Imagine you are the CEO of a big multinational who wants to start operating in Latin America. You want to open one branch in a large South American country to plan for your expansion in the region. Colombia quickly appears as a strong candidate for your pick. Yes, the country has had a difficult recent history, with all the drug lords, the guerrillas and the insecurity, but you know that the situation has improved to a great extent. You have read that fewer people are killed in Bogota than in Sao Paulo or Washington DC. You also know that the number of kidnappings in Colombia has gone down 87% since the year 2000. Today, the probability that you are kidnapped in Venezuela is two times greater than the probability that you are kidnapped in Colombia. You have also heard about the many foreign firms who are investing in Colombia, and how great they are doing. Foreign Direct Investment was around US$10 billion in 2008, and Colombian FDI seems surprisingly resilient even in the middle of the world recession. So perhaps you should invest in Colombia, too, and open your branch in one of those nice glass buildings being constructed in Bogota.
Well, hang on a minute.
All of a sudden you find out about something that bothers you. One of your associates points out that Colombia’s tax system is very complex –and expensive. She invites you to take a closer look. The Doing Business report by the World Bank says there are other 114 countries out there where it is easier and cheaper to pay your taxes than in Colombia. While the average tax rate in OECD countries (mostly developed) is 44 per cent of profits, in Colombia this same rate is a staggering 78.7%. In comparison, the tax rate for the average Latin American nation is 48.4%. You ask whether it is really that bad. Well, your associate responds, when you hire workers in Colombia you have to pay an extra 76% of the payroll for social security, including health care, pensions, a severance pay fund, and various mandatory payments to both public and not-for-profit private institutions (SENA, ICBF and Cajas de Compensación Familiar). This fact means that Colombia is the country with the highest labor costs in South America.
In addition, your associate points out that the Colombian corporate income tax is 34%, and that there are eight (!) different types of Value Added Tax, ranging from 7% to 45%, although the standard rate for most products is 16 %. Moreover, a 0.4% tax is charged on debit transactions in the financial system. By now, you do not seem as happy with the idea of opening your branch in Colombia. But there is more. You soon realize that the cost of importing and exporting merchandise to and from Colombia is high: the cost per container for each of these operations is around US$1,750, way above the average cost (around US$1,300) in the average Latin American nation. Perhaps your company would do better in another country.
But if the above has not totally convinced you, another look at the Doing Business report will do. Colombia is an incredibly bad place to enforce commercial contracts. There are 151 countries in the world where the judicial system will serve you better on this issue. It will take about four years (1,346 days!) for you to have the enforcement of a judgment on any contract. The trial alone can take about 913 days. For sure this is not an environment that can make you feel confident that the state will be on your side if your contractors do not keep their word. The risks of investing in Colombia just got much higher than you thought at first.
In comparison, take two other South American countries: Chile and Peru. The total tax rate in the latter is about 40% of profits, while companies working in Chile pay a mere 25.3%. Labor costs are also considerably lower in both of these countries. For example, social security contributions are about 9% of the payroll in Peru. Moreover, the cost of importing/exporting one container is about US$750 for Chileans, while in Peru you would pay US$875. Finally, in both Peru and Chile it takes an average of 450 days to have a contract enforced, about a third of the time it takes in Colombia. Needless to say, both Peru and Chile are safer than Colombia in terms of homicide, kidnapping and extortion levels. Where would you prefer to open your business?
Of course, the Uribe administration is aware of these realities (Minister of Commerce Luis Guillermo Plata is an avid reader of the Doing Business report) and has attempted to improve the situation. Just last year, Colombia climbed twelve positions in the Ease of Doing Business ranking, positioning itself as one of the top 40 economies for doing business. This is the result of reform, the reduction of paperwork, and greater protection to investors. The government has also created several Free Trade Zones (Zonas Francas), where corporate income tax is 15%. And of course, these FTZs are booming, for lower taxes seldom fail to attract more investors. But this is a bad solution for the overall high costs of making difficulty in Colombia. The nation as a whole needs a much lower corporate tax rate (say, about 20%), not only focused on a few FTZs prone to corruption and cronyism. More importantly, Colombia’s judiciary needs much larger funds so that it can become more efficient in enforcing contracts: in 2009 the judiciary received 1,5 billion pesos of the 134,5 billion pesos government budget. That means that the government spends a mere 1% of its money in the judiciary branch –and we still wonder why the rule of law is so elusive.
So, by all means, please invest in Colombia. As it was pointed out in an excellent column last week, there are fantastic opportunities in many sectors of the economy. I will thank you for the fact that your investment will help create jobs in a country that has South America’s highest unemployment rate, and you may even get juicy profits. I just think you should be mindful of the several obstacles the Colombian state will put before you along the way.