followed closely by violence (Rawlings and others 2002). V. Addressing the Emerging Challenges: Employment, the Efficient and Equitable Provision of Public Services, and Security To achieve the benefits of shared growth and address present vulnerabilities, Colom- bian public policy should focus on three dimensions of welfare improvement for the SHARED GRowrH, POVERTY, AND INEQUALITY 103 poor: enhancing their levels of income and consumption, ensuring equitable access and efficient provision of basic social services, and reducing their exposure to risk. Public policy instruments can tackle poverty by attacking its source, by attacking its most detrimental consequences, or both: that is, attacking the lack of income opportunities or attacking the lack of access to basic social services and social protection. First, sound macroeconomic management is critical to raising the income of the poor, since short-term income opportunities for the poor are strongly correlated with business cycles and unemployment levels. This makes the welfare of the poor quite sensitive to macroeconomic challenges, including management of the fiscal balance, interest rates, exchange rates, and inflation, through their impact on both the level and the variability of aggregate economic activity. Second, barriers to access to basic social services must be removed for the poor. These barriers usually bring irreversible human capital losses to vulnerable cohorts, especially children. Since children are among the most vulnerable to poverty in Colombia, subsidizing human capital accumulation helps to break the vicious cycle of poverty by putting assets in the hands of the children of the poor, thereby improv- ing social mobility and reducing inequality in the long term. At the same time, human capital investment constitutes a strategic component of long-term growth, reinforcing long-term poverty reduction. Finally, since economic insecurity has shown an increasing trend during the last decade, effective social risk management is a critical component of addressing vul- nerability. Safety assistance in the form of direct transfers in cash, kind, or physi- cal assets are becoming more relevant remedies for transitory lack of income among the poor In addition, social insurance mechanisms that rely on the pool- ing of risk, such as health insurance and pensions, can play an important role in risk management. These three challenges of enhancing the levels of income of the poor through employment, improving equity and efficiency in the provision of public social serv- ices, and reducing exposure of Colombians to risk are discussed below. a) Restore Economic Growth to Accelerate Job Creation and Reverse the Rise in Poverty Recovering high economic growth is a necessary condition for returning to the poverty-reduction path that Colombia followed until the recession of the late 1990s. In order to reduce poverty to its prerecession level of 1995, average annual GDP growth would have to be at least 4 percent during the first decade of this century. Figure 2 shows how from 1978 to 1995 poverty fell at an equal rate, with positive income per capita growth, and reached 48 percent in 1995. It also shows how the recession of the late 1990s brought negative income per capita growth and increased poverty to 55 percent. If the Colombian economy grows at 2 percent-barely above population growth-income per capita growth will be positive but negligible and, 104 COLOMBIA THE ECONoMic FOUNDATION OF PEACE Figure 2. The Poverty Rate Under High and Low Growth Scenarios, 2001-10, Urban Colombia Y 6%- -75% - 5%_ _- - _ - 70% o \<1978-1988 °°4%- A6 _ 5% 1988-1995 u 3% -_-1 - 60% _ 0 o~~~~~~~~~~~~~992 G 2 0%- 1995-1999 l -45% ~~~~~~~~5 ~~ ~ ~ ~ ~ 0 io-1%- ___ ______-____ - 40% < -2%- 35% 1978 1988 1995 1999 2010 Bars represent average annual income per capita growth rate Line represents poverty rate consequendy, poverty will fall by less than I percent during the next decade.i2 How- ever, if economic growth jumps to 4 percent, income per capita will grow at nearly 2.5 percent and, after 10 years, poverty will fall back to its 1995 level. In addition, the expected impact on extreme poverty will be even larger, considering that in the past it has been more sensitive to growth than the "normal" poverty rate. Recovering propoor growth will require addressing both macroeconomic and microeconomic reforms. Poverty-reducing growth will depend crucially on macro- economic reforms to stimulate the recovery of the private sector, the job provider for Colombia's poor households. Achieving this outcome will require fiscal reform to ensure sustainable public expenditures and to recover a favorable investment cli- mate, along with labor market reforms to ensure propoor access to employment. On the fiscal front, pension reform is critical to generating substantial public resources in the medium term without hurting the poor. In addition, real rates of interest must be set at efficient levels. On the labor market front, the elasticity of employ- ment to economic growth must be recovered, especially for low-skilled workers, via recovery of the building sector. This recovery will depend not only on reestablishing a vigorous flow of mortgage credit, but also on labor market policies that avoid inef- ficient payroll taxation and an excessive minimum wage. Attention also needs to be paid to the long-term micro determinants of income per capita growth and poverty reduction, particularly education and fertility, 12 Under the assumption that inequality remains constant SHARED GROWrFT, POVERTY, AND INEQUALITY 105 because these have important effects on labor force participation and productivity The rise in education levels of the labor force and the reduction in the dependency ratios via smaller family size explain most of income per capita growth during the last two decades. Moreover, in Colombia, more educated spouses tend to have fewer children, and in turn those two factors raise their chances of being employed and getting their household out of poverty. Income per capita gains among households with low-skilled heads are also explained by higher real wages.13 b) Improve the Equity and Efficiency of Public Social Services Section II discussed the growth in public social expenditures in the 1990s and the accompanying reforms in pensions, health insurance, and decentralization The evi- dence presented below suggests that Colombia devotes enough resources to public social expenditure relative to the magnitude of the poverty problem, but that these resources are allocated neither efficiently nor equitably. Public policy must address three main problems in the area of social expenditure: (a) pension reform to restore vertical and horizontal inequities and fiscal sustainability, (b) improvement in the cost inefficiencies in the provision of social services, and (c) attention to the equi- table coverage of social public services. i. Colombia's Ability to Tackle Poverty Available evidence demonstrates that thanks to its robust economic performance until 1995, Colombia is a great deal more capable of tackling poverty. Eliminating the extreme poverty gap in Colombia would require less than 3 percent of total household income in 1999 (Figure 3). Moreover, closing the poverty gap-that is, getting 55 percent of Colombians out of poverty-would require 25 percent of total household mcome.`4 Comparing the resources required to close the poverty and extreme poverty gap to the amount of resources devoted to public social policy leads to the unequivocal conclusion that today the Colombian public sector has more than enough resources to tackle the poverty problem, without abandoning other core mandates. In 1999 13 In fact, for the representative urban household, three quarters of the predicted rise in income between 1978 and 1999 is explained by growth of school endowments-32 per- cent-and one quarter by redLictions in the adult-to-family-size ratio-9 3 percent However, until 1995-before the recession-positive changes in employment ratios and wages helped to increase income per capita and made a contributioll to poverty reduc- tion, as well (see "Colombia Poverty Report" 2002, chapter III) 14 From 1978 until 1995, both economic growth and the reduction of the poverty gap- from 46 percent to 29 percent-reduced the share of total household income necessary to close the poverty gap from 58 percent to 20 percent, just a quarter of its original value. Similarly, the share of household income necessary to close the extreme poverty gap fol- lowed a similar trend 106 COLOMBIA. THE ECONOMIC FOUNDATION OF PEACE Figure 3. Share of Total Household Income Required to Close Poverty and Extreme Poverty Gaps 60%- 12% Poverty 50% \- \ _10% D 40%-- -- __ _ _ _ __ 8% & C o 30%- 6__ N _ _ ___6%_E u 20%-- ___ _ _4% U H Extreme Povert 0u 10% _- ________ 2% H 0%_ I I I _0% 1978 1988 1995 1999 Share 1978 1988 1995 1999 To close the extreme poverty gap 10.7% 4.3% 2.1% 2.5% To close the poverty gap 58% 25% 20% 25% public social expenditure was 15 percent of GDP, while total public expenditure was approximately three times larger. In summary, this evidence shows that the realloca- tion of 10 percent of public expenditure-a moderate amount-would have a major impact on the welfare of the poor. ii. Addressing Inefficiency in the Provision of Public Social Services Gains in the coverage of public social services achieved in the 1990s were not com- mensurate with the increase in expenditures. Table 6 shows changes in public expenditures, coverage rates, the total number of beneficiaries, and the public sec- tor share of coverage. By subtracting the growth rate in the numbers of people served from the growth rate in real expenditure, it is possible to make some indi- rect inferences about the growth in unit costs. This calculation reveals that in most cases the unit cost of services broadly doubled during 1992-97. The most severe problem seems to be in the area of health insurance and treatment, for which fund- ing increased by over 300 percent, but individuals insured or treated increased in much smaller proportions. Unless quality improvement was colossal, this seems to imply that despite the gains in the number of individuals treated (19 percent), much of the growth of expenditures registered over this period was absorbed by cost-inefficiency. SHARED GROWrTH, POVERTY, AND INEQUALITY 107 Table 6. Coverage and Expenditure for Social Services, Colombia 1992-97 (growth) Public Numbers served Real expenditure Coverage rate sector share Childcare -4% - -7% 2% Education Primary 4% 114% 8% 0% Secondary 15% 108% 12% 8% Tertnary 99% 164% 6% -8% Healthcare Insurance 116% 326%* 27% -25% Treatment 19% 6% - Utinties Electncity 35% - 2% - Water 36% 194% 3% - Sewerage 38% 194% 3% - 'Note Real expenditure in healthcare calculations are based on data from the National Deparrament of Planning that do not provide information about how total healthcare expenditure is allocated between insurance and treatment Table 7. Coverage Shortfalls and Targeting in Selected Social Programs Education Healthcare' Utilities Users Prnnary Secondary Tertiary C/ildcar Insurance Treratnent Water Sewerage Electr. Numbers (mill) Potential users 6.2 4 9 1.8 4 4 39.6 6.1 39 8 39.8 39 8 Covered 5.3 3.7 0.8 1 2 23.3 4.5 33 4 27.0 37.2 Not covered 0.9 1.2 1 1 3 2 16.3 1.6 6.4 12 8 2.7 Concentration Coefficient Potential users -0 19 -0.05 0.28 -0 19 -0.05 -0.02 0.01 0.01 0.01 Covered -0 16 -0.04 0.45 -0.07 0.05 0.02 0.05 0 11 0 03 Not covered -0 34 -0.07 0 14 -0.23 -0.21 -0.12 -0.26 -0 25 -0 3 Note A more negative concentration coefficient means more that more thani proportional benefits go to the poor * Figures for 1997 Source Columbia Poverty Report (2002) 108 COLOMBIA THE ECONOMIC FOUNDATION OF PEACE iii. Addressing Equity in the Provision of Public Social Services There are still substantial shortfalls in the coverage of social programs concentrated among the poor (Table 7). Overall, 66 percent of the corresponding age group lacks access to institutional childcare and 15 percent to primary school. Of those who complete primary school, 25 percent do not go on to secondary education, while of those completing secondary school, 57 percent do not go on to university. Further- more, 41 percent of the population is still not covered by health insurance, and 57 percent lacks connection to the sewerage network. The absolute size of the unserved population varies substantially across programs. Those who are not covered by health insurance represent the largest unserved group, amounting to 16.3 million people. The next-largest group is composed of those living in households without a sewerage connection, which accounts for 12.8 million people, while 6.4 million people live in households without access to water. It is no surprise to find that the population without access to public services is disproportionately concentrated among the lower-income deciles. For example, in the case of primary education, 19 percent of the unserved population fall into the first decile. An interesting exception is found in tertiary education, where the largest shortfalls in coverage are in the middle classes. Consequently, the most neg- ative concentration coefficients correspond to primary education, public utilities, and childcare. Today, the highest priorities for social service expansion among the poor are childcare, sewerage, and healthcare and health insurance. Among all basic social services, those four sectors have the largest relative access gaps between the poor and the better off.i5 iv. Instituting Pension Reform to Restore Equity and Fiscal Sustainability The public pension system is insolvent and pension subsidies (payments beyond contributions) disproportionately benefit the nonpoor. Reform is urgently needed to recover fiscal sustainability and reverse the offensive inequities imbedded in the system In relation to equity, the main principles of this reform should be to (a) unify the pension regimes to established horizontal equity-any two Colombians with the same productivity and age should receive equal treatment; (b) homogenize the conditions of accumulation of future benefits, accelerating the transition peri- ods; (c) adopt measures to limit the subsidy of retirement account of lower-income workers; and (d) impose contributions to persistent extraordinary benefits. 15 Relative to households in the sLxth income decile (that is, for the poorest 50 percent of households), the gaps in coverage for childcare, sewerage, and healthcare and health insur- ance are 20, 19, 17, and 10 percent, respectively Those rankings are relatively robust. Two sectors show similar ranking independent of the comparator income group used to calcu- late the coverage gap of the poor. childcare is almost always the highest priority service for expansion, while sewerage ranks as the second or third priority for expansion. SHARED GROWTH, POVERTY, AND INEQUALITY 109 c) Establish a Functional Social Safety Net A third major challenge facing Colombia is the establishment of a functional social safety net allowing Colombians to better manage their exposure to risk. This social safety net should take the form of a social risk-management system functioning in both normal and crisis periods, calling on both social assistance and social insurance components. This reformed safety net should aim to provide benefits to the chronic poor in extreme poverty, special vulnerable groups such as the internally displaced popula- tion, and those affected by idiosyncratic shocks such as poor health, unemployment, or disability. The safety net should also contemplate a countercyclical mechanism to ensure that assistance is available to those harmed by large covariate shocks (shocks that affect many people simultaneously) such as economic crises and natural disas- ters. A focus on an effective countercyclical mechanism that could be activated dur- ing times of economic crisis is critical to reversing historically procyclical patterns of social assistance spending.16 i. Colombia's Social Safety Net Historically, economic growth and the parallel expansion of basic social services served as a substitute for implementing a social safety net. Notably, social assistance was not included in the dramatic social sector reforms of the 1990s that resulted in increased spending and decentralization for health and education. Consequently, social assistance programs remain not only ill-suited to respond to large covariate shocks, but also underfunded, centralized, and lacking a strategic focus. In regard to the financing of social assistance, for example, whereas funding for health and edu- cation rose dramatically during 1991-96, central-government-budgeted expendi- tures on social assistance fluctuated around 1 percent of GDP during the first part of the 1990s, and fell to less than 0.7 percent by 2000.17 This is a very low level of social assistance spending compared to countries at a similar stage of development,18 16. A retrospective public social expenditure review reveals that for each peso of reduced GDP, social assistance spending fell by nine pesos, making social assistance the most pro- cyclical component of social sector spending (CRECE 2001). 17. Social assistance is defined as spending on the three main social assistance programs reported in aggregated budgetary data-the Colombian Institute for Family Welfare (ICBF), the Social Solidarity Network (RSS), and the National Institute of Social Inter- est, Housing, and Urban Reform (INURBE). The expenditure estimate does not include spending on the new temporary Red de Apoyo Social (RAS) conditional cash transfer, workfare, and youth training programs, nor does it take into account the substantial sub- national spending on social assistance, including utilities subsidies and the Cajas de Com- pensact6n programs 18 Each of the nine Latin America and Caribbean region countries included in a recent social protection expenditure review devotes a higher share of GDP to social assistance, including Argentina (0 9 percent), Mexico (1 1 percent), Peru (1.4 percent), Uruguay (3.4 percent), and Venezuela (I percent) (Dulitsky, Gragnaloti, and Lindert 2001). 110 COLOMBIA. THE ECONOMIC FOUNDATION OF PEACE and compared to the needs of specific vulnerable groups that lack access to key social assistance programs In sum, although substantial progress was made in health insur- ance for the poor, Colombia remains without a strategic social risk-management sys- tem, and social assistance programs remain fragmented, diffuse, and largely outside of the reach of those in the informal sector. ii. Priorities for Reform As in the other sectors, the program for strengthening social protection must address the issue of efficiency because of the country's tight financial constraints. But it is imperative for the government to find additional funding for social assis- tance because of its serious underfunding and because of the special attention required today by these vulnerable groups: children, adolescents, internally dis- placed people, and poor workers facing protracted unemployment. Drawing from the Social Safety Net and Pension Policy Chapters, the following measures should be considered in establishing a strongly propoor and efficient social safety net in Colombia: * Establish a countercyclical element of the safety net with clear saving and spend- ing rules that would allow Colombia to provide assistance to those most affected by the next large shock. Part of this process involves evaluating the new Red de Apoyo Social programs and integrating them into a coherent, reformed social safety net. If these programs are not assessed as part of a broader social safety net reform, they risk becoming another institutional layer within the diffuse collection of social assistance programs and a drain on financing for public social expenditures. * Expand the budgetfor social assistance to at least 1 percent of GDP through the redirection of funds to well-targeted social assistance programs and the increased use of poverty targeting. * Focus on streamlining the existing safety net system, not creating additional pro- grams, perhaps drawing on principles of social insurance. At the very least, reforms should focus on working within the existing system to improve poverty targeting, eliminate excessive program overlap and fragmentation, and restructure existing programs to improve coverage and quality. A more radical approach would develop a wholesale alternative to the existing system by replacing existing programs with a new system drawing on social insurance principles, as was done in the health system. What should clearly be avoided is the creation of new programs as add-ons to the existing system. * Address the needs of the Internally Displaced Population (IDP). Colombia needs to establish a strategy that would effectively address the IDP needs, starting with the dismantling of barriers to access preventing the IDP from benefiting from critical social assistance, health, and education programs. Such a strategy should also address security and stigmatization concerns regarding the use of an IDP registry. SHARED GROWTH, POVERTY, AND INEQUALITY 111 VI. Conclusion This Chapter has shown that for almost two decades Colombia made remarkable progress in reducing poverty and advancing the living standards of millions of citi- zens. It also underscored the serious setbacks experienced during the past decade the recession of the late 1990s reversed a decade of progress in poverty reduction, increased levels of violence affected the poor and nonpoor alike, and growing inse- curity left Colombians exposed to new types of risk. In addition, increasing income inequality in the 1990s exacerbated the negative impact of recession on poverty, and inefficiency and inequity in the provision of basic social services diminished the potential impact of these investments, particularly on the poor. These shocks and structural deficiencies ushered in new problems and exacerbated older ones, with the combined impact still apparent in the rise in unemployment, the protracted increase in poverty, the erosion of the social fabric, and the rise in vulnerability. To address those emerging challenges, public policy must concentrate on improv- ing three dimensions of welfare of the poor: raising their levels of income, ensuring equitable and efficlent provision of basic social services, and reducing their exposure to risk a) Raising the Income of the Poor Poverty-the lack of income opportunities-is derived from lack of assets and/or the inability to find markets for those assets. Hence, there are two types of poverty- reducing policies: policies that try to attack the source of the problem-lack of income-and policies that try to eliminate the most undesirable and intractable consequences of poverty-lack of access to basic social services and lack of social protection. Developing a strategy to attack those three dimensions of welfare for the poor involves selecting a range of policy options, with attendanit tradeoffs for gen- eratmig benefits at different points in time. In the short term, the easiest way to raise income of the poor is by achieving higher rates of economic growth and lower unemployment, which in turn increase the market demand for their human assets. Recovering higher sustainable rates of growth requires consistent macroeconomic policy and restoring security. An alter- native way of raising income in the short term is through direct cash transfers or sub- sidized access to nonhuman assets, such as housing. Increasing the wages and the demand for less-skilled workers can also be achieved though stimulating growth in low-skilled, labor-intensive sectors such as construction. Over the medium term, poverty can be reduced by raising the labor force partic- ipation of working-age adults in poor households, typically by incorporating female spouses into the workforce. This can be accomplished through different policy mechanisms, including increasing access to childcare and preschool services and lowering fertility rates through access to reproductive services. A more roundabout way to raise the income of the poor is by lowering the dependency ratio (that is, rais- 112 COLOMBIA. THE ECONOMIC FOUNDATION OF PEACE ing the adult-to-family-size ratio), which is typically achieved through better female education and easier access to reproductive health. Finally, the most effective long-term strategy for reducing poverty is to raise human capital endowments. This is generally achieved through providing educa- tion, which generates positive intergenerational effects of higher social mobility. b) Ensuring the Equitable and Efficient Provision of Basic Social Servzces Equitable access to basic social services is a crucial step in breaking the vicious cycle of poverty, and putting assets into the hands of the children of the poor. Improving the efficiency and equity of social public expenditures is critical to elevating the human capital accumulation for the poor. Therefore, the public provision of social services and subsidization of human capital accumulation can lead to improvements in social mobility and reductions in inequality and poverty in the long term. c) Reducing Exposure to Risk The persistent features of vulnerability provide an opportunity to target both social sector and social assistance programs to specific demographic groups. The "faces" of the poor are children of all ages, young low-to-middle-skilled household heads, recent migrants, and non-homeowners. These groups are clearly worse off than pensioners, the college educated, the elderly, and non-recent migrants related to displaced population. Moreover, certain low-frequency events may throw households into poverty, such as the presence of a disabled family member in the household, the loss of employment for the head, or being part of the internally displaced population. These phenomena require special attention through the mobilization of social insurance mechanisms that rely on the pooling of risk, or through programs to address groups like the internally displaced that encounter particular vulnerabilities. The presence of these vulnerabilities reflects Colombia's need for a functional social safety net to allow for better management of the increasing levels of risk. This social safety net should incorporate three components: (a) social assistance for the chronic poor and the internally displaced population, (b) a countercyclical compo- nent to alleviate covariate risk, and (c) social insurance to attend idiosyncratic risk. Priorities for action include expanding the budget for social assistance to the extent possible given the tight financial constraints; reforming the pension system to make it sustainable, and reducing the subsidization of well-off workers; and streamlining the existing safety net, and existing social assistance programs, perhaps drawing on principles of social insurance, while avoiding the creation of add-on programs. In summary, these propoor public policy options call for finding markets for assets of the poor and providing social assistance to the most vulnerable in the short term, and putting assets in the hands of the poor while permanently protecting those assets through social protection in the long term. SHARED GROWTH, POVERTY, AND INEQUALITY 113 Appendix Table A. 1. Summary of Issues, Objectives, and Recommendations by Sectors Eduncation Issues Policy Objectives Recommendations * About 12 percent of * Eliminate the educa- I Establish a stronger linkage between children age sLx to 11 tion inequities in the achievement of desired outputs and are still out of school, long term financing through with nearly all of * Good basic education * Sustained, if not accelerated, imple- these excluded chil- of allyoung children, mentation of the Law 715 formula dren belonging to the in particular the allocating education transfers to ter- lowest income achievement of uni- ritorial entities according to the num- groups versal completion of ber of students, population to be * The education gap primary education in attended, and poverty indicators. between the richest the next 4 years. * Encourage the territorial entities to income decale and the * Continuous improve- adopt policies that support schemes poorest decile is ments in the learning that link resources with desired out- roughly 7 years, and achievement of poor puts, e.g, PACES, Bogoti's con- increases over the children in basic edu- cession system (although, adapted to years cation, including en- local circumstances). * The gap against the hancement of their 2. Ensure. poor is wider at the ability to learn actively. * An explicit system of identifying secondary and terti- * Selective expansion of the poor and disadvantaged chil- ary levels. pre-and postbasic dren who merit special assistance * The education gap is education, focusing in education. exacerbated by differ- on the enrollment of * A credible program that makes sure ences m the learning poor children in that disadvantaged children get effec- achievement of poor effective schools. tive and efficient assistance, includ- and better-off chil- ing both supply- and demand- based dren in school. assistance; e.g., Famulias en accidn. 3. Improve the accountability and oversight of the performance of the Ministry of Education, De- partments, Municipalities, and schools in regard to the universal- ization of basic education comple- tion and the learming achievement of disadvantaged students through- Regular production and public dis- semination of a Report Card on the performance of these educational agencies, with special attention to the education of the poor (continues on next page) 114 COLOMBIA THE ECONOMIC FOUNDATION OF PEACE Table A.1. (continued) Education Issues Policy Objeetives Recommendations • Establishment of an independent body that would implement the Report Card system, consisting of eminent people from the business, teaching, and research communi- ties, and NGOs the work of which is focused on poverty and human development o Mobilization of poor parents to enable their effective participation in the development and implementa- tion of a propoor educational agenda and enlist the support of civil soci- ety and teachers sympathetic to the cause of poverty reduction and edu- cational equity 4. Strengthen the Ministry of Educa- tion's capacity to support the terri- torial entities to acquire the techni- cal capacity and information needed to increase their ability to reach the out-of-school children and improve the learning achievement of poor and disadvantaged chlldren through strategies such as Telesecundaria, Escuela Nueva, Accelerac7dn deApren- dazaje, and SAT (Tutorial Learning System). Health issues Policy Objectives Recommendations Passage of Law 100 Improve the health 1. Continued expansion of health in December 1993 status of the poor and insurance coverage of nonaffiliated made the system reduce their financial population including the poor and more equitable and risks from illness through: the self-employed through accessible to the poor o Achievement of uni- Full implementation of the health and vulnerable, com- versal health insur- reform law (Law 715) mandating pared to the begin- ance coverage transformation of supply to demand ning of the 1990s. subsidies for healthcare SHARED GROwTH, POVERTY, AND INEQUALITY 115 Table A.1. (continued) Health Issues Policy Objectives Recommendations However, implemen- * Strengthening of the * Reduction in the evasion and tation of the reform control of commu- underpayment of health insurance remains incomplete, nicable diseases contributions. (about 32 percent of * Exclusive use of the FOSYGA Sol- the poor are not cov- idarity Account resources for sub- ered by the health sidizing health insurance coverage. insurance system) * An improved communications For various reasons program informing the public in including inadequate general and the poor in particular financing and lack of about the affiliation process, eligi- clarity in the assign- bility rights, and allocation of ment of responsibility resources to territorial entities for for immunization, demand and supply subsidies. control of communi- 2. Full implementation of Law 715 cable diseases has mandate on quality assurance, deteriorated with de- promotion of public accountabil- centralization and iry of insurers and healthcare health reform providers with the support of a strengthened Health Superinten- dency, and development of citizen oversight (Veeduria Csudadana) of the use of public health resources 3. Optimization of the financial flow of health sector resources, includ- ing prevention of illegal use, reten- tion, or use for other purposes. 4 Restructuring the network of pub- lic hospitals in order to operate as efficient providers of healthcare services with limited direct govern- ment subsidies and adoption of a new healthcare model focusing on primary healthcare. 5. Full implementation of the meas- ures to strengthen the Expanded Program of Immunization based on the recommendations of the above- mentioned National Evaluation. (continues on next page) 116 COLOMBIA THE ECONOMIC FOUNDATION OF PEACE Table A. 1. (continued) Safety Net and Pensions Issues Poliey Objectives Recommendations * The social sector pol- Establishment of a * Expand the Budget for Social Assis- icy reforms intro- reformed Social Risk tance to at least I percent of GDP duced in the 1990s Management System * Reform the pension system guar- by the 1991 Con- to (a) improve the anteeing that (a) new generations stitution, Law 60, state of readiness of do not create new liabilities, (b) lia- and Law 100 did Colombia to assist the bilities from intermediate genera- not include social vulnerable poor dur- tions are cut, (c) unification ofpen- assistance. ing times of crisis; sion regimes (entry only into ISS * The public pension and (b) strengthen and private managed funds), and system is technically social assistance and (d) homogenization of conditions insolvent (net value insurance to chroni- for accumulation offuture benefits. of pensions in 2000 cally vulnerable poor * To develop the social risk-manage- amounted 200 per- during normal times; ment system, focus on streamlin- cent of GDP) and Improvement of the ing the existing system, not creating constitutes a ma)or quality and coverage additional programs risk to fiscal sustain- of early childhood * Establish a countercyclical element ability over the meds- development services, of the safery net. um and long term. and * Address the needs of the IDP * Causes of insolvency: - More effective assis- generous pension tance to the internally benefit guarantees, displaced population perverse incentives for (IDP). reserve management, * Special attention to and recent Constitu- the following groups tional Court rulings needs to be given: expanding pension children, adolescents, benefits. the elderly, the IDP, * Colombia's pension and the poor workers system constitutes a who have been serious drag on the unemployed due to ability of the govern- lack of employment ment to finance pro- opportunities poor social assistance * Reform the pension and other programs. system to make it sus- tamable and to reduce public subsidy of well-off workers SHARED GROwwH, POVLRTY, AND INEQUALITY 117 Table A. 1. (continued) Labor Market Issues Policy Objectives Recommendations • The labor market in * Labor market reform * Rationalization of payroll taxes (sub- Colombia is charac- to stimulate employ- stitutnng some of them with more terized by being rigid: ment growth, provide efficient taxes) real wage rigidities a more favorable envi- * Reduction of transaction costs for (minimum wages and ronment for acceler- "being formal." unions) The impact ating investments in * Elimination of the rigidities imposed of these rigidities is human capital, facil- by the minimum wage including, disproportionately itate movement of among others, allowing emergency negative on the poor, workers from low to public workfare programs for the rhe young, and high productivity poor to pay less-than-minimum- women activities, and pro- wage salary and exempting them * High unemployment mote equity from payment of obligatory fringe rates. average annual * Labor reform should benefits (prestaczones) so that they unemployment rate have in mind that can become self-targeting and reach during the last 10 payroll taxes (a) more poor, unemployed workers. years has been about finance major social Development of self-financing 14 percent assistance programs workers' income insurance scheme * The labor market in that benefit the poor to protect workers against spells of Colombia is highly (e.g, ICBF and social unemployment to replace costly job segmented-infor- health insurance), (b) security regulations mality close to 60% that they are a source * Acceleration of investment in the of the workforce. of funding for work- human capital of poor workers, * The labor market ers' training, and (c) including a reform of the Servzc:o presents low degree that job security reg- Nacional de Aprendizaje (SENA), of turnover between ulations protect (al- separating the finance and provi- the formal and infor- though, at high cost) sion of training programs based on mal sector There are currently employed workers' choice and competition low opportunity costs workers against un- involving botlI public and private of self-employment employment and the providers (recent data indicate that because of the low consequent loss of the impact on workers' salaries is productivity of the income. considerably greater for private than formal sector. public training) Improving the efficiency of pro- grams (e g, ICBF, SENA, and Social Health Insurance) funded by payroll taxes so that the actual value of the benefits from those programs is commensurate with the cost of the obligatory contributions (continues on next page) 118 COLOMBIA THE ECONOMIC FOUNDATION OF PEACE Table A. 1. (continued) Housing Issues Policy Objectives Recommendations Since 1990, commer- o Restore mortgage The government should urgently take cial banks were al- portfolio, expand measures to protect mortgage holders lowed to compete in mortgage stock as well against predatory lending behaviors the construction and as new productive and restore a sounder balance among mortgage markets, loans mainly through judges, lenders, and borrowers Actions which were domi- increasing housing to be considered include the following: nated by Corpora- demand. 1. Revise the system of a capped inter- ciones deAhorro y o Implement a legal and est rate for mortgage loans. The revi- V¼vuenda (CAV). regulatory framework sion should be consistent with the * The liberalization in- that restores housing Constitutional provisions set up to creased the cost of as collateral for the avoid predatory practices. CAV funds because lending institunons 2. Limit debt restructuring to cases of UPAC-savings be- Restore housing own- an unpredictable loss of borrower came less attractive. ership as a protection income followed by some credit The UPAC formula against poverty and solvency has changed several as a worthy form of 3. Fully inform mortgage consumers times to reflect that collateral. about new regulations regarding reality, introducing their rights and duties. instability into the 4. Adjust the Unidad de Valor Real housing market. (UVR) to reduce its role as a source • There was a boom in of volatility. poorly designed credit 5 Improve the overall structure of products between housing credits: 1995 and 1997, - Housing appraisal rules could be when the level of better adjusted to comparative mar- nonperforming loans ket trends was rising and hous- - The credit reporting system should ing prices started to not be limited to current records decline for upper seg- - Reduce delays in property ments. The deterio- registration. ration of the portfolio 6. FOGAFIN should consider was evident before strengthening the collateral require- the interest rate shock ments under the recapitalization of 1998. line by requiring collateral with lower-risk assets. 7. The Superintendency of Securities needs to expand its staffing and training by oversight inspections, detailing its regulations, and imple- menting prompt corrective actions. SHARED GROWrH, POVERTY, AND INEQUALITY 119 Table A.1. (continued) Indigenous Peoples and Afro-Colombian Communities Issues Policy Objectives Recommendations • The Afro-Colombian * Increase public invest- * Provision of adequate basic services, population has faced ment for indigenous particularly health, education, and historical deficit of peoples. services related to production public services such * Improve healthcare * Consolidation and demarcation of as health, education, services for these indigenous homelands and the com- and support services communities munal lands of Afro-Colombians for production * Improve quality of * Design of strategies for the protec- * The African-Colom- educational services, tion and conservation of special bian population is especially supply of ecosystems that contribute to the showing an accelera- well-trained teachers strengthening of territories and tra- tion of the migration in these communities. ditional systems of knowledge, con- process explained by servation, and sustainable use of the internal conflict biodiversity (Uraba, low and medium Atrato) and the violent process associated with the expansion of illegal crops * There is pressure on the indigenous home- lands and collective territories of Afro- Colombian commu- nities because of the colonization of farm- ers-especially those dedicated to illicit crops-and the inter- nal armed conflict. (continues on nextpage) 120 COLOMBIA THE ECONOMIC FOUNDATION OF PEACE Table A. 1. (continued) Forced Internally Displaced Popuiation (IDP) Issues Policy Objectives Recommendations Forced displacement o Make the problem of * Remove access barriers for the par- in Colombia is main- forced displacement ticipation of the IDP in the poverty- ly the result of the a priority targeted social programs including social and armed con- e Reduce displacement application of the Sistema de Selec- flict. It is the most by implementing ef- cion de Benefictanos (SISBEN) ques- serious humanitarian fective preventive tionnaire and issuance of the and social problem in measures at the local SISBEN cards through a plan Colombia today. level. designed jointly with the municipal - Adopt a common governments methodology among * Empower the IDP at the national key stakeholders for and local level. estimating the size Focus on regions, municipalities, and characteristics of and localties at high risk, and within the IDP those on the groups at high risk of - Create realistic incen- being threatened. tives and opportuni- * Increase incentives to resist dis- ties for the reestab- placement by ensuring protection of lishment-return, property rights on assets relocation, and inte- * Promote direct dialogue among local gration-of the IDP. authorities, organized citizens, and * Ensure access of IDP armed groups to demand respect for children to public human rights of citizens and to education. exclude from armed conflict areas such as hospitals, cultural centers, and homes. * Conduct a national survey based on a probability sample of the entire population displaced. * Establish regionally focused social funds as instruments that promote self-reliance in reestablishment proj- ects oriented to community action to secure or recover assets, commu- nity-driven reintegration and devel- opment activities, and social and economic stabilization of particu- larly vulnerable groups, such as female heads of household and youth (male and female) in those focused regions, municipalities, and localities. * Promote regional agricultural ini- tiatives that offer opportunities for the IDP to undertake productive activities. SHARED GRowrTT, PovERTY, AND INEQUALITY 121 Table A.1. (continued) Gender Issues Policy Objectives Recommendations * Colombia has made * Gender indicators I Crime and Violence significant progress in should continue to be * Retrain teachers to ensure they do reducing gender in- monitored to ensure not promote violent behavior among equalites-particu- that gains for women boys and submission among girls larly in improving the in education, literacy, Eliminate gender stereotypes in well-being of women health, and employ- textbooks and other pedagogical * While the status of ment are not eroded materials females has improved, by the continuing cn- - Develop innovative programs to male human capital sis in Colombia. teach children nonviolent resolu- has eroded on the * The approach to tion skills and promote civic values. health and education gender needs to be * Address gender issues in programs fronts. broadened from a aimed at reducing homicide rates, * Important interlink- conventional focus on such as Convivencia Ciudadana. ages exist between women to address the 2. Reproductive and Sexual Health gender, poverty, and negative dimensions * Develop integrated programs that inequality in Colom- of gender for men. address employment, violence, sex- bia Female-headed * Given the immediate Lality, and sexually transiiltted dis- households are more needs resulting from eases (STDs) and AIDS likely to be poor and the crisis, it is impor- * Use youth workers to reach other vulnerable than those rant to consider gen- youth, and men to reach men. headed by males. der in social safety net * Use participatory learning in the programs for the form of role-playing and assertive- poorest and most vul- ness exercises rather than traditional nerable-in particu- didactic training methods lar single-parent fe- * Address causal factors related to ado- male households. lescent sexual activity, including self- esteem, decisionmaking, gender roles, and valies. * Target youth and men where they normally gather 3 Support to Female Single-Parent Families * Increase poor women's access to childcare and family planning, con- tinue improvements in education, and reduce barriers to poor women's participation in the labor market Table A.2. Summary of Policy Handles that Impact Welfare in Three Dimensions: Income, Access to Social Service, and Risk Management Objective Short Term Medium and Long Term 1. Raise employment 1.1 Recover high positive economic growth. 1.5 Increase female participation by facilitating 1 2 Increase female participation by providing access to birth control mechanisms to reduce childcare and preschool services, and reducing fertility rates and by improving educational urban transport costs. endowments. 1.3 Reduce labor market rigidities such as minimum wages and costs of labor contracts. Labor 1.4 Reform temporary public employment Income programs and privilege household heads. 2. Raise productivity by g Increase 2 3 Workfare and youth training programs such as 2.1 Increase productivity by reducing education ° Income Jovenes en Acc:dn for youth and Manos a la inequities (access) and improving quality of Obra. education. 2.4 Provide services related to production for 2.2 Promote technical postsecondary education, I Indigenous and Afro-Colombian communities private sector and vocational training, and t internship and apprenticeship programs. 0 z 0 0 z 0 Table A.2. (continued) Objective Short Term Medium and Long Term 1. Promoting owsnership of assets I I Prevent predatory lending on mortgage credit. |1.2 Housing acquisition and housing subsidies. 0 2. In-kind or cash transfers such as: Nonlabor 2 1 Targeted subsidies via block tariff pricing of Income utilities. 2 2 Programs such as the PACES vouchers to allow poor students to pursue secondary education. 1. Provide basic education in poor neighborhoods 6. Improve water supply and sanitation in medium 2. Develop demand-side financing mechanisms in cities, small municipalities, and in the rural areas the form of conditional cash transfers to attract 7. Promote initiatives for adequate monitoring, More Equitable Access to and retain children in school. management, and disposal of wastewater Social Services 3 Provide healthcare for the poor. 8. Recover cost from nonpoor group beneficiaries of 4. Provide adequate basic services, particularly public social programs health and education, for Indigenous and Afro- Colombian communities. 5. Provide scholarships and educational credit for postsecondary education (continues on next page) Table A.2. (continued) Objective Short Term Medium and Long Term 1. Self-insuranec 1I.1 Promote housing ownership and real asset accumulation 1 2 Protect human capital assets (nutrition programs for the poor). 1.3 Reduce unwanted pregnancy rates, especially among teenagers. 2. Market insurance: 2.1 Implement policies that seek to expand () employment and increase productivity in the informal sector. o Economic Risk 2.2 Reduce costs of "being" formal (registration process and labor regulations) 3. Safety-net socialprotection m 3 1 Create alternatives for unemployment support 3.5 Establish a countercyclical element of safety net. ° Management systems (insurance scheme avoiding perverse 3 6 Expand the budget for social assistance to at 0 of Risk incentives). least I percent of GDP by redirecting funds to n 3.2 Create health insurance for the unemployed. well-targeted social assistance programs. o 3.3 Develop protection mechanisms for the 3.7 Expand minimum pension schemes. c informal sector. 3.8 Create assistance prograrms for the elderly 3.4 Subsidize healthcare and health insurance. (1% of payroll contribution that today subsidize o contributions for the poor) z > Table A.2. (continued) Objective Short Term Medium and Long Term 1. Vulnerability to violence and crime 1.1 Protect households, especially poor ones with 1 4 Protect the rights of common citizens to life low educational endowments, from intrafamilial and against insecurity, homicide, rape, fights, violence gangs, loitering, threats, and guerrilla and Other Risk 1 2 Reduce exposure to homicide risk, especially of paramilitary presence the poor, and the young male population. 1.5 Protect property rights. 0 1.3 Improve securty of employment generators z such as small businesses owners in poor neighborhoods 2. Internally DispLaced Population (IDP): 2.1 Facilitate access of IDP to public subsidies and Reduce rate of displacement by in-kind services by application of the SISBEN 2 5 Focusing on regions, municipalities, and questionnaire and issuance of the SISBEN cards localities at high risk and within high-risk 2.2 Empower IDP at the national and local groups governments 2.6 Increasing incentives to resist displacement by 2 3 Adopt a common methodology among ensuring protection of property rights on assets. stakeholders for estimating the size and 2 7 Promoting dialogue among local authorities, characteristics of the IDP. armed groups, and citizens to guarantee respect 2 4 Create incentives and economic opportunities for human rights of citizens for the return, relocation, and integration of the IDP. 126 COLOMBIA. THE ECONOMIC FOUNDATION OF PEACE Table A.3. Definitions Associated with Table 1 Indicator Definition Poverty line Value of a very basic basket of food products that provides mini- mum caloric intake of individuals of average age and sex. Extreme Poverty An Individual will be considered extremely poor if his or her household per capita income falls below the extreme poverty line defined by DANE, based on the 1985 Survey of Expenses and Income. Poverty A person is considered to be poor if his or her household per capita income is below the poverty line, a multiple (between 2 and 2.5) of the extreme poverty line, to take into account other basic necessities. Mean income Average household per capita income. Poverty gap Describes the average distance to the poverty line. Gini Coefficient Measures the expected difference between two Colombians' income picked at random. Quintiles (Top/Bottom) The ratio of the share of income held by the richest quintile to that held by the poorest. Inequality Urban-Rural Decomposition (Theil) Within Amount of income inequality explained by differences within rural and urban groups weighted by its share in the whole population. Betwveen Amount of income inequality explained by differences between rural and urban groups of population SHARED GROWTH, POVEWIY, AND INEQUALITY 127 Table A4. Inequality Decomposition, Urban Colombia Change in Gini Coefficient Income per Capita (% points) Decomposition Returns to Education Education Direct effect Indirect effect via Endowment Observed via price mean endowments Total Effect 1978-88 00 -19 33 1 4 -1.9 1988-95 4 2 -0 1 2 2 2.1 -1 7 1995-99 2.6 1.3 3 5 4 8 -3.0 1978-99 6.8 -07 9.0 8 3 -6 6 Source Velez et al (2002) 128 COLOMBIA THE ECONOMIC FOUNDATION OF PEACE References Arboleda, J., and E. Correa. 2002. "Internally Displaced People Policy Note." Wash- ington, D.C.: World Bank. Acosta, 0. L. 2000. "Gasto Puiblico Soclal y Arquitectura Financiera: C6mo las Condiciones Fiscales Existentes y Esperadas Afectan la Provisi6n de Servicios Sociales en Colombia." Washington, D.C.: World Bank. Bourguignon, E Ferreira, and P. G. Leite. 2002. "Beyond Oaxaca-Blinder: Account- ing for Differences in Household Income Distributions Across Countries." Washington, D.C.: World Bank Chiquier, Loic. 2002. "Housing Finance Policy Note." Washington, D.C.: World Bank. Correia, Maria. 2002. "Gender Policy Note." Washington, D.C.: World Bank. Centro de Esrudios Regionales Cafeteros y Empresariales (CRECE). 2001. "Disefio del Marco Normativo e Institucional y del Esquema de Toma de Decisiones de la Red de Protecci6n Social." Manizales, Colombia. Davis, S., and E. Sanchez. 2002. "Indigenous Peoples and Afro-Colombian Com- munities." Washington, D.C.. World Bank. Dulitsky, D., M. Gragnaloti, and K. Lindert. 2001. "Social Protection Expenditure Review." Washington, D.C.: World Bank, processed. Echeverry, J C., M. Santamaria, and A. Escobar. 2002. "Tendencias, ciclos y dis- tribuci6n del ingreso en Colombia: Una critica al concepto de 'modelo de desar- rollo "' Archzvos de Economia. Departamento Nacional de Planeaci6n, Colombia. Fretes Cibils, Vicente, and Vicente Paqueo. 2002. "Labor Markets Policy Note." Washington, D.C.: World Bank. Gavin, M., R. Hausmann, R. Perotti, and E. Talvi. 1996. "Managing Fiscal Policy in Latin America and the Caribbean: Volatility, Procyclicality and Limited Cred- itworthiness." Office of the Chief Economist, Working Paper #326. Washington, D.C.: Inter-American Development Bank. Gaviria, A. 2001. "Who Bears the Burden of Crime and Violence in Colombia?" Washington, D.C.: World Bank. Gaviria, A., and C. E Velez. 2001. "Who Bears the Burden of Crime and Violence in Colombia?" Washington, D.C.: World Bank. Gomez-Buendia, Hernando. 2002. "La Reforma Pensional." Revista Semana, July 1. Herrera, S., G. Perry, and N. Quintero. 1999. "Output Fluctuations in Latin Amer- ica: What Explains the Recent Slowdown?" Washington, D.C.: World Bank. Inter-American Development Bank (IDB). 1997. Llbhaber, Menahem, and Vivien Foster. 2002. "Urban Water and Sanitation Sector Policy Note." Washington, D.C.: World Bank. Panopoulou, Panagiota, and Maria-Luisa Escobar. 2002. "Health Policy Note." Washington, D.C.: World Bank. Panopoulus, G. 2001. "Subsidized Health Insurance, SISBEN and Demand for Health Care Among the Poor in Colombia." Washington, D.C.: World Bank. SHARED GROWTH, POVERTY, AND INEQUALITY 129 Partow, Z. 2002. "Colombia: Public Expenditure and Fiscal Adjustment" Wash- ington, D.C.: World Bank. Rawlings, Laura B. 2002. "Social Safety Net Policy Note." Washington, D.C.: World Bank. Rodrik, D. 1999. "Why is there so much insecurity in Latin America?" World Bank, October 1999. Wlez, C. E., and V. Foster. 2001. "Public Social Expenditure in Colombia: Inci- dence and Sector Priorities in the 1990's." Washington, D.C.: World Bank Vdlez, C. E., B. de la Briere, and N. Millan. 2001. "Poverty and Welfare in Rural Colombia During the Last Two Decades." Washington, D.C.. World Bank. Velez, C. E., J Leibovich, A. Kuigler, C. Bouill6n, and J. Nnfiez. 2001. "The Rever- sal of Inequality Trends in Colombia, 1978-1995: A Combination of Persistent and Fluctuating Forces." Washington, D.C.: World Bank. Velez, Carlos Eduardo, Vivian Foster, Mauricio Santamarfa, Natalia MillUn, and B1nMdicte de la Briere. 2001. "Colombia Poverty Report." Volume I. Washing- ton, D.C.- World Bank. Processed. Vlez, Carlos Eduardo, and Juanita Rlafio. 2002. "Colombia Policy Note on Inequality and Poverty Facing Increasing Poverty and Inequality in Colombia" Background Material. Washington, D.C.: World Bank. von Gersdorff, Hermann. 2002. "Pension Reform Policy Note." Washington, D.C.: World Bank. World Bank. 2002. "Colombia: Social Safety Net Assessment." Report #22255-CO. Washington, D.C.: World Bank. 4 The Demand for Governance and Quality of Government This Chapter was written by Fernando Rojas. I. Summary Since the 1 960s, Colombia has adopted two different governance standards.' One is government capacity to formulate and implement macroeconomic policies or reach aggregate economic targets. Another, much lower one, is the capacity of the national level to propose, enact, implement, and monitor sector-by-sector policies. The country was able to live with this separation while economic growth made sector inefficiencies relatively invisible. That changed recently with globalization, the intensification of the internal conflict, and-most obviously-when the country experienced years of stagnation or negative economic growth for the first time in nearly 50 years. It then became necessary to dig into the deeper causes of, and the linkages between, fiscal and monetary imbalances, on one hand, and sector ineffi- ciencies, low investment, political and social instability, and an inadequate business environment, on the other. This Chapter discusses (a) how and why Colombia came to need a comprehensive-rather than today's fragmented-approach to enhanced quality of government, (b) the main areas where higher quality of government appears to be most needed in the next few years, and (c) how the country could strategize about strengthening the quality of government. 1. This Chapter focuses on the quality of government As proposed in this Chapter, there is quality of government when governments not only have the necessary capacity to make and implement policy, but also the capacity and commitment to select policies that are socially, politically, and economically sustainable As such, the quality of governance includes checks and balances, legitimacy, and accountability Since quality of government includes repre- sentation, participation, social control, and anticorrtption capacity, it covers the Executive, the Legislative, the Judiciary, and all independent sanctioning and control organisms 131 132 COLOMBIA THE ECONOMIC FOUNDATION OF PEACE II. Background: A Dual Quality of Government How DID COLOMBIA COME TO Two STANDARDS OF PUBLIC SECTOR? It could be argued that the separation between economic policymaking and other public poli- cies began with the creation of the Junta Monetaria in 1963. Although the Minister of Finance was the President of the Junta, its creation was a significant step toward separation of economic policymaking from political interference. That separation was later ratified by the pathbreaking Estatuto Cambiario, or Decreto-Ley 444 of 1967. Those two reforms, together with the constitutional and administrative reforms of 1968, gave the government the initiative on (in some cases full control of) monetary, trade, exchange, and fiscal policy. Subsequent reforms, including strengthening of the independence of the Central Bank and elimination of budget subsidies in the Constitution of 1991, have further consolidated the independence of economic policymaking. Presidents have generally supplemented constitutional and legal provisions by appointing technically sound, politically independent ministers of finance and Central Bank presidents. As a mat- ter of fact, Colombian ministers of finance are usually selected out of a self-referred invisible college of distinguished economists that look to the international commu- nity of prominent economists and to international monetary and development insti- tutions as their mamn reference points. When the government's economic policy is restricted to regulation and supervi- sion (as in monetary, financial, and exchange matters), policy application generally has been satisfactory. When the government is also in charge of the administration (as in the case of internal taxes, customs, and the budget) (see Box 1), policy appli- cation is usually less satisfactory. Yet, substantial progress has been achieved over the years. Strengthening tax administration is a never-ending task in a country that has an average of one substantial tax reform every other year-and where the revenue impact of tax reform is generally short-lived. Likewise, budget transparency in terms of key budget classifications and reporting to the Congress and civil society is still far from contemporary good practices. Fiscal data are often late or unreliable (par- ticularly in the case of subnational governments) and the country still has a long way to go in terms of performance and results evaluation and in terms of e-government for purposes of real-time data collection and reporting. There is still room to either reinforce on the margin the independence of the Central Bank2 or protect it against politically pressured exchange or debt measures. As a result of the privileged institutional development of the economic policy sec- tor over the last 40 years, this sector is currently much better equipped than any other sector to make and implement policy. Likewise, the whole area of economic policy has been less contaminated by accusations of government corruption, and the area of macroeconomic policy has been largely isolated from corporate-based 2. As discussed, for instance, in the recent Alessina report regarding the composition of the Board of the Central Bank. THE DEMAND FOR GOVERNANCE AND QUALI IY OF GOVERNMENT 133 Box 1. Budget Implementation and Control The area of budget implementation and control reflects the ambivalent devel- opment of Colombia's governance and quality of government The country recently adopted the single account (Cuenta Unica del Tesoro) and integrated financial management. Both tools enhance the government's capacity to moni- tor the flow of public expenditures and enforce hard budget constraints and overall fiscal targets. However, Colombia still has a long way to go with respect to disclosure and transparency in budget reporting to the Congress and civil society.a The country is also far behind other Latin American countries such as Brazil, Chile, and Mexico with regard to transparency and control in the pro- curement process, anticorruption tools, and strategies for electronic govern- ment. Again, the primacy of macroeconomic goals has diverted institutional development from efficiency, accountability, and protection from anticorrup- tion in day-to-day government operations. a See Chapter on Budgetary InstitLtions. demands, stakeholder capture, or clientele-based political parties In sum, high qual- ity of government has ensured rather sound, sustainable economic policy and imple- mentation tools throughout the last 40 years. Other sectors have not followed the pace of macroeconomic policy in terms of governance strengthening, efficiency, or political and fiscal sustainability. Until recently, the general approach to governance strengthening was to create autonomous or semiautonomous institutions that were somehow protected from clientele capture and other forms of political interference and corruption.3 This approach generally failed, not only because most autonomous institutions proved to be vulnerable to political patronage and corporate control, but also because most of those institutions entailed some degree of bureaucratic duplication or parallelism, additional fiscal cost, and diffusion of monitoring and control. In addition, autonomous institutions often escaped from official controls and civil society super- vision. When one of those autonomous or semiautonomous institutions played a critical role in economic policymaking, as in the case of Empresa Colombiana de Petrdleos (ECOPETROL), the national oil company, economic policymakers pre- ferred the regulatory way to ensure transfer of the oil surplus for fiscal stabilization purposes, rather than the more personally painful and politically expensive way of 3 Depending on their nature and the fashion at the time, those autonomous or semi- autonomous institutions may have been called such things as empresasplbWcas, establec- imientos pdbhcos, or special funds 134 COLOMBIA. THE ECONOMIC FOUNDATION OF PEACE reforming the institution from within.4 When the country began to reconsider the role of the public sector, some of those autonomous agencies were either suppressed or transferred to the private sector. As reported in several other Chapters, most key Colombian government sectors have-to different degrees-partially fallen prey to their own corporate stakehold- ers or have been exposed to general patronage bonds. In both cases, rent-seeking practices feed political and individual interests on the supply side of government services. Transparency is restricted and control of the sector nurtures more-than- ordinary opportunities for corruption. Above all, protective barriers prevent either policymaking or effective implementation, thereby weakening governance. Education is perhaps the most visible case of corporate (teachers' trade union) control and prevention of reform. Health reform has also been either controlled or diverted by service providers. The same can be said about infant, youth, and family services under the umbrella of the Instituto Colombiano de Bienestar Famlizar (ICBF). Although the Calas de Compensacidn Famzliar appear to be more receptive to user demands than other social services, access to the Cajas still follows a closed- corporative structure-which is in turn due to the difficulty of proposing, agreeing to, enacting, and implementing overdue labor reform, including pension reform.5 As in other sectors, the country has not been able to appoint technically independ- ent managers for the labor sector. Or, when temporarily appointed, as in the recent case of the Instituto del Seguro Social (ISS), the interests of trade unions and con- tractors tend to prevail over the interest of the country as a whole. Restricting providers of labor, goods, or other services is also common practice in transportation or infrastructure investment. Since sector expenditure policy is geared toward guaranteeing supply or maintaining a certain production function- rather than satisfying demand or otherwise ensuring efficiency in results-stake- holder capture of a given chunk of sector expenditure generally goes unchecked. Trade unions often prevent expenditure rationalization and productive efficiency in electricity or public transportation.6 Although the procurement regulatory frame- work has been reformed time and again, the country is still far from the most advanced procurement reform, as exemplified by Brazil, Chile, or Mexico in the 4. One exception worth noting is the public utiliry company of Medellin, Empresas Ptiblicas de Medellin (EPM). A full account of this rather isolated best practice case remains to be added to the literature on Colombian public administration. 5. According to a recent World Bank survey, the Caja Nacional de Prevision Social (Govern- ment Employees Pension Fund, CAJANAL), the Caja de Previsidn Social de Comunica- ciones (CAPRECOM), and other pension and social security institutions are perceived to be among the most politicized and most corrupt in the country. The survey consulted employees, users of public services, and entrepreneurs. See Chapter on Corruption. 6. According to the World Bank survey cited in footnote 6, the Instituto Nacional de Vias (National Highway Institute, INVIAS) is perceived as one of the most corrupt and most politicized government institutions. See Chapter on Corruption. THE DEMAND FOR GOVERNANCE AND QUALITY OF GOVEFRNMENT 135 Latin American context. It is no surprise to see potentially strong suppliers shy away from bidding competitions because the odds of their winning have been largely reduced by predetermined government inclination in favor of another potential sup- plier. Accusations of overpricing and underreporting are also frequent. Unequal development in supervision, auditing, and sanctioning has also meant stronger governance capacity in the macroeconomic areas than in other areas of public sector activity. The Central Bank closely monitors monetary and exchange policies, while the Superintendencia Bancaria has kept a vigilant eye on savings and credit insti- tutions. More important, the quest for sustainable macroeconomic policies and a sound financial sector is matched by the cooperative ear of both the Ministry of Finance and the Planning Department. Taken altogether, the monitoring and supervision capacity of the macroeconomic and financial sector has prevented-with only a few, notable exceptions7-ma)or scandals in either macroeconomic policymaking or the day-to-day management of public debt, the country's reserves, or banking institutions. Supervision, auditing, and sanctioning of the public sector is a different story. Indeed, the country's capacity to monitor, audit, and sanction irregularities in the public sector is still far from the needs of market formation, globalization demands, and an enabling business environment. Different from the Superintendencia Ban- caria, most superintendencias were quickly captured by their own stakeholders (as in the case of the Superintendencia de Cooperativas for the solidarity sector) or by polit- ical parties and their clientele (as seems to be the case with the recently created Superintendencia de Salud). The institutional development of the Contraloria Gen- eral de la Repilblhca is another case in point. Although inspired by the same Kem- merer mission that recommended creation of the Central Bank and the Superinten- dencia Bancaria in 1923, the Contraloria was soon tied by the bonds of political patronage. Still, today the Contraloria General de la Reptiblca has been restricted by a mammoth organization where political appointees still manage to defend their interests at the cost of modernization and reform-minded staff. Other auditing and sanctioning institutions have roughly followed the fate of the Contraloria. Attempts to liberate the human resource policies of the Procuraduria General de la Reptiblica from political patronage ties have largely failed. Indeed, internal reform of the Procuraduria does not appear to have advanced as much as the reform of the Contraloria. The constitutional reform of 1991 followed a regionwide path toward the creation of technically competent judicial management. However, similar to other sectors, the top level of the Conseqo Superior de la Judicatura remains in the hands of former Judges and magistrates that tend to represent primarily their own corporate, monopolistic interests. There are even symptoms of magistrates' cap- ture of the Constitutional Court for the pursuit of their own political careers. The country is still far from timely and efficient administration of )ustice Likewise, Colombia has achieved only limited progress (compared to, say, Canada and the 7. Like the infamous case of the vanishing of US$13 million from the reserves managed by the Central Bank in the mid-l 980s, or the always debatable rescue of banks in times of crisis 136 COLOMBIA THE ECONOMIC FOUNDATION OF PEACE United States) in developing means of alternative dispute resolution; unequal access to justice still reinforces other sources of inequality of opportunity and reduces spillover of growth benefits. Since violence and the internal conflict have further debilitated property rights and safety and other basic human rights, large sections of the population are not protected in their lives or assets. As a result, large segments of the population cannot provide either personal or real guarantees to access capital or consumption markets. Because Colombia is one of the most decentralized countries in Latin America, strengthening governance there necessarily means strengthening the capacity of the public sector to deliver service and monitor compliance at subnational levels. How- ever, the way Colombia conceived and/or implemented decentralization has con- fused the division of responsibilities and weakened accountability. As discussed in the Decentralization Chapter, sector capture of deconcentrated or decentralized social services has now been compounded by subnational stakeholder protection of the current level of fiscal transfers. Mayors' and governors' associations have equated democracy with maintaining or increasing fiscal transfers regardless of the coverage and quality of services. The fiscal demands of subnational governments have been reinforced by trade unions and patronage-based political leaders that claim the need to equate transfers with the cost of clientele-controlled rigid production functions. As demonstrated by all reforms passed since the Constitution of 1991 and Law 60 of 1993, Colombia decentralization is supply targeted rather than demand driven. Not surprisingly, the most recent government evaluation of one decade of Colombia's decentralization is primarily a study on social expenditure growth-not an assessment of how decentralization per se enhanced quality, raised coverage, or otherwise stimulated higher efficiency in allocation and production.' In spite of Colombia's widely proclaimed regional leadership in fiscal decentralization, the country has yet to develop the essential monitoring and evaluation capacity to demonstrate how and to what extent decentralization has contributed to more effi- cient service provision than the previously centralized model of service delivery. III. The Problem with the Coexistence of Strong and Weak Governance WHY IS STRENGTHENED GOVERNANCE REQUIRED IN AREAS OTHER THAN ECONOMIC POLICY? For some years Colombia was able to grow and maintain good fiscal and financial performance while keeping the dualism in governance between economic policy and other sectors' policy. So-called first-generation economic reforms appear to demand only strong policymaking capacity in the areas of trade, monetary, exchange, and overall fiscal targets. Poliucally difficult as those reforms might have been, they penalized only a limited number of rather silent and shameful stakeholders that used 8. See Decentralization Chapter THE DEMAND FOR GOVERNANCE AND QUALITY OF GOVERNMENT 137 to benefit from protectionism or profit from inflation or erratic changes in the exchange rate. The damaging experience of hyperinflation or abrupt fluctuations of the exchange rate in Argentina or Brazil moved the country to remain faithful to the solid principles of the Estatuto Cambiario, first established in 1967. In addition, trade liberalization was never as swift in Colombia as it was in other Latin American coun- tries. The attentive eye of the international community has also helped the country maintain its traditional priority for sound, effective macroeconomic policy Several factors combined to put pressure on the country to adopt second- and third-generation reforms. The country urgently needs to offset the effects of low or negative economic growth in recent years on poverry expansion and reduced invest- ment. Coexistence between strong macroeconomic governance and weak govern- ment capacity in other sector policies was sustainable only while economic growth provided a cushion for sector inefficiencies The context of relatively open economies in an increasingly globalized world is finally pushing Colombia to explore all potential avenues for enhanced efficiency in resource allocation, higher productivity, a better savings and investment climate, and strengthened country competitiveness Sector rigidities that were long tolerated are increasingly perceived as adding unnecessary transaction costs that limit the country's competitiveness. As illustrated by the recent World Bank survey on corruption and politicizatioln, both employees and managers are now fully aware that built-in inefficiencies in social services prevent labor productivity enhancement, and restricted government con- tracting protects low capital productivity. It is nIow more clear-than, for instance, at the time of the 1991 Constitution-that labor rigidities and capital overpricing reduce government efficiency to the point where the only solution is additional gov- ernment indebtedness and crowding out the financial needs of the private sector. Besides the urgent need to reestablish a sustainable pace of growth and counter- act the frightening poverty effects of the ongoing economic slowdown, the fiscal and financial demands added by the Colombian internal conflict have made it evident that the country can no longer postpone long-overdue, sector-specific and across- sector reforms. Besides adding pressure on internal security expenditures, the inten- sification of Colombia's internal conflict has multiplied both poverty and the need for social safery nets. Enhanced quality of government is required not only for effi- ciency-seeking, sector-specific reforms, but to reestablish protection of the most basic personal and economic guarantees and behavioral incentives. Across-sector reforms are needed to extend land titling and registration and to guarantee conti- nuity in and equal access to justice, social services, and public utilities in conflict- ridden areas. It is not only that governance and high-quality government are needed to bring the internal conflict to an end; it is that governance is challenged and debil- itated by the mere continuation of the conflict. Bringing the conflict to an end is a prerequisite for savings and investment, and mobilization of resources that have been marginalized by the internal war. More so than sector-specific reforms, across- sector reforms for strengthening overall governance are required to develop a credi- ble enabling business environment. 138 COLOMBIA THE ECONOMIC FOUNDATION OF PEACE Today's economic policymaking and implementation goes beyond first-genera- tion reforms. Although all reforms are interlocked, making significant progress in transversal or across-sector areas such as monitoring, auditing, sanctioning, and pro- tecting basic rights is necessary to supplement sound macroeconomic management and enhance the investment climate and service sustainability. Colombians have known for some years what are the broad policy guidelines for second- and third-generation sector policy reform. In some cases, the specifics of those reforms-as proposed by certain other sector Chapters-have also been iden- tified. Subsequent to the initial wave of reforms in the early 1990s, the country is already aware of the implementation risks and the potential resistance of stakehold- ers that daunted the reform spirit and jeopardized sustainability of reforms in, for instance, health, labor, the judiciary, education, and decentralization. As demon- strated by recent surveys and electoral results, Colombians appear to be persuaded that those reforms-either sector or across sectors-would come to supplement tra- ditionally sound macroeconomic policy with the necessary microeconomic frame- work and incentives for economic agents to develop the full potential of labor, capi- tal, land, and technology. The problem is that those second- and third-generation reforms require strengthened governance and enhanced quality of government-and this is precisely what the country has been short of for the last 20 or 30 years. There appears to be a vicious circle that goes from the incapacity of government to formu- late and implement most needed reforms, to the fact that those reforms are precisely needed to strengthen governance in Colombia. Strategizing is needed to develop a virtuous cycle that connects incremental reform with the gradual building of high- quality government, then using new, strengthened government capacity for policy- making and implementing those reforms that are more difficult to pass and effec- tively apply. IV. Strategizing to Strengthen Governance: Selectivity and Gradualism in Building High-Quality Government As mentioned, Colombia is entering a new phase of its history-one that appears to have a propitious climate for strengthening governance. The new administration seems to give high priority to improving the quality of government, and citizens are demanding government reform for efficiency and sustainability of those other reforms analyzed in the accompanying Chapters. The challenge lies in translating growing awareness and demand into effective government strengthening for making and implementing sustainable policies. It should be noted at the outset that strengthening governance and enhancing quality of government is more an art than a science. The best public sector leaders (including the Legislature and the Judiciary) and analysts can do is to follow guid- ing principles, assess how those principles have been applied elsewhere and with what results, and adjust to government culture and local idiosyncrasies. THE DEMAND FOR GOVERNANCE AND QUALITY OF GOVERNMENT 139 THE SEARCH FOR HIGHER QUALITY OF GOVERNMENT AS A MEDIuM-To-LONG- TERM GOAL IN ITSELF. Quahty of government is needed for sustainable policies, and sustainable policies may in turn reinforce quality of government. One of the most frequently encountered problems when trying to build government capacity is to confuse strengthening governance and quality of government with sector reforms. Strengthening governance and enhancing quality of government is an end in itself. As such, it requires identification of problems, strategizing, implementation, moni- toring, and evaluation. As with any other program and project, improving the qual- ity of government requires-above all-a program structure and clearly identified responsible agencies for program formulation, financing, implementation, monitor- ing, dissemination, evaluation, and control. (See Box 2 for a description of how it was done in the Clinton-Gore Administration in the United States and the Fox Administration in Mexico.) Box 2. Efforts to Improve Quality of Government in the United States and Mexico The Clinton-Gore Administration in the United States created the National Performance Review (NPR), a White House Policy Council designed to rein- vent government. The NPR orchestrated the largest peacetime downsizing in U.S. history. In addition, the NPR prepared two major procurement reform bills, conducted two major performance audits of the federal government, and oversaw a major reform initiative aimed at improving the government's regula- tory agencies. The NPR also formed the National Partnership Council, which reshaped labor-management relations in the federal government. The Fox Administration in Mexico established the National Plan for Trans- parency and Anti-Corruption, primarily focused on the federal level. The federal government appointed an interministerial commission to monitor, evaluate, and revise the program. The Commission relies on a technical secretariat that moni- tors the program on a day-to-day basis and recommends program reforms. The recommendation for Colombia is to appoint either a presidential coun- cil-a la the United States-or an interminisrerial commission backed by the President or the Vice-President-i la Mexico. Implementation and dissemina- tion of the government's plan should go together. It is necessary to make citizens aware of the government challenge-and the need to support it if sector reforrms are to be effectively implemented. Good practices from other countries may also be widely publicized since the country needs a mirror in which to see itself. Monitoring and evaluating governance strengthening should be shared by nongovernment bodies and widely disseminated. Civil society, the Congress, and even subnational governments may all play a role in assessing progress in the government's plan to enhance quality of government. 140 COLOMBIA- THE ECONOMIC FOUNDATION OF PEACE SELECTING A MANAGEABLE PROBLEM AND PROPOSING STRATEGIES TO STRENGTHEN GOVERNANCE AND ENHANCE THE QUALITY OF GOVERNMENT. When it comes to strengthening governance in key sector areas, it is necessary to know what are the loopholes through which certain stakeholder interests restrict access-either legally or illegally-to government contracts, or otherwise restrict policymaking and imple- mentation to the point of their prevailing over the public interest. Targeting reforms on specific loopholes or corruption opportunities tends to be more effective than broad guidelines and corresponding uniform monitoring indicators (see Box 3). SELECTING THE RIGHT GOALS AND TooLs. Colombia's strategy to enhance good governance needs to include specific public sector reforms (goals and tools). What is needed in order to improve quality of government is to start with those gover- nance-enhancing reforms that are least likely to arouse stakeholder opposition-or at least opposition so strong that the government is not prepared to cope with it. Multisector reforms that strengthen government capacity-such as those targeted at the procurement system or integrated financial management-usually arouse less frontal opposition than sector-specific reforms that affect long-entrenched interests of sector-organized groups-such as trade unions in the areas of health and educa- tion, and corporate associations for road construction and water provision. (See Box 4 for a discussion of what Colombia must do to achieve good governance.) Similarly, focalized reforms-such as concentrating on a small number of gov- ernment agencies at a time or mapping and simplifying sector procedures-are more doable than all-encompassing, final reform proposals such as changing government culture or eliminating party patronage (see Box 5). Strengthening governance should follow a sequential strategy. Initial reforms should be selected in such a way as to ensure production of demonstration effects and some capacity building. From then on, the government may pursue more chal- Box 3. Targeting Reforms to Plug Loopholes The Colombian public sector usually has been characterized as patronage ori- ented and stakeholder or corporate dominated. However, that broad character- ization needs to be refined for governance policy reform. It is also widely accepted that the clientele-dominated rwo traditional political parties have been weakened by urbanization, party fragmentation, and electoral support of inde- pendent candidates. At this point the country needs to know how to formulate, discuss, and implement reforms that open up markets for public services, be it the labor market for public employment or the procurement market for outside provision of goods and services. In addition, the government needs to make sure that closing the loopholes that create rent-seeking opportunities also close the door to corruption-rent opportunities. THE DEMAND FOR GOVERNANCE AND QUALITY OF GOVERNMENT 141 Box 4. Steps to Ensure Good Governance in Colombia Reform of administrative processes is usually less vulnerable to strong political opposition (from political parties or other rent-seeking stakeholders) than elec- toral reform, congressional reform, or labor law reform. Colombia needs to clearly identify why and how corporate control infiltrates the procurement process so that fair competition is reestablished. It has been claimed, for instance, that respect for the specially designed procurement process at the Empresas Puiblicas de Medellin (EPM) largely accounts for this success story within the Colombian public administration. By analyzing key processes the Colombian government may close the loop- holes that prevent good government in policymaklng and implementation. Other multisector processes that impinge on Colombia's governance and quality of government are: * Results indicators and transparency in budget reporting and disclosure. As exemplified by the Australian, British, and New Zealand examples, budget classifications and reporting can be organized in such a way that it facilitates discussion and participation by the Congress and civil society regarding pol- icy objectives, result indicators, and budget execution.a * Open-ended contracts for intergovernmenr results agreements and corre- sponding earmarked transfers. Central government capacity to monitor, evaluate, and sanction noncompliance in case of "incomplete contracts" is essential to strengthen government capacity under decentralization. b a See Chapter on Budgetary Institutions b See Chapter on Decentralization. lenging-and politically riskler-reforms. It must be borne in mind that institution building for strengthening governance and enhanced quality of government is nec- essarily a phased-in, medium- to long-term process. (See Box 6 for a discussion of the experience of Singapore with phased-in government strengthening.) Therefore, identification of intermediate goals is key to assess progress and to gain political sup- port. In today's Colombia, it is necessary to avoid the risk of postulating-even accepting that-the end of the internal conflict is the true test of strengthening gov- ernance. Perhaps the best way to avoid such a risk is to elaborate on and demonstrate the linkage between intermediate achievements in building higher-quality govern- ment and the likely scenarios and phases for finalizing the conflict. Publicly com- mitting government to achieving certain intermediate goals, combined with disclo- sure and dissemination of progress evaluation, is perhaps the most powerful marketing tool for strengthening governance, and announcing broad goals and not being able to report on partial progress is usually a recipe for failure. 142 COLOMBIA THE ECONOMIC FOUNDATION OF PEACE Box 5. Focalizing Reforms Colombia has tried time and again to pass and implement comprehensive pub- lic sector reforms-most recently in 1992-93 and 1998-99. According to les- sons learned from best practice experience, analyzing an agency and coming up with a tailor-made plan for that agency-and it is better if the plan matches and enhances the feasibility of ongoing sector reform-is usually more doable and more productive than across-the-board reforms for the entire public sector. Reform of a handful of individual agencies that play a key role in preventing and sanctioning corruption, such as the Contralorfa General, the Procuraduria General, or some of the Supenntendencias, is likely to strengthen governance in most sectors of State administration. Likewise, reform of hard-to-transform government agencies such as the ISS and ECOPETROL could be precedent setting for the rest of the administration.2 a. Reform of key government agencies could be supplemented with case studies and dis- semination of best practice agencies such as the EPM. Box 6. Singapore's Experience with Phased-In Governance Strengthening Colombia might follow the best-practice case regarding phased-in governance strengthening in Singapore which, in a period of just a few years, transformed itself from being one of the most corrupt countries in Southeast Asia to being one of the Jewels of the world in the areas of transparency, anticorruption, and enhanced governance. The story of Singapore is one of giving the government the right tools to implement and evaluate reforms in any government sector. E-government, process simplification, improved regulatory frameworks, reduc- tion of public employee direct contact with private citizens, institutionalized citizen participation, strengthened disclosure and accountability, enactment of new guidelines for human resource management, and agency-by-agency publi- cation of customer service goals are some of the tools that empowered the gov- ernment and strengthened governance in Singapore. Enhancing the quality of government appears to be a prerequisite for policymaking and implementation of sector-by-sector reforms. In this regard, strengthening governance should come before-or at least be simultaneous with-sector-specific reforms pro- posed in other Chapters. Part II Achieving Fast and Sustainable Growth 5 Macroeconomic and Fiscal Frameworks This Chapter was written by Zeinab Partow. The crucial requirement for the Colombian economy at the new millennium is to return to a path of sustained and substantial economic growth that characterlzed the country until the mid-1990s. Analysis has shown that economic growth is the key fac- tor in poverty reduction in countries (Dollar and Kraay 2000). For Colombia, in par- ticular, growth has been the key to poverty reduction: each additional point of growth in gross domestic product (GDP) per capita reduced poverty by approximately 0.6 percentage points. At the same time, it has been shown that the substantial progress in poverty reduction achieved during the 1980s and 1990s was largely erased by a few years of low growth, and by the 1999 recession. In fact, the recession in the second half of the 1990s brought poverty levels down to 1988 levels (Velez 2002). Colombia's recent path threatens an unsustainable increase in deficits and debt, along with poor prospects for GDP growth and high unemployment. New realities have emerged in fiscal domain, including significant and persistent deficits and large future fiscal liabilities. The rapid expansion of the public sector over the previous decade, from spending one fourth of GDP in 1990 to over one third of GDP by the end of the decade, combined with growing liabilities, particularly on the pensions front, have led to significant and persistent deficits of a structural nature The pri- vate sector, on the other hand, languishes: while government consumption grew by two thirds between 1994 and 2001, that of household remained basically unchanged, and private investment fell by over 37 percent. The weakness of the pri- vate sector is at the center of Colombia's current economic woes. Private GDP has grown little since the mid-1990s, and private investment has deteriorated from its peak of near 12 percent of GDP in 1994 to under eight percent today. Total invest- ment now stands at a level of about 15 percent of GDP, incompatible with the resumption of significant growth Public sector consumption has in effect displaced the private sector as the major contributor to domestic demand. While the current 145 146 COLOMBIA THE ECONOMIC FOUNDATION OF PEACE administration has recognized the need to strengthen fiscal accounts and has begun to set a solid foundation for further reforms, these will need to be expanded and accelerated in the coming years. As public spending rapidly outstripped the sector's revenue generating capacity, much of the fiscal deficit, particularly since the mid-1990s, has been financed with debt, both domestic and external. Today, net public sector debt in Colombia stands at about 46 percent of GDP. In 1997, prior to the onset of the recession and to the rapidly deteriorating fiscal balances of 1998 and 1999, public debt stood at 27 per- cent of GDP. Spending on interest payments to service public debt now stands at near five percent of GDP, constituting approximately a quarter of the central gov- ernment's expenditures, more than twice its investment budget. Colombia now faces the combined challenges of reducing its debt levels to ensure sustainability and achieving growth rates that are sufficient to reduce poverty levels and increase employment. Continued fiscal adjustment is unavoidable if debt sustainability is to be attained; just as important, the quality of the adjustment is key for a return to growth rates in the four-to-five percent range. Macroeconomic management over the past decade has thus failed to deliver the habitual steady growth that characterized the country. The mix of reforms at the beginning of the decade, and more importantly, their implementation, generated inconsistencies that made the reforms incompatible as a package. The rapid fiscal expansion, and the resulting appreciation of the peso, was inconsistent with the goals of the apertura, or opening up of the economy (Echavarria, 2000).i The per- ceived "failure" of the apertura generated opposition to deeper reforms,2 and the combination of fiscal expansion and incomplete reforms resulted in Colombia's much-vaunted stability giving way to increasing volatility. Table I summarizes the volatility of a number of macroeconomic and fiscal vari- ables and shows that volatility increased for all of these with the exception of the terms of trade. This did not generally occur in other Latin American countries; a number of authors (among them Gavin et al. (1996), Herrera et al. (1999), IDB (1997)) have pointed out that domestic volatility in many countries of the region declined over the 1990s. As mentioned above, one hypothesis is that in Colombia, 1. Fiscal expansion was a major culprit in the revaluation of the peso during the 1990s, along with capital inflows, expectations of greater revenues from oil, the use of the exchange rate as nominal anchor, and productivity growth Analysts (e g Edwards, 1998; Cardenas, 1996; Zuleta aind Arias, 1997) disagree as to the relative importance of each of these fac- tors in the peso's devaluation. 2 Echavarrfa (2000) argues that Colombia's trade reforms were partial and relatively super- ficial, and that the country did not enjoy a significantly more open economy at the end of the 1990s as compared to the beginning of the decade. He notes that trade in goods and services as a portion of GDP has not changed over the past thirty years, and while there was an "opening" in trade of goods in particular, this was less marked that in other Latin American countries. MACROECONOMIC AND FiscAL FRAMEWORKS 147 Table 1. Increased Volatility in Colombia in the 1990s 1990s:1980s 1970s 1980s 1990s (percent) GDP volatillry 1 8 1 5 2 7 81 Fiscal volatility 1 3 1.4 2.7 91 Exchange rate volatility 1.1 1.5 2.4 57 Monetary volatility 6 8 3.5 3 7 56 Terms of trade volatility 13.0 10.4 5 8 -44 Note Data represent the standard deviation, in percentage terms, of changes in GDP, in the fiscal bilance/GDP, in the real exclaisge rate iidex, in Ml, an1d in the terms of trade as a result of the forces at play during the decade, namely a new constitution, large oil discoveries, an acceleration of illegal activities and an intensification of the inter- nal conflict, there was a loss of momentum in completing the reform agenda, and this exacerbated volatility. Along these lines, the IDB (1997) finds that on the whole, major reformers in the region enjoyed greater economic stability in the 1990s. Gavin et al. (1997) perform formal statistical tests of the empirical relation- ship found by Lora and finds that the relationship is signsficant and robust.3 It is important to note that while the country's long-standing internal conflict has undoubtedly played a role in heightening the degree of uncertainty facing economic agents, and is a constraint on Colombia's achievement of a higher level of potential GDP growth, it is not the sole constraint to growth. In this spirit, this Chapter reviews some of the factors that underlay the severe recession of 1998-99, and out- lines policy priorities to address the current challenges facing Colombia. These chal- lenges can be summarized as the need to attain primary balances that are sufficient to ensure sustainable debt-to-GDP ratios, while attending to the quality of adjust- ment such that growth is not compromised. I. The 1990s: From Rapid Growth to Recession Prior to the 1990s, Colombia was among the better performers in Latin America, with the enviable record of unbroken annual GDP growth for over 50 years, even during the "lost decade" of the 1980s.4 In the early 1990s, this trend seemed set to continue, or even accelerate, as important reforms were undertaken in the areas of trade, the financial sector, private sector participation, and decentralization. Sup- 3 The studies are not conclisive as to the direction of causality which may, of course, be in either direction from reforms to stability or vice versa 4 Garcia and jayasuriya (1997) argue, however, that government reaction to economic crises over the past 30 years and the policies chosen, while enabling the country to enjoy a rare stability, also prevented Colombia from enjoying higher growth and greater prosperity 148 COLOMBIA THE ECONOMIC FOUNDATION OF PEACE ported by the introduction of these structural reforms, output grew by 5 percent a year during 1992-95. By the middle of the decade, however, as many of its neigh- bors aggressively pursued wide-ranging reforms and saw improved growth, Colom- bia's performance began to weaken. The country's gradualist approach to policy- making and reform did not keep pace with that of other countries in the region.5 Throughout the 1990s, Colombia's fiscal accounts experienced a continual and accelerating deterioration. The Non-Financial Public Sector (NFPS) deficit wors- ened from a level of 0.2 percent of GDP in 1991 to 6.4 percent of GDP in 1999, largely as a consequence of the rapid growth in Central Government deficits which had increased from 0.4 percent of GDP in 1991 to 7.1 percent in 1999. Growing deficits and declining growth culminated, in 1998-99, in a recession of a magnitude unprecedented in the country's history. One of the major changes that took place in the fiscal arena during this period was the public sector's unprecedented expansion. Colombia began the