Economy of El Salvador
Encyclopedia
Opening
The GDP variable has been growing at a snail's pace since the signing of peace accords in 1992, in an environment of macroeconomic instability. A problem that the Salvadoran economy faces is the inequality in the distribution of income. In 1999, the richest fifth of the populationPopulation
A population is all the organisms that both belong to the same group or species and live in the same geographical area. The area that is used to define a sexual population is such that inter-breeding is possible between any pair within the area and more probable than cross-breeding with individuals...
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
Gresham's Law
Gresham's law is an economic principle that states: "When a government compulsorily overvalues one type of money and undervalues another, the undervalued money will leave the country or disappear from circulation into hoards, while the overvalued money will flood into circulation." It is commonly...
, 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
Indigo
Indigo is a color named after the purple dye derived from the plant Indigofera tinctoria and related species. The color is placed on the electromagnetic spectrum between about 420 and 450 nm in wavelength, placing it between blue and violet...
, but after the invention of synthetic dyes in the 19th century, Salvadoran authorities and the newly created modern state turned to coffee
Coffee
Coffee is a brewed beverage with a dark,init brooo acidic flavor prepared from the roasted seeds of the coffee plant, colloquially called coffee beans. The beans are found in coffee cherries, which grow on trees cultivated in over 70 countries, primarily in equatorial Latin America, Southeast Asia,...
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.
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
La Unión
La Union or La Unión may refer to:-Colombia:*La Unión, Antioquia*La Unión, Nariño*La Unión, Sucre*La Unión, Valle del Cauca-Peru:*La Unión Province, Peru...
in the east of the country, in order to use the area as a "dry canal" for transporting goods from Gulf of Fonseca
Gulf of Fonseca
The Gulf of Fonseca , part of the Pacific Ocean, is a gulf in Central America, bordering El Salvador, Honduras and Nicaragua.-History:Fonseca Bay was discovered in 1522 by Gil Gonzalez de Avila, and named by him after his patron, Archbishop Juan Fonseca, the implacable enemy of Columbus.In 1849, E. G...
in the Pacific Ocean
Pacific Ocean
The Pacific Ocean is the largest of the Earth's oceanic divisions. It extends from the Arctic in the north to the Southern Ocean in the south, bounded by Asia and Australia in the west, and the Americas in the east.At 165.2 million square kilometres in area, this largest division of the World...
to Honduras
Honduras
Honduras is a republic in Central America. It was previously known as Spanish Honduras to differentiate it from British Honduras, which became the modern-day state of Belize...
and the Atlantic Ocean
Atlantic Ocean
The Atlantic Ocean is the second-largest of the world's oceanic divisions. With a total area of about , it covers approximately 20% of the Earth's surface and about 26% of its water surface area...
in the north. Currently there are fifteen free trade zone
Free trade zone
A free trade zone or export processing zone , also called foreign-trade zone, formerly free port is an area within which goods may be landed, handled, manufactured or reconfigured, and reexported without the intervention of the customs authorities...
s 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
Export
The term export is derived from the conceptual meaning as to ship the goods and services out of the port of a country. The seller of such goods and services is referred to as an "exporter" who is based in the country of export whereas the overseas based buyer is referred to as an "importer"...
to the United States
United States
The United States of America is a federal constitutional republic comprising fifty states and a federal district...
.
El Salvador signed the Central American Free Trade Agreement (CAFTA), negotiated by the five countries of Central America
Central America
Central America is the central geographic region of the Americas. It is the southernmost, isthmian portion of the North American continent, which connects with South America on the southeast. When considered part of the unified continental model, it is considered a subcontinent...
and the Dominican Republic
Dominican Republic
The Dominican Republic is a nation on the island of La Hispaniola, part of the Greater Antilles archipelago in the Caribbean region. The western third of the island is occupied by the nation of Haiti, making Hispaniola one of two Caribbean islands that are shared by two countries...
, 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
Mexico
The United Mexican States , commonly known as Mexico , is a federal constitutional republic in North America. It is bordered on the north by the United States; on the south and west by the Pacific Ocean; on the southeast by Guatemala, Belize, and the Caribbean Sea; and on the east by the Gulf of...
, Chile
Chile
Chile ,officially the Republic of Chile , is a country in South America occupying a long, narrow coastal strip between the Andes mountains to the east and the Pacific Ocean to the west. It borders Peru to the north, Bolivia to the northeast, Argentina to the east, and the Drake Passage in the far...
, the Dominican Republic, and Panama
Panama
Panama , officially the Republic of Panama , is the southernmost country of Central America. Situated on the isthmus connecting North and South America, it is bordered by Costa Rica to the northwest, Colombia to the southeast, the Caribbean Sea to the north and the Pacific Ocean to the south. The...
, and increased its export
Export
The term export is derived from the conceptual meaning as to ship the goods and services out of the port of a country. The seller of such goods and services is referred to as an "exporter" who is based in the country of export whereas the overseas based buyer is referred to as an "importer"...
s to those countries. El Salvador, Guatemala, Honduras, and Nicaragua also are negotiating a free trade agreement with Canada
Canada
Canada is a North American country consisting of ten provinces and three territories. Located in the northern part of the continent, it extends from the Atlantic Ocean in the east to the Pacific Ocean in the west, and northward into the Arctic Ocean...
, and negotiations started on 2006 for a free trade agreement with Colombia
Colombia
Colombia, officially the Republic of Colombia , is a unitary constitutional republic comprising thirty-two departments. The country is located in northwestern South America, bordered to the east by Venezuela and Brazil; to the south by Ecuador and Peru; to the north by the Caribbean Sea; to the...
.
Fiscal policy
Fiscal policy
In economics and political science, fiscal policy is the use of government expenditure and revenue collection to influence the economy....
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
Social work
Social Work is a professional and academic discipline that seeks to improve the quality of life and wellbeing of an individual, group, or community by intervening through research, policy, community organizing, direct practice, and teaching on behalf of those afflicted with poverty or any real or...
. 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 pensioners covered in the old system. The government lost the revenues from contributors and absorbed completely the costs of coverage of retired pensioners. 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 facilitate 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 revenue
Revenue
In business, revenue is income that a company receives from its normal business activities, usually from the sale of goods and services to customers. In many countries, such as the United Kingdom, revenue is referred to as turnover....
s 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. However, some basic goods are exempt from the indirect 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
Gross domestic product
Gross domestic product refers to the market value of all final goods and services produced within a country in a given period. GDP per capita is often considered an indicator of a country's standard of living....
(GDP). As of April 2004, net international reserves stood at $1.9 billion.
In recent years inflation
Inflation
In economics, inflation is a rise in the general level of prices of goods and services in an economy over a period of time.When the general price level rises, each unit of currency buys fewer goods and services. Consequently, inflation also reflects an erosion in the purchasing power of money – a...
has fallen to single digit levels, and total exports have grown substantially.
Natural disasters: Hurricane Mitch (1998) and the earthquakes (2001)
Hurricane MitchHurricane Mitch
Hurricane Mitch was the most powerful hurricane and the most destructive of the 1998 Atlantic hurricane season, with maximum sustained winds of 180 mph . The storm was the thirteenth tropical storm, ninth hurricane, and third major hurricane of the season. Along with Hurricane Georges, Mitch...
hit El Salvador in late October 1998, generating extreme rainfall of which caused widespread flood
Flood
A flood is an overflow of an expanse of water that submerges land. The EU Floods directive defines a flood as a temporary covering by water of land not normally covered by water...
ing 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
Lempa River
The Lempa River is a 422 km long river in Central America. Its sources are located in between the Sierra Madre and the Sierra del Merendón in southern Guatemala, near the town of Olopa. In Guatemala the river is called Río Olopa and flows southwards for 30.4 km before entering Honduras and...
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
Agriculture
Agriculture is the cultivation of animals, plants, fungi and other life forms for food, fiber, and other products used to sustain life. Agriculture was the key implement in the rise of sedentary human civilization, whereby farming of domesticated species created food surpluses that nurtured the...
. Nearly 18% of the total 1998-99 basic grain
Cereal
Cereals are grasses cultivated for the edible components of their grain , composed of the endosperm, germ, and bran...
harvest was lost. Coffee
Coffee
Coffee is a brewed beverage with a dark,init brooo acidic flavor prepared from the roasted seeds of the coffee plant, colloquially called coffee beans. The beans are found in coffee cherries, which grow on trees cultivated in over 70 countries, primarily in equatorial Latin America, Southeast Asia,...
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
Sugarcane
Sugarcane refers to any of six to 37 species of tall perennial grasses of the genus Saccharum . Native to the warm temperate to tropical regions of South Asia, they have stout, jointed, fibrous stalks that are rich in sugar, and measure two to six metres tall...
, totaling 9% of the estimated 1998-99 production, were sustained primarily in the coastal regions. Livestock
Livestock
Livestock refers to one or more domesticated animals raised in an agricultural setting to produce commodities such as food, fiber and labor. The term "livestock" as used in this article does not include poultry or farmed fish; however the inclusion of these, especially poultry, within the meaning...
losses amounted to $1 million, including 2,992 head of cattle
Cattle
Cattle are the most common type of large domesticated ungulates. They are a prominent modern member of the subfamily Bovinae, are the most widespread species of the genus Bos, and are most commonly classified collectively as Bos primigenius...
. 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
Diarrhea
Diarrhea , also spelled diarrhoea, is the condition of having three or more loose or liquid bowel movements per day. It is a common cause of death in developing countries and the second most common cause of infant deaths worldwide. The loss of fluids through diarrhea can cause dehydration and...
, and conjunctivitis
Conjunctivitis
Conjunctivitis refers to inflammation of the conjunctiva...
.
Reconstruction from Mitch was still underway when, in early 2001, the country experienced a series of devastating earthquake
Earthquake
An earthquake is the result of a sudden release of energy in the Earth's crust that creates seismic waves. The seismicity, seismism or seismic activity of an area refers to the frequency, type and size of earthquakes experienced over a period of time...
s 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.
Manufacturing
El Salvador historically has been the most industrialized nation in Central America, though a decade of war eroded this position. In 1999, manufacturingManufacturing
Manufacturing is the use of machines, tools and labor to produce goods for use or sale. The term may refer to a range of human activity, from handicraft to high tech, but is most commonly applied to industrial production, in which raw materials are transformed into finished goods on a large scale...
accounted for 22% of GDP. The industrial sector has shifted since 1993 from a primarily domestic orientation to include free zone (maquiladora
Maquiladora
A maquiladora or maquila is a concept often referred to as an operation that involves manufacturing in a country that is not the client's and as such has an interesting duty or tariff treatment...
) 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.
Trade
El Salvador's balance of paymentsBalance of payments
Balance of payments accounts are an accounting record of all monetary transactions between a country and the rest of the world.These transactions include payments for the country's exports and imports of goods, services, financial capital, and financial transfers...
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 telecommunication
Telecommunication
Telecommunication is the transmission of information over significant distances to communicate. In earlier times, telecommunications involved the use of visual signals, such as beacons, smoke signals, semaphore telegraphs, signal flags, and optical heliographs, or audio messages via coded...
s 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.
Agriculture and land reform
