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Central America in the Global Context

Dominican Republic sets good example

Increasing competitiveness in Central America: Progress made and next steps.

During the last decade, Central America has experienced significant economic and political consolidation that has turned it into a platform for business and investment. Some of the highlights include: economic growth, trade openness, growth of foreign direct investment (FDI), the rise of productive sectors of high added value, more efficient companies and regional integration. All these factors are found within the framework of a politically stable climate and are the result of considerable efforts at both public and private levels to improve the conditions of the business climate in each of the Central American countries. In this article, we examine competitiveness in the region, including recent indicators of improvement as well as factors that still need to be overcome.

Comparing competitiveness on a global scale

According to the World Economic Forum’s 2007-2008 Global Competitiveness Index, which measures the competitiveness of countries, Panama leads the Central American region, ranking 59 out of 131 countries globally. Costa Rica, which climbed nine spots in 2007, was ranked second at 63 and El Salvador was ranked third at 67. Honduras and Guatemala also made serious strides in 2007. Honduras jumped 13 places to number 83 and Guatemala advanced 10 positions to 87. Rounding out the region, Nicaragua was ranked 111.

Central America ranked higher as a region than Latin America and the Caribbean and South Asia regions, and close to the emerging Central and Eastern European economies. However, it still has a way to go in comparison to the Asia-Pacific region and Organization for Economic Cooperation and Development (OECD) countries.

Important efforts to improve competitiveness can be seen in each Central American country.  In Panama, investment incentives, property rights protection, the quality of the country’s port and airport infrastructure, reduction in the time and requirements needed to open a new business and to import/export goods, the sophistication of the financial market, the availability of state-of-the-art-technologies, and the government’s strategy to differentiate the country from others in Central America all contributed to the country’s ranking.

In Costa Rica, drivers include the independence of the judicial branch, the quality of its educational system, the intensity of local competition, the professionalization of senior managers in local companies, the strength of the banking sector, the sophistication of the productive sector and the innovation level.

In El Salvador, standouts include the government’s fiscal management, transparent policies, and agricultural policies (including the low cost of subsidies); the infrastructure in general and airport in particular; the time required to open a business; the efficiency of the labor market; the openness to capital flows; and the strength of the banking sector.

In Guatemala, reductions in red-tape, especially in customs; a modern revenue system; the country’s openness to foreign capital; the positive relationship between workers and employers; and the government’s low debt level have all led to an increase in competitiveness.

In Honduras, improvements in reducing red tape and bureaucracy, upgrading of the port infrastructure, effectiveness of bankruptcy laws, and low labor costs and personnel obligations that favor the labor market’s efficiency and improve the investment climate have helped.

Finally, in Nicaragua the small number of steps required to set up a company, the relative efficiency of its labor market, and the openness to capital flows have been important drivers of competitiveness.

Ease of business

In the World Bank Doing Business 2008 Report, Panama and El Salvador ranked 65 and 69 respectively among 178 countries, placing them in the second quartile of the sample. However, Nicaragua, which ranked 93; Guatemala, 114; Costa Rica, 115; and Honduras, 121, are all located in the third quartile of the sample.

Panama stands out for both the short time and small number of procedures necessary to start a business, the open access to loans, and the ease of external trade. In El Salvador, property registry, access to bank loans, import and export activities, and efficient contract enforcement contributed to its high ranking. The efficiency of the law in enforcing contracts and the ease of shutting down a business are important advantages in Nicaragua. Guatemala and Costa Rica were both noted for the ease in registering property. In addition, Costa Rica has easy access to loans and small amounts of paperwork for the import/export process. Finally, in Honduras, access to loans is a plus; however, significant challenges persist in the number of procedures and costs needed to set up a company, despite substantial efforts made by the central government.

Economic freedom

In the Heritage Foundation 2007 Economic Freedom Index, El Salvador stands out as the most open country in the region with a score of 70.3 (out of 100) and ranked 29 out of a total of 157 countries. Panama and Costa Rica followed with scores of 65.9 and 65.1 respectively and rankings of 47 and 51. Nicaragua with a score of 62.7 ranked 61; Guatemala with a score of 61.2 ranked 68; and Honduras with a score of 60.3 ranked 76. All five countries are located in the second quartile of the sample.

In El Salvador, the government’s small size and low spending level (14.3 percent of gross domestic product); facilities for accessing capital; efficient regulations; and flexibility in the credit, labor and goods markets contributed to its high ranking. In Costa Rica, the government expenditures, and investment in climate and trade freedom were noted as outstanding features; however, inflation, excessive regulations for businesses, and the labor market were adverse aspects. In Panama, the government’s small size, moderated tax rates, ease to start a business, access to capital, and efficient regulations of the credit market contributed to high rankings in economic freedom; however, corruption and labor market restrictions were major challenges. In Nicaragua, Guatemala and Honduras, the governments’ small size and trade freedom were considered a plus; however, scarce guarantees to property rights, corruption and bureaucracy were major disadvantages.

As a region, Central America, with a score of 64.3, outranks the Economic Freedom scores of Latin America (61.5), the Asia-Pacific region (63.0), the Arab countries (57.4), and Southern Asia (55.0). Central America, after the OECD countries (74.3), is the region with the most economic freedom in the world.

Human development status

The Human Development Index (HDI) of the United Nations Development Programme shows two different categories among the Central American countries. The first one, represented by Costa Rica (with an HDI of 0.846 and ranked 48 out of 177 countries) and Panama (with a score of 0.812 and ranking of 62) are well regarded among the countries included in the Index. Iceland was the highest ranked country with a 0.968 score and Sierra Leona the lowest with 0.336. All countries with an index equal to or greater than 0.80 are considered to have high human development, those with scores from 0.50 to 0.79 are considered medium level and those below 0.50 are low.

The medium-level HDI countries are represented by El Salvador (with a score of 0.735 and ranking of 103), Nicaragua (0.710, ranked 110), Honduras (0.700, ranked 115) and Guatemala (0.689, ranked 118).

As a region, Central America scores an HDI of 0.729, which is higher than that of the Arab states, Southern Asia and Sub-Saharan countries, but still below the average of Latin America and the Caribbean (0.803), Central and Eastern Europe (0.808) and Eastern and Pacific Asian countries (0.771).

The major challenges to improve development levels in the region include: increasing the participation of the population, improving the quality of education, increasing productivity, decreasing poverty levels and inequality, and improving in the quality of life and life expectancy for most of the population.

The region has made considerable progress in terms of human development in the last few decades. In 1975, the combined HDI of the six countries on the isthmus (Guatemala, El Salvador, Honduras, Nicaragua, Costa Rica and Panama) was approximately 0.582, what nowadays is equivalent to the human development of Myanmar (ranked at 132 in 2007). Currently, the combined HDI of the region locates it at a level similar to Indonesia (approximately 107). While the improvements are noteworthy, many challenges remain.

Public sector and competitiveness

The Central American countries’ improvements to their national business climates should be highlighted. In general, all countries have responsibly managed their public finances and have made significant progress in deregulation, redefining the government’s role in the economy and adopting a free-market institutional framework. Additionally, big steps have been made towards liberalization and trade openness, as exemplified by the Dominican Republic-Central America-United States-Free Trade Agreement (DR-CAFTA), the ongoing conversations with the European Union to reach an Association Agreement, advances in the region’s Customs Union, and the series of bilateral trade agreements signed by the region’s countries. Other important achievements include poverty reduction and the increase of education and health coverage. The political development of the region and the consolidation of democratic systems after severe civil conflicts in the 1980s are also of note.

The Central American institutions have been strengthened as a result of competitiveness improvement programs, such as PRONACOM in Guatemala and Honduras Compite (Honduras Competes), and export and investment promotion agencies such as PROCOMER and CINDE in Costa Rica, PROESA in El Salvador and FIDE in Honduras. Regional efforts, such as the Puebla-Panama Plan, have given continuity to diverse regional projects as SIEPAC (the Central American Electrical Interconnection System) and the Logistic Corridor (between Honduras and El Salvador).

Each country has also made considerable efforts to develop its competitiveness level at a regional and global scale. In Guatemala, after the Competitiveness Agenda was launched in 2005 with the sponsorship of PRONACOM, there have been important improvements such as the creation of an electronic mercantile registry; improvements of customs’ controls and professionalization of customs agents; the promotion of the use of remittances in investment (instead of consumption, as has been the case); the creation of an e-regulations platform to support foreign and local investors and a one-stop shop to create and register new businesses; and the remodeling of La Aurora and Peto airports.

Honduras, after a two-year effort, has reduced the time to open a business from 62 to 21 days; started the Defense and Promotion of Competition Commission; promoted the National System of Quality Law; trained institutions involved in import and export activities; and made significant improvements in the Puerto Corto's infrastructure.

In El Salvador, improvements have been made in port and airport infrastructure, including the construction of Port La Union, which will be become the most modern deep water port in the region able to receive Panamax and Post Panamax ships. The government has also promoted teaching English in public schools and universities; supported local exporters, funding participation in trade fairs and business rounds abroad, training and advising in logistics and market information, and providing funds for export; launched the National Program of Entrepreneurs and Micro Credit Promotion; and encouraged the presence of companies and services such as call centers that rely on the existing infrastructure and human resources through the Telecommunications Law.

In Nicaragua, major improvements have been made in reducing red tape in the acquisition of operation licenses and construction permits. The government (in collaboration with the private sector) has also funded exporting companies to facilitate their access to the international markets.

In Costa Rica, the government, through the Secretariat of Competitiveness, has started a plan to reduce the time required to open a business and to obtain construction permits by 50 percent. The government has also invested in remodeling the Juan Santamaria International Airport infrastructure and improving the Liberia Airport infrastructure and important roads; granted the management of its port Puerto Caldera in the Pacific Ocean in order to increase efficiency; created a quality seal known as “Costa Rica Califica” (Costa Rica Qualifies), a locally developed quality certification that can be used as a basis for international certifications and was made to be more accessible to small and medium enterprises; and joined forces with the public and private universities and private sector to improve graduate-level education and to create local development programs in 12 provinces.

In Panama, there have been important achievements in improving public finances; restructuring foreign debt; reducing red-tape in opening a new business; creating an e-government structure, where the government purchases are made online; boosting tourism; and expanding the Panama Canal to create new jobs and fuel sustainable economic development for the country and the region as a whole.

The private sector’s contribution

Due to the regional governments’ endorsement of market openness and investment promotion over the past decade, the region’s entrepreneurs have been adding more value to their products and services. In 1999, coffee was the main export of the region representing 13.6 percent of the total regional exports, while machinery and electronic equipment exports represented only 3.4 percent. By 2006, machinery and electronic equipment represented 13 percent of the regional exports, while coffee dropped to 9.5 percent.

In addition, nontraditional products of high added value have emerged among regional entrepreneurs and foreign investors. These include business and contact centers, software development, medical devices manufacturing, and agro industry. The financial and banking sector has gained strength through mergers and acquisitions. The logistics sector has grown, as has the tourism sector, which generates approximately $4.5 billion in revenues each year and has seen a 15 percent increase in revenues in the last seven years.

The private sector has also been increasingly complying with responsible environmental and social practices. This also improves its competitiveness level, positively affecting the business climate in a number of ways.

In Costa Rica, Costa Rican Entomological Supplies (CRES) is a company dedicated to breeding, packing and exporting butterflies to exhibitors of live butterflies in the United States and Europe. CRES buys the butterflies from approximately 100 rural families in Costa Rica, integrating them into a supply chain that has allowed these families to substantially increase their income.

In Guatemala, the Central American Bottling Corporation created the technological Institute Santa Luisa de Marillac to provide basic primary and scientific education to employees’ relatives and members of the nearby community. The Institute has approximately 240 students between the ages of 4 and 17 years. The project has helped increase the qualification of labor in the area, which has been a key issue to attract new industries to the region.

Challenges ahead

Central America, with 0.6 percent of the world’s population, currently produces 0.2 percent of the world’s gross domestic product. It has a per capita productivity of $2,675 compared with the per capita of $5,300 in Latin America, $7,400 world average and $37,000 of the OECD countries. The region’s exports per capita are $920, versus $1,372 for Latin America, $2,220 world average, and $9,500 in OECD countries.

In order to make the region more competitive, it is necessary to increase its productivity. Major improvements are required to create a more attractive business climate. This includes foreign direct investment attraction, new entrepreneurial undertakings, a higher level of efficiency from the private sector, as well as the production of more value added goods and services.

Corruption and the inefficiency of the government bureaucracy are the main factors that hinder competitiveness in the region. Uncertainty and lack of transparency of policies and judicial framework for investments, weaknesses of the educational systems, crime and robbery, inadequate infrastructure and scarce access to credit are other main obstacles in some countries. In addition, each country faces individual issues, such as high inflation rates in Costa Rica in 2007 (10.8 percent) and labor regulations in Panama that affect employment flexibility and restrict efficient personnel practices.

Overall, increased productivity in the region’s companies is also needed, although important differences exist among the countries. In Costa Rica, workers have an average productivity of $6,250 in the agricultural sector, $13,700 in industry, and $10,580 in the services sector. Conversely, Honduran workers have an average productivity of $916 in the agricultural sector, $3,500 in industry, and $3,265 in services. Compared with a country such as South Korea, the difference in worker productivity is significant. In South Korea, average productivity for a worker in the agricultural sector is $12,980, $42,750 in industry, and $25,500 in services. Therefore, the region has still a long way to go to catch up with Southeast Asian levels of productivity.

Central American nations must address important challenges in improving their business climates and the sophistication of their business sectors if they are to increase their productivity and gain a more competitive edge in the global marketplace. These challenges include regulations, policies to attract investment, better financing systems and policies, education, and security and infrastructure, among others. However, it is certainly worth highlighting the efforts that the countries have made individually as well as regionally, which have allowed them to improve their competitive positions on the global stage. A push to develop regional infrastructure, reduce bureaucracy and create incentives for private investment should receive special attention from Central American governments to achieve higher levels of economic development.

From INCAE Business School




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