The Funes Government Faces an Economy on the Brink

November 2, 2009

The new president of El Salvador, Mauricio Funes, assumed office in June under a very challenging set of economic circumstances. Indeed, the country’s current economic performance is dismal by any measure. The month of August witnessed a year-on-year fall in exports and imports of 16.9% and 29%, respectively; as if that weren’t enough, the flow of remittances from migrants living abroad has declined sharply, falling 6% in August, an $18.3 million drop compared to the same month during 2008.1 Remittances are vital to preventing an increase in poverty in El Salvador. So, too, is the supply of manufacturing jobs, yet employment in that sector is taking a serious hit: In the formal economy alone, layoffs in recent months have eliminated almost 20,000 jobs, according to the Salvadoran Institute for Social Security. No less troubling, we are beginning to see signs of deflation, which could affect both trade and services, the two most dynamic sectors of the economy.

These trends are largely attributable to the adverse effects of the international financial crisis, which has compounded and intensified social problems that have already existed for quite some time, having arisen from the neoliberal economic policies implemented by governments led by the right-wing Nationalist Republican Alliance (ARENA). Yet the economic turmoil has generated widespread criticism, especially among the business elite connected to ARENA, of the new government.2 In September, for example, Chamber of Commerce president Jorge Daboub complained that “there are serious gaps and deficiencies in the [new administration’s] execution of public policies,” emphasizing the absence of an “effective plan to combat crime,” which is understood as a major impediment to foreign investment.3

To date, it’s true, the administration has not presented such a strategy. In June, however, the government announced an anti-crisis plan consisting primarily of short-term measures designed to mitigate the effects of the economic contraction on poor Salvadorans; these measures include creating temporary public-sector jobs, constructing new housing, and improving public utilities and the rural road infrastructure.4 Those who strongly criticize the new government for its supposedly inadequate response to the crisis are ignoring what it is up against: the legacy of ARENA’s failed economic policies. Indeed, ARENA administrations’ decisions to privatize public services, dollarize the economy, and sign free-trade agreements, to mention just a few, are largely to blame for the present predicament.

As a result of these policies, which did little to promote production over consumption, El Salvador became a predominantly import- and consumer-based economy.5 Farmers and industrialists were not given sufficient incentives, while everything was wagered on expanding manufactured exports (a low-value-added sector), transforming El Salvador into a “financial hub,” and more recently, developing tourism. This approach exacerbated long-standing structural characteristics like low wages, the extreme concentration of income, widespread poverty, and high foreign dependency.

Why were these past policies not as beneficial as they were proclaimed to be? Part of the answer can be found by considering the economy from the perspective of supply and demand. On the supply side, El Salvador’s economic profile has changed profoundly since 1989, when the first ARENA government came to power. Today El Salvador presents itself to the world as a modern nation, more urbanized than before, with large commercial enterprises, a complex network of highways, and a great majority of its population using cellular phones. Yet on the demand side, there are important deficits. Relentless levels of unemployment and under-employment, pervasive extreme poverty, and diminishing real wages are sources of weak demand; they have been bolstered only by the inflow of remittances and foreign direct investment. Without these resources, now jeopardized by the crisis, the economic situation could greatly deteriorate.

Those who designed economic policy under the previous governments ignored these fundamental economic questions, and today the business elites connected to ARENA continue ignoring them as they criticize the new administration. From the elite’s point of view, before the impact of the international crisis, the country had found the correct path for development, thanks to the economic model that has been implemented throughout the last two decades. They consider the new difficulties to result not from their own past strategies but from the international crisis and a new leftist government that has failed to establish clear economic policies.6

Yet before the economy was struck by the crisis, some of the problems that have characterized the nation in recent years had already intensified: low growth rates, the concentration of income, and levels of inflation that, though not very high, accelerated with dollarization and gradually eroded real household incomes. During the first years of the new century, the increasing deterioration of the economy caused some experts and analysts to declare that ARENA’s economic model had fallen apart.7 When the global economy was rapidly expanding between 2003 and 2005, the rest of Latin America experienced higher average growth rates than El Salvador did—despite the fact that the country was considered a leader in the implementation of economic reforms, having adopted the measures recommended by the Washington Consensus early on.8 (El Salvador was the first country to sign on to CAFTA, for example.)

According to the economic specialists, monetary stabilization, fiscal adjustment, and privatizations that were carried out in the 1990s would bear fruit in the medium and long term, creating a more dynamic economy. During the 1990s, the government and the defenders of the neoliberal doctrine spread the idea that privatizing state enterprises, relying heavily on indirect taxes—like the value-added tax—and swiftly opening to foreign trade would generate prosperity that sooner or later would benefit the poor. Once in private hands, state-owned corporations would be more efficient at attending to the public and that price wars among businesses would benefit low-income consumers.

But this did not happen. From 2004 to 2007, the number of households living in poverty was about 35%, while the percentage of Salvadorans suffering extreme poverty decreased only slightly, from 12.6% to 10.8%.9 Due to the low growth rates and the minimal advances made in reducing poverty, the government of Elías Antonio “Tony” Saca created the Solidarity Network, a program designed to fight extreme poverty. But this program was, in a way, an admission that ARENA’s policies were incapable of generating the benefits that were spoken of so often before and during the economic reforms. In short, the economic model applied in El Salvador simply did not yield the promised results at the social level.

As for fiscal policies, the government maintained that an emphasis on indirect taxes would facilitate capital accumulation, since businesses would have more resources for investment, causing more growth and greater demand for workers, in turn reducing unemployment rates. It was also said that the reduction of tariffs that began during the beginning of the 1990s and later with the approval of the Central American Free Trade Agreement (CAFTA) in 2006 would increase the supply of goods and services, while also promoting economic growth. Nevertheless, these measures did not lead to substantially improved social well-being. If there were benefits, they were certainly not felt by the majority of Salvadorans.

Thus, the effects of the world crisis in El Salvador compounded and amplified the consequences of an economic-management model that excluded and marginalized extensive sectors of the population. Meanwhile, the model expanded the service sector—especially financial and banking services. This built a services-driven economy that functioned to the detriment of those components of the economy that had the greatest capacity to generate aggregate value as well as employment: the industrial and agricultural sectors.


Thus, although the Funes government has not announced a definite economic strategy, it is likely to try revitalizing agriculture and industry, given the discouraging landscape of a failed economy based on low-value-added commercial activities and services. But placing its bets on developing a productive economy based on primary resources and industrial activities will not be an easy task, since promoting policies that systematically support the production and commercialization of goods requires a state with at least a modicum of resources. The low level of taxation and the dismantling of state capacity under ARENA governments make re-creating an institutional network capable of supporting social and economic development quite difficult. The government’s best hope of overcoming this may lie in implementing not isolated economic measures, but rather linked policies that will coordinate the interaction and integration of all the country’s economic sectors—a somewhat novel development that would depart substantially from the lack of planning that characterized the previous governments.

The challenges facing the export sector are no less important, since during the past 20 years the economy has been mainly based on imports, financed partly through remittances, while the country exported relatively little. This generated a trade deficit that grows with each passing year. The new leftist government knows that it is difficult to change this structural characteristic of the economy—the trade gap widens as the economy grows and lessens when it stagnates—but wants to reduce the deficit by increasing the supply of locally produced goods with stimulated domestic production, thus reducing the quantity of imported goods and services. In addition, one must keep in mind that the negative balance of trade contributes to the rise of the current accounts deficit, which is also related to the flow of remittances. As it happens, remittances finance the consumption of many imported goods and services, but on the other hand, they are important resources that prevent abrupt increases in poverty.

The new government assumed power with an unprecedented shortage of resources, with the recession causing a sharp fall in tax revenue. For that reason, the incoming FMLN government and the outgoing ARENA- administration held talks before the handover of power to agree on certain measures in the face of the fiscal problem. As a result, they obtained loans from international agencies, expecting that these resources would finance public activities for a few years. Nevertheless, it seems that it will be insufficient, and the new government therefore wants to push forward with a modest tax reform. The announcement of this plan has already generated protest among some in the private sector who contend that the Funes government should not promote changes in taxation without having first defined its overarching economic policies. As Luis Membreño, a Salvadoran businessman and economist, put it: “In times of crisis, more taxes will only hurt the population.”10

By considering the economic realm from beyond a strictly technical perspective, one can understand the very important challenges facing the Funes government. Its solutions to these challenges will determine whether it will overcome the current crisis and set the direction in which it will orient the Salvadoran economy during the years ahead. The first one of these challenges is nothing simple: changing the economic model that was promoted by ARENA for all these years. The administration must rethink the functioning of the economic apparatus, not in terms of the relations of production, but more as a rearticulation of the distinct sectors of the economy, aimed at reducing poverty, unemployment, informality, and the concentration of income, while diminishing other forms of social exclusion. What is needed is unprecedented: an economic system that provides more and better jobs, a system that provides a life of dignity for those who have been historically marginalized from the benefits of economic accumulation.

Second, for the country to develop a more productive, better-skilled workforce, one capable of generating wealth for the country—leading to increased productivity, higher wages, more purchasing power, and greater internal demand—higher public-sector expenditures in education and health are essential. Such expenditures will require higher tax revenues, which will come about only if there is consensus on how public investment should be allocated and how it will be financed. Thus, if fiscal reform is to be promoted, the government must begin an in-depth dialogue with the different sectors involved, especially with the private sector.

Finally, the point of redefining the Salvadoran state’s role in the economy is not to develop a paternalistic state that inhibits the private sector but one that intervenes in inefficient markets; thereby stimulating domestic production is essential if we are to achieve a better distribution of wealth. El Salvador needs a state that has sufficient resources to meet the social demands of the population. The economic challenges that face the new leftist government are urgent. How the Funes government will to address these urgent challenges, and whether this can be done quickly, will partly be defined by the depth of the global financial crisis.

In this context of crisis, sectors of the country’s civil society are also attempting to find solutions. The National Foundation for the Development (FUNDE), for example, has promoted dialogues during the last year addressing the fiscal problem, on the one hand, and employment and labor productivity, on the other. Unions, business associations, policy analysts, and academics have participated in these conversations.

Such efforts at dialogue about employment and productivity are crucial to address the negative effects of the mass layoffs in diverse sectors of the economy. This effort aims to create a transparent, participatory, systematic, and permanent means of building a basic consensus between workers and employers around how to formulate public policies that will contribute to creating decent jobs and greater labor productivity.11 Another- priority for FUNDE has been to stimulate dialogue on fiscal policy. The international crisis and the severe contraction of economic activity that results in the deterioration of tax revenues has undermined efforts to sustain healthy public finances, which are needed to respond agilely to the demands of the population, especially those from the most vulnerable social sectors.

This dialogue space emphasized the importance of rational and efficient use of public funds, as well as proper administration of public debt. Now that the recession has caused a fall in tax revenue, the adequate administration of public expenses and debt should be a central point of fiscal policy. And this is the crucial point: Even in the midst of the economic crisis, it is important that El Salvador have sufficient resources to carry out social spending, and thereby respond to the demands of marginalized groups.

Rommel R. Rodríguez is an economic analyst for the National Development Foundation (FUNDE), a progressive think tank based in San Salvador. Translated by Erwin Blanco and Eric Hershberg.

1. Central Reserve Bank of El Salvador, “Un vistazo a la economía,” statistics and statistical graphs available at

2. “Falta de señales claras en la economía,” El Diario de Hoy (San Salvador), September 8, 2009.

3. Katlen Urquilla and Lucinda Quintanilla, “Destacan ayuda a pobres, pero critican falta de seguridad,” El Diario de Hoy, September 4, 2009.

4. Karla Ramos and Amadeo Cabrera, “Anuncián plan para crisis por $475 millones,” La Prensa Gráfica (Antiguo Cuscatlán), June 1, 2009.

5. Rommel Rodríguez, “El modelo económico y los embates de la crisis internacional,” Proceso (San Salvador) no. 1286 (April 23, 2008): 6.

6. Rommel Rodríguez, “El gobierno reacciona frente a la crisis internacional,” Proceso no. 1287 (April 30, 2008): 6.

7. “Modelo agotado,” editorial, Estudios Centroamericano no. 663-664 (January/Febuary 2004): 3–18.

8. Fondo Monetario Internacional, “En El Salvador las reformas rinden fruto, pero factores externos opacan el crecimiento,” FMI Boletín 34, no. 4 (Marzo 14, 2005): 52.

9. National Center for Statistics and Census (DIGESTYC), Encuesta de hogares de propósitos múltiples 2007, Economic Ministry of El Salvador, p. 143.

10. “Cámara de Comercio teme que haya una fuga de ahorros,” La Prensa Gráfica, October 6, 2009.

11. National Foundation for Development (FUNDE), Diálogo sobre empleo y productividad (primera edición, El Salvador, 2009), 15.


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