Income distribution and economic growth in Colombia: a typical example of trade off in a developing country

The unfair income distribution in Colombia is well known in international scenario, everybody knows it but few papers deals this issue. This note shows the main economic variables to improve income distribution in Colombia and its trade off with economic growth. The main variable to improve income distribution are fair minimum wage (it is low to afford main goods, US$4,983 per year), taxes in industrial sector (they are low, it is just 33%-35% of profits), high unemployment rate  (9.2% in 2012) and royalties mismanaged (they are about 8% of GDP), moreover FDI in industrial sector contributes to economic growth but it does not to improve income distribution, this issue has to be dealt between government and multinationals.

Author: Humberto Bernal,  

Economist,

e-mail: zhumber@gmail.com

It can be download PDF @ click

Colombia shows a high unfair income distribution, according with the GINI coefficient, Colombia took the 11th place in 177 countries in 2011 where first places are for those countries with the worst income distribution. Figure 1 shows the dynamic of this index in Colombia between 1970 and 2011, one can explain this path through two main periods: 1970 to 1990, through this period Colombia faced the lower GINI index, it was due to low unemployment rate,  it reaches the lowest value of 7.0% in 1981; moreover Colombia exported huge volume of coffee, she reached an average of 13 million sack of 60 kilograms per year, nowadays Colombia exports as much 8 millions of sacks; violence and government corruption showed low levels but with positive trend, the homicide rate was 21 per thousand of people in 1970 and kidnappings were 43 cases on same year. Unfortunately these indicators went worst and started to make effect on incomer distribution after 1991 when starts the second period, Colombia missed the International Coffee Agreement in 1989; the crude oil contracts (contract of type association) were inefficient and the production went down at the end of XX century; moreover Colombia went into the worst internal war ever; and corruption took the Estate on the first decade of XXI century when Colombia faced the third wave of crude oil production through concession contracts. This facts can explain partially the dynamic of the GINI index.

Figure 1. GINI coefficient in Colombia 1970-2011

(0-1 index)

Source: Bureau of Statistics Colombia and own calculations.

As a citizen, one is interested on woking to get a better income distribution, literature and advices say that Foreign Direct Investment  (FDI) improve the society welfare, then I tested this issue in Colombia through economic indicator from 1970 to 2011 (annual data) and econometric tools. The first conclusion was most of FDI in Colombia goes to crude oil and mining sectors as figure 2 shows, this type of FDI does not improve income distribution directly, however it can be improved indirectly through well managed royalties. Nevertheless, I decided to work with FDI as stock in industrial sector, this FDI shared about 20% of total FDI as stock in 2011, it used to share about 25% in 70’s. The results are reported in table 1. I took GINI index (in natural logarithm) as  variable that I want to explain through minimum wage growth, Industrial taxes, unemployment, FDI as stock in industrial sector and so. The results were as I expected, as minimum wage grows about 1.0%, then GINI index improves about 0.1%; increasing in 1.0% taxes in industrial sector (profits taxes) improves this GINI index about 0.3%; crude oil and coffee production were significative due to they bring wealth through exporting them and royalties but there is an point to highlight,  their contribution are tiny; the FDI in the industrial sector does not improve the GINI index, according to these results as FDI in industrial sector increases about 1.0%, then GINI index increases about 0.14%, therefore although foreigners  improve the economic growth through their multinationals, they do not work hard to improve the income distribution in Colombia. Same situation is when GDP shows a growing of 1.0%, the GINI index increases about 0.7%, it can be explained by the principle of trading off between efficiency and distribution.

Figure 2. Foreign Direct Investment as Stock by economic sector in Colombia

(% of total FDI stock)

Source: Bureau of Statistics Colombia and own calculations.

The main conclusion is the delivering of economic variables which government and privates agents can take to improve income distribution in Colombia, the main ones are fair minimum wage (at the moment this wage is unfair as media and this note has broadcasted), increase industrial taxes (profit taxes), proper management of royalties and putting eye on FDI in industrial sector to bring fair income distribution.

Table 1. Explicatory variables for GINI in Colombia 1970-2011

(GINI is in natural logarithm, method of 3SLS)

Variable	Coefficient*
Minimum wage growth (%)	-0.001 (0.001)
Industrial taxes (% Industrial GDP)	-0.003 (0.001)
Ln[Real FDI stock industrial sector]	0.142 (0.039)
GDP growth (%)	0.007 (0.004)
Unemployment rate (%)	0.005 (0.004)
Ln(Volume of coffee)	-0.119 (0.040)
Ln[Education*)	-0.117 (0.068)
Ln[Crude oil]	-0.046 (0.023)
Constant	0.046 (0.514)
R2	0.742

*coefficients are statistically significative at 0.1. The 3SLS takes into account endogeny and multicollinearity problems).

(...): Standard Deviation.

Source: Bureau of Statistics Colombia and own calculations Stata 12.

Banana Republic part II: Colombia case in Latin American context

Latin America and Caribbean countries faces high economic growth rates, those countries that reached rates over 6.0% in 2011 were Panama, Argentina, Ecuador, Paraguay and Peru. Chile and Colombia were in the upper-middle position of 41 countries, both of them reached a economic growth of 5.9% in 2011. However, Colombia will face a strong backward economic growth in 2012, it is expected that this country faces a GDP growth of 3.8% while Chile and Peru will face an economic growth of 5.4% and 6.2% in 2012. Therefore, it is natural to ask why will Colombia face this strong backward situation?, one can give an answer that concerns 5 facts: 1. Colombia faces a Dutch disease due to mismanagement in public resources (royalties to reach economies of scale are few); 2. High government intervention in nominal exchange rate and protectionism through high tariff for those cheap products such as Chinese hats, these interventions let getting diseconomies of scale (lazy sectors for investing in technology); 3. high unemployment rate that pushes down economic growth, Colombia faces an unemployment rate of 9.2% in 2012 (november); 4. Low FDI inflows compared with other countries in the region, this fact does not let a proper dynamic to improve technology; and most of FDI in Colombia goes to mining sector compared to other countries such as Chile and Peru, FDI in mining sector in Colombia does not add high value added, instead Peru and Chile export mining products with high value added, again it is due to local government mismanagement, fortunately in 2014 Colombia will face presidential elections to put on the table these facts which increase the unfair income distribution.

Author: Humberto Bernal,  

Economist,

e-mail: zhumber@gmail.com

It can be download @ click

Latin America and Caribbean (41 countries according to World Bank) showed an annual growth of 4.7% in 2011 and it is expected to reach a 3.2% in 2012, those countries which pulled up the economy in 2011 were Panama, Argentina, Ecuador, Paraguay and Peru with rates over 6.0%, therefore Latin America faces an important economic growth that has to be well managed in order to reach a fair income distribution. Most of Latin American countries are aware of it and work hard to reach this target such as Peru. In the case of Chile and Colombia, both countries faced an annual economic growth of 5.9% in 2011. Forecasts for 2012 for most of these countries show a small contraction compared with those of 2011, for instance Chile is expected to face a growth of 5.4% and Peru 6.2% but other countries such Colombia faces a huge contraction, this country is expected to face a economic growth of 3.8% in 2012 when it was 5.9% in 2011 what sad. Therefore it is natural to ask why will Colombia face a smaller economic growth than Chile and Peru when they were similar in 2011?. One is tend to say that this high economic contraction is due to:

Table 1. Main economy indicators by country 2011 and 2012

Indicator	Chile	Colombia	Peru
GDP growth*	5.9	5.9	6.8
Mining exports (% of total exports)*	59.3	64.8	51.3
Industry GDP (% total GDP)*	39	37	36
Unemployment (%)**	6.2	9.2	5.9
GINI*	0.521	0.548	0.481
Corruption rank**	20	94	83
Poverty line (% total people)*	15.1	34.1	31.3
Homicide rate per thousand people*	3.2	31.0	10.3
Average GDP Growth 1960-2011	4.3	4.3	3.7

*2011

**2012

Source: World Bank, Trademap and Transparency International.

Colombia faces strong dependency of mining sector which lets a lagged industry sector, it is called the Dutch disease. Colombia has strong dependency in mining sector, for instance while Peru faced a share of 51.3% of these sector in her total exports  in 2011 and Chile faced 59.3%, Colombia faced 64.8%, moreover Chile and Peru exports mining products with high value added, for instance cables made of silver and gold and so, meanwhile Colombia exports mining products with few added value, for instance just crude oil and coal ashes.

The industry sector in Colombia is lagged and protected due to diseconomies of scale. Chile and Peru show an industrial sector which search for economies of scale, for instance while Lima (Peru) and Santiago de Chile (Chile) have an underground (metro), Bogota (Colombia) faces high government corruption, this city does not have a developed urban transport which contribute to economies of scale. Other example is while Peru gives the welcome to Free Trade Agreements and Chinese Foreign Direct Investment, Colombia rises tariffs for those cheap products from China, for instance tariff on cheap hats that increase the local consumer welfare. Other example is the frequently government intervention on nominal exchange rate to protect those lazy sectors which face diseconomies of scale due to lack of investment in technology. Therefore Colombia is working hard to be far away from those countries that understand the economic model for growing.

Colombia faces high unemployment rate. The unemployment rate faced by Colombia was 9.2% in 2012 (november) while Chile and Peru faced a unemployment rate of 6.2% and 5.9% in 2012 (november). It is other issue that local government flaw, due to it Colombia faces strong unfair income distribution and she will face a strong gap in economic growth compared with main Latino America economies such as Argentina, Chile and Peru.

High income inequality and lot of people in poverty. Colombia faces high inequality income distribution as table 1 shows with a GINI index of 0.548, this fact lets increasing people in poverty, Colombia faced a poverty rate of 34.1%  of total population in 2011 while Chile faced 15.1%, moreover this unfair income distribution lets increasing internal conflict that is evidenced by high homicide rate, for instance while Chile and Peru faced a rate of 3.2 and 10.3 per thousand of people in 2011, Colombia faced  a rate of 31.0.  

Figure 1. Foreign Direct Investment inflows as share of GDP by country 1971-2011

(%)

Source: World Bank (UNCTAD).

Colombia faces low FDI inflows compared with FDI inflows in Chile and Peru. Local government broadcast the huge FDI that came to Colombia in 2010-2012 but they do not realize that this volume was short compared with those flows in Chile and Peru. Figure 1 shows the FDI inflows for Colombia, Chile and Peru, while Chile and Peru got 7.0% and 4.7% of FDI inflows as a share of GDP in 2011, Colombia reached just 4.0%, moreover FDI inflows in Colombia contributes to Dutch disease and unfair income distribution, figure 2 shows the FDI stock in Chile, Colombia and Peru at the end of 2011, the main conclusion is Colombia work hard in promoting mining sector with 47% of total FDI as stock, while Chile and Peru are aware on reaching a balanced FDI inflows to get a strong development, these countries faced a share of 34% and 27% in total FDI as stock respectively. For instance Public Utilities (water, gas, transportation services,...) in Chile and Peru showed high FDI inflows, similar scenario in Transport and Telecommunications sector, these sectors are the clue to start reaching economies of scale and spillovers between economic sectors.

Figure 2. Foreign Direct Investment as stock  by sector and economy at the end of 2011 

(%)

Total FDI stock Chile: US$82,021 million.
Source: Foreign Investment Committee Chile).


Total FDI stock Colombia: US$100,199 million.
Source: Bureau of Statistics (DNP and Central Bank).


Total FDI stock Peru: US$22,019 million.
Source: Investment Promotion Agency (Proiversión).

How a country can get out of being a Banana Republic: Colombia case

A Country called Banana Republic faces a high dependence of natural resources or/and high volume of harvest controlled by local firms and multinationals, in addition royalties and taxes from these sectors are mismanagement by government. Colombia is inside of the group of countries called Banana Republic due to high dependence of mining sector (crude oil and coal production) and mismanagement of royalties evidenced by high unfair income distribution and diseconomies of scale in tradable goods. The total export’s value of mining sector shared  33.7% in the total exports’ value in 2001 and it reached 65.6% in 2011. Moreover employees are moving from Tradable goods sector to Nontradable goods sector and the contribution of mining’s growth rate in total GDP growth rate showed an increasing trend from -0.65% in 2001 to 1.04% in 2011, therefore Colombia faces her second Dutch disease due to crude oil and coal production, the first was due to coffee production in 1970-1980. To sort out this Dutch disease government has to work hard to reach economies of scale in Tradable goods with fair income distribution. To get it, resources which comes from royalties from mining sector must have a proper Cost-Benefit analysis that includes long run sustainability.

Author: Humberto Bernal,  

Economist,

e-mail: zhumber@gmail.com

It can be download PDF @ click

Dutch disease comes from a mismanagement of abundant and finite natural resources such as crude oil, coal and natural gas, there are other sources to get this disease such as huge volumes of agriculture commodity which faces high international price such as coffee or bananas. Countries which face these issues of plenty of natural resources or plenty of harvest with high international prices and mismanagement of their profits are called Banana Republics. Some facts which let thinking on a Dutch disease are nominal exchange rate appreciation; increasing of Nontradable goods’ price in terms of tradable goods; and there is lower production of Tradable goods than before of Dutch disease, nevertheless the last two facts are under diseconomies of scale (under economies of scale these facts change).

Colombia can be called a Banana Republic, unfortunately this country has faced two Dutch diseases, the first one was between 1970 and 1980 due to high coffee harvest and her high international price as Kamas, L (1986) pointed. Nowadays colombian coffee sector is in a deep crisis due to her diseconomies of scale which came from lacking of investment in Research and Development. Coffee exports used to share about 82% of total exports’s value in 1954, nowadays it shares with 4.3% as table 1 shows. The second Dutch disease started on 2003 with a high crude oil and coal production, these natural resources have faced high international prices and they share with high values in colombian exports as table 1 shows, the mining sector (crude oil, coal, gold and emeralds) shared in colombian exports' value in 33.7% in 2001 and 65.6% in 2011, moreover crude oil reserves will go until the end in 2019.

Table 1. Share of colombian exports by main sectors 

2001, 2005, 2011

(%)

Sector / Year	2001	2005	2011
Mining	33.7	40.4	65.6
Coffee	5.3	6.3	4.3
Other goods	45.8	42.0	22.2
Services	15.2	11.4	8.0
Total	100.0	100.0	100.0
US$million	14,444	23,486	61,072

Source: Bureau of Statistics (DANE, DNP, Central Bank).

Actually, there are other facts which confirms this second Dutch disease in Colombia. The appreciation of colombian nominal exchange rate in the last 5 years which come from a massive dollars supply from the Unites States and high international prices and local production of crude oil and coal. Other fact is the movement of labor supply from Tradable goods to Nontradable goods as table 2 shows, for instance there was 34.6% of total employees working in tradable goods in 2001 while this figure declined until 32.8% in 2011, it means that employees find attractive those economic sectors where government spend royalties from mining sector, for instance real state, health, education and so. However, manufacture goods with strong path to export have to sack employees due to lack of economies of scale.

Table 2. Share of colombian employment by sectors 2001, 2005, 2011

(%)

Sector / Year	2001	2005	2011
Tradable	34.6	33.1	32.8
Nontradable	65.4	66.9	67.2

Source: Bureau of Statistics (DANE, DNP, Central Bank).

Other fact is the economic growth contribution of mining sector in total GDP growth, this contribution has faced an increase since 2001 as table 3 shows. The total economic growth was 1.46% in 2001 where mining sector contributed with a negative rate of 0.65% but this contribution increased to 1.04% in 2011 when the total economic growth was 5.93% in Colombia. The main conclusion is Colombia faces a Dutch disease without doubt.

Table 3. Contribution to GDP growth in Colombia by tradable and nontradable goods 2001, 2005, 2011

(Growth rate %)

Sector / Year	2001	2005	2011
1. Mining (included crude-oil)	-0.65	0.26	1.04
2. Manufacture	0.39	0.63	0.53
3. Other tradable goods	0.37	1.17	1.27
Subtotal (2+3)	0.77	1.81	1.80
4. Nontradable goods	1.12	2.22	2.11
5. Taxes	0.23	0.42	0.98
6. GDP growth (1+2+3+4+5)	1.46	4.70	5.93

Source: Bureau of Statistics (DANE, DNP, Central Bank).

The medicine for Dutch disease

When countries faced a plenty of natural resources but short run limited such as Colombia (on the other hand Venezuela  faces 200 years of crude oil reserves, therefore, it is difficult to she faces Dutch disease in the sort run), they have to work hard to get a proper management of royalties which come from these natural resources, figure 1 shows the Production Possibility Frontier (PPF) for a typical underdeveloped country, when country faces plenty of a natural resource, she goes from 1 to 2, therefore there is more consumption and current account is balanced but when natural resource goes to the end, the country can face point 1 again if government mismanagement her royalties, moreover this country can face a point inside of PPF due to international market missed. On the contrary, if government does her proper job with royalties, after finishing natural resources, the country can face point 3 (more consumption and trade), this point shows economies of scale on tradable goods. The point to highlight is countries which face plenty of natural resources have to work on better Real State and technology to let reaching economies of scale in Tradable goods. To reach point 3 a proper Cost-Benefit analysis has to be done, it means long run economic sustainability.

Figure 1. Production Possibility Frontier (PPF) under plenty of natural resources and proper royalties management 

Colombian income distribution, crude oil sector and unfair taxes

Colombia internal war conflict comes from unfair income distribution, this unfair income distribution is deepened by three main sources, they are narcotic production (people want easy money due to high narcotic prices abroad), crude oil production and coal extraction (society watch how few people get rich through public resources and the majority of people are in poverty still). The Government Taking  in crude oil sector is about US$23.4 billions in 2011 or 25% of total government revenues or 40% of total crude oil production or 6.84% of total Colombian GDP, this government resource is huge but it is mismanagement due to lack of proper Cost and Benefit analysis, for example new infrastructure without proper accounted budget to future operation. The income distribution from crude oil sector is unfair, my proposal is 30% of total income for capital owners and 70% for employees and government instead of 50%-50% as it is nowadays. To reach this share, government has to charge a rate of 20% on profits repatriated by crude oil firms, moreover this tax is fair due to better security and government spending on crude oil sector promotion, one can calculate an increasing of 0.159% in foreign capital as kidnaping shows a reduction of 1.0%.

Author: Humberto Bernal,  

Economist,

e-mail: zhumber@gmail.com

It can be download @ click

In the last ten years, crude oil’s GDP in Colombia shared with 6% in Colombia total GDP and the main commodity exported by Colombia was crude oil with 50% of her total exports value. This economic sector is important in terms of monetary income for crude oil firms and government budget but in terms of valued added such as new permanent employment vacancies and income distribution is miserable. About 50% of total crude oil income goes to owners of crude oil firms, 40% of total crude oil income goes to government in forms of taxes and royalties (including profits from state firm called Ecopetrol) and 10% goes to direct employees in the sector, there are about 50 crude oil firms in Colombia which counts with 14,500 direct employees, therefore the income distribution in crude oil sector is sad. The total Government Taking from crude oil sector accounted US$23,387 million or 6.84% of GDP in Colombia in 2011 and it has showed an increasing trend since 1921 as figure 1 shows (it accounted taxes and royalties through whole Value Chain from concession contract for exploration to final products such as gas and diesel fuel passing through transport taxes), this Government Taking shared in about 25% of total government income (total government income includes central government and regions income), the big issue is these resources show a mismanagement, they are taking without long run Cost-Benefit analysis, for instance scholarships for university education without job centers, new hospitals without a future budget to give proper services and new recycling plants without future budget to proper operation, therefore these investments are waste of resources.

Figure 1. Government taking crude oil sector Colombia 1921-2011

(as percentage of GDP, %)

Source: Bureau of Statistics (DANE, DNP, Ecopetrol)

There is other issue to deal, many people say that government has to increase the Government Taking rate from crude oil sector and they are right due to 50% of total crude oil income is for owners of capital and 50% is for government and employees, a fair rate can be 30%-70% respectively with a production of a million of barrels per day. Figure 2 shows how Government Taking has increased as the crude oil production has, this increasing in Government Taking is due to more production but no due to higher tax rates or royalties, therefore the rates from Government Taking has to be modified in favor of Colombian society. A  proposal is to increase taxes from crude oil profits which are taken to source country, the profit income can be around 20%, and it is easy, Central Bank of Colombia knows the value of these profits due to crude oil firm must report them to be repatriated to source country.

Figure 2. Annual crude oil production and government taking 1921-2011

Source: Bureau of Statistics (DANE, DNP, Ecopetrol)

It is fair to charge a tax of 20% on profits repatriated for crude oil firms, Colombia internal conflict is due to unfair income distribution, this unfair income distribution is deepened by three main sources, they are narcotic production (people want easy money due to high narcotic prices abroad), crude oil production and coal extraction (society watch how few people get rich through public resources and the majority of people are in poverty still), therefore this tax is supported by better internal security, for instance a reduction of kidnaping in about 1.0% lets an increasing of 0.159% in foreign capital in crude oil sector as table 1 shows, moreover Colombia government has spent huge resources to improve crude oil extraction, for instance the Laws in 1978 and 2003 which let higher production as table 1 shows (the sign of coefficients is positive) but taxes  rates are unfair as it was pointed above.

Table 1. Three Last Squares Model of Foreign Direct Investment as stock in crude oil sector in Colombia 1970 to 2011**

(values at 2011 prices,  in natural logarithms)

Variables	Coefficient
Labor rate (percentage%)	-0.171* (0.091)
Ln[Crude Oil Production] (Annual volume)	0.575* (0.086)
Ln[Crude Oil Utilities] (US$ million at 2011 prices)	0.166* (0.046)
Ln[Kidnaping] (number)	-0.159* (0.070)
Dummy 1978 (0-1 variable)	0.509* (0.188)
Dummy 2003 (0-1 variable)	0.301* (0.137)
Constant	3.375* (0.897)

*all coefficient are statistical significative, strictly less than 0.1.

** The other equations are foreign crude oil utilities and kidnaping.

Source: Bernal. 2013. Foreign Direct Investment in Colombia through XX century and beginnings of XXI, for coming.