Competitiveness and Growth in El Salvador

1. Competitiveness and Growth in El Salvador Luis Felipe Zegarra Universidad de Piura, CIUP (Lima, Peru) Martha Rodríguez Universidad del Pacifico, CIUP (Lima, Peru) Carlos Acevedo UNDP (San Salvador, El Salvador)

2. Background • El Salvador implemented pro-market structural reforms in early 1990s • However, economic performance did not seem to respond: GDP´s growth rate has been low in the last 10 years

3. Stilized facts • GDP growth rates high in early 1990s, but much lower in 1995-2005. • Slow growth for Central American standards. • Low savings and investment rates. • Slowdown of export sector. • Slowdown of all productive sectors, especially agriculture and manufacture.

4. Annual growth rates (%)

5. Main questions • Why has El Salvador grown so slowly? • Why are investment rates so low?

6. General decision tree

7. Decision tree for low investment rates

8. Binding constraint: migration • Migration has affected GDP growth through: • Size of labor force • Population • Reservation wage • Competitiveness of trade sector • Quality of labor force (human capital) • Remittances and real exchange rate (aggravated by inflexibility from dollarization) • Also: unfavorable external factors • There is no much the government can do to solve these problems. • Then, it is crucial to deal with other problems

9. Other constraints • Cost of capital • For small firms • Appropriability of returns • High crime rates • Fiscal sustainability • Social returns to investment • *** Low human capital *** • Limitations in infrastructure • Lack of technological adaptation

10. Why does El Salvador grow slowly?

11. Migration and labor force • Migration has increased in recent years • Significant impact on the size of labor force

12. Number of migrants (000)

13. Number of occupied workers (official)

14. Migration and labor force • Preliminary estimates (2007 census) indicate that actual size of population is 1.3 million less than previous official figures. • Assuming the same growth rate of population for labor force, we adjust the size of labor force.

15. Labor and GDP per-worker, 1990-2005 • Labor force grew by 0.47% per year (rather than 2.8%) • GDP per worker grew by 3.29% per year (rather than 0.98%)

16. Annual growth rate of GDP per-capita (%), 1990-2005

17. Annual growth rate of real wages (%), 1990-2003

18. Gross-capital formation (% GDP), 2005 • Investment rate in El Salvador is low

19. Harvested land (has) • Harvested land has declined for more than 10 years

20. Decomposition of output • What explains economic growth? • Production factors (capital, labor, land)? • Or total factor productivity (TFP)? • Methodology: • Cobb-Douglass production function: Q=AKβLαT1-α-β • Kt=(1-δ)Kt-1+It • Assumptions: β=0.36,α=0.54, δ=2.5%, r=15%.

21. Decomposition of GDP, 1990-2005 • Labor and land explain much of the evolution of GDP • TFP grew by 1.7% per year (rather than 0.46%) • % TFP consistent with structural reforms

22. Why does El Salvador grow slowly? • Slowdown of labor force (migration) • Low investment rates • Decline in land usage

23. Why is investment in ES low?

24. I) Is cost of capital high?

25. National savings rate (% GDP), 2004 • Savings rate is low in El Salvador

26. Real interest rates (%), 2005 • If credit is a binding constraint, interest rate will be high. However, it is low for LAC standards.

27. Credit access is limited for small and micro enterprises

28. Cost of capital-Summary • Domestic savings rate in El Salvador is low. • However, El Salvador has a relatively easier access to credit than other countries. • Credit is limited for small and micro enterprises. For SME credit may be a binding constraint

29. II) Is appropriability of returns low? • Taxation • Institutions and micro risks • Macro risks • Externalities

30. Taxation • Taxation system is not a binding constraint for investment • Taxes in El Salvador are low • Tax administration doesn´t seem to be an obstacle to investment

31. Profit tax rate (% profit), 2005

32. Institutions • Institutions are pro-investment • The main problem: crime • Crime in El Salvador: one of the highest rates in the world

33. Murders per 100,000 persons, 2002

34. Index of property rights (0 to 100) • Greater value means better PR

35. Index of corruption, 2006 • Greater value means lower corruption

36. Macro risks • Inflation is low • Fiscal deficit is low • Vulnerabilities: • Subject to external real shocks (dollarization) • Fiscal sustainability is weak

37. Inflation rate (%), 2006

38. Fiscal sustainability • Estimates on the primary balance required for public debt sustainability. • Vergara (2003) estimates a fiscal adjustment of 2.5% of GDP of the trend primary balance

39. Externalities • Externalities may have affected self-discovery • But externalities exist everywhere • There is no strong evidence that externalities are the binding constraint for growth

40. III) Are social returns to investment low? • Human capital • Infrastructure • External conditions • Technological adaptation

41. A) Human capital • Low education of labor force: third major problem. • Low schooling rates

42. Illiteracy rate (%), 15 years and more, 2002 • Illiteracy in El Salvador is high

43. Migration and education • Migrants are better educated than non-migrants. • Outflow of talented people.

44. Distribution of Salvadorans (%)

45. Distribution of migrants (%)

46. High-skilled workers • Low percentage of population with tertiary education • Low availability of scientists and engineers

47. Population with tertiary education (%)

48. Quality of education • Quality of education in El Salvador is not high for Latin American standards: • Indicators of perception • Returns to schooling of migrants in U.S.

49. Index of quality of education (1 to 7)

50. Returns to schooling in U.S.