NS4540 Winter Term 2017 El Salvador Economy Federal Reserve Bank of Chicago, Strong Dollar Weak Dollar

Overview With a GDP per capita of US $7,613(ppp) in 2014 El Salvador is classified as a lower middle income country by the World Bank El Salvador is one of the least developed countries in Latin America and the Caribbean In 2014 the country was ranked 116th out of 188 countries in the UN’s Human Development Index (HDI) The country has one of the highest population densities in the western hemisphere (310 people per sq. km) A high level of violence is also a problem El Salvador has one of the highest murder rates in the world.

El Salvador: Stages of Growth I El Salvador has slowly moved from a primary-based economy to one that depends on manufacturing exports from free trade zones and remittances from abroad. This process of change has taken place in five different phases since independence in 1821 First, from the mid-19th century coffee superseded indigo and cotton as the dominant commodity Second, after the abolition of common land in 1882 vast haciendas emerged Third, coffee barons branched out into finance and commerce In the 1960s their capital helped establish a manufacturing base that exported throughout Central America

El Salvador Stages of Growth II The new process of industrialization based on the Central American Common Market (CACM) resulted in an acceleration of economic growth However deterioration in the price of coffee and other commodities, together with adverse international conditions and a crisis in the CACM led to a downturn at the end of the 1970s Unemployment, combined with underemployment affected more than 40% of the workforce In an attempt to ease social tensions the new military Government nationalized banks and the coffee industry and began breaking up large haciendas and handing them to worker co-operatives

El Salvador Stages of Growth III These reforms initiated a fourth phase of development which was hampered by the civil war from 1980-1992 War caused More than 80,000 deaths The internal and external displacement of over 1 million people A massive flight of capital, and Economic damage estimated at more than US $2,000m External assistance, 90% of which came from the US helped to keep the economy from sliding into recession Between 1980 and 1990 to total external financial assistance to El Salvador exceeded $5,000m One of the main purposes of US assistance was to offset economic sabotage – coffee, transport and power transmission by the FMLN

El Salvador Stages of Growth IV The fifth state of development began in 1980 involving the adoption of the Washington Consensus El Salvador one of the most radical reformers in Latin America and the Caribbean with policies ranging from External liberalization Domestic deregulation The dollarization of the economy and Privatization In 1989-94 Key public companies were returned to private ownership Public spending was cut and Price controls and subsidies were reduced or abolished The tax system was simplified and tariffs reduced

El Salvador Stages of Growth V Market reforms continued after the peace accords under successive governments Most important reform -- the dollarization of economy The colon was phased out by 2003, replaced by the US dollar Idea was to Reduce real interest rates close to US levels Encourage investment, and Integrate El Salvador into the global economy El Salvador was the first country to approve CAFTA-DR with the US – came into effect in 2006

El Salvador Stages of Growth VI Mauricio Funes from the left-wing FMLN became president in 2009 Emphasized moderate nature of his agenda Intent to develop a business environment attractive to investors Maintained broad continuity of economic policy rather than any significant change to the neoliberal model In march 2014 FMLN’s Salvador Sanchez Ceren former guerrilla won presidential election. Despite radical past Also adopted a moderate policy stance and pledged to maintain dollarization Has shown no sign of backtracking on these promises.

Outlook I Two decades of growth in which economic expansion averaged less than 2% annually points to structural problems in the economy that have to be addressed External conditions helped El Salvador to expand its economy faster between 2006 and 2008 than at any time in previous decade Global financial crisis slowed this considerably and exposed country’s vulnerability to high external food and energy prices Recovery has remained weak in 2016

Outlook II Despite reforms, many challenges persisted GDP per capita grew slowly and was affected by repeated natural disasters Poverty remained widespread, and Dollarization eroded some of the country’s competitive advantages Areas that need to be addressed in order to increase annual GDP growth rates High levels of poverty Exposure to agricultural price cycles Environment damage Increasing crime and violence and high levels of emigration

Outlook III Whether President Sanchez Ceren can overcome entrenched political polarization to implement an economic agenda capable to tackling long-standing structural issues remains to be seen As for now the country continues to have the weakest growth in central America Growth remains to weak to sustain the productivity and attractiveness of the country (least popular FDI destination in the region The level of criminality by discouraging investors and undermining consumer confidence is effectively restricting the the country’s economic growth rate

Outlook IV The limited purchasing power of households and lack of natural resources together with the level of corruption will also limit private investment In addition there is also the ongoing measures to balance that budget that are hampering growth Political disagreements between president Sachnez Ceren and the Legislative Assembly where his party has only 31 of the 84 seats are blocking the reforms needed to help reduce the budget deficit AREMA party wants to cut social programs and pensions which account for more than half of the budget. FMLN against cuts in these areas. Public spending will continue to increase in 2017 propelled in particular by subsidies (energy, agriculture and pensions and measures aimed at countering gang violence