An Explanation of the Tendency Towards Stagnation in the Salvadoran Economy

ABSTRACT: This paper presents an explanation for the persistent trend of stagnation that the Salvadoran economy has been experiencing for the last three decades. The explanation lies in the reforms carried out in the 1980's and 1990's, which included the unilateral reduction of import tariffs and income tax rates, and other measures in the fiscal and financial areas. The reforms resulted in the contraction of the participation in the manufacturing and agricultural sectors, which are the main determinants of economic growth, while the services sector, which has a negative relationship with the rate of economic growth, increased its participation in GDP. These processes of deindustrialization and deagriculturalization are also observed in the other Central American countries. The reforms also led to falling employment-to-population ratios as a result of the trend toward stagnation, which led to persistent flows of irregular migration that are manifested in the inflows of high amounts of remittances, thus observing the duality of relative economic stagnation and inflows of abundant remittances. In turn, remittances are related to consumption "booms", with the consequent fall in national savings and therefore a fall in investment, which reinforces the tendency to stagnation, which gives continuity to irregular migration. This is a vicious circle caused by the reforms. Also observed in the Salvadoran economy is the drop in the ratio of female and male employment in the industrial sector in relation to the corresponding female and male employment in the service sector, which is related to the contraction of labor productivity and exports, which deepens the tendency to stagnation. A computation of the cost of the reforms is made, and it is found that due to these structural distortions, the reforms have had an average annual cost in terms of lost economic growth of 3.4 percent. Another vicious circle should be noted: the reforms led to the contraction of the manufacturing and agricultural sectors, which constitute the aggregate supply of exports; the contraction of these sectors led to the contraction of exports, which has a negative impact on investment. Moreover, as reforms punish savings, they reduce investment and therefore manufacturing and agricultural production tends to decline. When comparing the trajectories of the economies of El Salvador and Costa Rica, we find that the ratio of their GDPs obeys the ratio of their respective expenditures in education, as well as the ratio of the number of students per teacher, which shows that the lag of the Salvadoran economy in Central America is associated with its relative backwardness in terms of human capital. The paper concludes by recommending efforts to reindustrialize and reagriculturalize the economy by supporting investment in these sectors, with a view to reducing imports of agricultural and manufactured goods and achieving a minimum of self-sufficiency in food. Simultaneously, it is recommended that major efforts be made to improve education and health indicators and lay the foundations for an economy based on knowledge and the generation of innovations.