1. NS4540 Winter Term 2018 El Salvador Up-Date 2018
Oxford Analytica, El Salvador: Low Growth to Dog Economy in 2018 January 12, 2018

2. Overview
Over last two decades El Salvador has lagged neighboring countries in economic growth performance
Not the result of a single factor
Instead the interaction of a range of political and economic problems that have resulted in insufficient levels of investment
Between 2000 and 2014 real GDP growth grew by 2.0% compared to 4.5% for the whole Central American region
Things have not improved since, with El Salvador looking set to fare poorly again in 2018

3. Central America Growth Patterns

4. Pattern of Low Growth
Low growth has been driven by insufficient investment
Gross capital formation has averaged 15.5% of GDP since 2000
Far below figures for Central America which have often topped 20% and reached 26.0% in 2016
El Salvador’s economic problems somewhat surprising
During 1990s country embraced Washington Consensus
Developed stronger state institutions than Guatemala and Honduras
Inequality also lower than in other Central American countries – 0.41 compared with Costa Rica at 0.48

5. Causes of Slow Growth
A series of unresolved political and economic shortcomings have nevertheless driven low GDP and investment growth
These include
High Migration
Violence and Crime
Low Competitiveness
Political Gridlock and
Fiscal Challenges

6. High Migration I
IMF estimates that around 20% of Salvadorans live in U.S.
Compared to fewer than 10% of nationals from any other Central American country
High migration levels have led to a reduction in labor supply – particularly of young, potentially productive workers
Although migrants generate large amounts of remittances – 17% of GDP in 2016, overdependence on such payments a major long-term problem
Revocation in January 2018 of El Salvador’s Temporary Protected Status (TPS) by US Department of Homeland Security has increased migrant and remittance concerns
Prospect of up to 200,000 Salvadorans having to return home.

7. High Migration II
While such an influx could bring valuable skills to the economy, any benefits likely outweighed by
loss of remittance income
Considerable extra pressure on housing, the job market and public services.
In reality not all those subject to TPS will return to El Salvador
But if a fraction do, government will struggle to cope – many may become victims of gangs

8. Violence and Crime
Gangs, strengthened by already poor employment opportunities have driven rampant crime rates
In 2015 (last date of available data) there were 109 homicides per 100,000 people in El Salvador – more than in any other reported country.
Dialogue with gangs in 2012 was initially successful, but ultimately failed due to insufficient political consensus and electoral backing
Government’s recent tough approach has not reduced crime significantly and has been widely criticized.
Continued insecurity
Affects labor supplies
Necessitates excessive spending on security measures and
Reduces incentives for investments

9. Low Competitiveness I El Salvador
Suffers a lack of investment in human capital
Many obstacles to starting a business and
Corruption is high
Nevertheless its competitiveness profile is similar to that of neighboring countries
In the World Bank’s Doing Business 2018 report, El Salvador ranks above Guatemala, Nicaragua and Honduras.

10. Low Competitiveness II

11. Low Competitiveness III

12. Low Competitiveness IV

13. Low Competitiveness II
More significant problem in this area is the management of the exchange rate
Dollarization of the economy in 2001 contributed to macroeconomic stability, but also caused overvaluation
IMF feels the overvaluation of the real effective exchange rate is around 10%
Leads tp expensive exports and cheap imorts
Impact of dollarization in Panama – Central America’s only other dollarized economy has been more positive because of its reliance on financial services and incme from the Panama Canal

14. Economic Elites I
Salvadoran elite is probably the most internationalized in Central America
Power family business groups have invested in
Real estate
Tourism and
Trade
Within the region and beyond
Other members of the elite have sold their domestic business altogether and moved their money abroad
Business groups sold their participation in the banking sector to international companies
El Salvador now has no domestically owned banks.

15. Economic Elites II
This business strategy negatively affects economic growth in a number of ways, by:
Contributing to the low investment rate as some of the wealthiest business conglomerates invest their profits abroad and
The foreign-owned financial sector is not particularly focused on domestic growth
Reducing the elite’s commitment to solving some of the country’s worst problems including low wage growth, excessive migration and igh crime rates, and
Limiting El Salvador’s capacity to invest in research and innovation and discover new products

16. Political Gridlock and Fiscal Challenges I
Since the signing of the peace accords after El Salvador’s civil war ( ) the political system has been dominated by two polarized parties with quite different agendas
Farabundo Marti National Liberation Front (FMLN) and
The Nationalist Rebublican Alliance (ARENA)
As neither has suatained a majority in Congress in recent years, implementing consistent policies has become increasingly difficult
Political gridlock is a particular problem in the fiscal area.
The public deficit has remained above 3.5% of GDP in recent years and public debt has increased steadily

17. Political Gridlock and Fiscal Challenges II
Part of the problem is the pension system that has increased the financial demands on the Salvadoran state significantly.
At the same time, pension fund returns have been insufficient, partly due to ineffective investment rules.
A fundamental reform of the pension system is urgently needed, but unlikely

18. Assessment I
None of these factors independently explains El Salvador’s poor growth performance
Migration and violence are nearly as high in Honduras as in El Salvador
Political paralysis is also a problem in Guatemala and Costa Rica and
Low competitiveness and fiscal shortcomings are a bottleneck in several countries
It is the combination of all these problems that complicates matters for El Salvador

19. Assessment II Specifically
High levels of migration together with dollarization have led to an overvalued exchange rate which
Has reduced employment opportunities feeding
Crime and violence while
Political gridlock and the preferences of the economic elite make policy change particularly difficult
If El Salvador is to move on from it low growth equilibrium it will require drastic measures such as
The introduction of a new national currency
The rapid expansion of research and development and
The establishment of political dialogue on key areas, including pensions

20. Assessment III
With all such possibilities highly unlikely in the short-to-medium term, the economy looks set to sffer for some time.
Summing up
Economic growth is likely to remain subdued in the short-to medium term perpetuating low employment creation and sustained violence
Neither political system nor economic elite is likely to find ways to collaborate towards a new growh agenda.
Fiscal consolidation and market-friendly reforms alone cannot resolve the deep structural obstacles that hinder the economy.