Fostering Diversification and Integration1
El Salvador has limited domestic production and export diversification. Diversifying exports, deepening integration into global production chains, and raising quality and sophistication of exports would raise growth. Supportive policies could include improving infrastructure and trade networks, investing in human capital, encouraging financial deepening, and reducing barriers to entry for new products.
1. Diversification and structural transformation influence macroeconomic performance and stability. Both theory and empirics show that diversification in exports and domestic production foster economic growth (IMF, 2014; Papageorgiou and Spatafora, 2013). Increased diversification is also associated with lower output volatility. Diversification in output and employment is associated with higher income per capita until a country reaches advanced-economy status (Imbs and Wacziarg, 2003). As economies diversify their production, export diversification as measured by changes in the type and quality of export products also increases (Papageorgiou and Spatafora, 2012). This section focuses on El Salvador’s potential for diversification in both exports (across products and partners) and in output, as well as increases in the quality of existing products.
Selected Countries: Annual Average Deviation of Country’s Real Exports Growth from World Real Exports Growth, 2003-12
Sources: WEO and Fund staff estimates.
Share in Value Added by Sector
Source: Central Bank of El Salvador.
Share in Employment by Sector
2. Limited domestic production diversification. Since the 1990s, El Salvador’s share of agriculture in output has declined significantly. The gap has been filled largely by low-productivity services/non-tradable activities, while the share of manufacturing has only slightly increased. Employment changes are similar to these structural changes (with employment declining in agriculture and rising in services).
3. Loss of market share and limited export diversification. El Salvador has lost market share over the past decade somewhat more than other countries in the region and emerging markets. El Salvador relies on a narrow range of export products. As a share of total exports, textiles, food, and knowledge intensive products amount to 40 percent, 28 percent, and 9 percent, respectively. It also relies on a few export markets—the U.S. (47 percent share of exports) and CAPDR (33 percent). The comparative advantage of textiles has been rising from the early 1990s to the mid-2000s and has barely been maintained since then; the comparative advantage in food rapidly declined until 2002, with some modest recovery thereafter. The comparative advantage in consumer goods has been rising from the early 1990s to 2000, but has been flat thereafter, while the comparative advantage in raw materials has disappeared since the 1990s (Figure 1). El Salvador’s real GDP growth could rise by up to 0.7 percentage points per year by improving logistics, increasing partner diversification, deepening integration into global production chains, and raising technological sophistication of exports to the levels of the five largest Latin American countries (and by up to 1.5 percentage points per year if it matches the EU in export structure and regional/global trade integration) (Medina Cas, Swiston, and Barrot, 2012).
Figure 1.El Salvador: Exports and Revealed Comparative Advantage
Source: WITS World Bank, UNSD Comtrade, and Fund staff estimates.
1/ Other CAPDR includes Costa Rica, Honduras, Nicaragua, El Salvador, Panama and the Dominican Republic.
2/ Knowledge Intensive products include transport, electrical equipment, machinery and chemicals.
3/ The stages of processing include capital goods, consumer goods, intermediate goods and raw materials.
4/ The Revealed Comparative Advantage index of country i for product j is measured by the product’s share in the country’s exports in relation to its share in world trade: RCAij = (xij/Xit) / (xwj/Xwt) Where Xij and XWj are the values of country i’s exports of product j and world exports of product j and where Xit and Xwj refer to the country’s total exports and world total exports. A value that exceeds unity implies that the country has a revealed comparative advantage in the product.
Logistics Performance Index
Source: World Bank.
4. Scope to upgrade quality. Small economic size and limited potential to exploit economies of scale may imply that the cost of moving into many new products is high, making quality upgrading within existing products a more feasible route to diversify. Producing higher quality varieties of existing products can build on existing comparative advantages and can boost export revenue potential through the use of more physical- and human-capital intensive production techniques. Thus, quality upgrading opportunities in El Salvador are strongest in manufacturing/ textiles and chemicals, but also exist in agriculture.
El Salvador: Quality Ladder, 2010
Source: UN Comtrade and Fund staff estimates.
El Salvador, Highest Export Shares and Quality Index
Source: UN Comtrade and Fund staff estimates.
HennC.PapageorgiouC. and SpataforaN.2013. “Export Quality in Developing Countries.” IMF Working Paper 13/108May (Washington: International Monetary Fund).
Medina CasS.SwistonA. and BarrotL.2012. “Central America, Panama, and the Dominican Republic: Trade Integration and Economic Performance.” IMF Working Paper 12/234September (Washington: International Monetary Fund).
Prepared by Iulia Teodoru.