Economic Openness and Stagnation In Central America

Central American countries undertook ambitious programs of economic liberalization during the 1980s' and 1990's, particularly in areas of trade reform, which implied the elimination of import controls and quotas, and substantially lowering import tariffs. The objectives of such reforms were to gain economic efficiency and more dynamic economic growth; however, the results are distant from such objectives. Economic growth has been slower than in the period previous to reform when import substitution policies were in vigor, and the main manifestation of trade reform has beenhigh trade deficits, falls in national savings and investment, and economic stagnation, which has given rise to emigration and high volumes of remittances. This paper analyzes the economic growth experience of the Central America countries in the past two decades, to explain the causes behind the stagnation tendencies that set in after two decade of trade liberalization, and to seek answers to the question of what policies should be undertaken to accelerate economic growth. After a review of the literature on the economic repercussions from trade liberalization in developing countries, a Var model is estimated with the variables: national savings, public and private investment, the level of the external tariff, trade balance and economic growth. The Var permits quantifying the impulse responses of said variables to increases in the external tariff. The results show that an increase in the external tariff would lead to increases in national savings, public and private investment, and in economic growth, and as well, would give rise to a reduction in the trade deficit. Moreover, it is argued that the low growth rates resulting from trade liberalization lead to rising unemployment, and thus give impetus to emigration; the resulting remittances finance the trade deficit and thus the cycle continues in a sort of openness trap. However, by restoring import substitution policies this trap can be overcome. It is recommended that trade protection policies should be implemented so as to create room for investment and thus impart dynamism to economic growth. It is recommended that trade protection should be complemented by human capital policies so as to create a virtuous circle of human capital, governance, productivity, export development and economic growth. It is argued that dynamic economic growth would be conducive to increasing tax revenues which would impart sustainability to health and education investments.