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  Number 386 | Septiembre 2013
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El Salvador

Has the FMLN government been an economic failure?

In an interview with envío, Dominican economist César Villalona, who has lived in El Salvador for 23 years working as an economic and social researcher, unravels all the rightwing propaganda on the “economic failure” of President Mauricio Funes’ government.

Elaine Freedman

Just months shy of the March 2014 presidential elections, every topic that appears in the public arena is quickly pounced on as an electoral campaign issue for any of the parties or their allies. The country’s economic situation is no exception. “The FMLN government’s economic failure” is a centerpiece of the Nationalist Republican Alliance (ARENA) party’s campaign under the slogan “We’ll recover El Salvador.”

Salvadoran economists are acting like strategic bishops on a chess board, facing off from the Right and Left during the election campaign. About ten economists are writing on a daily basis in the country’s newspapers, appearing in television interviews and on radio programs. They’re political actors. Institutions such as the Salvadoran Foundation for Economic and Social Development (FUSADES), speaking as a “think tank,” and the National Association of Private Enterprise, speaking as a business association, discuss the economy every day in a political capacity. They are constantly working to turn public opinion against the FMLN government and as such are one of the rightwing opposition’s ideological mainstays.

But other economists, like César Villalona, try to explain, question and teach. In the following interview, Villalona responds to the main lines of attack from ARENA, the business associations and the political and economic analysts in the front lines of the right wing’s battlefield of ideas.

Growth and capital flight

EF: Miguel Lacayo, minister of the economy in Francisco Flores’ administration, states that “while our neighboring countries are growing at rates more than double our own, reducing their inhabitants’ poverty, El Salvador is getting more in debt than ever and only grew 1.6% in 2012.” Is this true?

CV: The Salvadoran economy has had the lowest growth rates in Central America for many years now, starting long before Mauricio Funes’ government. This is because the country’s big business, which has the main economic responsibility because it manages the largest portion of the national income, invest a good part of itsr resources outside El Salvador. According to the NGO Global Financial Integrity, Salvadoran big business invested US$8.7 billion abroad between 2001 and 2010. Saying the Salvadoran economy isn’t growing much isn’t exactly news. It amounts to stirring up a national reality that’s been that way 15 years now.

The government doesn’t have enough resources to promote solid growth in production. When ARENA was governing, the State received 13.5% of the national income via taxes and now gets 15.5%. So it has a little bit more, but the tax burden is still one of the lowest in Central America. To provide a parameter, the average in Latin America is 25% of the GDP. The governments of Costa Rica and Nicaragua receive 25% and 22%, respectively.

Second, the GDP actually fell 3.1% in 2009, the last year of the ARENA government and first year of the Funes government. That was the worst economic year since 1983. The GDP has since grown by an average of 1.7% a year between 2010 and 2012, and this year it is estimated that it could grow by 2%, even though the capital flight has continued. Foreign investment has also increased slightly, reaching a bit more than US$500 million compared to just over US$330 million in 2009. In other words the economy has moved from a fall to slight growth. It’s lower than in the other Central American countries, but restarting a collapsed economy is no small thing. And that has happened during the current government.

EF: Why the capital flight?CV: It started in the late nineties. What happened is that the country’s big businesspeople accumulated too much wealth between 1989, when ARENA took government for the first time, and 1997. They couldn’t invest it all in El Salvador because it would generate overproduction, given the limits of the domestic market. The businesspeople benefitted from an economic program they themselves initiated under the government of millionaire Alfredo Cristiani, which continued under the three subsequent ARENA administrations. That program weakened the State but strengthened private enterprise. It had three main areas. The first was the privatization of public businesses such as the banks, the telephone company, electricity distribution companies, pensions, the sugar mills… The second was a tax reform that consisted of relieving the rich and oligarchs of taxes while at the same time making ordinary people pay more. They did that by removing coffee and sugar export duties and the capital gains tax and lowering the tax on business profits. Eliminating the coffee tariffs alone put over US$100 million more into the oligarchs’ hands. For the people, they established value added tax, which is very regressive. And finally, they eliminated the price controls on 230 products, freed up bank interest rates and input prices and reduced import tariffs to stimulate imports.

As if all this wasn’t enough, the country’s reconstruction with the end of the war meant an inflow of $1.5 billion in donations. This money went into the Central Reserve Bank (BCR) in dollars and the BCR issued the government colons [the former Salvadoran currency] to finance the reconstruction. The amount of dollars in the economy increased, allowing an exchange rate of 8.7 colons to the dollar. This benefitted importers, who bought dollars and imported rice, beans and maize, putting many small-scale growers out of business and forcing them to emigrate. As a result, remittances started increasing, which in turn strengthened private banking and the big importers even more, particularly since they were one and the same.

This is how the business elite became flooded with money and flooded the country with products. In the post-war boom between 1992 and 1995 the GDP increased by an average of 7%, but in 1996 they realized a problem was looming. Their profits were so enormous they could no longer invest much in the country because the domestic consumption capacity was very limited, precisely due to the concentration of wealth and income and the low spending power of most of the population. If they invested a lot in El Salvador it would generate over-production, as in fact happened in 1999 causing negative inflation.

Since the market couldn’t absorb any more, they started sending an important part of their capital abroad, particularly to other Central American countries, setting up investments in Guatemala, Honduras and Nicaragua. The Poma family established a Metrocentro shopping mall and vehicle importing companies in each Central American country; the Simán family created department stores in several of the countries; all of the banks opened branches in neighboring countries and new hotels sprang up across the region. That was before dollarization.

They continued investing most of their capital in El Salvador, however, with only the excess going to Central America as well as to investments as far away as Colombia and Miami. When the Salvadoran currency was dollarized it made it even easier to send capital out of the country as they no longer had to buy dollars with colons.

The economy hasn’t been energized because a bigger domestic market would have to be created for that to happen, and that can only be done with a more equitable distribution of wealth and income. The Gini index, which is a way to measure a country’s income distribution, has improved slightly—from 48 to 42—with the Funes government, but remains much higher than the average. The distribution of wealth is better in Nicaragua, Costa Rica and even Honduras.

To redistribute income, businesspeople would have to pay better wages and more taxes. More taxes allow governments to invest in social and agricultural support programs, which beef up the markets and put more money in the hands of the grassroots majorities. Obviously, wage increases are a more direct way of doing this. Honduras’ tax burden is still low, but wages increased a lot during the Zelaya government and measures were applied that increased peasant production and improved income in the countryside.

But Salvadoran businesspeople find it more profitable for 34% of households to continue living in poverty because they only invest in the consumption of the non-poor population and send the rest of their capital abroad. It goes without saying that the investments they make in other countries feeds the GDP of those countries, not El Salvador. Yet they act surprised that the other economies are growing more...

Foreign investment

EF: Salvador Samayoa, a former FMLN leader and later a top official in Francisco Flores’ ARENA government, says that “according to ECLAC, El Salvador is the country that has received the least direct foreign investment in the region. The World Economic Forum shows El Salvador having dropped ten places in the last year in terms of competitiveness while the World Bank shows it dropping two places in the ease of doing business index, and the ultra-conservative Heritage Foundation says El Salvador dropped 12 places in the economic freedom index. Anyone can argue with these indexes, but they can’t all be wrong. The climate has evidently not been good and both the government and the parties supporting it must share an important degree of responsibility.” What do you think?

CV: El Salvador has received the least foreign investment of any Central American country since 2006. Even before then, Guatemala, Honduras and Costa Rica were already ahead of it and, according to ECLAC, Nicaragua overtook it that very year. And that has happened despite all the promises that dollarization and the free trade agreements signed with the United States, Chile and Mexico would attract more foreign investment. That hasn’t turned out to be true.

Foreign investment hasn’t actually fallen during this government. In 2009, the last year ARENA governed, foreign investment was under $100 million. It started to increase significantly in 2011, reaching $382 million, and totaled $525 million in 2012. It is less than the other Central American countries, but it was before the current government as well, whereas the amount has grown in the last two years.

It has to be said that foreign businesses don’t invest much in production for national consumption because they would also generate over-production. They’ve mainly bought up existing companies. 1998 was a peak year for foreign investment with the purchase of the telephone system, electricity distribution and part of the pension scheme. We had our second peak in foreign investment in 2007-2008, when entrepreneurs sold off their banks and insurance and pension companies.

Competitiveness vs. subsidies

The term “competitiveness index” should be eliminated from economic dictionaries. It makes no sense. Is the US economy competitive? I’d say it isn’t. If it were, it wouldn’t have to grant so many subsidies. Agriculture is subsidized in the United States. If the farmers didn’t receive those subsidies, they wouldn’t be able to produce, even though their country has a high level of technology and a lot of skilled labor. The same is true in Japan or South Korea, and production subsidies are even higher in Europe.

Labeling an economy either competitive or not is a perverse analysis. Why not remove the subsidies from US corn farmers? Then we’d see whether Salvadoran farmers are more productive. That competitiveness isn’t proven. It’s an index the international organizations use to say which countries are doing well and which are doing badly. And generally speaking, as in the case of drugs, those classified as high risk are those where the Left or progressive forces are governing.

I ask myself what gives an international financial organization the moral authority to say which countries are a greater or lesser risk. These organizations were painting a rosy picture of the world economy when it was on the verge of collapsing with the crisis in the United States and Europe. They had just applied an adjustment policy when the crisis came and the World Bank asked for forgiveness for the errors it had committed. They have economists there that earn $50,000 a month yet they got all of their calculations the wrong way round.

Salvadoran businesspeople really like the topic of “business climate.” They say it’s very complicated to set up a business here because there are many procedures. But they fail to mention other elements that favor businesses here. There are 26 laws here that allow them not to pay taxes, loopholes available through the tourism law, the free trade zone law, the seeds law... The ARENA governments lowered tariffs in such a way that there are virtually no obstacles to importation, which was even further stimulated by the dollarization. There are no obstacles to a bank deciding the interest rates it wants to establish for its loans, or to a business setting any price it wants. El Salvador must be the Central American country with the fewest obstacles to doing business.

Sometimes a country’s level for one of the indexes drops not because that country has gotten worse, but because others have improved. El Salvador recently moved up in the specific human development indicators established by the United Nations Development Programme, but dropped from 103rd to 104th in the overall ranking because two other countries made relatively greater progress. Spokespeople for FUSADES, which is made up of representatives of private big business, appeared on television screaming blue murder because we’d dropped a place, without mentioning that the country’s real figures actually improved. This is neither ethically nor technically correct; it’s pure political manipulation.

The fiscal deficit

EF: Economist Claudio de Rosa, ARENA’s municipal director in Zacatecoluca, argues that “the high debt and public spending levels explain why the government hasn’t managed to bring the fiscal deficit to under 2%, as it outlined in the 2010-2014 Five-Year Development Plan, or even to 2.5% as it promised to the International Monetary Fund. In fact, last year’s fiscal deficit was 3.5% and it is estimated at between 3.7% and 4% for 2013.

CV: The fiscal deficit was a little over $1.14 billion in 2009, equivalent to 5.7% of the GDP. Calculating the deficit as a percentage of the GDP is a strange indicator but I use it here because it’s the one the Right most likes to use for this issue. By 2012 the deficit was down to $826 million, equivalent to 3.4% of the GDP. In other words, the government has improved the economic situation over what it inherited from ARENA.

Now, there are two ways to finance a deficit: go into debt or sell assets. Selling off state assets is like a family selling off a fridge to get money to pay off its debts. But Funes hasn’t privatized any company. His government went into debt to finance the deficit, and because the deficit has dropped over the last three years, so have the loans required to finance it. By this logic, the previous ARENA government indebted itself more than this one.

The public debt

The payment of pensions has a big influence on this government’s debt. Of today’s deficit of $426 million, over $400 million goes to pension payments. Because ARENA privatized the pension system in 1998, the National Institute for Public Employee Pensions (INPEP) continues paying out to retirees without receiving any new pension payments for the past 13 years, when everyone under the age of 35 had to transfer to the private system. During Saca’s government, INPEP went into crisis because of this. Violating the Constitution—because it was a loan acquired without getting the required absolute majority vote in the Assembly—a trust fund was approved through which the Private Pension Fund Administrators (AFPs) could lend the Treasury Ministry money through the Multisectoral Investments Bank. Funes had to increase the trust fund as more people from the public system reach retirement age. That situation will continue until all the pensioners who paid into the public system have died. Meanwhile the APFs are making money off the plight INPEP was thrust into.

But we need to be very clear about another truth regarding the debt. This government inherited 103 loans that must be paid now. And Funes has been earning a good reputation because he has paid everything: so far a total of some $3 billion in loan amortization and interest payments. And most of that money isn’t going toward paying his own government’s loans since those from 2009 and 2010 are only just beginning to be paid now.

I want to demonstrate that the current debt isn’t greater than the previous one. Fifteen indicators are used internationally to analyze a country’s debt: export income vs. debt servicing; export income vs. debt interest; monetary reserves vs. debt; debt servicing vs. debt disbursements, and so on. But the IMF, World Bank and rightwing economists only use one: the relationship between the public debt and the GDP. They tell you that when this government came to power the debt represented 54% of the GDP and now represents 60%. But this debt isn’t paid with the GDP; it’s only paid with public income and the State only owns 15.5% of the GDP.

How does this work? Let’s say I’m a salary earner working in industry and I earn $1,000 a month. What’s my part of the GDP? It’s $12,000 a year through my salary, and I have to calculate my debt in relation to that $12,000, not the whole GDP, because those who have the majority of the GDP in their hands—the businesspeople—aren’t going to pay my debt. Nor will the government or the country’s other salary earners pay it with their part of the GDP. It’s the same with the government debt. It isn’t paid by businesspeople, who taken together receive 60% of the GDP. My creditors only care about whether I can pay my debts with my earnings, just as the relevant question for the government is whether it can pay its debt with its own income. Continuing with the same example, if I earn $12,000 a year and my debt is $3,000, that debt burden may not be too heavy. But it’s more difficult for someone to pay off a debt that size while only earning $6,000 a year.

It should also be stressed that it’s a bit misleading to talk about public sector debt, because the public sector has three parts: the central government; public institutions such as the Río Lempa Hydroelectric Executive Commission (CEL) or the National Water and Sewerage System Administration; and public financial institutions such as the Central Reserve Bank, the Agricultural Development Bank (BFA), the Mortgage Bank and the recently-created El Salvador Development Bank (BANDESAL). And the public institutions are responsible for their own debts, not the central government. They each pay their debts with their own income.

So let’s analyze the central government’s debt. When Funes took office, it was approximately $8.8 billion and today it’s nearly $10.6 billion. But if we compare the State’s income to its debt, it was only able to pay 29% of the debt in 2009 compared to 31% in 2012, meaning that the debt is currently less of a burden. That’s the indicator that needs to be used. El Salvador is actually in a pretty acceptable position regarding this and most other indicators, in fact it’s better than the previous administrations.

Public spending

EF: Yet when rightwing economists talk about the fiscal deficit, they attribute it to a policy of irresponsible current expenditure and social spending by the Funes government.

CV: But that isn’t real. I repeat that this government has only 15.5% of the GDP, approximately $3.6 billion. As one of the Latin American governments with the least amount of money, it’s also one of those that spend the least.

El Salvador’s fiscal deficit isn’t because the government is spending a lot, but because it doesn’t have a lot of income coming in. And that’s for three main reasons. The first is tax evasion. Alexander Segovia’s book El camino del cambio en El Salvador [The road to change in El Salvador] estimates 33% tax evasion. Before Funes it was even worse: 38%. If we calculate this for 2012, we’re talking about $1.7 billion, which would be enough to pay off the deficit and more, but it remains in the hands of businesspeople.

The second reason is fiscal avoidance, those 26 laws that allow tax exoneration or exemptions. According to a research study by the Legislative Assembly on this very point, which they euphemistically call “fiscal spending,” these laws stopped an average of $900 million a year from coming into the budget between 2001 and 2009. The most recent figures are for 2011, when such avoidance amounted to $1.2 billion.

The third reason is the tax structure. In this country the government is sustained by the consumer population through the value added tax, import tariffs, FOSALUD (taxes on drinks, cigarettes and arms), FOVIAL (the road fund), etc. It is also sustained through the income tax collected from wage earners. Taken together all of this represents 82% of public income, while the tax on business profits only brings in 18% of the government’s tax income. This means that businesspeople, who receive 60% of the GDP, only contribute 18% of government’s tax income, while working people, who only receive 25% of the GDP through their salaries, contribute the other 82%. In other words, the people who don’t have much money sustain the government, while the businesspeople who have a lot of money don’t, and don’t believe they should have to.

EF: What’s the explanation for the 5% reduction in tax evasion achieved by this government?CV: It’s partly due to improved auditing controls. For example, customs is now using laser equipment to check trucks, which reduces the possibility of contraband. The Treasury Ministry has also been a bit more aggressive in pursuing tax evaders. There’s still a high level of evasion, even if we accept the international finance organizations’ idea that 15-20% evasion is an “acceptable” or “tolerable” level. No tax evasion should be “tolerable,” because it implies millions of dollars being paid by the people and stolen by private enterprise.

The 33% in El Salvador is significantly above those levels. Yet tax evaders still have the cheek to say the government is spending too much on education and health programs. This deserves to be publicly denounced because they are the ones responsible for the government not having enough resources to substantially reduce infant mortality, malnutrition and illiteracy. A lot could be done with the $1.7 billion they evade paying.

EF: Miguel Lacayo has accused Funes of the following: “He prefers to fatten the ranks of state bureaucracy without providing improvements in the public services or seeking spending efficiency, but rather complicating the services and making them worse. The government is practicing clientelism by hiring over 20,000 people for the public sector and increasing wage spending to the detriment of investment in infrastructure.” How do you respond to that?

CV: If the government has only created 20,000 new public sector jobs, then that’s a very small amount. It’s normal for a government that increases its health and education budget to hire more people. If you’re going to reduce illiteracy, more schools and above all more teachers are obviously needed. This government has built various hospitals and clinics and they require more doctors, nurses and service personnel to staff them. That’s a good thing. People need jobs.

The increase in wages can’t be understood as clientelism. It’s fair because we have very low minimum wages in this country. Wages in the countryside don’t pass the $110 a month mark, while in the public sector it’s $300. And these low wages are a factor in generating poverty. The increase in July has been almost imperceptible—only 4%— thanks to the protests from businesspeople, and I’m not talking about small and medium ones, but the big ones who opposed any greater increase. The proposed 14% increase was in the interests of small and medium businesspeople because while the measure would have increased their costs, it would also have meant there more money in the streets, allowing greater consumption, which would have benefitted them. Who doesn’t benefit from a wage increase and increased consumption? The answer is the roughly 1,850 exporters, because they sell abroad so they aren’t affected by an increase in national consumption. Less than 50 businesspeople from this group are classified as “small” or “medium.”

TACA, now AVIANCA, had $351 million in profits in 2012. This is an interesting and terrible figure, because if we divide it by the annual minimum wage in the rural area that year, which was $1,260, we see that AVIANCA’s profits equaled the annual salary of almost 280,000 peasants. So it would take a Salvadoran peasant 280,000 years to earn what AVIANCA earned in one year. How can they say that a salary of $300 a month is clientelism?

It’s absolute nonsense to say that public salary spending has been at the expense of national infrastructure. It’s false because this is the government that has been responsible for the most public works. The Ministry of Public Works budget has increased by 40%. And contrary to what happened under the governments of Francisco Flores and Antonio Saca, the works have actually been done. Hundreds of drainage channels have been repaired, highways have been finished and others constructed, and hospitals and schools have been built, among other works.

Poverty and unemployment

EF: But Miguel Lacayo insists that “There are more poor people, more unemployed and less optimism about the future today than when Funes and the FMLN took the helm of this country.” And Salvador Samayoa adds that “right from the start of his mandate the President completely misplaced the papers related to his main promise: job creation. And the people have felt the effects. In the last opinion survey by JBS Market Research for El Diario de Hoy, 92% of those polled said the employment situation is the same or worse. It’s an overwhelming figure. And it’s no trick or manipulation of the figures, like others do when consolidating answers for the benefit of their own arguments. In this ‘same or worse’ figure the vast majority of people (68.5%) think the employment situation is worse.” What do you think about this?

CV: The Multi-Purpose Household Survey, conducted every year since the seventies by the Economy Ministry’s General Directorate of Statistics and Censuses, reported a national poverty rate of 40% in 2008. In 2012 the rate had dropped to 34%. When President Funes took office, unemployment was calculated at 7.3%. In 2012 it was 6.1%. I’m referring to open employment here. Under-employment has neither risen nor fallen, remaining at 35-40%. Although that’s significant under-employment, Miguel Lacayo’s statement got things completely the wrong way round.

Certainly, the majority of people are still in a very difficult situation and the 34% poverty rate is still a high figure. For someone living in poverty, the fact that the rate has dropped a few percentage points doesn’t mean anything, because personally speaking the situation hasn’t changed. But that doesn’t mean that the overall situation in the country hasn’t improved.

Funes’ campaign promise was to create 100,000 jobs in five years. So far, according to figures of the Salvadoran Social Security Institute (ISSS), 89,000 new jobs have been created, i.e. 89,000 more people are now registered with the ISSS than in June 2009. Most of them work in private companies, with a minority in the public sector and an even smaller minority in the cooperative sector. Funes’ promise could still be achieved in the final months of his government. When President Flores signed the Central American Free Trade Agreement (CAFTA), he also said that it would generate 100,000 new jobs. But during his government only 25,000 new jobs were created, and a somewhat higher 60,000 were created under Antonio Saca’s administration.

An important measure that came into force on April 4, 2013, and could have a significant impact on people’s perception is the Medicines Act, which introduced a new price system. The JBS survey referred to by Samayoa was done in the third week of April, so the law probably hadn’t yet had any impact at that time. It is calculated that it will produce savings of $60 million a year among the population. The law establishes that the prices for over 7,000 medicines cannot exceed the regional average price, and three to five times the international reference price set by the World Health Organization. Although the laboratories and drugstores are repeatedly seeking ways to skirt the law and turn the population against it, this has so far proved to be one of this government’s most important measures because at the time the law was passed, El Salvador was considered one of the countries with the most expensive medications in the world.

Subsidies vs. tax evasion

EF: According to former economy minister Miguel Lacayo, “Rather than allocating a big enough budget to repair schools, buy hospital supplies and medicines, and repair streets and hospitals, the government prefers to squander public resources by subsidizing many people who don’t need it. The FMLN government spent $470 million on subsidies (electricity, gas, water and public transport) in 2012, but a very high percentage of these subsidies favored the higher-income population. Half of the electricity subsidy and a quarter of the water subsidy was received by the 20% of the population with greater spending power, while the 40% of Salvadorans with lower income receives only 12% of that energy subsidy. Public transport owners were given $64 million without anything being required of them in return, without having to pay their fines or respect the most basic traffic rules and without requiring them to treat the population with respect.” How would you respond to this?

CV: To begin with, those four subsidies were approved during the ARENA governments. If it’s true that they benefit the rich, that would be because they were designed that way and this opinion is a manipulation by a former minister who participated in some of the designs.

In any case, these subsidies shouldn’t be compared with the government’s other public spending. It makes no sense to say “instead of repairing schools, buying hospital supplies…” as this government has increased the social budgets and public works. In the case of the Ministry of Health, investment has increased. During the last ARENA government, the Ministry managed to cover approximately 60% of the medicines in public sector hospitals, compared to 80% coverage today, which is very good; no country has 100% civerage. This has been achieved despite the greater demand since the government eliminated the “voluntary” quota clients were forced to pay against their will. The subsidies aren’t at the expense of the social budgets.

Why hasn’t the government removed the subsidies? Because it would result in a significant cost to the 34% of the population living in poverty. The middle sectors also benefit from certain savings through the subsidies, which is important. The middle classes complain about the lack of benefits from this government, and it’s true to the extent that Funes has aimed his policies at the most marginalized population, particularly in rural areas. Criticizing what has been done seems insane, perverse to me.

Could the subsidies be corrected to benefit those below a little bit more and those in the middle a little bit less? Yes, they could, but that’s not going to significantly influence the government’s financial problem. The Inter-American Development Bank just published a study recommending that the government target the subsidies better in order to save $45-60 million a year. In a country whose fiscal deficit is $826 million, that saving doesn’t represent a lot of money. Let’s not forget that tax evasion is $1.7 billion. I’d leave the subsidies alone for now and focus the fight on tax evasion, which would eliminate the deficit without any need for a loan.

Elaine Freedman is a grassroots educator and the envío correspondent in El Salvador.

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