In the 1990s El Salvador embarked in a series of sound economic reforms in order
to foster investment and economic growth. This country liberalized its economy, stabilized
prices and privatized public enterprises. However, this economy has not achieved high rates
of economic growth. After a short period of high growth, in 1995-2005 the Salvadoran
economy grew by only 2.6% per year, and total investment only accounted for 16% of
GDP.
In comparison to other economies in the region, the performance of El Salvador
has not been favorable. El Salvador´s growth rates have been below those from other
Central American and other Latin American economies. This sluggish growth of the
economy is surprising considering that El Salvador has adopted pro-investment policies
and ranks among the best in economic freedom, and secure property rights.
Why did El Salvador not achieve high rates of economic growth? What were the
structural factors that explain the slow growth of the economy? This research is an attempt
to answer these questions. This report is divided in 9 sections. Section 1 presents stylized
facts of the Salvadoran economy. Section 2 presents a preliminary analysis and the
hypothesis of this study. In particular, this section presents the decision tree analysis for
this study. Section 3 presents the decomposition of output and analyzes the contribution
of physical factors of production and productivity on economic growth. Section 4 analyzes
cost of capital. Section 5 the factors affecting social returns to investment, in particular,
human capital, infrastructure, innovation and technological diffusion, and external
conditions. Section 6 describes the factors that affect the appropriability of returns, such as
taxes, micro risks and macro risks. Section 7 analyzes the role of migration on real
exchange rate and consumption. Section 8 explores product innovation and export
sophistication. A final section presents the conclusions of this study.