Download Determinants of Nicaragua`s long-term economic growth

June 2011
Determinants of Nicaragua’s
long-term economic growth
Mario A. De Franco
Series of special
studies
Number 7
3
decisions of the rest of society. In poor countries, the
different types of poverty traps that typically exist tend to
mutually support each other.
Graphic 1: Nicaragua, growth by periods.
GDP per person
4.500
What are poverty traps?
3.000
4%
2,8%
3%
2,1%
1,4%
0,8%
2.500
3.504
1.500
1.000
500
-0,3%
4.232
2.000
-3,1%
1.640
2%
1%
0%
-1%
2.916
2.605
1,0%
1.918
2.081
2.421
Percentage
-2%
-3%
1920-2007
2001-2007
-4%
1991-2000
0
1920-1950
It is important to identify the type of trap in which a country
or family is found so as to identify how to get out of that
vicious circle. There are various types. Some of the cases
studied are Externalities derived from learning by doing,
Externalities of business partners and Externalities due to
financing restrictions. There are also theories that explain
poverty traps due to the institutional agreement that
predominates in society, an agreement that only favors a
small group that exercises power, generating uncertainty
and instability that affect the saving and investment
US$ PPC 2005
3.500
A poverty trap refers to a condition in which an economy,
a family or an individual is trapped in a persistent vicious
circle of poverty and low growth that is self-perpetuated
and self-reinforcing.
3,0%
4.000
Growth %
1979-1990
The central hypothesis of this document is that Nicaragua’s
growth is caught in a poverty trap. The country cannot
grow because it has a per person capital stock below
what is needed to grow so that, even with an important
investment injection, it could again fall into a poverty trap
unless the factors that lead to capital insufficiency are
eliminated.
Between 1920 and 1950, the per-capita GDP (US$ PPP)
grew 1.4 percent annually; between 1951 and 1960,
when this indicator grew the most, it did so at a rate of
3 percent annually. At 2.8 percent, annual growth was
also high from 1961 to 1972, and between 1973 and 1978
it grew at 2.1 percent annually. Between 1979 and 1990,
the per-capita GDP rate was -3.1 percent annually and it
continued dropping between 1991 and 2000, although at
the much lower rate of -0.3 percent annually. In recent
years, between 2001 and 2007, the per-capita GDP began
to grow again, but only at an annual rate of 0.8 percent.
Nicaragua’s per-capita GDP has been below Central
American countries between 1950 and 2007, with the
exception of Honduras between 1953 and 1978. Starting in
1979 the differences between Nicaragua and the region’s
other countries began growing exponentially.
1973-1978
The growth of Nicaragua’s average per-capita Gross
Domestic Product (GDP), measured in terms of purchasing
power parity (PPP), has only been 1 percent annually
between 1920 and 2007. In addition to growing minimally
in absolute terms and decreasing in comparative terms,
the results have been unequally distributed and have
caused a large part of the population to live permanently
in conditions of poverty and extreme poverty.
In constant 2005 US$ PPP, Nicaragua’s per-capita GDP
was US$1,526 in 1920 and US$2,183 in 2007, which means it
grew an average of US$7.30 each year.
1961-1972
Centering the problem
Economic growth facts
1951-1960
Executive
summary
Source: Based on Penn World Table 6.3
Economic trends and cycles. Over these nearly ninety
years of its history, Nicaragua has gone through a dozen
economic boom and bust cycles. This large number
of economic cycles demonstrates the vulnerability
characterizing the economy, a vulnerability that has been
influenced over time by changes in international prices,
4
DETERMINANTS OF NICARAGUA’S LONG-TERM ECONOMIC GROWTH
both internal and external social problems and problems
of war as well as natural disasters, among others.
Graphic 3: Nicaragua, Distribution of Income by percentiles.
Percent of total income
1920-2007
Number of years
1998
2001
2005
90
Graphic 2: Nicaragua, duration of the economic cycle.
13
12
11
10
9
8
7
6
5
4
3
2
1
0
1993
100
80
70
60
50
40
30
20
10
0
0
19201922
19231926
19271932
19331936
19371949
19501960
19611972
19731979
19801993
19942003
20042009
Duration of
cycle
2
3
5
3
12
10
11
6
12
9
5
Duration of
growth
1
1
2
1
4
4
4
4
7
5
4
Source: Based on Penn World Table 6.3
Growth and decline. Economic theory indicates that
countries with the lowest per-capita income show a
greater number of times of negative growth rate. These
decelerations have not necessarily been associated
as much with external factors as with internal ones, as
countries with a similar foreign trade structure are likely
to have had similar behavior.
Results of the growth: exclusion and poverty. Nicaragua’s
economic growth, in addition to a decelerating trend, have
also been characterized by an excluding and povertygenerating one. There is no unified theory that shows the
correlation between growth and poverty, but there are
empirical theories that confirm that inequality diminishes
as a country grows. Inequality is one of Nicaragua’s
major problems. The country’s income distribution for
1993, 1998, 2001 and 2005 show that in general there are
no important changes during that period; on average
the poorest 40 percent of the population has around 10
percent of the income and the wealthiest 20 percent has
over 40 percent of it.
10
20
30
40
50
60
70
80
90
100
Population percentiles
Source: Based on CEDLAC and World Bank data
Sources of growth
In conducting the traditional Growth Accounting exercise
(which measures the contribution of the factors to
growth) in different periods of approximately decades, the
following is observed:
Human capital has not made a significant contribution in
any of the periods studied.
The total productivity of factors only contributed positively
to growth between 1961 and 1972 and between 1973 and
1978, and only minimally in that latter period. In the other
periods its contribution has been negative.
The labor force has participated more or less constantly,
between 1.8 percent and 2.5 percent.
Capital’s contribution, which has always been positive,
has had a dramatic and permanently decreasing behavior.
Graphic 4: Accounting of Growth in Nicaragua.
(contribution of factors)
7
5
3
1
-2
-4
1961-1972
1973-1978
1979-1990
1991-2000
2001-2007
PTF
1,1
0,1
-3,0
-0,4
-0,3
H
0,5
0,3
0,4
0,7
0,7
L
2,2
2,5
2,1
1,9
1,8
K
2,4
2,3
0,4
0,5
0,6
GDP
6,1
5,2
-0,2
2,7
2,8
Source: Based on data of Daude and Fernandez-Árias (2010)
5
EXECUTIVE SUMMARY
In Central America, only Honduras has had similar
behavior to Nicaragua’s with respect to total productivity.
Sources of growth: the demand side. The contributions to
total growth of each of the components on the demand
side can be calculated. In the 1950s and 60s (up to 1972),
Nicaragua’s growth was explained first by the growth of
domestic demand, particularly the strong increase in
private consumption and per-capita investment. The
reduction of growth that occurred between 1979 and 1990
was based on an extremely high per-capita compression
of consumption of 4.1 percent annually, and on a percapita reduction of exports of 1.2 percent.
Public spending was cut drastically between 1991 and
2000, particularly in the second half of the decade. Private
per-capita consumption increased and investment grew
at an annual rate of 1.8 percent while per-capita exports
grew 1.1 percent.
The exceedingly modest growth achieved from 2001 to
2007 is explained by the growth of exports. The per-capita
private consumption growth was 1 percent. Furthermore,
in this last period, the growth rate of investment was
negative.
From the 1950's to the early 70's, exports evidently grew at
high rates, although due to their relative weight they did
not have an equal impact on the growth rate per se, but
perhaps more importantly they did result in income growth
of individuals, which meant that private consumption and
domestic demand grew.
Per-capita capital and investment-GDP: a
Poverty Trap
Although Nicaragua has had the highest proportion of
investment to GDP in Central America in the past fifty
years, per-capita investment as of 1978 has been among
the lowest. While a lot is invested as a proportion of
today’s GDP, investment may be insufficient to contribute
to growth due to the low accumulated levels.
Nicaragua had per-capita capital of US$ 7,799 in 2007, but
the minimum required to get onto a sustained growth
path is US$14,083, according to the methodology and data
used, which indicates that the country is in a poverty trap.
Taking into account that its per-capita GDP that same year
was US$2,180 in 2005 dollars, the investment required to
achieve the minimum capital required would be nearly
290 percent of the GDP, much higher than that observed in
the current Nicaraguan economy, which does not exceed
30 percent, including public investment.
Graphic 6: Capital per person.
(US$ 2005)
kel_p
150.000
140.000
130.000
120.000
110.000
100.000
90.000
80.000
70.000
60.000
50.000
40.000
30.000
20.000
10.000
0
High threshold
Los threshold
Nic 2007
Nicaragua
(2007), US$
7,799.01
Graphic 5: Nicaragua, sources of aggregate demand growth.
Internal demand
Growth rate %
4,0%
3,5%
3,0%
2,5%
2,0%
1,5%
1,0%
0,5%
0,0%
-0,5%
-1,0%
-1,5%
-2,0%
-2,5%
-3,0%
-3,5%
-4,0%
2,99%
2,79%
Export
Import
2,22%
Source: Based on data of Daude and Fernandez-Árias (2010).
GDP
0,75%
0,73%
-0,22%
-3,16%
19511960
19611972
19731978
Import
-0,9%
-0,8%
Export
0,8%
0,9%
Internal demand
3,1%
GDP
3,0%
Source: Based on Penn World Table 6.3
19791990
19912000
20012007
19512007
-0,6%
0,1%
-2,9%
-1,4%
-1,1%
-0,1%
-1,2%
1,1%
1,7%
0,5%
2,7%
3,0%
-2,1%
1,6%
0,5%
1,3%
2,8%
2,2%
-3,2%
-0,2%
0,7%
0,7%
Determinants of private investment
Even if an investment level is provided exogenously such
that a minimum threshold required or even more comes
into the country, it could again lead to a poverty trap
due to capital insufficiency if the factors that led to its
reduction are not eliminated.
The results of the econometric model used show that the
investment in any quarter pulls 29 percent of the private
6
DETERMINANTS OF NICARAGUA’S LONG-TERM ECONOMIC GROWTH
investment from the previous quarter, an increase of
1 percentage point of the profitability expected in the
second quarter generates a private investment increase
of 2.3 percent of the GDP and a 1 percent increase in the
product gap generates a private investment increase of
0.5 percent of the GDP.
Furthermore, a 1 percent increase in the real wage
generates a private investment increase of 0.2 percent
of the GDP, which suggests the presence of the efficiency
wage effect, and/or the effect on the salary mass and
aggregate demand. On the other hand, the reduction of
uncertainty in one unit generates a private investment
increase of 0.5 percent of the GDP. Similarly, an increase
in the credit portfolio of 1 percent of the GDP generates
a private investment increase of 0.6 percent of the GDP.
Lastly, a public investment reduction of 1 percent of
the GDP generates a private investment increase of 0.6
percent of the GDP.
Decomposition of business profitability
The net profitability of capital explains 54 percent of
the changes in the evolution of private investment as a
percentage of the GDP. In this regard, the most efficient
way to stimulate private investment in Nicaragua is to
create the conditions for average business profitability to
increase considerably.
Profitability components in Nicaragua
Financial restrictions: Credit has been very costly, scarce,
concentrated in a small group of activities and businesses,
and reduced to the short term. There has been little
access, legal limitations and distribution of a broad array
of alternative sources of financing and other financial
services.
Relative prices: Relative prices have not benefited
Nicaragua, until finally in 2007. Starting in the third quarter
of that year, the competitiveness of its exports improved
and the international market became more attractive
than the national market.
Salary, employment and labor productivity: Labor
productivity is low due to problems with workers’
health and education, their insufficient training and
skills, inadequate supervision and incentives, and low
opportunity costs of losing a job because the probability
of finding work (with low income or underemployment) is
high, the probability of receiving remittances is high and
real wages are low. The rigidity of the labor market, hiring
and firing of employees and cooperation in employerworker relations do not seem to represent a problem in
Nicaragua. The problems rather seem to have to do with
the fragile institutionality and structural issues, resolvable
in longer time periods.
Tax burden and incomes: Nicaragua’s tax system still suffers
from a set of incentives, exemptions and exonerations,
which means that some activities, population segments
and economic groups pay a high tax rate and others pay
little or nothing. Nicaragua’s total tax burden is among the
highest in Latin America, with an average of 17.7 percent
of GDP, and is mainly collected on the population’s
consumption.
Energy: Nicaragua has the most expensive energy of
any country in Central America. The high costs inhibit
technological development and productivity increases,
for example through irrigation in agriculture, and impact
directly on family incomes.
Logistics costs: Logistics and infrastructure also cover
costs associated with suppliers’ prices. These costs in
Nicaragua could represent between 17 and 48 percent of
the delivery price of a set of products. Logistics costs in
developed countries do not exceed 10 percent.
Innovation. The objective of innovation is to improve
processes aimed at developing the businesses, which
involves investing, but the high risk-uncertainty levels
make investing in innovation unattractive.
Uncertainty. Uncertainty about institutionality issues is
reflected in alarming indicators. The factors perceived
as the most problematic in Nicaragua include political
instability,
corruption,
inefficient
governmental
bureaucracy, inadequate education of the labor force,
inadequate provision of infrastructures, and others, in
that order.
7
EXECUTIVE SUMMARY
Recommendations
In addition to maintaining and deepening the
macroeconomic stability, the following should also be
done: re-found the public finances management system
and eliminate the tax system’s horizontal and vertical
inequalities; reduce the forms of protection enjoyed by
some sectors; relax the financial restrictions; improve
competitiveness and labor productivity; reduce energy
and logistics costs; re-found the road infrastructure;
increase social spending, particularly in education; and
reduce uncertainty through the establishment of the rule
of law. Some specific corrective measures are presented
below:
Financial restrictions. Produce a more competitive
environment in the financial market: make possible
the existence of more and more diverse financial
intermediation businesses in the national market. The
whole process regarding land ownership and all those
assets whose rights are still in litigation or lacking some
procedure to be able to alienate, sell, etc. should be
speeded up and finalized. In addition, social security must
be reviewed, as this is one of the few sources of long-term
funds in Nicaragua and mechanisms should be designed
that permit those funds to be able to profitably, safely and
reliably finance long-term projects.
Relative prices. It is crucial to keep Nicaragua’s inflation
in line with international inflation and to revalue the
exchange rate system. The process of transmitting
international prices to the national market must be
improved, which would strengthen competition.
Salary, employment and labor productivity. Implement
more continual and intense induction and training
systems at a business level and review remuneration and
incentive schemes that link payments to workers directly
to productivity and quality. Also establish a close and
ongoing relationship between companies and technical,
vocational and commercial training schools, as well as
with public and private universities.
Tax burden and incomes. Improving Public Finance
Management is fundamental. It requires a realistic budget
to which the public can have access and which is prepared
taking public policy into account. Mechanisms of control
and custody of public funds must exist; registries must
be prepared and revealed: and mechanisms to scrutinize
public finances must be applied. It is also crucial to make
explicit all public money and all public spending and tax
spending; evaluate the impact and scope of spending;
evaluate the consequences of the current tax burden; and
move to a budget by objectives that can be monitored and
evaluated independently and continuously.
Energy. Ways must be found to lower energy prices to
increase competitiveness. Investments in this area need
to be increased to generate more energy, preferably
renewable, and modernize the institutional and
operational framework of the Central American electricity
market.
Logistics costs. Implement a National Infrastructure Plan
and review the procedures related to the entire “supply
chain,” particularly customs and warehousing red tape, to
simplify and modernize them without neglecting control.
Innovation. Establish an innovation policy.
Uncertainty. It is necessary to promote the construction of
a new social order among the diverse groups of society as
well as society as a whole in which all citizens have equal
rights and social and legal duties and in which the laws
and compliance with them are for everybody.
It is not possible to substantively change Nicaragua’s
economic trends without constructing a new set of values
on which society is based, a new set of rules of the game
applicable to all and conceived for all. This is an urgent
task, but one with long-term results.
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Determinants of Nicaragua’s
long-term economic growth
June 20 11
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