Background

The economy of El Salvador recovered rapidly from the civil war, which ended in 1992 after over a decade of turmoil. The gross domestic product (GDP) increased during the postwar period of 1992-95 at the average annual rate of 6.2% (Central Reserve Bank of El Salvador). The economic growth slowed down subsequently to attain the average annual growth of GDP at 3.0% for 1995 through 2000. The economic growth has further slowed down thereafter partly due to the devastating earthquakes of early 2001.

The population of El Salvador started to increase at a high rate after the civil war. It increased from 5.1 million in 1990 to 5.6 million in 1994 at the average annual rate of 2.4%. The population growth has slowed down subsequently to the level of 1.9% per annum.

The relatively high economic performance of El Salvador has been supported by the economic reform program of the Government, including trade liberalization, privatization and dollarization. The program has helped suppress inflation and stabilize the macro economy, and El Salvador is assessed by the Heritage Foundation as one of the three Latin American countries in which economic liberalization is most advanced.

Challenges

While the Salvadoran economy has diversified during the recovery period, overcoming the dependence on coffee, sugar and other traditional industries, it has become increasingly dependent on the low value-added textile industry. Following the establishment of free trade zones, export of textile products through "maquila" increased to claim a 60% share in the total export value, dominated by the export to the U.S.

The trade balance has been consistently in the red, compensated largely by remittance from overseas Salvadorans, which has accounted for 13-15% of the GDP in recent years. The gross capital formation (GCF) accounted only for 17% of the GDP in 2000, among the lowest of Central American countries, and the ratio of gross domestic saving to the GDP was mere 2% in 2000. Although foreign direct investment and development aid increased significantly during the recovery period, they accounted for 8.3% and 8.0% of the GCF respectively in 2000, generally lower than the levels in other Central American countries.

Through the economic recovery, disparities among the people and the regions have widened. The average income in the western frontier along the borders with Honduras and in the Eastern Region is much lower than the national average. The poverty incidence in Morazan in the northeast, for instance, was 58.5% as compared to the national average of 38.8%.

Extensive agricultural practice relying on generally rich soil and water resources has resulted in reduced land productivity in some areas. Forest resources degraded further due to the civil war. These conditions make the land of El Salvador vulnerable, aggravating damages by natural disasters such as the Hurricane Mitch in 1998 and the earthquakes in 2001.

Need for the Study

El Salvador needs to overcome the problems in the economic, social and environmental sectors as outlined above in order to attain sustainable development. To continue the economic growth in increasing globalization of the world economy and further trade liberalization, El Salvador needs to deepen its economic structure through increase in foreign direct investment and introduction and innovation of associated technologies. The planned revitalization of the La Union port may be effectively utilized to increase trade and attract foreign investment.

To realize sound and sustainable development, however, such foreign trade and investment must be utilized to benefit the people of El Salvador through creation of income generating opportunities and development of domestic industries based on indigenous resources as well as imported goods and materials. To utilize indigenous resources effectively, environmental quality and capacity need to be restored and enhanced through proper management of land and water resources, human resources capacity expanded, and resources of overseas Salvadorans mobilized.

Increase in foreign trade and investment and development of indigenous industries in association with the export industry including export processing and transshipment need to be planned carefully so that they will contribute to deepening the economic structure, generating income and employment opportunities and alleviating poverty. A planning study (the Study, hereafter) should delve into all the possibilities, both positive and negative, that may evolve from the expected revitalization of the La Union port.