Abstract
This Selected Issues paper and Statistical Appendix examines factors that have determined long-term growth in Nicaragua. Stylized facts suggest that government policies have had a decisive influence on growth. In particular, productivity and capital accumulation suffered during periods of excessive deficit spending and inadequate enforcement of private property rights. A sectoral analysis of growth reveals that liberalization and deregulation in the 1990s led to deep structural changes in the economy. The paper also describes the main characteristics of Nicaragua’s tax system, identifying key weaknesses and their economic costs.
I. Factors Underlying Growth in Nicaragua1,2
Nicaragua has experienced large swings of income over the past 40 years. The analysis in this chapter shows that the long-run swings in GDP growth were determined to a large extent by changes in total factor productivity (TFP). Government policies have played an important role in shaping productivity, which has been decelerating recently. Fiscal consolidation, a reduction of public domestic debt and strengthening the financial sector are important conditions for the resumption of productivity growth. In addition, to sustain higher growth rates over the medium term, Nicaragua will need to redress its product mix towards higher-value added goods.
1. This chapter examines factors that have determined long-run growth in Nicaragua. Stylized facts suggest that government policies have had a decisive influence on growth. In particular, productivity and capital accumulation suffered during periods of excessive deficit spending and inadequate enforcement of private property rights. A sectoral analysis of growth reveals that liberalization and deregulation in the 1990s led to deep structural changes in the economy, with the resulting rapid growth being led by capital accumulation and productivity growth.
A. Stylized facts on Growth in Nicaragua
2. Nicaragua has experienced large swings of income over the past 40 years (Figure 1). The country enjoyed an export-led boom from the 1950s to 1977, the year prior to the Sandinista revolution. Per capita income rose by 70 percent between 1960 and 1977, with average GDP growth of 10 percent a year. Initially, rapid growth of cotton exports was at the core of the expansion. Later on, cotton was joined by other primary exports (sugar, beef, shellfish, etc.) and an expansion of agroindustrial and manufacturing exports. However, in the 1980s, growth was disrupted by the revolution, war, aggressive nonmarket policies, and the buildup of macroeconomic imbalances. These developments led to a steady decline of GDP, with per capita income in 1990 at less than one-third of its value in the late 1970s. Although market-friendly reforms led to a recovery during the 1990s, per capita income has recovered only marginally.
GDP Per Capita, 1960-2001
Citation: IMF Staff Country Reports 2002, 269; 10.5089/9781451829181.002.A001
Sources: Central Bank of Nicaragua; and Fund staff estimates.GDP Per Capita, 1960-2001
Citation: IMF Staff Country Reports 2002, 269; 10.5089/9781451829181.002.A001
Sources: Central Bank of Nicaragua; and Fund staff estimates.GDP Per Capita, 1960-2001
Citation: IMF Staff Country Reports 2002, 269; 10.5089/9781451829181.002.A001
Sources: Central Bank of Nicaragua; and Fund staff estimates.3. Economic policies during the 1960s-1970s were characterized by prudent macropolicies, while significant structural distortions were allowed to lowered up. Until the late 1970s, policy makers resorted to import substitution and wide-ranging controls on the domestic economy. These controls included high import tariffs and price and interest rate controls, which resulted in extensive price distortions and negative real interest rates. Protectionism encouraged the rise of an uncompetitive manufacturing sector at the expense of Nicaragua’s traditional strength in agriculture. Prudent fiscal and monetary policies ensured low inflation rates, although reconstruction efforts after the 1972 earthquake prompted fiscal deficits of more than 5 percent of GDP on average in the late 1970s. The economic strain was increased by current account disequilibria after the two oil shocks in the mid-1970s, a reduction of trade within the region, overvaluation of the domestic currency, and significant capital flight in the months before the victory of the Sandinistas.
4. The Sandinista period witnessed a wholesale shift toward central-planning and deficit spending. The government created a large and costly parastatal sector by nationalizing large properties, the financial system, foreign trade, large-scale mining (particularly gold), forestry and fishing. These policies were accompanied by massive budget deficits that were largely monetized. The macroeconomic imbalances resulted in hyperinflation and a huge build-up of external debt (around 700 percent of GDP by the end of the 1980s). As a result of the distortions and the widespread sense of insecurity about property rights generated by those policies, the economy experienced a severe decline during this period.
5. During the early 1990s, Nicaragua achieved macroeconomic stabilization and moved toward a market-based economy. Financial policies were strengthened, most price controls were eliminated, and the foreign exchange and trade system was liberalized. This restored to some extent Nicaragua’s competitive advantage in agriculture. Over the past 10 years, the agriculture sector employed about 40 percent of the labor force and contributed to GDP growth twice as much as the other two sectors (Figure 2 and Figure 3).
GDP by Sectors, 1960-2001
Citation: IMF Staff Country Reports 2002, 269; 10.5089/9781451829181.002.A001
GDP by Sectors, 1960-2001
Citation: IMF Staff Country Reports 2002, 269; 10.5089/9781451829181.002.A001
GDP by Sectors, 1960-2001
Citation: IMF Staff Country Reports 2002, 269; 10.5089/9781451829181.002.A001
Sectoral Contributions to Growth, 1960-2001
Citation: IMF Staff Country Reports 2002, 269; 10.5089/9781451829181.002.A001
Sectoral Contributions to Growth, 1960-2001
Citation: IMF Staff Country Reports 2002, 269; 10.5089/9781451829181.002.A001
Sectoral Contributions to Growth, 1960-2001
Citation: IMF Staff Country Reports 2002, 269; 10.5089/9781451829181.002.A001
B. Growth Accounting
6. The long run swings in GDP growth were determined to a large extent by total factor productivity. In fact, long waves in TFP tended to precede turning points in GDP growth. The method of growth accounting helps to reveal major changes in the production function of Nicaragua.
The model
7. The model used goes back to the growth accounting literature of the 1960s. A standard production function was estimated in order to identify the contribution to GDP growth of the input factors labor, capital and total factor productivity (Box 1).
Investment, capital, and employment
8. Investment as a share of GDP has been quite volatile (Figure 4). In 1978-79, it fell dramatically as result of the destruction of buildings, stocks, and equipment, looting of inventories, slaughter of cattle, and smuggling of herds. Official national accounts record a loss of inventories of more than 14 percent of GDP in 1978-79. After the Sandinistas took power, investment recovered mainly with the help of large financing from other countries with centrally-planned economies. However, the quality of investment was inadequate, reflecting public sector inefficiency, high inflation and overvaluation of the currency, and diversion of a large amount of resources into unproductive defense spending. In the early 1990s, as peace and democracy were reestablished and the government initiated a transition to market-based policies, the investment ratio began to recover. Boosted further by aid flows after the 1998 Hurricane Mitch, investment peaked at over 30 percent of GDP in 1999. Figure 5 shows the resulting capital stock series for Nicaragua.
Investment Ratio, 1960-2001
Citation: IMF Staff Country Reports 2002, 269; 10.5089/9781451829181.002.A001
Investment Ratio, 1960-2001
Citation: IMF Staff Country Reports 2002, 269; 10.5089/9781451829181.002.A001
Investment Ratio, 1960-2001
Citation: IMF Staff Country Reports 2002, 269; 10.5089/9781451829181.002.A001
Capital Stock, 1960-2001
Citation: IMF Staff Country Reports 2002, 269; 10.5089/9781451829181.002.A001
Capital Stock, 1960-2001
Citation: IMF Staff Country Reports 2002, 269; 10.5089/9781451829181.002.A001
Capital Stock, 1960-2001
Citation: IMF Staff Country Reports 2002, 269; 10.5089/9781451829181.002.A001
The Production Function Approach
The model used relates GDP growth to changes in the supplies of factors of production (labor and capital) and total factor productivity (TFP). The supply side of the economy is described by a Cobb-Douglas production function:
Y = AKαN1 − α,
Where Y is output, A is total factor productivity, K is capital and N is labor.
The capital stock was estimated using the perpetual inventory method.1 This method constructs a time series for the capital stock from real investment data and two assumptions concerning the initial capital stock (K) and the rate of depreciation (8). In general, the capital stock grows according to:
Kt + 1 = (1 − δ)Kt + It.
The initial capital stock is constructed by using the fact that over the long run (in the steady state), the growth rates of output and capital tend to be equal: gK = gY.
Combining this with the equation on capital accumulation yields the steady-state relation
K* = I*/gY + δ)
Where a star denotes steady state values. Using the real GDP value for I960, the average investment share of 18.1 percent of GDP (1960-2001), and the average annual rate of real GDP growth of 2.6 percent yields an initial capital stock (1960) of almost 15 billion cordobas (in constant 1980 prices).
With data for GDP, employment and the capital stock, a time series for TFP can be obtained as a residual—the so-called Solow residual.
In this calculation, an income share of capital (a) of 0.37 is used, with the share of labor (1 - a) of 0.63. According to national account statistics, the share of dependent labor in GDP was 63 percent on average during the years 1960-78 (when data on the cost composition were still available).2 This value is somewhat lower than that in industrialized countries, where the labor share is around 75 percent. Generally, a positive correlation is found between per capita income and the labor share.
1For a recent description see Barro and Sala-i-Martin (1995).2United Nations National Accounts Statistics, several issues.9. Employment also contracted sharply during the years of civil strife and hyperinflation (Figure 6). After rising steadily through the mid-1980s, employment fell by over 1 million as a result of the crisis in the late 1980s.
Employment, 1960-2001
Citation: IMF Staff Country Reports 2002, 269; 10.5089/9781451829181.002.A001
Sources: International Financial Statistics (IFS); and Fund staff estimates.Employment, 1960-2001
Citation: IMF Staff Country Reports 2002, 269; 10.5089/9781451829181.002.A001
Sources: International Financial Statistics (IFS); and Fund staff estimates.Employment, 1960-2001
Citation: IMF Staff Country Reports 2002, 269; 10.5089/9781451829181.002.A001
Sources: International Financial Statistics (IFS); and Fund staff estimates.Productivity
10. Total factor productivity collapsed in the post-revolutionary period, followed by a moderate recovery in the early 1990s (Figure 7). Many influences converge in the Solow residual, including infrastructure, the quality of regulation and the legal framework, education and governance. The slump in productivity during the 1980s can be attributed to the combined effect of extensive nationalization, rapid expansion of the public sector, the widespread use of price controls, high military spending, monetary expansion, exchange-rate misalignment, import controls and international isolation.
Total Factor Productivity, 1960-2001
Citation: IMF Staff Country Reports 2002, 269; 10.5089/9781451829181.002.A001
Sources: Central Bank of Nicaragua; International Financial Statistics; and Fund staff estimates.Total Factor Productivity, 1960-2001
Citation: IMF Staff Country Reports 2002, 269; 10.5089/9781451829181.002.A001
Sources: Central Bank of Nicaragua; International Financial Statistics; and Fund staff estimates.Total Factor Productivity, 1960-2001
Citation: IMF Staff Country Reports 2002, 269; 10.5089/9781451829181.002.A001
Sources: Central Bank of Nicaragua; International Financial Statistics; and Fund staff estimates.11. A turnaround came in the early 1990s when a new, democratically-elected government initiated a comprehensive effort of adjustment and reforms. In addition to macroeconomic stabilization, most price controls were removed, foreign trade was liberalized, and the banking system as well as numerous enterprises were reprivatized. Moreover, substantial progress was achieved in obtaining debt relief from external creditors. The resulting pick up of growth since 1995 was led by higher total factor productivity. Much of this increase took place in the agricultural sector (see Figure 2). At a later stage, capital accumulation and employment growth also contributed (Figure 8). The increase in capital accumulation was supported by both a rebound in savings and large-scale external assistance.
Contribution of Employment, Capital Stock and Productivity to Growth, 1960-2001
Citation: IMF Staff Country Reports 2002, 269; 10.5089/9781451829181.002.A001
1/ The Hodrick-Prescott (HP) filter is a statistical method that removes short-term fluctuations. Its trend line adapts to the underlying “long waves” of a time series.Source: Central Bank of Nicaragua; International Financial Statistics; and Fund staff estimates.Contribution of Employment, Capital Stock and Productivity to Growth, 1960-2001
Citation: IMF Staff Country Reports 2002, 269; 10.5089/9781451829181.002.A001
1/ The Hodrick-Prescott (HP) filter is a statistical method that removes short-term fluctuations. Its trend line adapts to the underlying “long waves” of a time series.Source: Central Bank of Nicaragua; International Financial Statistics; and Fund staff estimates.Contribution of Employment, Capital Stock and Productivity to Growth, 1960-2001
Citation: IMF Staff Country Reports 2002, 269; 10.5089/9781451829181.002.A001
1/ The Hodrick-Prescott (HP) filter is a statistical method that removes short-term fluctuations. Its trend line adapts to the underlying “long waves” of a time series.Source: Central Bank of Nicaragua; International Financial Statistics; and Fund staff estimates.12. At the end of the 1990s, however, output and productivity growth tapered off again. Reconstruction after Hurricane Mitch initiated an increase of public spending that interrupted the process of fiscal adjustment. Large fiscal deficits led to rapid accumulation of domestic debt and crowding out of credit flows to the private sector, which plummeted from over 50 percent of GDP in 1999 to close 30 percent of GDP in 2000. Growth was further affected by a banking crisis (2000-01) and a large external terms-of-trade shock (cumulative decline of almost 28 percent in 1999-2001). As a result, private investment declined to about 15 percent of GDP and economic growth fell to an estimated 1 percent in 2002.
C. Conclusion
13. Nicaragua has experienced large swings of growth over the past 40 years. The analysis in this chapter shows that the long-run swings in GDP growth were mostly driven by changes in total factor productivity growth (Table 1).
Nicaragua: Sources of Growth
(In percent)
Nicaragua: Sources of Growth
(In percent)
| Period | Annual GDP Growth | Contribution to GDP Growth | ||
|---|---|---|---|---|
| Labor | Capital | TFP | ||
| 1960-1977 | 6.4 | 1.9 | 1.9 | 2.6 |
| 1978-1991 | −3.0 | 0.6 | 0.0 | −3.4 |
| 1992-2001 | 3.8 | 1.4 | 1.1 | 1.4 |
Nicaragua: Sources of Growth
(In percent)
| Period | Annual GDP Growth | Contribution to GDP Growth | ||
|---|---|---|---|---|
| Labor | Capital | TFP | ||
| 1960-1977 | 6.4 | 1.9 | 1.9 | 2.6 |
| 1978-1991 | −3.0 | 0.6 | 0.0 | −3.4 |
| 1992-2001 | 3.8 | 1.4 | 1.1 | 1.4 |
14. The history of Nicaragua’s growth and its main driving forces suggest that macroeconomic stability and market-oriented reforms are essential for the resumption of total factor productivity growth. In particular, fiscal consolidation, reduction of public domestic debt, and strengthening the financial sector are important pre-conditions for higher growth rates over the medium term. In addition, Nicaragua will need to redress its product mix towards higher value added goods. Due to the country’s dependence on a few commodity exports, its terms of trade have been on a declining path over most of the past 40 years (Figure 9). This dependence could be reduced by diversifying into tourism and nontraditional export activities, including assembly for re-export (maquila) in sectors such as textiles. These activities would tap the potential of the sizable young labor force and complement the country’s traditional strength in agriculture.
Terms of Trade, 1960-2001
Citation: IMF Staff Country Reports 2002, 269; 10.5089/9781451829181.002.A001
Sources: Central Bank of Nicaragua; and Fund staff estimates.Terms of Trade, 1960-2001
Citation: IMF Staff Country Reports 2002, 269; 10.5089/9781451829181.002.A001
Sources: Central Bank of Nicaragua; and Fund staff estimates.Terms of Trade, 1960-2001
Citation: IMF Staff Country Reports 2002, 269; 10.5089/9781451829181.002.A001
Sources: Central Bank of Nicaragua; and Fund staff estimates.References
Barro, Robert J., and Xavier Sala-i-Martin, 1995, Economic Growth (New York: McGraw-Hill).
Baumeister, Eduard, and Oscar Neira, 1986, The Making of a Mixed Economy: Class Struggle and State Policy in the Nicaraguan Transition, In Transition and Development: Problems of Third World Socialism, ed. R. R. Fagen, C. D. Deere, and J. L. Coraggio (New York: Monthly Review Press) pp. 171–191.
Ocampo, Jose Antonio, 1991, Collapse and (Incomplete) Stabilization of the Nicaraguan Economy, In The Macroeconomics of Populism in Latin America, ed. R. Dornbush and S. Edwards, (Chicago: The University of Chicago Press) pp. 331–368.
Ruccio, D., 1987, The State and Planning in Nicaragua, In The Political Economy of Revolutionary Nicaragua, ed. R. J. Spalding, Chapter 3 (Boston: George Allen & Unwin).
United Nations National Accounts Statistics, 1978, 1985, and 1992.
World Bank, 1981, The Challenge of Reconstruction (Washington D.C.: World Bank), October.
Prepared by Monica Perez dos Santos.
The analysis in this chapter is based on Nicaragua’s official National Accounts. The Central Bank of Nicaragua is preparing a revised National Accounts series for the years starting in 1994. It is likely that the revised series will imply a significantly higher GDP and a change in its sectoral composition. However, the broad trends that are relevant for this study are not likely to change significantly.
