BOGOTÁ—Colombia’s GDP growth plummeted last year, falling to just 0.6% from 7.3% in 2022. This rapid decline in economic expansion was largely expected, but the extent of the country’s fixed investment contraction was surprising, declining to the lowest level since 2005. Nineteen years later, with an embattled government, Colombians are hoping for a return of high growth and lower unemployment. Will they get it?
Rising interest rates and a corporate tax rate among the world’s highest help explain the massive drop in fixed investment—a 9% decline in real terms to represent only 17.8% of the nation’s GDP—but they are only part of the story. Increased economic and political uncertainty has also played a significant role as President Gustavo Petro faces a pivotal moment in his four-year term to get at least some of his key reforms approved by Congress.
To the increasing doubts stemming from the lengthy discussions of the structural reforms, the government has fanned more uncertainties by announcing controversial measures in strategic economic sectors while floating the idea of a new Constitution. All are having a compounded effect on both investment and Colombia’s growth prospects. On May 2, the OECD urged authorities to apply policies to revive investment, while forecasting a meager GDP expansion of 1.2% for 2024.
Pending reforms
Petro’s government has invested—and depleted—its political capital in three ambitious structural reforms. The healthcare reform has faced strong technical and political opposition, as it attempts to implement a completely new model. Although Congress recently rejected the proposal, the government plans to present a more concise version, albeit with the same objectives. Consequently, investment in the health sector remains mostly stagnant, pending resolution of this uncertainty.
A labor market reform aims to protect formal workers—a minority—by increasing the cost of formal employment. According to our calculations at Fedesarrollo, the reform is expected to eliminate about 400,000 formal jobs and won’t address the most pressing issues in the country’s labor market: high unemployment and high informality. If anything, the reform will likely exacerbate both problems. The uncertainty surrounding this highly opposed and poorly timed reform further deters investment.
Finally, the pension reform attempts to resolve many of the problems in Colombia’s current pension system, which only covers 25% of the elderly and directs 54% of public pension subsidies to the top 20% of income earners—the bottom 20% receive just 5%. There is an ongoing debate about the size of the public pillar and the fact that the reform does not adjust basic parameters such as pension age and replacement rate. Moreover, provisions for women, who could obtain a pension with just 850 weeks instead of the standard 1,300 required weeks of pension contributions, are likely to make the reform significantly more costly, putting additional pressure on the limited fiscal space the government has. Despite these concerns, the Senate recently approved the reform, and it is likely to pass in the lower house.
Government measures
The Petro administration has added to the uncertainty with announcements and measures that have negatively impacted at least three key sectors: oil and gas, mining, and infrastructure. The oil and gas and mining sectors bore the brunt of the 2022 tax reform, accounting for more than 50% of the estimated new tax revenues (about 1% of GDP per year). The government has not allowed new contracts for oil and gas exploration, and Petro has unfavorably compared oil and carbon to cocaine, sending a discouraging signal to prospective investors.
On infrastructure, the government decided last year not to increase road tolls to offset inflation, even though such adjustments are explicitly stated in public-private contracts. Reneging on the clause has cost the government financially, as it must now cover the lost income for private contractors. The reputational cost is bigger: This unilateral breach undermines current and future investors’ confidence in the government and its willingness to honor its contractual obligations. Although the Petro administration has discussed advancing on a new round of public-private partnerships, the so-called ‘5G’ projects, prospects appear bleak in the current environment.
President Petro announced the government’s intention to revise the 1991 Constitution, purportedly to ensure it fulfills its main objectives. Although most political analysts believe this proposal is dead on arrival, the mere discussion of drafting a new Constitution suggests that there is a small, yet real, possibility of a new set of rules for private investors. This represents another potential barrier to investment growth.
Implications for growth
Fedesarrollo has developed several scenarios to forecast Colombia’s potential output growth under varying long-term investment rates. Our low scenario assumes the fixed investment rate remains at its current 17.8% of GDP, which would result in a long-term growth rate of approximately 2.3%. The middle scenario assumes a recovery in oil and gas and infrastructure investments, boosting the investment rate to 19.6% of GDP and increasing the long-term growth rate to 2.9%. The high scenario projects that the investment rate will rise to 23.1%, akin to the peak rates observed earlier this century, potentially elevating Colombia’s long-term growth rate to 4%.
Accelerating the long-term growth rate from 2.3% to 4% would see incomes doubling approximately every 17 years, compared to every 30 years. This would reduce by almost half the time it would take for Colombia to achieve high-income status. The economic acceleration would translate into faster job creation, enhanced public services, and a more rapid reduction in both poverty and extreme poverty rates. These improvements are critical for the well-being of Colombia’s population.
What’s next
While the government has shown fiscal responsibility—most notably by eliminating expensive gasoline subsidies with a more than 60% price increase and adhering to the fiscal rule—these actions alone aren’t sufficient to ensure sustainable economic growth. A recent announcement by the government about relaxing the fiscal rule is both unnecessary and counterproductive.
Long-term growth depends not only on meeting fiscal targets but also on maintaining a stable regulatory environment. Investors are generally willing to embrace risk, but they shy away from uncertainty. After 20 months in office, Petro’s legacy in growth and employment hangs in the balance, and the government still has an opportunity to steer the economy and the country as a whole back on track.
