Executive summary
El Salvador has made significant headway on its development path in the past 30 years, including the peaceful resolution of its civil war and major institutional reforms. These paved the way for an open, export-led development model, and significant improvements in the well-being of Salvadorans. Poverty and inequality have declined steadily since the turn of the century, overcoming setbacks suffered with the global financial crisis of 2008/09 and more recently, the COVID-19 pandemic.
Despite these successes, neither the institutional reforms of the post-civil war period, nor the export-focused model of economic development that it has pursued, have fully delivered on expectations. High levels of violence, polarised politics, and only modest advances in reducing vulnerability led to a weakened social contract. Economic growth has been tepid, slowing to 1.5% during the 2000s, and only picking up to a modest 2.4% in 2014-18. It has been mired by low levels of both foreign and domestic investment, low investment in education, and low productivity growth. The economy has also failed to significantly expand the supply of good quality jobs, and informality has persisted over time.
The new political configuration that emerged from the presidential elections of 2019 and legislative elections of 2021 has severely disrupted the prevailing political balance. It has granted ample room for manoeuvre to the executive branch and ushered in a period of intense reform activism and policy experimentation. It has also accelerated improvements to public security, albeit at the expense of temporarily curtailed civil liberties and a growing population in detention centres. The appropriate combination of pragmatism and dialogue would contribute to the sustainability of the reform agenda.
To make the most of its potential, El Salvador should seize the opportunity to set in motion a real development strategy that corrects key structural constraints. This strategy should recognise that, as the country develops, certain structural challenges persist even as new opportunities and challenges arise. The diagnostic phase of this Review identified key constraints to El Salvador’s development across the five P’s of the 2030 Agenda: People, Prosperity, Partnerships, Peace and Institutions, and Planet. These can be subsumed into three inter-related constraints.
Firstly, inconsistencies in the country’s model of economic development limit its potential to deliver robust and inclusive growth. While the model is based on growth driven by the private sector and exports, significant barriers to entry and to doing business persist, and these harm small and medium-sized enterprises (SMEs) and new entrants. They include cumbersome bureaucratic processes, inefficient markets for certain key inputs, and insufficient provision of key public goods, including infrastructure, skills formation, and efficient administration. Dollarisation also limits the scope for adjustment in the search to diversify export markets, resulting in a loss of international competitiveness. The export-led model appears in fact to be in competition with a model based on internal demand fuelled by migrant remittances.
Secondly, the capacity of the state to provide public goods and services is limited by the country’s institutional features, and by a vicious circle of vulnerability, low growth and low capacity that weakens the legitimacy of state institutions. Access to key public services has improved significantly since 1992, but large gaps remain. Enrolment in secondary education reached 77% in 2013 before falling again. Access to health services has improved, but access gaps concern a quarter of the population. Most notably, the state’s ability to ensure the rule of law has been limited by the presence of criminal gangs and a culture of violence and impunity that is yet to be fully eradicated. The limitations of the state constrain growth due to the limited provision of key public goods. Conversely, the lack of state legitimacy, plus low levels of economic growth, limit the prospects of the formal economy and keep fiscal revenues low, constraining the administration’s margin for manoeuvre. The unfinished reform of the pension system exemplifies this vicious circle, as a regressive system with limited coverage generates debt that undermines fiscal space.
Thirdly, the management of fragile natural resources, especially water, needs to improve in order to secure future livelihoods and economic opportunities. El Salvador has a natural environment that has potential for agriculture and tourism, but one that is also highly vulnerable to natural disasters. This vulnerability is exacerbated by climate change, and by a history of mismanagement of forest and water resources. Water stress generates trade-offs between economic development and access to drinking water that could be avoided in the future if the institutional capacity of environmental authorities is increased and the value of environmental resources is recognised by all actors in society.
In order to respond to the structural constraints that continue to hinder its development, and capitalise on its assets, El Salvador needs to take policy action in four critical policy areas.
First, El Salvador needs a productive transformation. Productivity growth amounted to just 0.1% per year during the 2010s, which is too slow to put the country on a path to convergence with advanced economies. To accelerate economic transformation, it is necessary to address obstacles to competitiveness and productivity growth: from mitigating the impact of crime in the economy to improving infrastructure and reducing red tape. There is also ample scope for more active modern industrial policy to steer economic development, accelerate digitalisation and put innovation at the centre of productive development policy.
Second, the country needs to invest in the education of its youth and build relevant skills for its population. Sustaining the increase in public expenditure in education is a key ingredient. Encouraging youth to complete secondary school should be a priority, as well as increasing the quality of education though policies to better manage and equip teachers with the skills they need in the classroom. Building on public-private dialogue to ensure that students receive relevant labour market skills is necessary for education to be a gateway to the labour market.
Third, better management of scarce water resources is needed to ensure access to clean water and sustainable livelihood opportunities to all. The adoption of the General Law on Water Resources in 2022 was a key milestone in this regard. El Salvador should build on the new legal framework to establish basin-based water management and adopt a risk-management approach to better manage scarcity, pollution and flooding. Moving towards full cost recovery through a revision of pricing structures, overseen by an independent regulator, would help generate the necessary resources for water supply and sanitation.
Fourth, the modernisation of the State would strengthen the ability of the administration to perform its functions effectively. The ongoing digitalisation drive should be complemented by the institutionalisation of critical functions of government. A dedicated strategy unit with the time and capacity for medium and long-term thinking and a more robust framework to monitor and evaluate strategic priorities would strengthen the capacity to drive sustainable transformation. A specific institution in charge of leading and overseeing human resource management in the administration would help overcome capacity limitations and administrative silos. It is also necessary to renew the country’s commitment to open government, to transparency and to stakeholder participation to ensure policy solutions are fit for purpose and can form the basis of a new consensus for development.