## _wp16250

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---

### Introduction: recent patterns and outlook
- Potential output growth across Central America has declined in recent years; for most countries the decline started after the global financial crisis (GFC).
- Panama: potential growth has not been affected by the crisis and has continued at rates similar to pre-GFC.
- Dominican Republic, Guatemala, and El Salvador: potential growth has recovered somewhat in the past two years but remains well below pre-crisis rates (only in Nicaragua it fully recovered to pre-crisis rates).
- El Salvador has the lowest potential growth in Central America: 1.8 percent.
- All economies, except Panama, exhibit lower potential growth compared to other emerging markets: 5.4 percent.
- Drivers of the recent weakness: weak investment, somewhat stagnant employment creation, and low growth in total factor productivity (TFP).
- Medium-term expectation: potential growth in most Central American economies is expected to continue at an average of 4 percent during the medium term.
- Policy priority: increase potential growth through structural reforms improving business conditions, product and labor markets, and innovation capacity.

### Key findings on historical evolution and the GFC impact
- Pre-crisis (2001–07) average potential growth increased from 3 1/3 percent to 5 1/3 percent; Panama, the Dominican Republic, and Costa Rica drove much of this increase.
- Post-crisis (2006–07 to 2013–14) changes in potential growth:
  - Declined by about 2 percentage points in Costa Rica, the Dominican Republic, and Honduras.
  - Declined slightly more than 1 percentage point in El Salvador.
  - Declined less than 1 percentage point in Guatemala and Panama.
  - Increased slightly in Nicaragua.
- Comparison: potential output in emerging markets declined by about 2 percentage points over the same period, with lower TFP accounting for much of the decline (WEO, April 2015).
- Repeated downward revisions to medium-term forecasts and worse-than-initial outturns highlight substantial uncertainty about potential output growth trajectories.

### Methodology: multivariate filter and growth accounting
- Estimation approach: multivariate Kalman-filter framework that conditions potential output and the output gap on inflation and unemployment relationships (Phillips curve and Okun’s law).
- Observable data used: real GDP growth, CPI inflation, and the unemployment rate.
- Expectations augmentation: WEO forecasts are incorporated for real GDP growth (five years following the sample) and inflation (one year following the sample).
- Stochastic structure for output uses three core equations and three shock types (level shocks, growth-rate shocks, output-gap shocks), including:
  - (1) Y_t = Y_{t−1} + G_t + ε^Y_t
  - (2) G_t = θ G_SS + (1−θ) G_{t−1} + ε^G_t
  - (3) y_t = φ y_{t−1} + ε^y_t
  - Output gap: y = Y − Ȳ
- Phillips curve and unemployment dynamics specified as:
  - (5) π_t = λ π_{t+1} + (1−λ) π_{t−1} + β y_t + ε^π_t
  - (6) U_t = (τ_4 U_ss + (1−τ_4) U_{t−1}) + g^U_t + ε^U_t
  - (7) g^U_t = (1−τ_3) g^U_{t−1} + ε^{gU}_t
  - (8) u_t = τ_2 u_{t−1} + τ_1 y_t + ε^u_t
  - (9) u_t = U_t − Ū_t
- Prior beliefs and identification: model assumes supply shocks are the primary source of real GDP fluctuations in Central America, assigning much observed GDP volatility to potential GDP fluctuations. Steady-state priors for unemployment and potential GDP growth are provided in estimation.
- Growth-accounting framework: Cobb-Douglas production function with capital share α set at 0.35. Potential TFP is calculated as the residual A_t where Y_t = A_t K_t^α L_t^{1−α}.
- Capital stock construction: perpetual inventory method with initial capital stock set for 1990 assuming a constant depreciation rate of 5 percent per annum and a constant investment share of GDP.

### Drivers: TFP, capital accumulation, and labor
- Aggregate decomposition: increases in potential growth during 2001–07 were mostly attributable to:
  - Increases in labor (Guatemala) and less drag from TFP.
  - Increases in capital accumulation and TFP in Costa Rica, the Dominican Republic, Honduras, and Panama.
- TFP growth before the crisis (2006–07 vs 2001–03):
  - Costa Rica: almost 2 percent in 2006–07 (up from near 1 percent in 2001–03).
  - Dominican Republic: over 3 percent in 2006–07.
  - Panama: close to 5 percent in 2006–07 (from close to 1 percent in 2001–03).
  - Honduras and Nicaragua: improvements to about 1 percent.
- Possible contributors to pre-crisis TFP gains: shifts to higher-productivity export sectors, export diversification, and rising economic complexity (Costa Rica and the Dominican Republic cited).
- TFP shortfalls and constraints: El Salvador and Guatemala exhibited absent or minimal TFP growth; factors include lags in R&D and technology adoption, lower human capital growth, migration of high-skilled workers, lack of competition and high market concentration, weak business environment (political/economic uncertainty, poor security, high red tape and corruption, lack of legal/judicial stability), and high infrastructure costs and poor quality.

### Demographics and potential employment growth
- Demographic transition: share of working-age population increased in all economies; timing and completion of transition varies by country.
- Completed transition shares by 2007: Costa Rica, Panama, and the Dominican Republic had completed between 50-60 percent of their transition; Guatemala, Honduras, Nicaragua, and El Salvador had completed only 10-40 percent.
- Dependency ratio: by mid-2000s, Costa Rica, Panama, and the Dominican Republic had dependency ratios below two-thirds; other economies had higher ratios (above two-thirds), with Guatemala still high and not declining much.
- Working-age population and employment growth specifics (2001–07):
  - El Salvador: potential employment growth increased from 1.5 percent to 1.9 percent (mainly attributable to higher working-age population growth).
  - Guatemala: potential employment growth increased from 3.3 percent to 3.5 percent (mainly attributable to higher working-age population growth).
  - Dominican Republic, Honduras, and Nicaragua: potential employment growth continued at similar rates over 2001–07.
  - Costa Rica: potential employment growth fell from 3.5 percent to 3.1 percent during 2001–07.
  - Panama: potential employment growth fell from 2.8 percent to 2.6 percent during 2001–07.
- After the GFC (2006–07 to 2013–14):
  - Potential employment growth fell by 0.8 percentage points in Costa Rica, by 0.3 percentage points in the Dominican Republic and Panama.
  - Potential employment growth remained broadly stable in Honduras and Nicaragua.
  - Potential employment growth increased by about 0.2 percentage points in El Salvador and Guatemala.
- Immigration and remittances flows appear to have slowed significantly from 2008 to 2013–14, given lower labor demand in the U.S., which could explain part of the stable or increasing employment growth in El Salvador, Guatemala, Honduras, and Nicaragua.

### Capital growth and investment dynamics
- Capital growth evolution during 2001–07:
  - Panama: capital growth increased from 3 percent to 6.8 percent.
  - Honduras: capital growth rose from over 4.7 percent to 6.8 percent.
  - Costa Rica, the Dominican Republic, and Guatemala: important increases in capital growth from the mid-2000s.
  - Nicaragua and El Salvador: declines in capital growth (El Salvador declined by almost 1 percentage point).
- Drivers: acceleration in capital accumulation driven by strong increases in investment-to-capital ratios:
  - Panama: investment-to-capital ratio rose from 7.5 percent to 11.5 percent.
  - Honduras: investment-to-capital ratio rose from 9.2 percent to 11.5 percent.
  - Declines in Nicaragua and El Salvador driven by declines in investment-to-capital ratios.
- Mid-2000s surge in capital goods imports led to overhauling of physical capital in most economies, supporting increases in potential growth (except Nicaragua and El Salvador).
- After the GFC, decline in capital growth accounted for a large part of the decline in potential growth:
  - Decline in capital growth was over 2 percentage points in the Dominican Republic, Guatemala, and El Salvador.
  - Decline in capital growth was over 3.5 percentage points in Honduras.
  - Panama experienced expansion in capital growth (of 4 percentage points) due to canal expansion and other large projects (metro line, new highways, urban development).
  - Nicaragua experienced an increase in capital growth due to new energy projects.
  - Costa Rica’s capital growth appears not to have been affected by the crisis.
- Investment-to-capital ratios since 2011:
  - Rebounded somewhat in Costa Rica and Nicaragua.
  - Fallen slightly in the Dominican Republic and Honduras.
  - Largely unchanged in El Salvador, Guatemala, and Panama.
- If investment-to-capital ratios remain at rates observed in 2014, capital growth will remain 2 to 2.5 percentage points below pre-crisis rates in all economies (and over 3.5 percentage points in Honduras), except in Costa Rica, Panama and Nicaragua where the investment-to-capital ratio have not been affected by the crisis.
- Nicaragua’s capital growth rebounded in 2011-14 to higher than pre-crisis rates, which, if sustained, could support higher potential growth.

### Total factor productivity (TFP) developments and projections
- TFP growth declined in many Central American economies after the GFC, contributing to declines in potential growth.
- TFP growth declined by up to 1.9 percentage points from 2006–07 to 2013–14.
- Possible explanations for lower TFP:
  - Reduced investment in innovation and research and development following the crisis.
  - Continued weaknesses in institutional, regulatory, and legal environments.
  - Lower human capital growth.
- Country-specific notes:
  - The Dominican Republic, Nicaragua, and Guatemala: TFP growth recovered to pre-crisis rates.
  - The Dominican Republic and Panama: contribution of TFP to potential growth remained over 2.5 percent; these two countries have the highest TFP growth in the region.
- TFP assumptions for projections:
  - TFP is projected to grow at the 2002–14 average growth rates.
  - For Guatemala: TFP is assumed to grow at the 2011–14 average growth rates.
  - For Nicaragua: TFP is assumed to grow at half the rate of the 2011–14 average growth rates.
- Nicaragua: recent increase in TFP growth to above 1 percent; continued upward trend since 2011; boost in potential growth in 2011-14 that surpasses pre-crisis rates.
- Projection caveat: if TFP performance proves weaker than envisaged (i.e., below the 2002–14 average), the impact on potential growth rate could be substantial.

### Potential growth trajectories and scenario analysis (2015–20)
- Scenario baseline: potential growth likely to remain on average at 4 percent during 2015–20.
- Scenarios do not assume policy changes that could boost potential growth; they build on analysis through 2014, projected demographic patterns, and experience from past financial crises affecting investment-to-capital ratios.
- Potential employment growth is expected to decline further in the medium term, with highest declines in Costa Rica, Honduras, and Nicaragua, reflecting demographic drags on working-age population and trend labor force participation.
- Specific medium-term expectations:
  - Costa Rica: working-age population growth expected to decline from an average of 2.1 for 2008–14 to an average of 1.6 percent for 2015–20; potential employment growth expected to fall from 2.6 to 1.9 percent.
  - Honduras, Nicaragua, and the Dominican Republic: potential employment growth expected to fall by 0.3–0.4 percentage points.
  - Panama: potential employment growth expected to fall by 0.2 percentage points.
  - El Salvador: working-age population growth expected to decline while labor force participation growth is expected to increase, resulting in slightly lower potential employment growth.
  - Guatemala: potential employment growth is not expected to change much in the medium term.
- Capital growth outlook: expected to slow further from current rates due to less favorable external financing conditions, infrastructure bottlenecks, and weaknesses in institutional, regulatory, and legal environments.
- Overall medium-term implication: potential growth in Central American economies is likely to remain below pre-crisis rates through 2015–20, subject to significant uncertainty and country-specific factors.

### Policy implications and recommended structural priorities
- Main constraints lowering potential growth: structural constraints to capital and employment growth, and low TFP growth, possibly reflecting insufficient efforts to foster technological progress and weak institutional, regulatory, and legal environments.
- Policy objectives to raise potential growth and rebuild buffers:
  - Strengthen investment (raise capital accumulation).
  - Foster employment creation and improve labor market functioning.
  - Raise TFP through policies that:
    - Improve business conditions and reduce administrative burdens.
    - Enhance competition and reduce market concentration.
    - Improve infrastructure quality and access to finance.
    - Promote innovation, R&D, and technology adoption.
    - Stabilize institutional, regulatory, and judicial frameworks.
- Realizing demographic dividends:
  - Policies focused on education, timing and level of childbearing, incentives for young parents to work, health care, tax incentives, and pensions.
  - Encourage saving for retirement to raise capital relative to output.
- Mobilize domestic savings and attract investment:
  - Reduce policy uncertainties, strengthen institutions to secure property rights and reduce red tape and corruption, ensure legal and judicial stability, and improve security.
  - Increase and improve public investment to address infrastructure deficiencies.
- Address labor market rigidities and informality:
  - Facilitate access to social security systems, reduce tax distortions, simplify tax filing and business licensing procedures.
- Improve innovation-related metrics where Central American economies perform poorly relative to emerging economies, including:
  - spending on R&D,
  - tertiary enrollment rates,
  - number of patent applications,
  - FDI inflows,
  - ease of protecting investors,
  - knowledge-intensive employment,
  - creative services exports.
- Fiscal implications: lower potential growth will make it difficult to rebuild fiscal buffers or reduce high debt ratios in some economies, reinforcing the need for structural reform.

### Estimation priors and selected steady-state values
- Steady-State Unemployment Rate and Steady-State Potential Output Growth (reported table):
  - CRI: 6.5 / 4.5
  - DOM: 14.0  1 5.0
  - GTM: 3.0 / 3.5
  - HND: 4.0 / 4.0
  - NIC: 7.0 / 3.5
  - PAN: 5.0 / 6.5
  - SLV: 5.3 / 2.0
- Note excerpt preserved verbatim: "1 According to the ILO definition, which takes into account those actively searching for a job, and the "tasa de desempleo abierta", the unemployment rate is lower (6%)."

### Appendix I: Global Competitiveness Index (highlights)
- Source: Global Competitiveness Index, 2014-15.
- Costa Rica (component rankings listed in order shown: Institutions; Infrastructure; Macroeconomic environment; Higher education and training; Labor market efficiency; Goods market efficiency; Financial market development; Technological readiness; Market size; Innovation):
  - 50, 76, 80, 33, 53, 65, 96, 53, 84, 35
- Comparative EMs sequence shown for Costa Rica:
  - 124, 110, 119, 96, 118, 99, 86, 76, 68, 115
- Other countries: figure panels indicate component sequences for DOM, GTM, HND, NIC, PAN, and SLV, with EMs comparative sequences reported in the excerpt (partial numeric listings preserved where provided).

*Content drawn from IMF staff estimates and the specified chapter text.*

### 1. Output Compared to Precrisis Expectations in Central America.........................................19

### 1. Output Compared to Precrisis Expectations in Central America.........................................19

### Major sections and themes
- 1. Output Compared to Precrisis Expectations in Central America.........................................19
- 2. Contributions of Components of Potential Output Growth in Central America .................20
- 3. Contributions of Components of Potential Output Growth in Central America .................21
- 4. Components of Capital Growth in Central America............................................................22
- 5. Components of Capital Growth in Central America............................................................24
- 6. Components of Potential Employment Growth in Central America ...................................25
- 7. Components of Potential Employment Growth in Central America ...................................26
- 8. Investment-to-Capital Ratio in Central America .................................................................27
- 9. Components of Potential Employment Growth in Central America ...................................28

*Source: _wp16250 - 1. Output Compared to Precrisis Expectations in Central America.........................................19*

### 10. Contributions of Components of Potential Output Growth in Central ..............................29

### 10. Contributions of Components of Potential Output Growth in Central ..............................29

### Introduction: recent patterns and outlook
- Potential output growth across Central America has declined in recent years; for most countries the decline started after the global financial crisis (GFC).  
- Panama: potential growth has not been affected by the crisis and has continued at rates similar to pre-GFC.  
- Dominican Republic, Guatemala, and El Salvador: potential growth has recovered somewhat in the past two years but remains well below pre-crisis rates (only in Nicaragua it fully recovered to pre-crisis rates).  
- El Salvador has the lowest potential growth in Central America: 1.8 percent.  
- All economies, except Panama, exhibit lower potential growth compared to other emerging markets: 5.4 percent.  
- Drivers of the recent weakness: weak investment, somewhat stagnant employment creation, and low growth in total factor productivity (TFP).  
- Medium-term expectation: potential growth in most Central American economies is expected to continue at an average of 4 percent during the medium term.  
- Policy priority: increase potential growth through structural reforms improving business conditions, product and labor markets, and innovation capacity.

### Key findings on historical evolution and the GFC impact
- Pre-crisis (2001–07) average potential growth increased from 3 1/3 percent to 5 1/3 percent; Panama, the Dominican Republic, and Costa Rica drove much of this increase.  
- Post-crisis (2006–07 to 2013–14) changes in potential growth:  
  - Declined by about 2 percentage points in Costa Rica, the Dominican Republic, and Honduras.  
  - Declined slightly more than 1 percentage point in El Salvador.  
  - Declined less than 1 percentage point in Guatemala and Panama.  
  - Increased slightly in Nicaragua.  
- Comparison: potential output in emerging markets declined by about 2 percentage points over the same period, with lower TFP accounting for much of the decline (WEO, April 2015).  
- Repeated downward revisions to medium-term forecasts and worse-than-initial outturns highlight substantial uncertainty about potential output growth trajectories.

### Methodology: multivariate filter and growth accounting
- Estimation approach: multivariate Kalman-filter framework that conditions potential output and the output gap on inflation and unemployment relationships (Phillips curve and Okun’s law).  
- Observable data used: real GDP growth, CPI inflation, and the unemployment rate.  
- Expectations augmentation: WEO forecasts are incorporated for real GDP growth (five years following the sample) and inflation (one year following the sample) to help identify shocks and improve end-of-sample estimates.  
- Stochastic structure for output: three core equations and three shock types (level shocks, growth-rate shocks, output-gap shocks):  
  - (1) Y_t = Y_{t−1} + G_t + ε^Y_t  
  - (2) G_t = θ G_SS + (1−θ) G_{t−1} + ε^G_t  
  - (3) y_t = φ y_{t−1} + ε^y_t  
  - Output gap: y = Y − Ȳ (deviation of log real GDP from potential).  
- Phillips curve and unemployment dynamics:  
  - (5) π_t = λ π_{t+1} + (1−λ) π_{t−1} + β y_t + ε^π_t  
  - (6) U_t = (τ_4 U_ss + (1−τ_4) U_{t−1}) + g^U_t + ε^U_t  
  - (7) g^U_t = (1−τ_3) g^U_{t−1} + ε^{gU}_t  
  - (8) u_t = τ_2 u_{t−1} + τ_1 y_t + ε^u_t  
  - (9) u_t = U_t − Ū_t  
- Prior beliefs and identification: model assumes supply shocks are the primary source of real GDP fluctuations in Central America, assigning much observed GDP volatility to potential GDP fluctuations. Steady-state priors for unemployment and potential GDP growth are provided in estimation.  
- Growth-accounting framework: Cobb-Douglas production function with capital share α set at 0.35. Potential TFP is calculated as the residual: A_t where Y_t = A_t K_t^α L_t^{1−α}.  
- Capital stock construction: perpetual inventory method with initial capital stock set for 1990 assuming a constant depreciation rate of 5 percent per annum and a constant investment share of GDP.

### Drivers: TFP, capital accumulation, and labor
- Aggregate decomposition: increases in potential growth during 2001–07 were mostly attributable to:  
  - Increases in labor (Guatemala) and less drag from TFP.  
  - Increases in capital accumulation and TFP in Costa Rica, the Dominican Republic, Honduras, and Panama.  
- TFP growth before the crisis (2006–07 vs 2001–03):  
  - Costa Rica: almost 2 percent in 2006–07 (up from near 1 percent in 2001–03).  
  - Dominican Republic: over 3 percent in 2006–07.  
  - Panama: close to 5 percent in 2006–07 (from close to 1 percent in 2001–03).  
  - Honduras and Nicaragua: improvements to about 1 percent.  
- Possible contributors to pre-crisis TFP gains: shifts to higher-productivity export sectors, export diversification, and rising economic complexity (Costa Rica and the Dominican Republic cited).  
- TFP shortfalls and constraints: El Salvador and Guatemala exhibited absent or minimal TFP growth; factors include lags in R&D and technology adoption, lower human capital growth, migration of high-skilled workers, lack of competition and high market concentration, weak business environment (political/economic uncertainty, poor security, high red tape and corruption, lack of legal/judicial stability), and high infrastructure costs and poor quality.

### Demographics and potential employment growth
- Demographic transition: share of working-age population increased in all economies; timing and completion of transition varies by country.  
- Completed transition shares by 2007: Costa Rica, Panama, and the Dominican Republic had completed between 50-60 percent of their transition; Guatemala, Honduras, Nicaragua, and El Salvador had completed only 10-40 percent.  
- Dependency ratio: by mid-2000s, Costa Rica, Panama, and the Dominican Republic had dependency ratios below two-thirds; other economies had higher ratios (above two-thirds), with Guatemala still high and not declining much.  
- Contribution to potential growth: increases in potential employment growth accounted for part of the pre-crisis acceleration in some countries (example beginning sentence: "In El Salvador, potential employment growth increased from" — the source excerpt cuts off before the full figure).

### Policy implications and recommended structural priorities
- Main constraints lowering potential growth: structural constraints to capital and employment growth, and low TFP growth, possibly reflecting insufficient efforts to foster technological progress and weak institutional, regulatory, and legal environments.  
- Policy objectives to raise potential growth and rebuild buffers:  
  - Strengthen investment (raise capital accumulation).  
  - Foster employment creation and improve labor market functioning.  
  - Raise TFP through policies that:  
    - Improve business conditions and reduce administrative burdens.  
    - Enhance competition and reduce market concentration.  
    - Improve infrastructure quality and access to finance.  
    - Promote innovation, R&D, and technology adoption.  
    - Stabilize institutional, regulatory, and judicial frameworks.  
- Fiscal implications: lower potential growth will make it difficult to rebuild fiscal buffers or reduce high debt ratios in some economies, reinforcing the need for structural reform.

### Estimation priors and selected steady-state values (as reported in the source)
- Steady-State Unemployment Rate and Steady-State Potential Output Growth (reported table):  
  - CRI: 6.5 / 4.5  
  - DOM: 14.0  1 5.0  
  - GTM: 3.0 / 3.5  
  - HND: 4.0 / 4.0  
  - NIC: 7.0 / 3.5  
  - PAN: 5.0 / 6.5  
  - SLV: 5.3 / 2.0  
- Note excerpt in source: "1 According to the ILO definition, which takes into account those actively searching for a job, and the "tasa de desempleo abierta", the unemployment rate is lower (6%)." (preserved verbatim from the source).

*Italic: Content drawn from IMF staff estimates and the specified chapter text.*

### 1.5 percent to 1.9 percent and in Guatemala from 3.3 percent to 3.5 percent during the 2001-

### _wp16250 - 1.5 percent to 1.9 percent and in Guatemala from 3.3 percent to 3.5 percent during the 2001-

### Demographics and potential employment growth (2001–07 and aftermath)
- Working-age population growth increased potential employment growth in El Salvador (from 1.5 percent to 1.9 percent) and Guatemala (from 3.3 percent to 3.5 percent) during the 2001-07 period, mainly attributable to higher working-age population growth.
- El Salvador: fertility rates were falling for several decades (dropped 30 percent by the 80s from the 60s); mortality rates were dropping and life expectancy increasing, contributing to a steady increase in the working-age population.
- Guatemala: fertility rates and population growth are among the highest in Central America and life expectancy has been steadily increasing, partly explaining high working-age population growth.
- Potential employment growth continued at similar rates over 2001-07 in the Dominican Republic, Honduras, and Nicaragua. Fertility reductions occurred earlier in the Dominican Republic (almost halved by the 1980s from the 60s) and more recently in Honduras and Nicaragua; these transitions coincided with lower mortality and higher life expectancy.
- Potential employment growth fell in Costa Rica (from 3.5 percent to 3.1 percent) and Panama (from 2.8 percent to 2.6 percent) during 2001–07, mainly attributable to reduced growth rates of the working-age population despite an increasing share of working-age population in total population.
- After the GFC (2006–07 to 2013–14):
  - Potential employment growth fell by 0.8 percentage points in Costa Rica, by 0.3 percentage points in the Dominican Republic and Panama.
  - Potential employment growth remained broadly stable in Honduras and Nicaragua.
  - Potential employment growth increased by about 0.2 percentage points in El Salvador and Guatemala.
  - Immigration and remittances flows appear to have slowed significantly from 2008 to 2013–14, given lower labor demand in the U.S., which could explain part of the stable or increasing employment growth in El Salvador, Guatemala, Honduras, and Nicaragua.

### Capital growth and investment dynamics
- Capital growth evolution was diverse across countries during 2001–07:
  - Panama: capital growth increased from 3 percent to 6.8 percent.
  - Honduras: capital growth rose from over 4.7 percent to 6.8 percent.
  - Costa Rica, the Dominican Republic, and Guatemala: important increases in capital growth from the mid-2000s.
  - Nicaragua and El Salvador: declines in capital growth (El Salvador declined by almost 1 percentage point).
- Drivers: acceleration in capital accumulation driven by strong increases in investment-to-capital ratios:
  - Panama: investment-to-capital ratio rose from 7.5 percent to 11.5 percent.
  - Honduras: investment-to-capital ratio rose from 9.2 percent to 11.5 percent.
  - Declines in Nicaragua and El Salvador driven by declines in investment-to-capital ratios.
- Mid-2000s surge in capital goods imports led to overhauling of physical capital in most economies, supporting increases in potential growth (except Nicaragua and El Salvador).
- After the GFC, decline in capital growth accounted for a large part of the decline in potential growth:
  - Decline in capital growth was over 2 percentage points in the Dominican Republic, Guatemala, and El Salvador.
  - Decline in capital growth was over 3.5 percentage points in Honduras.
  - Panama experienced expansion in capital growth (of 4 percentage points) due to canal expansion and other large projects (metro line, new highways, urban development).
  - Nicaragua experienced an increase in capital growth due to new energy projects.
  - Costa Rica’s capital growth appears not to have been affected by the crisis.
- Investment-to-capital ratios since 2011:
  - Rebounded somewhat in Costa Rica and Nicaragua.
  - Fallen slightly in the Dominican Republic and Honduras.
  - Largely unchanged in El Salvador, Guatemala, and Panama.
- If investment-to-capital ratios remain at rates observed in 2014, capital growth will remain 2 to 2.5 percentage points below pre-crisis rates in all economies (and over 3.5 percentage points in Honduras), except in Costa Rica, Panama and Nicaragua where the investment-to-capital ratio have not been affected by the crisis.
- Nicaragua’s capital growth rebounded in 2011-14 to higher than pre-crisis rates, which, if sustained, could support higher potential growth.

### Total factor productivity (TFP) developments
- TFP growth declined in many Central American economies after the GFC, contributing to declines in potential growth.
- TFP growth declined by up to 1.9 percentage points from 2006–07 to 2013–14.
- Possible explanations for lower TFP:
  - Reduced investment in innovation and research and development following the crisis.
  - Continued weaknesses in institutional, regulatory, and legal environments.
  - Lower human capital growth.
- Country-specific notes:
  - The Dominican Republic, Nicaragua, and Guatemala: TFP growth recovered to pre-crisis rates.
  - The Dominican Republic and Panama: contribution of TFP to potential growth remained over 2.5 percent; these two countries have the highest TFP growth in the region.
- Projection: TFP growth is expected to remain below pre-crisis rates over the next six years, consistent with more sluggish potential growth in advanced economies.

### Potential growth trajectories and scenario analysis (2015–20)
- Scenario baseline: potential growth likely to remain on average at 4 percent during 2015–20.
- Scenarios build on analysis through 2014, projected demographic patterns, and experience from past financial crises affecting investment-to-capital ratios; they do not assume policy changes that could boost potential growth.
- Potential employment growth is expected to decline further in the medium term, with highest declines in Costa Rica, Honduras, and Nicaragua, reflecting demographic drags on working-age population and trend labor force participation.
- Specific medium-term expectations:
  - Costa Rica: working-age population growth expected to decline from an average of 2.1 for 2008–14 to an average of 1.6 percent for 2015–20; potential employment growth expected to fall from 2.6 to 1.9 percent (largest decline in the region).
  - Honduras, Nicaragua, and the Dominican Republic: potential employment growth expected to fall by 0.3–0.4 percentage points due to declines in working-age population growth and labor force participation growth.
  - Panama: potential employment growth expected to fall by 0.2 percentage points due to declining growth in working-age population and labor force participation.
  - El Salvador: working-age population growth expected to decline while labor force participation growth is expected to increase, resulting in slightly lower potential employment growth.
  - Guatemala: potential employment growth is not expected to change much in the medium term.
- Capital growth outlook: expected to slow further from current rates due to less favorable external financing conditions, infrastructure bottlenecks, and weaknesses in institutional, regulatory, and legal environments.
- Overall medium-term implication: potential growth in Central American economies is likely to remain below pre-crisis rates through 2015–20, subject to significant uncertainty and country-specific factors.

*Source: Excerpt from IMF working paper content (figures and data as presented in the supplied text).*

### Chapter 3 of the April 2015 WEO). TFP is projected to grow at the 2002–14 average growth

### _wp16250 - Chapter 3 of the April 2015 WEO

### TFP assumptions and projections
- TFP is projected to grow at the 2002–14 average growth rates, given that pre-crisis rates were relatively high compared to historical rates.
- Assumptions for Guatemala and Nicaragua are different:
  - For Guatemala, it is assumed that TFP will grow at the 2011–14 average growth rates, given consistently smaller negative TFP growth rates turning into small positive TFP growth rates in the past few years.
  - For Nicaragua, it is assumed that TFP will grow at half the rate of the 2011–14 average growth rates, given certain improvements in TFP in this period compared to the negative TFP in the 2000s (Figure 10).
- Nicaragua: the recent increase in TFP growth to above 1 percent could be sustained, given its continued upward trend since 2011, and contribute to higher potential growth in the coming years; in fact, Nicaragua experienced a boost in potential growth in 2011-14 that surpasses pre-crisis rates.
- TFP performance remains a concern in many Central American economies despite its recent improvement (i.e., in the Dominican Republic and Nicaragua), and will be pivotal to sustain growth rates in the region in the future.
- In case TFP performance proves to be weaker than envisaged (i.e., below the 2002–14 average), the impact on potential growth rate could be substantial.

### Risks, natural constraints, and channels affecting potential growth
- Possible moderation of capital accumulation and existence of natural constraints on labor imply potential growth will remain moderate unless TFP improves significantly.
- Growth of physical capital likely to remain below pre-crisis rates because of:
  - less favorable external financing conditions with respect to 2007,
  - weaknesses in the institutional, regulatory, and legal and judicial environment.
- Contribution of labor to output growth will likely decline due to some natural constraints:
  - (i) slower population growth;
  - (ii) population ageing;
  - (iii) limited room to further increase labor force participation rates, given that they are already high compared to other emerging economies;
  - (iv) limited space for further increases in employment rates—unemployment rates have declined significantly and are now at the NAIRU in most countries (except in Costa Rica where they are higher than the steady-state (long-run) rates and in the Dominican Republic where they remain at 14 percent).

### Policy levers and recommendations
- Realizing demographic dividends:
  - First dividend depends on the level of education of the young, timing and level of childbearing, and incentives for young parents to work.
  - Policies that focus resources on health care and those related to tax incentives and pensions could support productivity at older ages.
  - Second dividend could be realized if workers are encouraged to save for retirement and invest their savings domestically which will raise capital relative to output.
- Enhance R&D/technological diffusion by:
  - Strengthening institutions, human capital and research.
  - Achieving higher business and market sophistication, and competition in product and labor markets.
  - Important improvements in the quality of schooling are needed to enhance human capital.
- Mobilize domestic savings and attract investment:
  - Policies should prioritize mobilizing domestic savings to invest and build a higher capital stock.
  - Attracting private domestic and foreign investment will require reducing policy uncertainties, strengthening institutions to secure property rights and reduce red tape and corruption, ensuring legal and judicial stability, and improving security (Appendix II Figure 4 on crime).
  - Higher and more efficient public investment is critical to address infrastructure deficiencies.
- Address labor market rigidities and informality:
  - World Economic Forum-based surveys suggest inefficiencies in wage determination, alignment of pay with productivity, capacity to retain talent, mismatches between skills and jobs, and high informality in several Central American economies (i.e., Dominican Republic, Honduras, Nicaragua, El Salvador).
  - Facilitating access to social security systems, reducing tax distortions, simplifying tax filing and business licensing procedures are reforms that would help reduce informality.
- Improve innovation-related metrics where Central American economies perform poorly relative to emerging economies, including:
  - spending on R&D,
  - tertiary enrollment rates,
  - number of patent applications,
  - FDI inflows,
  - ease of protecting investors,
  - knowledge-intensive employment,
  - creative services exports.

### Key statistics and figure highlights from the chapter
- TFP growth reference periods and assumptions: 2002–14 average; Guatemala: 2011–14 average; Nicaragua: half the rate of the 2011–14 average.
- Nicaragua: recent TFP growth to above 1 percent; continued upward trend since 2011; boost in potential growth in 2011-14 that surpasses pre-crisis rates.
- Dominican Republic: unemployment rate remains at 14 percent.
- Labor constraints called out include NAIRU status for most countries; exception noted for Costa Rica where unemployment rates are higher than steady-state (long-run) rates.
- Numerous figures and panels present country-level decompositions across periods 2001–07, 2006–14, 2008–14, and projections for 2015–20, covering:
  - Components of potential output growth (K, L, Potential TFP Growth, Potential Growth) for CRI, DOM, GTM, HND, NIC, PAN, SLV.
  - Components of capital growth and investment-to-capital ratios (2001–07, 2006–14, and 2001–19 series).
  - Capital goods imports-to-total imports (2000–14) for CRI, DOM, GTM, SLV, HND, NIC, PAN.
  - Components of potential employment growth (WAP, LFPR, 1-NAIRU) across multiple periods including 2001–07, 2006–14, 2002–20.
  - Global Innovation Index and related innovation metrics (Tertiary enrollment, Gross expenditure on R&D, Gross capital formation, Ease of protecting investors, PCT resident patent applications, PPP $ GDP, FDI net outflows, Knowledge-intensive employment, Cultural & creative services exports) for Central American countries; source: Global Innovation Index, 2014-15.

*Source: Chapter 3 of the April 2015 WEO (excerpt provided in the content unit).*

### Appendix I. Figure 2. Global Competitiveness Index

### _wp16250 - Appendix I. Figure 2. Global Competitiveness Index

### Overview
- (Higher ranking  means lower competitiveness  for a country)
- Source: Global CompetitivenessIndex, 2014-15.

### Costa Rica (CRI): Global Competitiveness Index Ranking 2014-15
- Comparison group: EMs
- Component rankings (in order shown: Institutions; Infrastructure; Macroeconomic environment; Higher education and training; Labor market efficiency; Goods market efficiency; Financial market development; Technological readiness; Market size; Innovation):
  - 50
  - 76
  - 80
  - 33
  - 53
  - 65
  - 96
  - 53
  - 84
  - 35

- EMs comparative sequence (as shown):
  - 124
  - 110
  - 119
  - 96
  - 118
  - 99
  - 86
  - 76
  - 68
  - 115

### Dominican Republic (DOM): Global Competitiveness Index Ranking 2014-15
- Comparison group: EMs
- Component rankings:
  - 1
  - 144
  - (component labels repeated in figure)
- EMs comparative sequence (as shown):
  - 111
  - 78
  - 71
  - 105
  - 90
  - 66
  - 43
  - 84
  - 76
  - 90

### Guatemala (GTM): Global Competitiveness Index Ranking 2014-15
- Comparison group: EMs
- Component rankings:
  - 1
  - 144
  - (component labels repeated in figure)
- EMs comparative sequence (as shown):
  - 134
  - 115
  - 103
  - 110
  - 142
  - 114
  - 61
  - 103
  - 94
  - 123

### Honduras (HND): Global Competitiveness Index Ranking 2014-15
- Comparison group: EMs
- Component rankings:
  - 1
  - 144
  - (component labels repeated in figure)
- EMs comparative sequence (as shown):
  - 100
  - 105
  - 97
  - 109
  - 107
  - 122
  - 104
  - 119
  - 102
  - 99

### Nicaragua (NIC): Global Competitiveness Index Ranking 2014-15
- Comparison group: EMs
- Component rankings:
  - 1
  - 144
  - (component labels repeated in figure)
- EMs comparative sequence (as shown):
  - 66
  - 37
  - 57
  - 68
  - 75
  - 35
  - 16
  - 47
  - 81
  - 36

### Panama (PAN): Global Competitiveness Index Ranking 2014-15
- Comparison group: EMs
- Component rankings:
  - 1
  - 144
  - (component labels repeated in figure)
- EMs comparative sequence (as shown):
  - 130
  - 72
  - 102
  - 100
  - 121
  - 77
  - 101
  - 109
  - 90
  - 96

### El Salvador (SLV): Global Competitiveness Index Ranking 2014-15
- Comparison group: EMs
- Figure indicates SLV data present but numeric component sequence is not legibly separated in the excerpt.
- The figure layout repeats component labels: Institutions; Infrastructure; Macroeconomic environment; Higher education and training; Labor market efficiency; Goods market efficiency; Financial market development; Technological readiness; Market size; Innovation.

*Source: Global CompetitivenessIndex, 2014-15.*

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