Over the last decade, Central American countries—Costa Rica, El Salvador, Guatemala, Honduras,
and Nicaragua—have made significant progress in social and economic areas. In particular, they
have stabilized their economies after decades of civil war and the economic volatility that plagued
the region through the 1990s. Most countries in Central America have taken important steps to
improve their business climates, particularly by enhancing macroeconomic stability, improving
the soundness of their financial systems, making improvements in infrastructure services and trade
facilitation, reducing red tape, and simplifying their regulatory and tax frameworks. As a result,
before the 2008 financial crisis, GDP per capita in Central America grew at an average rate of 3
percent per year from 2003 to 2008, which, albeit modest, was the most robust and stable period of
growth the region had witnessed since the early 1990s. However, despite this achievement, Central
American economies are still lagging behind the rest of Latin America and other middle-income
countries by per-capita growth rates of 0.5 to 2 percentage points. Even more worrying are the levels
of poverty and inequality, which show the lack of inclusiveness in their growth models. Moreover,
recent developments in the region show a number of red flags that are weakening macroeconomic
and democratic stability. Significant structural changes are urgently needed to secure sustained and
inclusive growth.
Given its small domestic markets, Central America has put the promotion of international trade
at the center of its development agenda. In recent years, the region has witnessed the successful
conclusion of negotiations for a significant number of free trade agreements (FTAs), most notably
the Dominican Republic–Central America Free Trade Agreement (DR-CAFTA) with the United
States and the Association Agreement (AA) with the European Union. However, the extent to
which Central American countries take full advantage of the opportunities and benefits offered
by these trade initiatives will depend on whether they address a number of pending issues that are
hampering their international competitiveness.
Securing sustained growth, alleviating poverty, and reducing inequality are indeed tall orders
and complex undertakings. While we of course recognize that there are many relevant factors
(political, socioeconomic, as well as those related to natural disasters and external shocks) affecting
those objectives, in this paper we identify five critical areas where improvements need to be
made if Central American countries are to become more competitive and consequently achieve
significant economic growth and poverty alleviation. Thus, the concentration of the analysis on a
few key areas should not be interpreted to mean that other socioeconomic and political factors are
not important and relevant; instead, it should be clear that the focus of this report is on areas where
technical recommendations can be advanced to promote growth and poverty alleviation. The five
identified areas are as follows:
1. Innovation, Knowledge Transfer, and Quality Systems
2. Infrastructure and Logistics
3. Mainstreaming the Activities of Small and Medium Enterprises (SMEs)
4. Education and Human Capital
5. Crime, Violence, and Weak Governance2 Center for Global Development
In all five areas we find that international donors can play an essential role in complementing the
efforts of countries’ authorities and the local private sectors.
One clarification is in order: This report does not attempt to explore and analyze all five identified
areas in equal depth. For example, our coverage of the issues related to crime and violence is
rather limited, since the complexities of this topic deserve a report of their own. Also, we address
only indirectly—through the strengthening of specific institutions—issues of governability, transparency,
and democracy of the political systems, which indeed are critical if Central American
countries are to secure sustainable private investment. However, the reader should not be confused
by the short amount of space assigned to the section on SMEs. Indeed, the theme of mainstreaming
SMEs permeates the other sections and is cross-referenced in them as well.
The rest of the paper is organized as follows: Section II presents a brief overview of key economic
and social characteristics of the Central American countries. Section III shows that the five
key areas identified as priorities for dealing with growth and development problems in the region
can be derived from analyzing the existing literature and surveys on the region. Sections IV through
VII analyze each of the five key areas in turn. In each section, we first describe the problems and
shortcomings in the priority area and then provide specific recommendations for improvement. In
making these recommendations, we emphasize the positive role that donors can play.