By Mario Pezzini, former Director of the OECD Development Centre and Special Advisor to the OECD Secretary General on Development[i]
A call for a new social contract
Despite significant economic growth over the past years, middle-income countries (MICs) face increasingly complex challenges related to, among others, a growing demand from their new and still vulnerable middle-classes. As middle-classes have grown in recent decades, so have citizens’ aspirations and demands for quality public goods, better services and a more responsive and transparent state. More educated, better informed, and more connected than ever before, citizens are asking for more voice in public decisions. In parallel, growing aspirations confronted with chronic vulnerability of middle-classes tend to generate frustration and, more and more frequently, social turbulence. Discontent has been erupting for several years in many of these countries, going back to the Arab Spring, with recent examples like Lebanon, and some Latin American countries, including high-income countries like Chile. Today, challenges are exacerbated as the COVID-19 crisis pushes members of the middle class who had previously escaped extreme poverty, back into it. Governments seem increasingly incapable of understanding how people perceive their quality of life.
Why aren’t middle-income countries rising to meet citizens’ expectations?
MICs are under pressure to reform public programmes and policies, but to adequately respond to social demands, they need to mobilise additional resources. Given the often low levels of domestic resource mobilisation, fiscal reforms are becoming increasingly urgent, but a number of obstacles constrains their scope and (even more so) their implementation.
First, domestic resource mobilisation is effective only if it comes hand in hand with a clear view of future development, adapted to the complex environments that MICs face.
Closely linked to the above obstacle is deteriorating trust in governments. Trust in institutions has deteriorated in recent years due to real or perceived lack of transparent, responsible and strong spending. On average over the last decade, 62 percent of the Latin American population had little or no trust in their governments. In south-east Africa, up to 70 percent of the population feels their government is corrupt.
Finally, developing countries suffer from weaker institutional capacity and are highly vulnerable to tax evasion, complexity, and avoidance. For example, they are disproportionately affected by evasion practices common to multinational enterprises and high-net-worth individuals, that not only reduce fiscal revenue, but also undermine middle classes’ willingness to pay taxes. Added to this, MICs have to tackle illicit financial flows and deal with the complex tax implications of digitalisation.
While the implied long-run revenue losses for OECD countries are in the order of 1 percent of GDP, revenue losses in developing countries have been calculated at around 1.3 percent of GDP. This is a significant difference, especially relative to the average low tax-to-GDP ratios in MICs.
There is no magic recipe
Two main recommendations emerge in terms of both revenue and expenditure.
First, middle-income countries should regenerate tailor-made national strategies aimed at accelerating development and rebuilding citizens’ trust, which would in turn allow for increased domestic resource mobilisation. These strategies should be designed involving citizens’ voices and should widely experiment citizen-driven development initiatives. National development plans can be useful tools for countries to define shared development objectives aligned with a commonly agreed long-term vision. They are the appropriate strategic tool to “negotiate” sustainable fiscal reforms.
Second, international co-operation should be leveraged to fight tax avoidance and evasion and to build countries’ institutional capacities. Multilateral co-operation plays an indispensable role in tackling challenges to taxation, which are no longer just a domestic issue. International peer pressure on tax challenges can help create the political space for domestic action, plugging the leaks in the tax system, and showing that multinational enterprises and elites are being taxed fairly. Fortunately, information and knowledge exchange through multilateral co-operation has expanded since the global financial crisis, boosting governments’ capacity to put an end to bank secrecy and curtail illicit financial flows.
In short, middle-income countries hold untapped potential, waiting to be unleashed. This potential is a rare resource for a global recovery that desperately needs engines of growth and development. However, difficulties arise as middle income countries find themselves trapped by persisting and now exacerbated vulnerabilities due to the COVID-19 crisis. A “geography of discontent” continues to take shape as a response to middle classes’ unmet demands. MICs need to exploit their opportunities for development, improve their quality of spending and undertake important fiscal reforms. However, immediate fiscal consolidation would be counter-cyclical and detrimental, reproducing and even worsening the mistakes made after the 2008 crisis. Therefore, countries need to carefully design the sequence and content of their strategic reforms. New national development strategies will be indispensable for recovery and for middle-income countries to tackle long-lasting development traps, set the right pace for tax reforms, and negotiate their debts. MICs need to develop a strong and shared vision built on a broader and multidimensional understanding of well-being. In other words, they need to renew the social contract. At the same time, the international community must drive further efforts to address the debt burden of these countries, and continue to reduce tax evasion and avoidance, at least for what concerns their international dimensions.
[i] “Citizens’ Rising Expectations: A Call to Rebuild the Social Contract?” by Mario Pezzini in: Trapped in the Middle? Developmental Challenges for Middle-Income Countries. Edited by: José Antonio Alonso and José Antonio Ocampo, Oxford University Press (2020). © José Antonio Alonso and José Antonio Ocampo.