Competitiveness and Growth in El Salvador
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Competitiveness and Growth in El Salvador
Luis Felipe ZegarraUniversidad de Piura, CIUP (Lima, Peru)
Martha RodríguezUniversidad del Pacifico, CIUP (Lima, Peru)
Carlos AcevedoUNDP (San Salvador, El Salvador)
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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
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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.
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Annual growth rates (%) 1990-95 1995-2000 2000-05 Latin America 3.7 3.1 2.3 México 1.5 5.5 1.8 South America Argentina 5.7 2.5 2.0 Brazil 3.1 2.1 2.2 Chile 7.8 6.3 4.4 Peru 5.6 2.4 4.2 Others 3.9 1.3 3.0 Central America El Salvador 6.2 3.1 2.2 Others 4.6 4.8 3.4 Notes and sources: GDP is in constant prices. For El Salvador, the source is CEPAL (2006a). For the rest of countries, the sources are CEPAL (2003) for 1990-95 and 1995-2000, and CEPAL(2006a) for 2000-05.
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Main questions
• Why has El Salvador grown so slowly?
• Why are investment rates so low?
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General decision tree
Problem: Low growth rates of GDP Slow growth of capital Slow growth of labor Slow growth of land Slow growth of TFP Low returns to High cost of finance to investment
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Decision tree for low investment rates
Problem: low investment rates
Low returns to economic activity High cost of finance Low social returns to Low appropriability investment Human Infrastructure Innovation External Tax Externalities Bad Bad capital conditions system local international finance finance Micro Macro risks risks
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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
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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
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Why does El Salvador grow slowly?
Problem: Low growth rates of GDP Slow growth of capital Slow growth of labor Slow growth of land Slow growth of TFP Low returns to High cost of finance to investment
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Migration and labor force
• Migration has increased in recent years
• Significant impact on the size of labor force
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Number of migrants (000)
-200
0
200
400
600
800
1000
1951-55 1956-60 1961-65 1966-70 1971-75 1976-80 1981-85 1986-90 1991-95 1996-2000 2000-05
Source: UNDP (2005)
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Number of occupied workers (official)
500000
1000000
1500000
2000000
2500000
3000000
1950 1953 1956 1959 1962 1965 1968 1971 1974 1977 1980 1983 1986 1989 1992 1995 1998 2001 2004
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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.
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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%)
GDP(million Labor (thousands GDP per-worker Labor (thousands GDP per-worker
colons 1990) occupied workers) (million colons 1990) occupied workers) (million colons 1990)
1990 36,487 1,720 21,214 1,720 21,2142005 63,421 2,591 24,477 1,863 34,047
3.75 2.77 0.98 0.47 3.29
Official labor Adjusted labor
Annual growth rates (%), 1990-2005
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Annual growth rate of GDP per-capita (%), 1990-2005
-0.5 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 4.5
Source: CEPAL* The actual growth rate of GDP per-capita is 1.8% per year in 1990-2005
Argentina
Bolivia
Brazil
Chile
Colombia
Costa Rica
Ecuador
El Salvador
Guatemala
Honduras
Mexico
Nicaragua
Panama
Paraguay
Peru
Uruguay
Venezuela
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Annual growth rate of real wages (%), 1990-2003
-5 -4 -3 -2 -1 0 1 2 3 4
Source: ILO, ECLAC
Argentina
Bolivia
Brazil
Chile
Colombia
Costa Rica
Mexico
Nicaragua
Paraguay
Peru
Uruguay
Venezuela
El Salvador
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Gross-capital formation (% GDP), 2005
• Investment rate in El Salvador is low
10
15
20
25
30
35
40
El Salvador Low-middle income Latin American andCaribbean
East Asia and Pacific South Asia
Source: World Bank
2000 2005
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Harvested land (has)
• Harvested land has declined for more than 10 years
500000
550000
600000
650000
700000
750000
800000
850000
900000
1961 1964 1967 1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003
Source: FAO
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Decomposition of output
• What explains economic growth?– Production factors (capital, labor, land)?– Or total factor productivity (TFP)?
• Methodology:– Cobb-Douglass production function: Q=AKβL
αT1-α-β
– Kt=(1-δ)Kt-1+It– Assumptions: β=0.36,α=0.54, δ=2.5%,
r=15%.
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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
GDP Capital Labor Land TFP Capital Labor Land
Official labor 3.75 5.22 2.77 -0.77 0.46 1.88 1.50 -0.08Adjusted labor 3.75 5.22 0.47 -0.77 1.70 1.88 0.25 -0.08
Annual growth rates (%) Contribution to growth (%)
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Why does El Salvador grow slowly?
• Slowdown of labor force (migration)• Low investment rates• Decline in land usage
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Why is investment in ES low?
Problem: low investment rates
Low returns to economic activity High cost of finance Low social returns to Low appropriability investment Human Infrastructure Innovation External Tax Externalities Bad Bad capital conditions system local international finance finance Micro Macro risks risks
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I) Is cost of capital high?
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National savings rate (% GDP), 2004
• Savings rate is low in El Salvador
0 5 10 15 20 25 30 35Source: WDI, 2006
Mexico
Venezuela
Uruguay
Peru
Ecuador
Colombia
Chile
Brazil
Argentina
Panama
Nicaragua
Honduras
Guatemala
Costa Rica
El Salvador
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Real interest rates (%), 2005
• If credit is a binding constraint, interest rate will be high. However, it is low for LAC standards.
-20
-10
0
10
20
30
40
50
Ven
ezuela
Arg
entina
Nicar
agua
Ecu
ador
El Salva
dor
Mex
ico
Guat
emala
Pan
ama
Hondura
s
Colo
mbia
LAC
Per
u
Bolivi
a
Uru
guay
Costa R
ica
Dom
inican
Rep
.
Par
aguay
Bra
zil
The World Bank, World Development Indicators
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Credit access is limited for small and micro enterprises
Main sources of financing for SMEs in El Salvador
75.2%
9.7%
3.2%
11.9%
Retained earnings
Remittances
Credit from suppliers
Other
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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
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II) Is appropriability of returns low?
• Taxation• Institutions and micro risks• Macro risks• Externalities
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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
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Profit tax rate (% profit), 2005
0 10 20 30 40 50 60 70
Source: Doing Business, 2006
Venezuela
Uruguay
Peru
Paraguay
Ecuador
Colombia
Chile
Brazil
Bolivia
Argentina
Mexico
Panama
Nicaragua
Honduras
Guatemala
Costa Rica
El Salvador
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Institutions
• Institutions are pro-investment• The main problem: crime
– Crime in El Salvador: one of the highest rates in the world
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Murders per 100,000 persons, 2002
0 10 20 30 40 50 60 70
USA
Phillipines
Thailand
Uganda
Papua New Guinea
Latvia
Belarus
Estonia
Sri Lanka
Mexico
Kazakhstan
Russian Federation
Guatemala
El Salvador
Venezuela
Jamaica
South Africa
Colombia
Source: Crime and Development in Central America (2002)
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Index of property rights (0 to 100)
• Greater value means better PR
20 30 40 50 60 70 80 90
Source: The Heritage Foundation, 2007
Venezuela
Uruguay
Peru
Paraguay
Ecuador
Colombia
Chile
Brazil
Bolivia
Argentina
Mexico
Panama
Nicaragua
Honduras
Guatemala
Costa Rica
El Salvador
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Index of corruption, 2006
• Greater value means lower corruption2 3 4 5 6 7 8
Source: Transparency International, 2006
Venezuela
Uruguay
Peru
Paraguay
Ecuador
Colombia
Chile
Brazil
Bolivia
Argentina
Mexico
Panama
Nicaragua
Honduras
Guatemala
Costa Rica
El Salvador
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Macro risks
• Inflation is low• Fiscal deficit is low• Vulnerabilities:
– Subject to external real shocks (dollarization)
– Fiscal sustainability is weak
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Inflation rate (%), 2006
0 2 4 6 8 10 12 14
Source: ECLAC
Venezuela
Uruguay
Peru
Paraguay
Ecuador
Colombia
Chile
Brazil
Bolivia
Argentina
Mexico
Panama
Nicaragua
Honduras
Guatemala
Costa Rica
El Salvador
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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
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Externalities
• Externalities may have affected self-discovery
• But externalities exist everywhere• There is no strong evidence that
externalities are the binding constraint for growth
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III) Are social returns to investment low?
• Human capital• Infrastructure• External conditions • Technological adaptation
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A) Human capital
• Low education of labor force: third major problem.
• Low schooling rates
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Illiteracy rate (%), 15 years and more, 2002
• Illiteracy in El Salvador is high
0 5 10 15 20 25
Source: The World Bank, World Development Indicators, 2006
Venezuela
Uruguay
Peru
Paraguay
Ecuador
Colombia
Chile
Brazil
Bolivia
Argentina
Mexico
Panama
Nicaragua
Honduras
Guatemala
Costa Rica
El Salvador
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Migration and education
• Migrants are better educated than non-migrants.
• Outflow of talented people.
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Distribution of Salvadorans (%)
No schooling or incomplete primary;
70.5%
Complete primary or incomplete secondary;
15.2%
Complete secondary; 3.7%
Tertiary education; 10.6%
Source: International Data on Educational Attainment (Barro and Lee, 2000)
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Distribution of migrants (%)
No education or incomplete primary; 8.6%
Complete primary or incomplete secondary;
41.8%Complete secondary education; 27.9%
Tertiary education; 21.7%
Source: UNDP
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High-skilled workers
• Low percentage of population with tertiary education
• Low availability of scientists and engineers
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Population with tertiary education (%)
5 7 9 11 13 15 17 19 21 23
Source: International Data on Educational Attainment (Barro and Lee, 2000)
Venezuela
Uruguay
Peru
Paraguay
Ecuador
Colombia
Chile
Brazil
Bolivia
Argentina
Mexico
Panama
Nicaragua
Honduras
Guatemala
Costa Rica
El Salvador
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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.
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Index of quality of education (1 to 7)
1.5
2.0
2.5
3.0
3.5
4.0El
Salva
dor
Cos
ta R
ica
Gua
tem
ala
Hon
dura
s
Nicar
agua
Pana
ma
Mex
ico
Arg
entin
a
Boliv
ia
Braz
il
Chi
le
Col
ombi
a
Ecua
dor
Para
guay
Peru
Uru
guay
Ven
ezue
la
Public schoolsMath and science education
Note: The indexes measure the quality of public schools and math education. They range from 1 to 7, where a greater value indicates higher quality.Source: World Economic Forum, The Global Competitiveness Report, 2005-06
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Returns to schooling in U.S.
0.010 0.015 0.020 0.025 0.030 0.035 0.040 0.045 0.050 0.055
Source: Bratsberg & Terrel (2002)
Uruguay
Peru
Ecuador
Colombia
Chile
Brazil
Argentina
Mexico
Panama
Honduras
Guatemala
Costa Rica
El Salvador
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Is low schooling rate a binding constraint?
• Marginal returns– If low schooling is a binding constraint, then
marginal returns to schooling will be high– Hausmann, et al: schooling is not a binding
constraint; but they don´t control for quality– Our evidence: marginal returns to schooling
are not high, even after controlling for quality
• Survey data– Education is not binding
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Returns to education and quality
Dominican Rep
Venezuela Uruguay
Ecuador
Colombia
Brazil
Bolivia
Argentina
MexicoChile
BoliviaNicaragua
Honduras
Costa Rica
El Salvador
Peru Paraguay
Panama
Guatemala
0.06
0.07
0.08
0.09
0.10
0.11
0.12
0.13
0.14
1.5 2.0 2.5 3.0 3.5 4.0 4.5
Quality of education
Ret
urns
to edu
catio
n
Sources: World Economic Forum, 2005-06; Hausmann et al (2005)
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Does the education system meet the needs of a
competitive system? Index (1 to 7)
1.5 1.7 1.9 2.1 2.3 2.5 2.7 2.9 3.1 3.3 3.5
Venezuela
Uruguay
Peru
Paraguay
Ecuador
Colombia
Chile
Brazil
Bolivia
Argentina
Mexico
Panama
Nicaragua
Honduras
Guatemala
Costa Rica
El Salvador
Note: This index measures the quality of the educational system, which indicates whether the educational system meets the needs of a competitive economy. It ranges between 1 and 7, where a greater value indicates that the educational system meets the needs of a competitive economy better. Source: World Economic Forum, The Global Competitiveness Report, 2005-06
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Human capital-summary
• El Salvador has low levels of human capital
• Low human capital represents a serious problem in order to upgrade its productive structure (to enhance productivity)– Low tertiary education– Lack of self-discovery
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B) Infrastructure
• Roads, airports, ports, electricity• Average: among the best in the
region• Main problems: roads, electricity
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Infrastructure gap: among the best Infrastructure Gap
0
2
4
6
8
Boliv
ia
Peru
Col
ombi
a
Ven
ezue
la
Braz
il
Gua
tem
ala
Uru
guay
Dom
inican
Rep
.
Arg
entin
a
Mex
ico
El S
alva
dor
Chi
le
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Main problems: roads, electricity
0 5 10 15 20
BoliviaPeru
ColombiaVenezuela
BrazilGuatemala
UruguayDominicanArgentina
MexicoEl Salvador
Chile
Infrastructure gap by sector
Road InfrastructureGapPort InfrastructureGapAirportInfrastructure GapElectricityInfrastructure Gap
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Infrastructure-summary
• El Salvador has good indicators of infrastructure for Latin American standards.
• However, higher economic growth will require greater investment in infrastructure.
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C) External conditions
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Decline in terms of trade in the last 10 years
Terms of trade (1990=100)
70
80
90
100
110
120
130
1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004
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Competition from China
• Chinese exports to the US has increased in the last 10 years
• Salvadorian maquila has been affected
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External conditions-summary
• Unfavorable terms of trade• Increasing competition from Chinese
textiles
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* Migration, remittances and RER *
• Migration has affected economic growth through:– Slowdown of labor force– Outflow of talented people
• Also: remittances and RER– Migrants send remittances to their relatives
in El Salvador– Inflow of remittances decreases real
exchange rate– Remittances have mostly funded
consumption rather than investment
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Remittances (% GDP), 2005
0 5 10 15 20 25
Source: World Development Indicators, 2006
Argentina
Bolivia
Brazil
Colombia
Costa Rica
Ecuador
El Salvador
Guatemala
Honduras
Mexico
Nicaragua
Panama
Peru
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Annual growth rate of RER (%), 1994-2006
-3 -2 -1 0 1 2 3 4 5 6 7
Source: ECLAC, Estudio Económico de América Latina y el Caribe, 2005-06; 2002-03
Argentina
Bolivia
Brasil
Chile
Colombia
Costa Rica
Ecuador
El Salvador
Guatemala
Honduras
Jamaica
México
Nicaragua
Panamá
Paraguay
Perú
Uruguay
Venezuela
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Remittances and RER-summary
• Migration has increased remittances to El Salvador.
• The large flow of remittances has reduced the RER, which has affected competitiveness of Salvadoran trade sector.
• Remittances have mostly funded consumption (non-traded prices, deficit on trade balance).
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D) Technological adaptation
• Lack of innovation• Lack of technological diffusion
– Low payments of royalties– Low share of capital imports (% GDP)– Low FDI (% GDP)
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Classification by technological activityHigh Moderate Low InsignificantAustralia Argentina Bolivia BangladeshAustria Brazil China CameroonCanada Chile Colombia El SalvadorDenmark Costa Rica Ecuador MozambiqueFinland Czech Republic Guatemala NigeriaFrance Slovenia Honduras PakistanGermany Greece India ParaguayHolland Hungary Indonesia TanzaniaHong Kong Mexico NicaraguaIreland Poland PanamaIsrael Portugal PeruJapan South Africa PhilippinesNorway Spain Saudi ArabiaSingapore Uruguay ThailandSweden VenezuelaSwitzerlandUnited KingdomUSASource: Lall (2003), CAF (2006)
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Royalties and license fees payments and receipts per-
capita (US$), 2004
0
2
4
6
8
10
12
14
16
18
Chile Costa Rica El Salvador Guatemala Nicaragua Honduras Latin America
Source: The World Bank, Knowledge for Development Program
Payments Receipts
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Technological adaptation
• Innovation and technological diffusion in El Salvador are very limited
• Efforts of innovation are concentrated in large exporting firms
• Main constraints for innovation (Fusades´ survey):– Lack of technological information– Lack of technicians and skilled labor
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* Product transformation and self-discovery*
• No diversification in the last 15 years• Decline in agricultural exports, but
no new products• Non-traditional exports have
increased, but remained concentrated in processors of raw-material and low-technology manufactures
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Exports of El Salvador (US$ million)
0
500
1000
1500
2000
2500
3000
3500
4000
1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006
Source: Banco Central de Reserva de El Salvador
TotalTraditionalNon-traditionalMaquila
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EXPY (US$ 000)
• El Salvador: low EXPY
0
2000
4000
6000
8000
10000
12000
1975 1980 1985 1990 1995 2000 2004
Source: Hausmann & Klinger Data
Argentina Chile Colombia
El Salvador Guatemala Nicaragua
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Product transformation
• Self-discovery is low in El Salvador• Why?
– Human capital– Distorting incentives– Externalities? (what about other
countries?)
• Some recent self-discovery: latest dynamism of some new non-traditional exports
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Conclusions
• Migration is the main binding constraint. It has affected:– Size of labor force
• Population• Reservation wage
– Competitiveness of trade sector• Human capital• Remittances and RER
• Also: unfavorable external factors
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Conclusions
• Important to deal with other conventional factors that affect competitiveness of Salvadoran trade sector:– Problems of access to credit to small firms – High crime rates– Unconsolidated fiscal sustainability – ***Low shooling rates*** – Limitations in infrastructure– Weak technological adaptation
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Natural disasters
• Hurricane Mitchell (1998), two earthquakes (2001), volcano and tropical storm (2005)
• Effects of eruption of volcano Ilamatepec and tropical strom Stan (2005)– Overall: More than 60,000 Has. (9.1%
land size).– Coffee: 43,500 Has. (27% of land size)
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Imports (US$ million)
0
500
1 000
1 500
2 000
2 500
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
Consumption goods Intermediate goods Capital goods
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Sectorial growth
1990-95 1995-2000 2000-05 Total GDP 6.2 3.1 2.2 Agriculture & livestock 1.4 1.0 1.4 Manufacture 5.7 4.8 2.3 Commerce 8.7 2.6 2.0 Construction 7.5 2.3 2.0 Others 7.8 3.7 2.1 Source: Central Bank of El Salvador, website. Data is in constant prices.