Panama—Economic Quantum Leap
Chances are that you have heard about Panama in the context of the Panama Canal, or perhaps that the country competed in its first World Cup last year in Russia. But what is less known is that Panama has been the most dynamic economy in Latin America for the last three decades—achieving one of the highest per capita incomes in the region. To ensure inclusive growth for future generations, Panama will need to continue with policiesthat boost productivity.
Strong growth performance
For Latin America, Panama’s growth story is an important one. The economy grew by about six percent annually for a quarter of a century–well above other traditionally strong performers like Chile, Dominican Republic and Peru, as well as twice the growth rate of Latin America as a whole. Panama also managed to achieve one of the highest per capita income levels in the region—ahead of other countries like Argentina, Mexico and Uruguay.
So, how has Panama sustained strong growth over the years?
Following a period of economic instability in the 1980s, Panama decided to implement policies that improved the business climate, opened up trade, and privatized public enterprises. Other economic policies included adopting modern practices on banking regulations, adhering to fiscal discipline, and strengthening its dollarization regime—Panama uses the U.S. dollar as their currency.
These policy changes were supported by a decade of uninterrupted IMF programs, which provided needed policy know-how and technical assistance—for example, in tax administration and debt and asset management. Key public works projects like the expansion of the Panama Canal supported growth and greatly enhanced the productive capacity of the economy.
As a result, GDP per capita expanded five-fold—from around $5,000 in 1990 to over $25,000 in 2018—trade flourished, the financial system blossomed, and public debt shrank as a ratio to GDP. Also, poverty was greatly reduced, while investment reached levels similar to those of the Asian Tigers (e.g. Singapore).
The World Economic Outlook forecasts that Panama’s per capita GDP will surpass Chile’s in 2019. IMF staff estimates potential growth in Panama at 5 ½ percent. Further, if Panama’s economy grows at potential over the next five years, Panama’s per capita GDP will reach US$35,400, which is similar to that of Lithuania, Slovak Republic and Slovenia—all advanced economies. In other words, Panama has a good chance at becoming the first advanced economy in Latin America over the next several years.
Top global performer
Is Panama’s growth a world record and how does it compare to other episodes of high growth in the world?
Globally, Panama’s growth story stands out as a top performer. Panama is the 23rd fastest growing economy in the world over the last 25 years, which is almost in the top 10 percentile of high growth events in the world. Typically, gas and oil economies like Azerbaijan, Equatorial Guinea, and Turkmenistan, dominate the ranks of high growth episodes in the world together with China.
But on closer inspection, Panama has a distinctive feature. Except for Qatar, Panama is the economy with the highest growth given its level of income. In other words, there is no economy in the world (other than Qatar) that has experienced more growth at a higher per capita income than Panama in the last quarter of a century.
Middle Income Trap
How long will this growth momentum last? A recent IMF staff study on Panama analyzes growth episodes for countries that reached levels comparable to Panama’s current level of per capita GDP. It finds that average growth moderated from 5.3 percent in the year when they reached Panama’s level to 2.9 percent 10 years afterwards.
While such evidence is indicative and deeper analysis is necessary to understand the underlying growth dynamics, it suggests that growth might moderate after countries surpass certain threshold of income per capita and their convergence gap has narrowed.
Furthermore, contributions to growth from capital and labor are likely to moderate in the future too. As population growth continues to decline, labor’s annual contribution to growth is projected to go down by about 0.3 percentage points relative to the last decade.
Following an extraordinary investment cycle over the same decade that also saw the expansion of the Panama Canal, the investment share in national income is projected to converge to a more sustainable level — implying a decline in capital contribution to growth of about one percentage point per year.
The path forward
While Panama’s growth performance has been remarkable at the regional and global levels, to sustain high growth critically depends on policies that continue to improve productivity — which will be a challenge to the new administration that is taking office on July 1. Here are some thoughts on priority areas that are likely to yield considerable growth dividends:
- Education and health. Focus should be put on education quality, improvements in public health services, and an upgrade of skills and training programs. Such measures are essential in developing a more knowledge-based diversified economy.
- Labor supply. Relaxing tight regulations that prevent attraction of foreign talent in many professions will be essential for productivity. Facilitating work permits for highly-skilled workers will help eliminate gaps and boost Panama’s growth potential.
- Governance. Enhancing financial transparency, tax information exchange, and the investment climate will be important. By continuing to strengthen financial transparency and integrity, Panama could further leverage its unique geographical location and its regional financial center to support investments in global logistics, transportation, trade, and a finance hub.
- Fiscal discipline. This can be achieved by preserving the prudent management of fiscal policy, following the fiscal rule, and supporting the recently created fiscal council to ensure that the public debt-to-GDP ratio continues a downward trajectory.
Source: Alejandro Santos and Metodij Hadzi-Vaskov | Diálogo A Fondo