Journal Issue

Panama: Selected Issues

International Monetary Fund. Western Hemisphere Dept.
Published Date:
August 2015
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Panama: Investment and Growth8

A. Executive Summary

1. Panama’s growth has been strong over the last decade, supported by productivity enhancement and public investment.

2. There is evidence that public investment has had a positive impact not only on growth but also on private investment (crowding-in).

3. Going forward, sustaining a strong growth performance will depend more on productivity and human capital accumulation, hence the quality of macroeconomic policies and structural reforms will remain crucial.

B. Brief Review of Economic Growth

4. Panama’s growth performance has been strong compared to other countries in the region. Between 1990 and 2014, growth averaged 6.5 percent in Panama, compared with 3.1 percent for the region and 3.6 percent for global output. Between 2007 and 2014, average growth rate accelerated to 8.7 percent, placing Panama as one of the fastest growing economies in the world. This note attempts to highlight the main drivers behind Panama’s strong growth performance. In particular, it investigates the contribution of public investment to growth and shows the implications for future economic performance.

Chart 1.Panama: Average Output Growth


Source: World Economic Outlook

Chart 2.Panama: GDP Growth


Source: National Authorities and World Economic Outlook

5. Reflecting its comparative advantage, Panama’s economic development has focused on services. The service sector benefited significantly from the rapid expansion of global trade since the 1990s, the economic boom of the region, and the strong demand from emerging Asia. Accounting for about ¾ of total GDP and about ⅔ of employment, the services industry is the most important contributor to the economy. The shares of agriculture, fishing and manufacturing have been decreasing in GDP over the years, but they still account for about ⅓ of employment.

Text Table 1Panama: Sector Shares of GDP(1997-2014)
Agriculture, and fishing6.07.14.5
Mining & quarrying1.20.81.6
Transport and communications18.415.122.5
Commerce, restaurants, and hotels18.817.120.8
Financial Intermediation8.48.58.3
Source: Panama National Authorities and staff estimates.
Source: Panama National Authorities and staff estimates.

Chart 3:Panama: Sector Contribution to GDP

6. Panama has experienced a number of negative external shocks since 1980s and the economy became more resilient since the 1990s. Panama’s economy suffered substantially during the Latin American debt crisis in the early 1980s and the U.S. invasion in the late 1980s. In contrast, during the Tequila crisis in 1994-95, the global economic slowdown in 2000-01, and the global financial crisis in 2008-09, Panama’s economy demonstrated impressive resilience. It maintained positive growth during these periods, and recovered relatively quickly from them. Sector performance during the shocks showed that the manufacturing industry is more volatile and susceptible to shocks than the primary and service industries.

C. Growth Accounting

7. To assess the drivers of economic growth in Panama, we first calculated the contribution to growth from factor inputs, namely, labor, capital and total factor productivity (TFP). Capital input is generated using the usual perpetual inventory model9. Assuming a Cobb-Douglas production function, we obtain the following:

where Yt is the level output, Kt is capital input; Lt is labor input, (the number of employees in the economy adjusted by education attainment represented by average years of schooling obtained from Barro and Lee (2013)), while At is the technology or total factor productivity (TFP) and α is assumed at 0.5. TFP is then computed via:

The resulting GDP growth decomposition is presented in the following table.

Text Table 2.Panama: Real Growth and Input Contributions (%)
Memorandum item
Investment/GDP (%)19.311.221.925.0

Chart 4.Panama: Growth and Input Contribution

8. The decomposition suggests that labor contribution to output growth has been relatively stable. Employment increased as the economy grew, while education indicators improved over the years. Enrollment rates compare favorably with peers in the region. In particular, tertiary education enrollment accelerated since the 1990s, and doubled from 22.7 percent in 1991 to 45.7 percent in 2010. Average years of schooling of the population of 15 years and older increased from 7.7 years in 1990 to 9.6 years in 2010. However, the quality of education could be a constraint to human capital accumulation. In 2009, Panama participated for the first time in the Program of International Student Assessment (PISA) administered by the OECD. The result indicated that Panama performed below what its income and investment in education would predict, as did a large number of Latin American countries10.

Chart 5.Panama: School Enrollment (%, 1970-2012)

Source: World Bank

Chart 6.Panama: Years of Average Schooling of +15 Year Olds

Source: Education attainment dataset.

9. The quality of education and the mismatch between demand for skilled labor and supply could potentially be an impediment to medium term growth. The current unemployment rate, at about 4.8 percent, indicates tight labor market conditions. As output grows fasters in sectors that are skill intensive, human capital may become a constraint. To address this issue, it is important to increase the efficiency of investment in education and further reform the labor market to alleviate skill mismatches and ensure better job opportunities.

10. Capital input contribution to output increased over time. While the 1980s were marked by a lack of investor confidence, private investment surged with remarkable strength in the 1990s. Since the turn of the century, both private and public investment have boosted growth. In the period between 2007 and 2014, output growth averaged 8.7 percent, above the potential output growth, with fixed asset investment by both public and private sectors contributing to almost half of output growth.

Chart 7.Panama: Output Growth and Capital Formation

Sources: National Authorities and staff estimate.

11. TFP did not contribute to output growth until 2004. TFP registered negative contribution to growth in the 1980s and 1990s, indicating weaknesses in improving economic efficiency during the period. In the last decade, however, TFP’s contribution accounted for about ¼ of output growth. The results regarding TFP’s contribution are robust to alternative assumptions about the capital share. In particular, TFP growth remained consistently negative for the 1980s and 1990s, and consistently significant and positive for the last decade when intensive reforms took place in Panama.

Text Table 3.Panama: Sensitivity Test: TFP Growth with Alternative Factor Shares
Assumption of capital shareTFP contribution to growth (%)
Source: Staff estimate.
Source: Staff estimate.

12. Structural reforms over the years helped to improve the competitiveness of the economy. Beginning in the 1990s, the authorities adopted an economic strategy aiming at a permanent reduction of public sector indebtedness and an economy-wide increase in productivity. Structural reforms were implemented in the 2000s to remove impediments to productivity growth and private sector investment, and to enhance the public sector capacity. They include significant efforts in privatization, trade and market liberalization, strengthening financial supervision and promotion of the private sector investment. As part of the institutional improvements to attract foreign investment, an agency for the Attraction of Investments and Promotion of Exports (Proinvex Panama) was established as a one-stop-shop that allows the potential investors to easily identify all the investment instruments and relevant information for foreign direct investment. Measures have also been taken to increase labor mobility.

13. Private sector confidence improved. The improvements in the efficiency of the economy as well as in public finances, the better climate for private sector activities, the investment opportunities opened up by privatizations, and the reverting of the Panama Canal and the neighboring land contributed to enhancing investor confidence. Private sector investment averaged about 22 percent of GDP in 1990-2012, a substantial increase over the 9 percent average for 1980-1990. As of today, Panama ranks among the top Latin American countries in the major competitive indicators. For instance, it is the second most competitive economy in Latin America (after Chile) in the 2014 World Economic Forum Global Competitive Index. It also improved its ranking in the ease of doing business index from 65 in 2008 to 52 in 2014.

D. Impact of Public Investment on Real GDP and Private Investment

14. Results from an econometric exercise indicate that public sector investment has had a positive impact on output growth as well as on private investment. To gauge the impact of public investment on the economy, we estimated a vector error correction (VEC) model including real GDP, as well as real public and private investment (all in logs), using annual data for the period 1969-2014 (46 observations).11 The Figure below presents the responses of GDP and private investment to a one-percent permanent shock in the level of public investment. Real GDP increases initially by about one-tenth of the increase in public investment, with a somewhat larger increase after four years.12 Importantly, private investment also rises in response, by about one-third of the increase in public investment, with most of the effect already taking place during the first year. This confirms the “crowding-in” effect of public investment on private investment.

Chart 8.Panama: The Response to a One-Percent Public Investment Shock 1/

VEC model based on annual data for 1969-2014

1/ Point estimates and confidence intervals of the impulse-response functions were obtained through a bootstrap procedure.

E. Public Investment Since 2007

15. The economy has been in an investment boom since 2007. A number of sectors have been identified as the growth engines of the economy, including logistics, tourism, agriculture, and financial services. The vision was for Panama to become a hub for logistics services, financial services, and tourism. Consistent with the growth strategy, the authorities identified areas in which public investment and government action would yield better returns in terms of sustained economic growth and job creation. As an important component, a third set of locks on the Canal are being built to enable the transit of post-Panamax containerships through the Canal. Total investments in the Canal expansion project are estimated at US$5.3 billion. Once operational—expected in early-2016—the expanded Canal would double the transit capacity, boost growth, and facilitate other trade-related activities. The latest Strategic Plan of the government released in January 2015 announced the plan to invest US$19.5 billion over the years 2015-19, most of which would be invested in long-term infrastructural projects, including new highways, airports, roads, ports, urban infrastructure, new subways, sewage systems, and healthcare facilities.

Text Table 4.Panama: Indicative Public Investment Plans, 2015-2019(In millions of US$)
20152016201720182019Total 2015-2019% of Total
Water and sanitation649,978.7663,386.1770,376.7758,344.9844,681.73,686,768.118.9
Urban sanitation21,019.916,817.814,217.812,017.810,200.074,273.30.4
Urban transportation448,535.0651,880.7775,523.8666,681.3667,765.43,210,386.216.5
Social transfers193,432.9246,463.3297,501.5331,624.7331,358.41,400,380.87.2
Basic education374,337.6364,774.3347,603.8365,446.7397,021.81,849,184.29.5
Technical training124,779.2121,591.4115,867.9121,815.5132,340.6616,394.63.2
Zoning Improvements1,734.94,460.84,461.25,421.85,485.021,563.70.1
Environmental management15,614.240,148.040,152.248,796.549,365.3194,076.21.0
Institutional reforms58,912.247,859.241,658.443,762.535,852.5228,044.81.2
Justice and securities125,898.9142,016.7147,482.7162,375.0167,350.0745,123.33.8
Memorandum: as % of GDP7.

16. Public finances improved significantly in the last two decades. The transition of the Panama Canal and the land around the canal area to the Panamanians in 1999, the efficient management of the canal as a commercial entity, and successful tax reforms increased tax revenue, significantly improved tax buoyancy in the last decade, and improved the public sector financial position. Public sector debt declined from over 70 percent of GDP in the 1990s to about 40 percent now. A Sovereign Wealth Fund was established to help institutionalize the positive loop of public savings. All major rating agencies have granted Panama above investment-grade ratings. Going forward, the medium-term fiscal framework needs to be strengthened to enhance its efficiency, credibility, and—in the absence of monetary policy—to build buffers to guard against shocks.

Chart 9.Panama: Savings as % of Nominal GDP

F. Going Forward

17. Growth projections for the next five years using the production function approach coincide with the authorities’ projection of 6-7 percent. Taking into account the public sector investment plans for 2015-19, assuming other factor contributions and TFP follow past trend, it can be projected that growth in the next five years is likely to fall in the range between of 6-7 percent.

18. The quality of public investment and accompanying macroeconomic policies will remain crucial. In particular, investment should be sustainably financed to avoid buildup of public debt. In addition, structural reforms to improve the business climate would encourage complementary private sector investment. And finally, procedures need to be in place to ensure the quality of public investment, including project selection, implementation and monitoring.

19. As large public investment is expected to slow down in the medium term, growth will depend more on productivity and human capital accumulation. Private investment is assumed to continue its growth momentum. Nonetheless, with the increase of public capital stock and the normalization of public investment, the challenge is to develop the strategy to maintain a more sustainable and inclusive growth. It is imperative to increase the efficiency of education investment and further reform the labor market to alleviate skill mismatches and ensure better job opportunities.

G. Conclusions

20. Panama’s growth has been strong over the last decade, supported by productivity enhancement and public investment. Until the 2000s, Panama’s growth performance was mainly due to factor accumulation. It was in the last decade that TPF contributed significantly to growth. This coincided with the surge in public investment and more importantly, the structural reforms aimed at improving the efficiency and competitiveness of the economy.

21. There is evidence of complementarities between public investment and private investment. Since the public investment provide much needed resources in areas where the private sector is unable or unwilling to, these public investment are largely complementary to private investment and make them more efficient. The Canal expansion has fostered the developments of ports, the building of roads has improved connectivity between logistics centers, and the expansion of airports in the provinces has fostered private investment in tourism as well as higher value-added agricultural exports. Public investment was also aimed at developing new industries around the logistic hubs, such as light manufacturing and value-added warehousing. Investment in education and hospitals should help improve social condition and human capital over the medium term.

22. Going forward, sustaining a strong growth performance will depend more on productivity and human capital accumulation, hence the quality of macroeconomic policies and structural reforms will remain crucial. Public finances improved significantly in the last two decades, and all major rating agencies have granted Panama above investment-grade ratings. Going forward, investment should be sustainably financed to avoid buildup of public debt, and—in the absence of monetary policy—to build buffers to guard against shocks. As large public investment is expected to slow down in the medium term, growth will depend more on productivity and human capital accumulation. Given the inevitable lags in influencing productivity, it is crucial to intensify efforts in areas that still need progress, for example by improving the quality of public education and healthcare, addressing skill mismatches through internship and training programs, promoting greater female labor force participation (e.g. by increasing the flexibility of working arrangements), and strengthening institutions. Doing so will enhance human capital, reduce skills shortages and youth unemployment, improve the business environment, as well as raise productivity and living standards.


Prepared by F. Yang and D. Cerdeiro. We are grateful to A. Buzaushina to valuable contributions.

Kt = (1 - δ)Kt-1 + It where depreciation rate δ is assumed at 0.05, a quite common assumption in non-OECD countries.

Alejandro J. Ganimian and Alexandra Solano Rocha (2011): “Measuring Up? How did Latin America and the Caribbean Perform on the 2009 Program for International Student Assessment (PISA)?” Partners for Educational Revitalization in the Americas.

We first ran a battery of unit root tests, and could not reject the null hypothesis of unit root for any of the three variables. Since the series were then found to be cointegrated, we chose to model the dynamics through a VEC (rather than a VAR in first differences). Shocks were identified through the following Cholesky ordering: public investment, GDP, and private investment. The model was estimated with two lags.

Our results are consistent with those of Bom and Lighart (2013), who found that the average output elasticity of public capital amount to about 0.1 based on 578 estimates collected from 68 studies: What Have We Learned from Three Decades of Research on the Productivity of Public Capital? Journal of Economic Surveys 12037.

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