The Future of Democracy and the Market Economy in Colombia

The Future of Democracy and the Market Economy in Colombia Introduction by Juan Felipe Mejía Dean School of Economics and Finance Universidad EAFIT Medellín, Colombia Martín Posada Botero Student Universidad EAFIT Medellín, Colombia May 22, 2014 In a speech at the United Nations on September 22, 2010, Colombian president Juan Manuel Santos highlighted that Colombia, which had been considered an almost-failed state, was transforming itself into an attractive nation. Only five years earlier Colombia had ranked 14 out of 178 countries on the Failed States Index designed by the Fund for Peace. In 2010 it ranked 45 and in 2013 it occupied 57th place. Even though there are still incidents that trigger

preoccupation about the country s situation, Colombia has shown that there is more to it than drug traffickers, leftist guerrillas and a persistent war. In addition, according to the World Bank, Colombia is now considered an upper-middleincome economy. The accelerated economic growth that it experienced between 2002 and 2007 a result of advances in the domestic-security situation, rising commodity prices and pro-market economic policies, has been notable. Investor-friendly reforms in the hydrocarbon sector and the signing of the U.S.-Colombia Free Trade Agreement (FTA) in 2011 have attracted record levels of foreign investment over the past few years (Mejia, 2011). Given that in the 1990s Colombia was on the verge of a social and economic collapse, its comeback has been impressive indeed. At the same time, however, Colombia s scientific and technological capabilities are inadequate, its physical infrastructure is poor and a sense of insecurity remains, despite the recent initiation of the peace process or dialogue with leftist guerrillas. Poverty remains one of Colombia s main challenges, alongside inequality, whose rate is one of the highest in Latin America. Underemployment and drug trafficking, despite the unquestionable advances of the last few years, still are urgent problems that need to be addressed (Mejia, 2011). According to the National Administrative Department of Statistics (DANE), Colombia s current unemployment rate is 9%, while 32.2% of the population lives below the poverty line. The need of a more vigorous job-creation strategy is evident, given that 49.2% of Colombia s labor force works in the informal economy 1. Colombia has one of the longest-lasting democratic traditions in the world. In this respect, it has been the exception in a region characterized by dictatorships and military regimes in the twentieth century and self-proclaimed socialist governments in the twenty-first century. Nevertheless, an extreme polarization of ideas and absurd levels of corruption continue to characterize the Colombian political environment. President Juan Manuel Santos, who took office in 2010 and is seeking re-election this week, has faced a number of difficulties during his administration. The fierce opposition of former President Alvaro Uribe (2002-2010) and the strikes and social unrest in various sectors of the economy (e.g., agriculture, transportation and mining) have helped undermine his popularity. Only a few months ago, Santos popular support stood at 21%, the lowest level for a sitting Colombian president in more than a decade 2. With elections scheduled for May 25, 2014, Colombian politics will be defined, to a great extent, by the competition among presidential candidates, including Juan Manuel Santos himself, and by the peace talks that the government has been conducting with the guerrilla group Fuerzas Armadas Revolucionarias de Colombia (FARC), since September 4, 2012. 1. Colombia s Current Economic Situation in a Global and Regional Perspective The Global Context As is widely known, the financial crisis in the United States in mid-2007 provoked a global recession, whose effects are still being felt throughout the world. Europe followed America into recession in 2008 and, one by one, each and every economy of the world began 1 DANE (2013) 2 The Wall Street Journal, Colombian President's Approval Ratings Plunge Amid Nationwide Strikes (2013). 2

decelerating to various degrees, causing the global economy to experience its greatest contraction since World War II. Global GDP per capita, which has been expanding at a rate of 2.2% annually, fell by four percentage points to 1.8% 3. In the case of the United States, Solow (2009) estimated that American housing wealth decreased from $64.4 trillion in 2007 to $51.5 trillion in 2008. Emerging economies, however, have not been as affected by the crisis as had been forecast by many analysts when the crisis began. Although there has been a notable slowdown of economic growth in these economies, only a few have contracted. China, India and other emerging countries have not only been able to stay afloat, but have also maintained their growth trends. The most prestigious global economic analysts, however, remain pessimistic. In the last World Economic Outlook Update: Growing Pains, from July 2013, the International Monetary Fund (IMF) argued that global growth for 2013 is projected to remain modest, at slightly above 3 percent, the same as was reached in 2012 (see Graph 1). This underperformance of the global economy is explained by three key groups of factors: 1) slow growth, caused by infrastructure bottlenecks, a reduction of external demand and a decline in commodity prices; 2) the recession in the euro area, which has been much deeper than expected, with internal demand not yet recovering; and 3) the slower-than-expected U.S. economic recovery, due to strong fiscal contractions (IMF, 2013). Graph 1 Latin America The international commodity boom that occurred in the first decade of the twenty-first century made it appear as if Latin America could decouple from developed economies such as the United States. However, the financial crisis eventually caused a decline in the price of 3 For further information see Claessens, Kose, Laeven, & Valencia (2013), Understanding Financial Crises: Causes, Consequences, And Policy Responses. 3

commodities, which considerably affected the economic performance of the region (Ocampo, 2009). Latin America s continued dependence on exports remains. A 2010 study, published by the World Bank, reports that between 2000 and 2010, 52% of the region s exports consisted of commodities. In contrast, commodity exports in the more dynamic developing regions of East Asia and the Pacific represented only 30% of their exports (The Economist, 2010). In the case of Colombia, the energy sector (e.g., petroleum, natural gas, and coal) has become increasingly important: it accounts for 8% of the GDP. Since 2008, the sector s annual growth has greatly exceeded the economy s overall growth and accounts for a majority of the country s export income. Such export concentration increases Colombia s vulnerability to sharp declines in terms of trade, as well as to the risks associated with foreign-exchange volatility. Any kind of export concentration, be it in commodities, industrial products or services, is detrimental to growth (Mejia, 2011). The financial crisis arrived in Latin America with a time lag, just as the Asian crisis of the 1990s had done (French-Davis, 2009). Initially, Latin America had been able to avoid serious economic contagion and even experience some growth. Analysts predicted a growth rate of 2.7% for the region in 2013, a rate slightly lower than that of the global economy. The slowdown of domestic demand combined with the U.S. Federal Reserve Bank s recent decision to start raising interest rates, generated large capital outflows from the region and caused declines in its stock markets and the devaluation in its exchange rates. Still, despite these negative developments, Latin American countries are expected to grow in 2014 at rates greater than 4% (see Graph 2) and foreign direct investment (FDI) levels in these countries are expected to remain stable and relatively high (BBVA, 2013). Graph 2 Colombia On November 2011, Les Echos, a well-known French business daily, published an article entitled La Résurrection de la Colombie. It noted that Colombian bonds had received investment-grade status, the free trade agreement (FTA) between Colombia and the United 4

States had been signed and Colombia had joined with Mexico, Chile and Peru in a free trade pact called the Pacific Alliance. More recently, Colombia s National Department of Statistics announced that the country s annual GDP growth for the 2nd quarter of 2013 had been 4.2%, when most analysts had been expecting it to be slightly above 3%. On the demand side, consumption increased 4.4%, government expenditure grew 5%, capital formation grew 2.9% and exports showed a surprising 7.6% increase. The two sectors that showed the greatest changes were agriculture (7.6%) and construction (6.4%). In addition, the construction sector has been expanding significantly for the past couple of years due to an increase in both public and private demand. The current government s plan to build 100,000 homes for the poor has had an important impact on the sector, as well as the creation of a new national infrastructure agency called Agencia Nacional de Infraestructura (ANI). The government has also launched a very ambitious plan for building 8000 kilometers of roads over six years in order to reduce travel times in the country, thereby increasing Colombia s productivity and competitiveness. The government s budget for transportation infrastructure has to triple, from $3 billion to $10 billion (approximately 3% of the GDP), in order to achieve these goals (BANCOLOMBIA, 2013). The transport, financial, trade and industrial sectors all experienced growth, but at a lower rate than GDP growth over the same period. Manufacturing had a slight recovery (1.2%), reversing three-quarters of decline. Nevertheless, business leaders are skeptical about the country s business climate. The last two quarters of 2013, especially the third, were expected to post weaker growth due to the that involved important sectors of the economy and caused shortages in Colombia s main cities. Another troubling aspect of Colombia s economic performance is the appreciation of the peso over the past few years. The Santos administration s objective (and one of its priorities) has been to maintain an exchange rate that ranges from 1,900 to 1,950 pesos per US dollar, a rate that is beneficial for exporters and importers. The national government and the Banco de la República (Colombia s central bank) have taken all the necessary measures to achieve this goal, which should have significantly increased the global competitiveness of Colombian firms. However, this effort has not produced the desired results, given the decision of the U.S. Federal Reserve Bank (Fed) to begin tapering its purchases of $85 billion worth of bonds per day in assets. The Fed s announcement immediately caused the value of Colombia s currency to fall to 1891 pesos per US dollar. 4 2. Economic Forecasts Due to Colombia s high dependence on global commodity prices, the country will not surpass its growth rate of the last few years (5.4% from 2004-2008). The Economist Intelligence Unit, the IMF s World Economic Outlook, BBVA Research, Bancolombia (Colombia s largest commercial bank), the Banco de la República and even the minister of finance, Mauricio Cardenas, all agree that Colombia s GDP growth rate in 2013 will exceed the growth of the global economy (3%). Some even predict, such as Mr. Cárdenas, that Colombia s economy will grow as much as 5% and at an average rate of 4.4% over the next 4 Refer to Tomaselli s (2013) article Colombia s manufacturing sector picked up in July. 5

five years due to its macroeconomic stability and the eventual (although not certain) peace agreement with the FARC. According to BBVA Research, The Colombian economy will continue, therefore, being one of the fastest-growing economies in Latin America. Fortunately, inflation does not seem to be a problem. Colombia s Banco de la República adopted a policy of inflation targeting in 1999. The target for 2013 was 3%, with bands at 1% above and below. According to the last report of Banco de la República, the October 2013 inflation rate reached 1.84%. Colombia plans to keep its inflation rate in check. According to The Economist Intelligence Unit, inflation will average 2.9% annually for the next four years. Yet, harsh weather conditions may alter this forecast since Colombia is vulnerable to foodsupply shocks. In the meantime, the Banco de la República has been actively buying foreign currency (US dollars) in order to weaken the Colombian peso, which helps make the country s exports more competitive. In January 2013, the exchange rate was 1,773 pesos per US dollar; in November it averaged 1,921 pesos per US dollar (Banco de la República, 2013). Forecasts point to a slow depreciation that will reach 2127 pesos per US dollar by 2017. 5 Colombia is the third-largest Spanish-speaking country in the world (after Mexico and Spain). By 2017, its population will reach 51.1 million. Positive economic growth, a declining birthrate and a weaker peso will increase per capita income to $10,193 dollars. Yet poverty will remain one of the country s greatest challenges. As birthrates decline, the population will inevitably get older, a development that the government is planning to mitigate with reforms of the pension and healthcare systems. Finally, as poverty levels slowly decrease (due to the increase of per capita income and the continuation of a number of conditional cash transfer programs), a new middle class with consumption desires will emerge and strengthen internal demand. The domestic economy is used to positive growth rates, despite the armed conflict and violence of the past five decades. However, the World Bank has estimated that per capita income would today be 50% above current levels if peace had been achieved 20 years ago. Mauricio Santa María and his colleagues, in their 2013 publication, estimate that Colombia has lost between 1.5% and 2% of additional GDP growth annually during the guerrilla conflict. We still do not know if the peace negotiations between the national government and the FARC will succeed, but if an agreement is reached and peace is achieved, the country s GDP will grow an additional 1.77% and, by the eighth year of the post-conflict period, more than 1.3 million new jobs will have been created, reducing unemployment rates considerably. However, even if the 50-year-old conflict is resolved, violence is still expected to remain high due to drug-trafficking cartels and urban criminal bands. 3. Political Context Colombia s democracy has a long tradition and is admired for its ability to survive in the changing Colombian and Latin American environments. Yet, it is also known for its corrupt and polarized political system, its failing justice system and its inability to satisfy Colombia s most urgent needs. In fact, Transparency International, an international non-governmental organization that monitors public and corporate corruption, ranked Colombia 94 out of 176 countries (1 being the least corrupt) in its Corruption Perception Index (Transparency 5 Economic Indicators Review, (BANCOLOMBIA, 2013). 6

International, 2012). While it is true that Colombia s situation has significantly improved over the past decade, when the Fund for Peace first declared Colombia a failed state in 2005, the country was in fact a failed state. In the 1990s the murder rate was the highest in the world (76 per 100,000 inhabitants), the 40-year-old armed conflict was at its crudest stage, foreign-direct investment (FDI) was practically nonexistent and fear was the predominant feeling among the population. The first decade of the twenty-first century was the inflection point of this situation. President Alvaro Uribe (elected in 2002) changed the course of politics in the country and declared a fierce war against illegal armies and drug trafficking. As security increased, so did Colombia s main economic indicators: GDP has increased at an average of 4.5% for the last 10 years from levels of 2.7%; FDI has recovered (reaching $16.5 billion in 2013, from $2.4 billion in 2000); and unemployment rates, which historically had remained in the double digits, finally reached 9%. Juan Manuel Santos was elected president of Colombia in June 2010 with the highest number of votes in the history of Colombia s democracy. However, his government has been the target of criticism from a number of sectors and individuals and his popularity sank to its lowest level immediately following the strikes in September 2013. His 21% approval rating reflected the government s inability to deal with the protests. At first, Santos did not pay enough attention to the protests and failed to take measures to end them. Colombians distrust of the FARC and Santos launch of a peace process with this illegal group also contributed to Santos low ratings. The possibility of a total amnesty for the FARC s leaders is something that Colombians refuse to accept. They do not want those who terrorized the country for decades to be acquitted and allowed to actively participate in politics. The military has also often complained about how they felt abandoned by the government, which refuses to guarantee their rights. Finally, there is discontent among the population regarding the different reforms that the Santos government plans to implement, such as healthcare, pensions, taxes and education (The Economist, 2013). The most important priority for the current government is the signing of a peace agreement with the FARC. The main purpose of the negotiations, which began in Havana in November 2012, is the demobilization of 8,000 soldiers and the culmination of a 50-year-old armed conflict that has left thousands dead and caused an immense slowdown of the national economy. The peace negotiations involve a five-point agenda consisting of the following themes: agrarian reform; FARC s participation in politics; drug trafficking; victim reparation; and an end to the conflict 6. These negotiations were supposed to last only one year. However, the time limit has been reached and there have only been agreements on the first three issues, which has created skepticism among the population. President Santos has, on several occasions, stated that there is no reason to worry, and has insisted that the dialogues continue and that there will be no impunity for crimes linked to violations of human rights. Yet criticism, including from the International Criminal Court, continues to appear 7. The government has also had problems dealing with sectoral problems. In 2013, there were strikes against the government in three sectors: agriculture, mining and transport. A reduction of the 2014 aid budget for the agriculture sector, a rise in the price of fuel and attempts to reform both the mining and education sectors led to the strikes. In reaction, Santos negotiated 6 Refer to the document Acuerdo general para la terminación del conflicto y la construcción de una paz estable y duradera, (2012). 7 See Alsema s article Santos calls on world to respect eventual peace deal with FARC (2013). 7

additional aid of $1 billion for the agriculture sector, as well as the regulation of fertilizer prices. For the transport sector, diesel prices were frozen until December 2013 and the smallscale miners were granted more time to legalize their businesses (The Economist, 2013). Despite the fact that the protests have ended, there is general disappointment across the different sectors and some workers have tried to revive the protests. The 2014 parliamentary and presidential elections, in March and May respectively, will define the political environment in the short term, while the ongoing peace negotiations in Havana will help shape the outcome of both elections. Juan Manuel Santos is running for a second term in this year s presidential elections and recent polls indicate that he will probably be re-elected, but his re-election is not assured. Santos strongest opponents in the election are right-wing candidate and former president Alvaro Uribe s ally Oscar Iván Zuluaga, who has announced that he will cancel the peace process if the FARC does not accept a unilateral ceasefire; the Conservative Party s Marta Lucía Ramírez, former minister of defense in Alvaro Uribe s government; Enrique Peñalosa, former mayor of Bogotá and member of the Green Alliance Party; and Clara López, the left-wing candidate of the Polo Democrático. 4. Conclusion President Juan Manuel Santos has been trying to construct a peaceful and attractive nation that can maintain, or even increase, the remarkable growth rate of the last several years. A number of obstacles, however, have made it difficult for the country to prosper. There is skepticism regarding the peace process. Colombians simply do not trust the FARC and the government has not made an official announcement of what and how things are being negotiated in Havana. There has also been poor management of sectoral discontent by the Santos administration, which has increased the dissatisfaction among the population and some of the most important sectors of the economy. Despite these difficulties, the domestic economy is expected to grow at a rate of 4.4% annually for the next four years (and even 1.77% above this if a peace agreement is signed); competitiveness is predicted to improve as the country s road network expands; foreign ties are expected to grow stronger because of the multiple free-trade agreements and integration alliances that have been approved; inflation rates will remain stable due to the solid macroeconomic management; and the recent decision of the Fed to temporarily stop the monetary tapering will lead to a depreciation of the exchange rate. In addition to these economic factors, the upcoming election will be crucial in determining the future course of the country. The election results, in turn, will strongly depend on the state of the peace negotiations between the national government and the FARC. It is still too early to know for certain how these processes will turn out. 8

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World Bank and International Finance Corporation. (2013). Doing Business 2013: Smarter Regulations for Small and Medium-Size Enterprises. World Bank Group. World Bank and International Finance Corporation. (2013). Doing Business 2013: Smarter Regulations for Small and Medium-Size Enterprises. World Bank Group. World Bank. (2013, November). World Development Indicators. Retrieved November 2013, from World Bank: http://databank.worldbank.org/data/views/variableselection/selectvariables.aspx?source=worl d-development-indicators#s_u Juan Felipe Mejía is currently the dean of the School of Economics and Finance at Universidad EAFIT in Medellín, Colombia. He is also associate professor of international economics and research associate with the Center for Research on Economics and Finance at Universidad EAFIT. Prior to joining EAFIT, Dr. Mejia was senior analyst at CORFINSURA (Corporación Financiera Nacional y Suramericana), a financial company that is part of Bancolombia. Between 1997 and 2000, he worked at F. Hoffmann La Roche Ltd.; served as academic director of COLFUTURO, a Colombian non-profit foundation; and was executive director of FUNDEXCOL (Foundation for the Development of the Universidad Externado de Colombia). Dr. Mejía is the author of the book Export Diversification and Economic Growth: An Analysis of Colombia s Export Competitiveness in the European Union s Market, published by Springer (2011). His columns and articles have appeared in Portafolio, Dinero and El Colombiano. Martín Posada Botero is an undergraduate economics student with a concentration in applied quantitative analysis at Universidad EAFIT. He has worked as research assistant at the Center for Research on Economics and Finance (CIEF) on topics related to economic informality (and the formalization process) and enterprise growth. He is currently working as a student intern with the economic research department at Bancolombia. All statements of fact or expression of opinion contained in this publication are the responsibility of the authors. 11