Economy of El Salvador

[edit] Overview

The Salvadoran economy has experienced mixed results from the ARENA government's commitment to free market initiatives and conservative fiscal management that include the privatization of the banking system, telecommunications, public pensions, electrical distribution, and some electrical generation, reduction of import duties, elimination of price controls, and an improved enforcement of intellectual property rights. The GDP variable has been growing at a steady and moderate pace since the signing of peace accords in 1992, in an environment of macroeconomic stability. A problem that the Salvadoran economy faces is the inequality in the distribution of income. In 1999, the richest fifth of the population received 45% of the country's income, while the poorest fifth received only 5.6%.

As of December 1999, net international reserves equaled US$1.8 billion or roughly five months of imports. Having this hard currency buffer to work with, the Salvadoran Government undertook a monetary integration plan beginning January 1, 2001, by which the U.S. dollar became legal tender alongside the colón, and all formal accounting was undertaken in U.S. dollars. This way, the government has formally limited its possibility of implementing open market monetary policies to influence short term variables in the economy. Since 2004, the colón stopped circulating and is now never used in the country for any type of transaction; however some stores still have prices in both colones and U.S. dollars. In general, people were unhappy with the shift from the colón to the U.S. dollar, because wages are still the same but the price of everything increased. Some economists claim this rise in prices would have been caused by inflation regardless even had the shift not been made. Some economists also contend that now, according to Gresham's Law, a reversion to the colón would be disastrous to the economy.

Some banks however claim that they still do some transactions en colones, keeping this change from being unconstitutional.

The change to the dollar also precipitated a trend toward lower interest rates in El Salvador, helping many to secure credit in order to buy a house or a car; over time, displeasure with the change has largely disappeared, though the issue resurfaces as a political tool when elections are on the horizon.

A challenge in El Salvador has been developing new growth sectors for a more diversified economy. As many other former colonies, for many years El Salvador was considered a monoexporter economy. This means, an economy that depended heavily on one type of export. During colonial times, the Spanish decided that El Salvador would produce and export indigo, but after the invention of synthetic dyes in the 19th century, Salvadoran authorities and the newly created modern state turned to coffee as the main export of the economy. Since the cultivation of coffee required the highest lands in the country, many of these lands were expropriated from indigenous reserves and given or sold cheaply to those that could cultivate coffee. The government provided little or no compensation to the indigenous peoples. On occasions this compensation implied merely the right to work for seasons in the newly created coffee farms and to be allowed to grow their own food. Such policies provided the basis of conflicts that would shape the political situation of El Salvador in the years to come.

For many decades, coffee was one of the only sources of foreign currency in the Salvadoran economy. The civil war in the 80's and the fall of international coffee prices in the 90's, pressured the Salvadoran government to diversify the economy. ARENA governments have followed policies that intend to develop other exporting industries in the country as textiles and sea products. Tourism is another industry Salvadoran authorities regard as a possibility for the country. But rampant crime rates, lack of infrastructure and inadequate social capital have prevented these possibilities from being properly exploited. The government is also developing ports and infrastructure in La Union in the east of the country, in order to use the area as a "dry canal" for transporting goods from Fonseca Gulf in the Pacific Ocean to Honduras and the Antlantic Ocean in the north. Currently there are fifteen free trade zones in El Salvador. The largest beneficiary has been the maquila industry, which provides 88,700 jobs directly, and consists primarily of cutting and assembling clothes for export to the United States.

El Salvador signed the Central American Free Trade Agreement (CAFTA), negotiated by the five countries of Central America and the Dominican Republic, with the United States in 2004. In order to take advantage of CAFTA, the Salvadoran government is challenged to conduct policies that guarantee better conditions for entrepreneurs and workers to transfer from declining to growing sectors in the economy. El Salvador has already signed free trade agreements with Mexico, Chile, the Dominican Republic, and Panama, and increased its exports to those countries. El Salvador, Guatemala, Honduras, and Nicaragua also are negotiating a free trade agreement with Canada, and negotiations started on 2006 for a free trade agreement with Colombia.

Fiscal policy has been the biggest challenge for the Salvadoran government. The 1992 peace accords committed the government to heavy expenditures for transition programs and social services. The Stability Adjustment Programs (PAE, for the initials in Spanish) initiated by President Cristiani's administration committed the government to the privatization of banks, the pension system, electric and telephone companies. The total privatization of the pension system has implied a serious burden for the public finances, because the newly created private Pension Association Funds did not absorb coverage of retired pensionists covered in the old system. The government lost the revenues from contributors and absorbed completely the costs of coverage of retired pensionists. This has been the main source of fiscal imbalance. ARENA governments have financed this deficit with the emission of bonds, something the leftist party FMLN has opposed. Debates surrounding the emission of bonds have stalled the approval of the national budget for many months on several occasions, reason for which in 2006 the government will finance the deficit by reducing expenditure in other posts. The emission of bonds and the approval of a loans need a qualified majority (3/4 of the votes) in the parliament. If the deficit is not financed through a loan it is enough with a simple majority to approve the budget (50% of the votes plus 1). This would agilize an otherwise long process in Salvadoran politics.

Despite such challenges to keep public finances in balance, El Salvador still has one of the lowest tax burdens in the American continent (around 11% of GDP). Many specialists claim that it is impossible to advance significant development programs with such a little public sector (the tax burden in the United States is around 25% of the GDP and in other developed countries of the EU it can reach around 50%, like in Sweden). The government has focused on improving the collection of its current revenues with a focus on indirect taxes. Leftist politicians criticize such a structure since indirect taxes (like the value added tax) affect everyone alike, whereas direct taxes can be weighed according to levels of income and are therefore fairer taxes. A 10% value-added tax (VAT), implemented in September 1992, was raised to 13% in July 1995. The VAT is the biggest source of revenue, accounting for about 52.3% of total tax revenues in 2004.

Remittances from Salvadorans working in the United States sent to family members are a major source of foreign income and offset the substantial trade deficit of around $2.9 billion. Remittances have increased steadily in the last decade and reached an all-time high of $2.9 billion in 2005—approximately 17.1% of gross domestic product (GDP). As of April 2004, net international reserves stood at $1.9 billion.

In recent years inflation has fallen to single digit levels, and total exports have grown substantially.

[edit] Foreign Debt and Assistance

El Salvador's external debt decreased sharply in 1993, chiefly as a result of an agreement under which the United States forgave about $461 million of official debt. As a result, total debt service decreased by 16% over 1992. External debt stood at $2.8 billion at the end of 1999. Debt service amounted to 2.5% of GDP in 1998 and is considered moderate. The Government of El Salvador has been successful in obtaining significant new credits from the international financial institutions. Among the most significant loans are a second structural adjustment loan from the World Bank for $52.5 million, another World Bank loan of $40 million for agricultural reform, a $20 million loan from the Central American Bank for Economic Integration to be used to repair roads, and a $60 million Inter-American Development Bank loan for poverty alleviation projects. Total non-U.S. Government aid, excluding NGO assistance and bilateral loan programs, reached $38 million in 1999. Although official figures show relatively small and diminishing aid flows, the total is probably larger. Significant amounts come in through nongovernmental organizations and are channeled to groups not generally included in official statistics, such as political parties, unions, and churches. Some $300 million has been contracted from international institutions and governments for infrastructure works and social programs to be undertaken. The debt profile is expected to increase over the next several years as the international donor community has pledged $1.26 billion to finance El Salvador's reconstruction and modernization. Large loans now being sought to finance reconstruction from the 2001 earthquakes will further alter the country's debt profile.

[edit] Natural Disasters: Hurricane Mitch (1998) and the Earthquakes (2001)

Hurricane Mitch hit El Salvador in late October 1998, generating extreme rainfall of which caused widespread flooding and landslides. Roughly 650 km² were flooded, and the Salvadoran Government pronounced 374 people dead or missing. In addition, approximately 55,900 people were rendered homeless. The areas that suffered the most were the low-lying coastal zones, particularly in the floodplain of the Lempa and San Miguel Grande Rivers. Three major bridges that cross the Lempa were swept away, restricting access to the eastern third of the country and forcing the emergency evacuation of many communities. The heavy rainfall, flooding, and mudslides caused by Hurricane Mitch also severely damaged El Salvador's road network. Along with the three major bridges over the Lempa River, 12 other bridges were damaged or destroyed by the Mitch flooding.

The largest single-affected sector was El Salvador's agriculture. Nearly 18% of the total 1998-99 basic grain harvest was lost. Coffee production was hit particularly hard; 3% of the harvest was lost in addition to 8.2% that was lost earlier in the year due to El Niño. Major losses of sugarcane, totaling 9% of the estimated 1998-99 production, were sustained primarily in the coastal regions. Livestock losses amounted to $1 million, including 2,992 head of cattle. In addition to these losses, El Salvador also had to face the threat of disease outbreak. The Ministry of Health recorded a total of 109,038 medical cases related to Hurricane Mitch between October 31 and November 18, 1998; 23% of these cases were respiratory infections, followed by skin ailments, diarrhea, and conjunctivitis.

Reconstruction from Mitch was still underway when, in early 2001, the country experienced a series of devastating earthquakes that left nearly 2,000 people dead or missing, 8,000 injured, and caused severe dislocations across all sectors of Salvadoran society. Nearly 25% of all private homes in the country were either destroyed or badly damaged, and 1.5 million persons were left without housing. Hundreds of public buildings were damaged or destroyed, and sanitation and water systems in many communities put out service. The total cost of the damage was estimated at between $1.5 billion and $2 billion, and the devastation thought to equal or surpass that of the 1986 quake that struck San Salvador. Given the magnitude of the disaster, reconstruction and economic recovery will remain the primary focus of the Salvadoran Government for some time to come.

The Hurricane Mitch disaster prompted a tremendous response from the international community governments, nongovernmental organizations (NGOs), and private citizens alike. Sixteen foreign governments--including the U.S., 19 international NGOs, 20 Salvadoran embassies and consulates, and 20 private firms and individuals provided El Salvador with in-kind assistance. The Government of El Salvador reports that 961 tons of goods and food were received. The Ministry of Foreign Affairs estimates that contribution in cash given directly to the Salvadoran Government totaled $4.3 million. The U.S. Government has provided $37.7 million in assistance through USAID and the U.S. Departments of Agriculture and Defense.

Following the 2001 earthquakes, the U.S. Embassy assumed a leading role in implementing U.S. sponsored assistance. The U.S. Government responded immediately to the emergency, with military helicopters active in initial rescue operations, delivering emergency supplies, rescue workers, and damage assessment teams to stricken communities all over the country. USAIDs Office of Foreign Disaster Assistance had a team of experts working with Salvadoran relief authorities immediately after both quakes, and provided assistance totaling more than $14 million. In addition, the Department of Defense provided an initial response valued at more than $11 million. For long-term reconstruction, the international community offered a total aid package of $1.3 billion, over $110 million of it from the United States.

[edit] Manufacturing

El Salvador historically has been the most industrialized nation in Central America, though a decade of war eroded this position. In 1999, manufacturing accounted for 22% of GDP. The industrial sector has shifted since 1993 from a primarily domestic orientation to include free zone (maquiladora) manufacturing for export. Maquila exports have led the growth in the export sector and in the last 3 years have made an important contribution to the Salvadoran economy.

[edit] Trade

El Salvador's balance of payments continued to show a net surplus. Exports in 1999 grew 1.9% while imports grew 3%, narrowing El Salvador's trade deficit. As in the previous year, the large trade deficit was offset by foreign aid and family remittances. Remittances are increasing at an annual rate of 6.5%, and an estimated $1.35 billion will enter the national economy during 1999. Private foreign capital continued to flow in, though mostly as short-term import financing and not at the levels of previous years. The Central American Common Market continued its dynamic reactivation process, now with most regional commerce duty-free. In September 1996, El Salvador, Guatemala, and Honduras opened free trade talks with Mexico. Although tariff cuts that were expected in July 1996 were delayed until 1997, the Government of El Salvador is committed to a free and open economy. Total U.S. exports to El Salvador reached $2.1 billion in 1999, while El Salvador exported $1.6 billion to the United States. U.S. support for El Salvador's privatization of the electrical and telecommunications markets has markedly expanded opportunities for U.S. investment in the country. More than 300 U.S. companies have established either a permanent commercial presence in El Salvador or work through representative offices in the country. The Department of State maintains a Country Commercial Guide for U.S. businesses seeking detailed information on business opportunities in El Salvador.

[edit] Agriculture and Land Reform

Cotton field, Usulután Department

Before 1980, a small economic elite owned most of the land in El Salvador and controlled a highly successful agricultural industry. About 70% of farmers were sharecroppers or laborers on large plantations. Many farm workers were under- or unemployed and impoverished. The civilian-military junta, which came to power in 1979, instituted an ambitious land reform program to redress the inequities of the past, respond to the legitimate grievances of the rural poor, and promote more broadly based growth in the agricultural sector. The ultimate goal was to develop a rural middle class with a stake in a peaceful and prosperous future for El Salvador. At least 525,000 people--more than 12% of El Salvador's population at the time and perhaps 25% of the rural poor--benefited from agrarian reform, and more than 22% of El Salvador's total farmland was transferred to those who previously worked the land but did not own it. But when agrarian reform ended in 1990, about 150,000 landless families still had not benefited from the reform actions. The 1992 peace accords made provisions for land transfers to all qualified ex-combatants of both the FMLN and ESAF, as well as to landless peasants living in former conflict areas. The United States undertook to provide $300 million for a national reconstruction plan. This included $60 million for land purchases and $17 million for agricultural credits. USAID remains actively involved in providing technical training, access to credit, and other financial services for many of the land beneficiaries.

[edit] See also

• El Salvador
• Economy of South America
• Economy of North America

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Categories: Articles lacking sources from October 2006 | All articles lacking sources | WTO member economies | Economy of El Salvador