Central America Growth Potential

Prior to Covid-19, the Central America region grew at an average rate of more than 4.5 percent a year for nearly

three decades. The region's exports of goods and services grew robustly, including its manufactured exports.

Poverty fell and per capita incomes rose. Panama has made the most notable progress in catching up with the

level of U.S. per capita income, followed by Costa Rica. El Salvador and Guatemala moved up more slowly but

steadily, while Nicaragua and Honduras lagged others in catching up.

This sustained economic growth in 1991-2017 was achieved with little productivity growth. Labor accounted

for two-thirds of the region's GDP growth and capital for the rest. Rapid growth of the working-age population

made those increases in labor inputs possible. While labor's contribution will continue to be important, it is

likely to be less dominant in the future as the growth of the working-age population is projected to decline

sharply. Rising investment rates could compensate for this fall, provided their returns remain attractive. However,

given the existence of diminishing returns on capital accumulation, the sustainable growth in the long

term needs to come largely from improving efficiency in the use of factors. Higher productivity growth will

thus be essential to sustain robust economic gains and finding strategic options to ensure that outcome will be

paramount going forward.

The pandemic pushed the region into its deepest economic contraction in 2020 with recovery expected sometime

in 2021. The stimulus packages, that included higher social transfers, helped support citizens but it also

raised public debt and reduced fiscal space. Fortunately, the external environment has been faring better.1

Global trade in goods has returned to pre-pandemic levels, commodity prices are holding up, and remittances

are higher than a year earlier; Covid-19 has also accelerated the ongoing regionalization of global value chains

(GVCs). These developments augur well for the recovery of small open economies. Today is the time to write

the new phase of the region's future, for the benefit of current and future generations. To double its GDP per

capita in the next twenty years, the region's GDP would need to grow at a minimum rate of 3.5 percent annually,

not as high as was it was achieved in 1991-2017. In order to meet this target, raising productivity growth will

be crucial. Sustained growth in productivity is critical for economic prosperity as well as for lifting people out

of poverty. Long-term increases in earnings can only be maintained by raising productivity. Thus, the road to

poverty reduction and employment also requires higher productivity-growth.

However, in the past decades the region has been unable to experience sustained productivity growth, which

indicates the necessity to introduce reforms consistently over time to generate a significant structural change.

Investments in productivity-enhancing innovations can raise a country's economy-wide productivity growth

but the extent of their success depends on the availability and adequacy of complementary factors like education,

infrastructure, the efficiency of markets and the quality of institutions. Though Costa Rica and Panama are

better placed than others in the region, all countries compare unfavorably with their relevant peers, in respect

to these four factors.