Can a Regional Alliance Lift Up Central America?

There has been a push toward regionalization in Central America. Government and business leaders understand the importance of uniting a region inhabited by an estimated 42,000,000 people. Officials believe they must work together to build economies that compete on a global scale.

As El Salvador President Mauricio Funes said at a summit meeting in 2010, “Only by joining forces would we be able to lift our peoples from . . . poverty.” But, much like everything else in Central America, regionalization has moved at a snail’s pace. Each country faces political, social, and economic challenges that hamper development. (See the section at the end of this article for a snapshot of each country’s current economic situation.)

Regional integration is nothing new in Central America. In 1951, Costa Rica, El Salvador, Guatemala, Honduras, and Nicaragua signed a treaty creating the Organization of Central American States. ODECA was designed to improve regional trade and promote unity. However, in 1969 the Football War between El Salvador and Honduras crushed regional integration and in 1973 ODECA was suspended.

In 1991 renewed efforts toward regionalization saw the creation of the Central American Integration System. SICA, designed to integrate the political, economic, and social organizations of Central America, is comprised of all seven countries as well as the Dominican Republic. SICA has succeeded in removing duties on many products and creating unified tariffs to increase trade. The average tariff in Central America fell from 45% in 1985 to 6% by 2000. Intraregional trade has increased from just over $500 million in 1990 to $5.9 billion by 2010.

The Dominican Republic-Central America Free Trade Agreement (DR-CAFTA) was approved by the U.S. Congress in 2005 and later received approval from most Central American countries between 2006-2009. The treaty is designed to immediately cut tariffs on 80% of U.S. exports and subsequently eliminate all tariffs over the next 10 years. One of the principal goals of DR-CAFTA is to protect investors from member countries from unfair or discriminatory actions when investing in another member country. Ideally, this regulation will promote investment throughout the region.

Most recently, regional efforts have focused on improving infrastructure throughout Central America. The Mesoamerica Project (MP) is a portfolio of nearly 100 projects designed to bring over $8 billion in investments in energy, telecommunications, and transportation among other areas. MP’s two major projects are the construction and rehabilitation of the International Network of Mesoamerican Highways initiative (RICAM), and the Electric Integration System of Central America (SIEPAC).

RICAM, estimated to cost $1.3 billion, will construct and repair more than 8,000 miles (13,000 km) of roads connecting Mexico to Panama. Preconstruction studies found the average speed of freight trucks from one country to another was 6.2 mph (10 km/h). Trucks often took 24 hours to travel 80 miles (130 km) from El Salvador through Honduras to Nicaragua. The new highway, along with efficiency gains from harmonizing customs procedures, is expected to cut border wait time to 8 minutes and dramatically improve the transfer of goods between countries.

SIEPAC, a $494 million project designed to connect Central America’s energy grid, will provide 230 kilowatts of energy from Guatemala to Panama. The final phase of construction is expected to be completed by the end of this year and enter into operation in 2012. By 2014 it is expected Colombia and Mexico will also be connected to the SIEPAC grid. SIEPAC is predicted to decrease the cost of energy for consumers by as much as 20%.

“Social Exclusion and Poverty”

In June of 2010, regional leaders held a summit and vowed to work together to continue to integrate Central America. El Salvador President Mauricio Funes said, “Only by joining forces would we be able to lift our peoples from social exclusion and poverty. Relaunching Central America’s integration was necessary to face these new challenges with the new institutions arising from a regional union.”

While integration is increasingly important to Central America’s future, Funes’ quote illustrates some of the major issues currently facing the region; notably social exclusion and poverty. Throughout Central America inequality, political instability, corruption, and the drug trade are ravaging the economies and the people.

The economies in Central America’s “northern triangle,” made up of Guatemala, Honduras, and El Salvador, are currently under siege by drug traffickers. These three countries have some of the highest murder rates in the western hemisphere. Guatemala, with 46 murders per 1,000 people, is more than double that of Mexico. Honduras and El Salvador experience more than 60 murders per 1,000 people.

As the fight against drug trafficking increases in Mexico, the problem is exacerbated in Central America. Traffickers are moving further south to keep their operations productive. A report by the World Bank in April detailed rising violence from drug cartels and street gangs cost the region 8% of GDP. Further estimates indicate a 10% reduction in the murder rate could boost the Central American annual economic growth by 1% of GDP.

Just south of the triangle lies Nicaragua, a country stuck in poverty. Nicaragua is currently plagued by social inequality and a president trending toward socialist dictator, Daniel Ortega. In September of 2010, Ortega’s Sandinista party rewrote the Constitution—while Nicaraguan legislators were on a weeklong vacation—to include a provision allowing him to run for another term in 2011. Felix Maradiaga, a political science professor at Universidad Americana, had this to say: “This eccentric and arbitrary decision by President Ortega is a demolition blow to the rule of law and a step towards a totally lawless government.”

As Ortega continues to consolidate power, the people of Nicaragua suffer more and more. His policies keep an industrious people mired in poverty while foreign investors steer clear of the country. The 2010-2011 Global Competitiveness Report by the World Economic Forum listed policy instability, corruption, and inefficient government bureaucracy as the three most problematic factors for doing business in Nicaragua.

Costa Rica and Panama are faring much better than their neighbors to the north; however, these countries are not without problems. Even with a relatively higher GDP, both have high poverty rates and unequal distributions of income. Panama is estimated to have the second worst income distribution in all of Latin America. Costa Rica and especially Panama are also main transit ways for the drug trade to the United States. This has led to an increase in violence in recent years.

Furthermore, because of their more advanced economies, these countries have become money-laundering havens for drug traffickers and tax evaders. According to Vice Minister Frank De Lima, Panama is currently changing its laws to make individual and company tax information more transparent.

Regionalization is a key for economic growth in Central America. Despite some of the different issues facing each country, they share similarities. Each must provide order for their citizens, making safety a top priority. And each must recognize that an end to corruption and inequality are required in order for the region to develop. They must also be dedicated to the goal of building up a middle class of skilled workers.

Regionalization can help make Central America a healthy player in the global economy, but if the lucky few in Central America don’t help their own people, it will all be for naught.

Brendan Wolters lives in Panama City, Panama, and works at The Solace Group, which helps foreign investors identify opportunities in Central America. You can contact him at bwolters@thesolacegroup.com.

CENTRAL AMERICA: ECONOMY SNAPSHOTS

The region between Mexico and South America was hit hard by the global recession due to its reliance on the United States for foreign direct investment and remittances. Here’s a brief summary of the economic situation in each country in the Central America zone.

Guatemala, Central America’s most populous country, experienced real GDP growth of .6% in 2009 and 2.2% in 2010. The Guatemalan economy is agrarian, with 15% of GDP, and nearly half of its labor, working in agriculture. Poverty and malnutrition is a major issue. More than half the population lives under the poverty line, and 43% of children under 5 are chronically malnourished.

Belize, the northernmost nation in Central America, relies on tourism to drive its economy. Services play a major role with more than 70% of the labor force working in this sector. The economy has been stagnant during the global recession with no real GDP growth in 2009 and 1.5% growth in 2010. Despite the relatively high per-capita GDP at $8,400, the country faces high poverty with 43% of the population living below the poverty line and high unemployment at 13.1%.

El Salvador, despite being the smallest country in Central America, has the third largest economy. Real GDP contracted by 3.5% in 2009 and slowly recovered in 2010, increasing by 1.2%. The economy is serviced-based, which in recent years has seen the privatization of its telecom, electricity, and banking sectors. Foreign direct investments, a key component for growth, decreased from $784 million in 2008 to an estimated $72 million in 2010. The decrease has been attributed to a lack of trust and confidence in the government. In 2010, only 14 companies arrived in El Salvador to install and operate there.

Honduras is the second poorest country in Central America, with an estimated 65% of the population living below the poverty line. Roughly half of the economy is tied to the United States through exports and remittances, leading to a contraction of real GDP by 2.1% in 2009. The economy slowly rebounded in 2010, growing by 2.5%. While agriculture plays a large role in the economy, the service sector is rapidly growing, with Honduras exporting apparel and automobile parts.

When it comes to poverty and deprivation, it does not get much worse than Nicaragua. By most measures, Nicaragua is the second poorest country in the Western Hemisphere (behind Haiti) and the poorest in Central America. The GDP per capita income is the second lowest in the Americas at $2,900. Most recent data from the UNDP estimates that nearly 1 in 3 people live on less than $2 per day. Agriculture accounts for 17.6% of GDP, more than any other nation in Central America. Services make up 56% of GDP and 53% of labor. This segment includes telecommunications, transportation, and warehousing.

Moving further south, economic prospects are brighter. Costa Rica has the second highest per capita GDP in Central America at $11,400. Much like most of the region, Costa Rica suffered from an economic slowdown with real GDP falling by .7% in 2009. The economy rebounded and grew by 4% in 2010. Driven by the $2 billion tourist industry, services play a significant role in the economy, accounting for 70.8% of GDP in 2010. Although traditional agricultural exports of bananas, coffee, and sugar still play a major part in the commodity export trade, exportation of electronics, pharmaceuticals, and software have had an increasingly important role in the Costa Rican economy.

Panama has recently been the shining star of the Central American economies. Panama was able to weather the recession with real GDP growing by 3.2% in 2009 and an astounding 7.5% in 2010. Economists from the IMF predict Panama will have the highest growth in all of Latin America, averaging greater than 6.5% over the next five years. The economy relies heavily on services, which account for 77.6% of GDP. The main source of income is derived from the Panama Canal; however, banking, logistics, container ports, and tourism all play an important role. In 2010 Panama was upgraded to investment-grade status by the three major ratings industries.

Brendan Wolters currently lives in Panama City, Panama. He works at The Solace Group, which helps foreign investors identify opportunities and invest in Central America. Contact him at bwolters@thesolacegroup.com.