El Salvador

Trade and Trade Policy

Port expansion at Acajutla
Courtesy Inter-American Development Bank

El Salvador's degree of dependence on imports of intermediate and capital goods changed little between 1978 and 1985. Moreover, its dependence on a few agricultural export commodities, such as coffee and sugar, and its failure to explore nontraditional exports continued to limit growth potential. Despite government promotion of nontraditional export products, exports actually became less diversified throughout the seven-year period, with manufactured goods falling as a share of total exports from a 40 percent share to only 20 percent, and coffee rising to a 40 percent share from 24 percent.

The country's import trade dependence also continued unchanged. Intermediate and capital goods represented about 60 percent of imports in 1985. That imports of these goods continued to constitute such a significant share of total imports reflected the failure of import substitution industrialization (see Glossary) programs to replace imports with locally produced goods.

The value of imported and exported goods and services was equivalent to over 50 percent of GDP in 1985. Lacking a diversified export sector and given its high degree of dependence on imports of capital and intermediate goods, the Salvadoran economy was vulnerable to variations in the terms of trade. Since the world market prices of El Salvador's primary exports, especially coffee, were highly volatile, fluctuations in the terms of trade were common. For example, if 1980 equals 100 percent, the country's terms of trade went from 72 percent in 1984 to 90 percent in 1986 and to 54 percent in 1987. These fluctuations underscored the economy's instability and stunted the country's potential growth.

Trade policy in El Salvador changed significantly between 1960 and 1987, reflecting the emergence--and subsequent decline-- of the CACM, price fluctuations for coffee and other commodities, and the evolution of the Salvadoran economy. Past failures and mismanagement prompted the IMF to effect commercial policy changes in 1982 and 1986.

The 1960s have been characterized as the Golden Age for El Salvador and the rest of Central America. The establishment of the CACM in 1960 reduced intraregional trade barriers and drastically cut import duties--normally an important source of government revenue. The CACM made it possible for the Salvadoran government to pursue import substitution industrialization policies then in vogue in Latin America because the reduction in intraregional trade barriers effectively increased aggregate demand for nontraditional export products. For El Salvador--more than for any other CACM member--these policies favored the development of a significant manufacturing sector. The protective tariffs established by the CACM on manufactured goods encouraged its countries to develop competitive domestic industries. Trade barriers restricted imports of finished goods from non-CACM members and reduced tariffs on foreign raw materials.

Even with these and other changes, however, El Salvador's trade policy continued to center on the promotion of agricultural exports, a promotion essential to the government's industrialization plans. The earnings from agricultural exports were diverted (through export taxes and other charges) to the purchase of raw materials, machinery, and other unavailable domestic capital goods. Despite the rapid growth of manufacturing industries in El Salvador during the 1960s, most manufactured exports by 1970 (especially food products, beverages, and textiles) were shipped to the CACM. Three export products-- coffee, cotton, and sugar--accounted for 90 percent of extraregional exports.

When the CACM began to decline in the 1970s, policymakers established an industrial free zone, which provided some incentives to export manufactured goods outside the CACM. The industries that were in the free-trade zone, however, tended toward the production of intermediate goods that required costly imported inputs. Consequently, these industries neither created value added for the Salvadoran economy nor improved El Salvador's balance of payments position. These new industries, however, increasingly tailored Salvadoran manufactured exports to North American and West European markets by the end of the 1970s. Nevertheless, a fixed exchange rate program continued to discriminate against exports because the dollar exchange rate remained overvalued. As a result of this policy and the country's increasing political instability, by the end of 1980 only four foreign companies continued to operate joint ventures in the free-trade zone.

The establishment in 1982 of a dual exchange rate pegged the United States dollar at c2.50 on the official market, while the rate on the parallel market fluctuated with market forces. Until 1985, as the country responded to balance of payments pressures, an increasing percentage of external transactions was shifted to the parallel market. Even with the gradual shift of transactions toward the parallel rate, a 20 percent real appreciation of the colon undercut the competitiveness of Salvadoran tradables. Following the rates unification in 1986, the colon remained fixed, and currency was overvalued.

Two other important changes affected Salvadoran trade policy in the 1980s. First, producers of goods exported outside of the CACM were allowed to establish United States dollar-denominated accounts in Salvadoran banks. Second, exporters of nontraditional goods, e.g., beverages and processed food, were permitted to hold dollar accounts and sell them to the Central Reserve Bank at their discretion; the exporters were not required to report the exchange rate of these transactions. In a sense, these changes signaled the return to a nonunified exchange system.

Data as of November 1988

El Salvador - TABLE OF CONTENTS