How to be small and successful in Latin America

Items

• Introduction

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  The recently concluded Fifa World Cup, held in Russia, surprised many sports commentators. Some of the ‘big country’ teams with an impressive football heritage crashed out early – a list that included the likes of Brazil, Germany, and Argentina. Some ‘small country’ teams did exceptionally well. Uruguay, Panama, and Costa Rica – three countries that we will be examining in some detail later on in this report, all qualified for the tournament (in the case of Panama, this was for the first time ever). Other small countries exceeded expectations, including Iceland, with a population of just over 340,000, which held the mighty Argentina (population 44.2m) to a draw. And of course, Croatia (population 4.12m) went all the way to the finals, albeit eventually losing to France (population 67.1m). Many commentators highlighted these disparities in population size and sporting success; some outlined a whole range of other factors that might be in play: team spirit, footballing strategy, tactical skill, patriotism, and cultural attitudes among them.

  Could there be a parallel with other types of performance? Perhaps the important point to come out of the World Cup is that size may matter, but it is not necessarily decisive, and may in some ways and at some times be trumped by a whole set of other factors and influences. The same seems to be the case in the economic, political, and social performance of nation states. There is a tendency to assume that the bigger countries – measured in terms of population, area, and natural resources – must in some senses be more successful, better positioned to seize the advantages of economies of scale, and therefore more likely to be competitive and to really make their mark on the global economy. This report looks at arguments that challenge that hypothesis.

  In an attempt to be slightly provocative we have identified five groups, each made up of three countries, to compare and contrast. The group we are most interested in, we have called ‘Latin America’s small and successful’. It is composed of three countries: Uruguay, Panama, and Costa Rica. In effect the central aim of this report is to ask if these three countries have a legitimate claim to being ‘special’ and more successful than their neighbours in terms of economic growth and competitiveness, quality of life, and other factors (for example protection of the environment). As part of assessing their regional performance we have selected two other groups. ‘Latin America’s big and struggling’ is formed by Argentina, Mexico, and Brazil, countries with large populations (between them, over half the regional total) that nevertheless in recent years have been experiencing domestic political conflict and lower growth. These big countries are widely seen as having the power to shape the regional environment. For comparative purposes, another regional group is tagged ‘Latin America’s small and failing’ and is formed by El Salvador, Guatemala, and Honduras. These three countries have similar population sizes to those of the ‘small and successful’ group, and so pose interesting questions of why performance has diverged. Finally, we have grouped together the United States, China, and India as ‘global giants’ – three countries which, we expect, will have a big impact on the shape of the global economy over the next few decades.

  A major issue is of course how to measure ‘success’. In economic terms alone there are a whole range of options: gross domestic product (GDP), average annual GDP growth, GDP per capita, and so on. But there is also widespread recognition of the limitations of GDP as a measure of wellbeing. One of the best alternatives has been promoted by the United Nations Development Programme (UNDP), which since the 1990s has compiled a Human Development Index (HDI). This is based on the view that there are three basic dimensions in human development: a long and healthy life, knowledge, and a decent standard of living. To compile the index, the UNDP therefore uses measures of life expectancy at birth, mean and expected years of schooling, and gross national income (GNI) per capita, measured using purchasing power parity (PPP) methodology. It also has to be said that in this report we will be looking at our country groups from a range of different perspectives and ‘rankings’ – among them the Global Competitiveness Index (GCI) compiled by the World Economic Forum.

  The table below presents some initial basic information on our country groups. It includes the latest available HDI rankings and scores, the HDI categories, population, and GNI per capita data. A first comment is that there are different and sometimes conflicting measures of performance. Average incomes in Australia are below those in the United States, yet Australia scores significantly higher in HDI terms: in fact, along with Norway and Switzerland it is one of the three countries with the highest HDI scores (which we have described as the ‘global leaders’ country group). A second interesting point is that a country’s average income does not tell us how equally or unequally that income is distributed. UNDP has therefore calculated what it calls an ‘Inequality adjusted HDI’. While the United States was ranked 10^th in the world in terms of HDI, it fell by 10 positions – down to 20^th in terms of the inequality adjusted HDI.

  How some of the players shape up
  	2015 HDI rank/188	2015 HDI score	HDI Category	Population 2017 (m)	GNI per capita (current US$, PPP)
  Leaders of the pack
  Norway	1	0.949	Very High Human Development	5.282	63,530
  Australia	2	0.939	Very High Human Development	24.598	45,780
  Switzerland	3	0.939	Very High Human Development	8.466	65,910
  Global giants
  United States	10	0.920	Very High Human Development	325.719	60,200
  China	90	0.738	High Human Development	1,386.395	16,760
  India	131	0.624	Medium Human Development	1,339.18	7,060
  Latin America's small and sucessful
  Uruguay	54	0.795	High Human Development	3.456	21,870
  Panama	60	0.788	High Human Development	4.098	21,890
  Costa Rica	66	0.776	High Human Development	4.905	16,100
  Latin America's big and struggling
  Argentina	45	0.827	Very High Human Development	44.271	20,270
  Mexico	77	0.762	High Human Development	129.163	17,740
  Brazil	79	0.754	High Human Development	209.288	15,160
  Latin America's small and failing
  El Salvador	117	0.680	Medium Human Development	6.377	7,540
  Guatemala	125	0.640	Medium Human Development	16.913	8,000
  Honduras	130	0.625	Medium Human Development	9.265	4,630
  Sources: United Nations Development Programme, World Bank

• The global role of small countries

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  Various analysts have noted that despite getting comparatively little coverage in the media, various small countries perform notably well in the global economy. Writing in the Singapore-based Straits Times Tommy Koh, an official at the ministry of foreign affairs, has argued that it is a mistake to equate size with success. Defining a small country as one with a population of less than 10m, he calculates that 14 out of the world’s 20 richest countries (using GDP per capita) are small. Small countries also account for 12 out of the global top 20 when ranked by HDI (the list includes Switzerland, New Zealand, Denmark, Iceland, and Luxembourg). Small countries account for 13 of the 20 least corrupt countries in the world (as listed in Transparency International’s Corruption Perceptions Index or CPI). They account for 14 out of the top 20 when ranked for gender equality (using the UN’s Gender Inequality Index), and for eight out the 11 best educated countries in the world (based on a ranking by the World Economic Forum).

  Koh’s conclusion is that “A pattern seems to be emerging from these facts and figures. Some small countries are extremely successful because they are well governed (non-corrupt), pro-women (high gender equality), and pro-inclusive growth (high score on the Human Development Index). I would add two more factors to account for their success. The first is that they have educated and trained their population well. The second is that they are open economies, with an outward orientation, and are highly globalised.”

  Patrick Emmenegger, a professor of public policy at University of St Gallen in Switzerland makes the interesting and paradoxical point that small countries’ weakness may be a source of their strength. He argues “As a rule, they are not powerful enough to impose their influence on world affairs in any substantial way. In economic terms, they have to accept prices rather than fix them. Decisions made by other, bigger countries often have a disproportional impact. In brief, it looks as if small countries usually get the short end of the stick.” However, he cites US political scientist Peter J Katzenstein who, after analysis of Switzerland and other small European democracies, concluded that small countries can compensate for this perceived disadvantage “by means of a high degree of flexibility and adaptability”. Also working in their favour, according to Emmenegger, is an awareness of vulnerability which makes them better disposed to cooperate across borders, conduct frequent interactions with different parties and interests, and build inter-personal trust. He concludes that “A country’s awareness of its distinct vulnerability owing to its small size results in an increased readiness to compromise in view of the possibly disastrous consequences of lasting conflict.” In Switzerland’s case, he describes this as “an ability to compromise internally and to adapt externally”.

  A 2014 study by the Credit Suisse Research Institute, ‘The Success of Small Countries’, makes the important point that there are now a lot more small countries in the world than there used to be. The study defines small states as those with a population of under 10m. Since 1945 the number of nation states has quadrupled, with UN membership rising from nearly 50 then to 193 now. The report calculates that 77% of all small states in the world have formed during the last 70 years. While no new states emerged in this period in Spanish and Portuguese speaking Latin America, a significant number did so in the English-speaking Caribbean. Worldwide, the process has appeared to be connected with globalisation, which is seen as both enabling and challenging smaller countries. The emergence of small new states in the context of globalisation is described as one of the key geo-economic megatrends of the past 30 years. To the extent that globalisation allows truly free trade (something now in question given the re-emergence of protective sentiment and action) political borders become less important and small countries can be as successful as some of the larger ones, since they too can access large domestic markets.

  

  While some may question this assertion, the report argues that small countries tend to be more homogeneous in cultural, ethnic, religious and linguistic terms, and that this helps them to be more successful. It goes on to say that on the whole small countries have embraced globalisation and free trade more than large ones. It states “Trade openness is another factor that is statistically relevant in determining the success of a country. Increased specialisation helps small countries be more successful in an increasingly competitive environment.” It does however note that small countries are more likely to experience higher volatility in GDP growth rates.

  Interestingly and contrary to expectations, the Credit Suisse report did not find strong evidence that larger countries benefit significantly more from greater economies of scale. Small countries do appear to spend more on education and healthcare as a proportion of GDP, key factors for long-term success. Small countries also have a highly urbanised population, with city-states such as Hong Kong and Singapore doing particularly well in the global HDI ranking. While the world’s largest corporations are mainly headquartered in large countries, up to a third of their workforces are based overseas. Small countries can specialise in areas that give large corporations a degree of competitive advantage.

  The report did find a significant difference between what it calls “old” small countries and “new” ones. It suggests this is because in some new countries the institutional and legal framework is not yet sufficiently developed. Credit Suisse also argues strongly for the importance of what it calls “intangible infrastructure”, consisting of education, governance, the rule of law, the ability to manage globalisation and macro volatility, and human development factors. These, it says, drive the success of small countries, with corporate tax receipts, size, democracy, and intellectual property being much less important factors.

• What is the evidence for faster growth?

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  While the limitations of GDP as a measure of wellbeing are noted, it is still relevant to ask whether there is evidence that the group we have described as Latin America’s small and successful really has outperformed. We chose the annual change in gross national income (GNI) per capita, expressed in US dollars, as the most appropriate indicator, since it accounts for growth in income net of population change. The World Bank has GNI data series going back to the 1960s, but unfortunately there are some gaps. There are no data for Costa Rica from 1991-2007. In addition there are no data for Brazil (part of our Latin America’s ‘big and struggling’ country group) and no data for El Salvador (part of Latin America’s ‘small and failing’ country group) before 1990.

  As a result we calculated the GNI per capita growth rate data over a 30-year period for three groups of two countries: Uruguay and Panama for ‘small and successful’, Argentina and Mexico for ‘large and struggling’ and Guatemala and Honduras for ‘small and failing’. Within each of these pairs, the GNI growth figures were weighted for population size, and turned into an index with 1985 as the base year. What this gave us was a 30-year period of data running up to 2015. The graph can be seen below. It shows that over time the ‘small and successful’ group has lived up to its name, with per capita GNI rising the most, followed by the ‘big and struggling’ group and then by the ‘small and failing’. The graph is also interesting because it suggests that the ‘big and struggling’ group has suffered sharper cyclical downturns than the smaller successful economies, particularly in 2008 and 2009. In the five years to 2015, average annual GNI per capita growth for the ‘small and successful’ group was 4.3%, followed by 1.6% for the ‘small and failing’ group (suggesting our description of it may be a little unfair), and with the ‘big and struggling’ group in third place with 0.9%. This may indicate that for the some of the larger economies the end of the commodities boom may have been a particularly difficult period.

  Small countries out in front
  Index of GNI per capita, 1985=100

  

  Source: World Bank and own calculations

• Panama background

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  For over a decade Panama has been one of the world’s fastest growing economies. GDP growth averaged 7.2% from 2001-2013. Growth has recently decelerated a little, coming down to 5.1% in 2014, 5.6% in 2015, 5.0% in 2016, and 5.4% in 2017. The medium-term outlook is for growth to remain strong, supported by a large public investment programme (for example the construction of the Panama City Metro lines) and big revenue flows from ships using the Panama Canal (which was enlarged in 2016). Key sectors such as transport and logistics, mining, financial services, and tourism are all posed for growth.

  There has been significant though in some ways patchy poverty reduction in the country. Using the international poverty line of US$4 a day, Panamanians experiencing poverty fell from 21% to 17% of the population between 2011 and 2015. Pockets of poverty remain, however, particularly in rural indigenous areas known as comarcas. In some of these as much as 70% of the community is poor. There is also a deficit in services such as drinking water, sanitation, and health.

  The World Bank argues that the government has been paying renewed attention to the need for inclusive economic policies. However, to maintain strong growth further structural reforms will be necessary, particularly in areas such as infrastructure, education and skills, and public sector institutions and governance. The government’s current five-year strategic development plan (2015-2019) seeks to boost both inclusion and competitiveness.

  The last Article IV consultation between Panama and the IMF was concluded in May 2017. The IMF report said that the country was expected to continue as one of the most dynamic in the region, with strong growth, low and stable inflation, sustainable debt, and a declining current account deficit. The outlook was described as favourable despite heightened external uncertainty, with growth supported by shipping revenues generated by the expanded Panama Canal and a wide range of public and private investment programmes. The non-financial public sector (NFPS) deficit was expected to gradually decline to around 1% of GDP over the medium term. Diversification of exports and the opening of a major new copper mine were expected to help further narrow the current account deficit. Downside risks included delays in the process of improving tax transparency and AML/CFT (anti-money laundering and countering the funding of terrorism) regulations. Panama might also be affected by weaker-than-expected global growth. Other risks were faster-than-expected US monetary tightening, and continued appreciation of the US dollar (the Panamanian currency is pegged to the US dollar, so a stronger dollar makes the country’s exports less competitive and discourages inward tourism).

  One of the IMF’s main recommendations for the Panamanian authorities was that they should do more to enhance financial integrity and the AML/CFT framework. It also called for more action to strengthen fiscal discipline. It noted that despite recent improvements Panama’s tax revenues remain among the lowest in the region.

  Panama Key Indicators (IMF Article IV, May 2017)
  Annual % change, unless otherwise indicated
  	2012	2013	2014	2015	2016	2017f
  Real GDP growth	9.2	6.6	6.1	5.8	4.9	5.1
  Consumer prices eop	4.6	3.7	1.0	0.3	1.5	2.5
  Gross domestic investment (% of GDP)	44.4	45.8	47.0	46.6	46.3	45.2
  Gross domestic savings (% of GDP)	34	36.0	33.4	39.3	41.0	40.5
  Current account balance (% of GDP)	-10.5	-9.8	-13.7	-7.3	-5.6	-6.2
  Foreign Direct Invesmtent (% of GDP)	8.7	8.1	8.4	7.6	9.2	8.9
  Public Sector fiscal balance (% of GDP)	-3	-4.0	-4.7	-4.3	-3.0	-2.0
  Public Sector fiscal balance excluding Canal Zone	-1.4	-2.3	-3.3	-2.3	-2.2	-1.7
  Non financial public sector debt (% of GDP)	27	27.3	29.2	30.0	30.7	29.0
  Memo Item: GDP (US$bn)	39.95	44.9	49.2	52.1	55.2	59.1
  Source: IMF

• Panama’s political context

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  Panama became independent from Spain in 1821 (as part of Greater Colombia) and seceded from Colombia in 1903, a rebellion supported at the time by the United States. Washington had been keen to secure the rights to build and operate the Panama Canal. In fact, Panama’s history as in independent republic is closely linked to the Canal. Until 1999 the Panama Canal was operated as a US enclave on Panamanian soil; the Carter-Torrijos pact of 1977 had set the stage for full Panamanian control of the canal to be re-established starting from 2000. However, decades of close association with the US have left their mark. The economy remains dollarised and in both the widespread use of the English language and in middle-class life styles and aspirations US influence is very present.

  Democracy is still relatively new in the country. From 1968-1989 there was a period of continuous military rule, first under General Omar Torrijos, a nationalist who enjoyed relatively high levels of popularity, and then, after 1983, by General Manuel Noriega, more of a traditional military strongman. After indicting Noriega on drug smuggling, racketeering, and money laundering charges, the US invaded Panama to oust him from power. Democratic governments have ruled the country since then – for almost three decades. The current government of President Juan Carlos Varela, of the Partido Panameñista (PPa), can be characterised as centrist and populist. The next elections are due in May 2019.

  According to the 2017 Democracy Index published by the Economist Intelligence Unit (EIU), Panama is ranked 45^th in the world out of a total of 167 countries assessed, and was described as a “flawed democracy”. The ranking tracks 60 indicators designed to measure pluralism, civil liberties, and political culture. The EIU describes flawed democracies as nations where elections are free and fair and basic freedoms are honoured, but where there are shortcomings of different types, such as restrictions on media freedoms, an under-developed political culture, low levels of political participation, or problems with the quality of governance. Panama scored highest for its electoral processes and pluralism and for civil liberties. Its lowest scores were for political culture and political participation.

• The performance debate about Panama

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  There is a tendency among Latin American journalists and economists to compare their own countries with their nearest neighbours, sometimes leading to hyper-critical views of the ‘home team’. It can however offer interesting insights into the perceived strengths and weaknesses of different economies. In this context the views of Costa Rican journalist Daniel Salazar Murillo, writing in newspaper El Financiero, and comparing his country’s performance to that of Panama, are of interest.

  In his view both Panama and Costa Rica are Central America’s success stories. Murillo says Panama’s great asset is the Canal but it faces important social and political challenges. Costa Rica in turn is seen as having a bigger state and stronger social inclusion, but is losing speed with “a less competitive and productive economic engine”. Murillo notes that from 2010-2015 Panama grew at an average annual rate of 7.5%, while Costa Rica did so at a slower 4.3%. Costa Rica’s unemployment rate was double Panama’s; Panama performed better in logistics, infrastructure and financial market development.

  Panama was seen as having a clear strategy based on becoming an international logistics hub. It was also seen as having a smaller but more flexible state. Costa Rica’s development path, focused on exports of technology and services, was seen as requiring more highly qualified staff. This was described as one of the reasons for having a more equal distribution of income and a greater emphasis on equality of opportunity. Panama’s less inclusive path meant greater inequality and poverty. It also performed less well in education. However, its faster economic growth and revenues meant it had a “golden opportunity” to invest in improving its social indicators.

  Another comparison, highlighted by Ricardo Eskildsen in La Prensa, is with the United Arab Emirates. Eskildsen says both Panama and the UAE have achieved sustained periods of high economic growth with significant private sector involvement. Both are trading hubs; both are cosmopolitan and have invested heavily in infrastructure; and both have achieved significant political stability. Eskildsen goes on to argue that both have successfully built a diversified economy based on revenues from a single plentiful natural resource: oil and gas in the case of the UAE, and water in the case of Panama.

• Costa Rica background

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  The World Bank has described Costa Rica as a “development success story” having experienced 25 years of steady economic expansion, based on outward oriented growth, openness to foreign investment, and gradual trade liberalisation. The country has also paid particular attention to protecting the environment and promoting itself as a ‘green’ tourism destination. Costa Rica pioneered the concept of payments for environmental services (PES) to further forest and biodiversity conservation. It is the only tropical country in the world to have reversed deforestation.

  Costa Rica has one of the lowest poverty rates in Latin America, although recent progress in poverty reduction has been comparatively small. The proportion of the population living in poverty fell from 20.5% in 2016 to 20.0% in 2017. Between the same two years those suffering extreme poverty fell from 6.3% to 5.7%. Per capita GDP has tripled since 1960; growth in per capita GDP averaged 4.5% from 2000-2013, above the Latin American average of 3%. Despite the country’s achievements it faces at least two pressing development challenges: a deteriorating fiscal situation and stubborn inequality.

  The last Article IV consultation mission and report on Costa Rica conducted by the International Monetary Fund (IMF) was in June 2017. The mission said that the Costa Rican economy was growing at its trend rate of around 4.25%, with inflation rising moderately but still within the 2%-4% target range. The financial system was described as sound, with credit growth consistent with “healthy financial deepening and macroeconomic trends”. However, the IMF warned that the fiscal deficit remained high, with public debt continuing to rise rapidly. Growth was expected to slow, with the current account deficit widening to around 4% of GDP given rising energy costs. The IMF said that downside risks included persistent high fiscal deficits, rising public debt, the heavy dollarisation of bank assets and liabilities, and a less favourable external environment. It called for a comprehensive strategy to achieve long-term fiscal sustainability, along with structural reforms, particularly in transport and education, to increase the country’s competitiveness.

  Costa Rica Key Indicators (IMF Article IV, June 2017)
  Annual % change, unless otherwise indicated
  	2013	2014	2015	2016	2017f	2018f
  Real GDP growth	2.3	3.7	4.7	4.3	4.0	4.0
  Consumer prices eop	3.7	5.1	-0.8	0.8	3.0	3.0
  Gross domestic investment (% of GDP)	19.0	18.8	20.2	19.7	19.6	19.5
  Gross domestic savings (% of GDP)	14.1	13.9	15.9	16.5	15.6	15.6
  Current account balance (% of GDP)	-4.8	-4.9	-4.3	-3.2	-4.0	-4.0
  of which Trade Balance (% of GDP)	-11.0	-10.4	-9.0	-7.8	-8.5	-8.5
  Financial and capital account balance (% of GDP)	-6.1	-6.0	-4.9	-3.7	-3.7	-3.7
  of which Foreign Direct Invesmtent (% of GDP)	-4.8	-5.6	-4.8	-4.6	-4.6	-4.5
  Public Sector fiscal balance (% of GDP)	-5.4	-5.5	-5.8	-4.6	-5.6	-6.1
  Public sector debt (% of GDP)	41.8	42.8	45.4	49.2	51.9	54.1
  of which External public cebt	8.7	10.2	11.3	11.3	11.1	10.6
  Memo Item: GDP (US$bn)	50.3	51.3	55.5	58.1	60.0	63.7
  Source: IMF

• Costa Rica’s political context

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  One of the most-cited events in Costa Rican history is the civil war of 1949, which led to the abolition of the army and, in the eyes of many historians, a decisive break with the patterns of military interventions that have punctuated the timelines of many other Latin American countries. The civil war was fought after a disputed presidential election, and left a death toll of an estimated 2,000 people. José Figueres Ferrer, leader of the armed uprising, promoted a new constitution that guaranteed universal suffrage. The army was replaced by a civilian police force. The constitution came into force in 1953. Since then Costa Rica has celebrated 17 consecutive presidential elections (the latest was held this year). In other words, the country has enjoyed 65 years of uninterrupted democratic rule.

  According to the EIU’s Democracy Index 2017, Costa Rica was ranked 23^rd out of 176 countries in 2017, and classified as a “flawed democracy”. Its strongest scores were for electoral process and pluralism, civil liberties, and the functioning of government. It scored less well for political culture and political participation.

  General elections were held in Costa Rica in early 2018. Although Fabricio Alvarado Muñoz, an evangelical senator with conservative social views won the first round in February, a convincing victory was achieved in the second round on 1 April by Alvarado Quesada, a former labour minister under the unpopular outgoing administration of President Luis Guillermo Solis (2014-2018). Some observers noted however that the country’s traditional political parties lost ground in the elections. Quesada campaigned as an outsider. The Partido de Liberación Nacional (PLN) only supported Quesada in the second round.

• The performance debate about Costa Rica

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  Writing for the Harvard International Review in 2015 María José Sada described Costa Rica as Latin America’s success story, with high levels of economic growth, foreign direct investment, and literacy. Sada noted that on some indicators the country performed better than developed countries (in 2000 the World Health Organisation ranked Costa Rica’s universal health care system as better than that of the United States). Costa Rica also had ranked first in recent editions the Happy Planet Index, which combined life expectancy, wellbeing, and ecological data to calculate sustainable wellbeing.

  A significant part of this successful trajectory was attributed to the decision to abolish the army. Although the decision itself reflected narrow political interests (Figueres wanted to prevent new challenges to his rule) Sada said it led to “tremendous, if accidental benefits”, adding “Without a military to fund, Costa Rica’s government has found itself with a surplus of funds to finance social programmes, from high quality healthcare services to universal education, all of which helped strengthen Costa Rica’s workforce and laid the foundation for substantial economic growth.” Growth was later enhanced in the 1990s with the country’s move into high-tech industry, attracting companies like Intel, Microsoft, and Hewlett-Packard. As a result exports have now diversified beyond agricultural goods to include computer components and software. In addition, the country has been able to brand itself as a major eco-tourism destination. Costa Rica is now the most-visited country in Central America, with net revenues of over US$1.2bn.

  Sada noted however that Costa Rica suffered threats to its prosperity derived in part from its geographical location close to major drug- and people-smuggling routes. It has responded with a policy of strengthening its border controls and police patrols. Sada’s conclusion was that “Good governance, or a lack thereof, will determine whether the country will continue to receive millions of dollars in foreign direct investment and will set the stage for the country’s future in tourism, both areas which have fuelled Costa Rica’s impressive economic boom in the past decade.”

  In an article published in May this year US economist Joseph Stiglitz praised Costa Rica for its many achievements, but warned that it faced two key problems: a persistent structural fiscal deficit and a gridlocked political system. Of the two, he considered the first to be relatively easier to fix. It required a combination of boosting economic growth, raising taxes, or lowering expenditure. The newly elected government should avoid the temptation of reducing spending on infrastructure, Stiglitz argued, but instead should reform the tax system, enhancing its progressive nature and perhaps introducing a carbon tax on cars to encourage a transition to electric vehicles. Stiglitz praised the new president for his attempts to break the deadlock between existing parties, but warned that in the absence of cooperation across the political divide “deficit and debts can explode, with no path towards resolution”.

  Some locally-based analysts detect a sense of malaise, or at least one of looming new challenges to the country’s continuing prosperity. Jorge Vargas Cullell, of think tank Programa Estado de la Nación, says that in the second half of the twentieth century the country achieved three things that no one believed could be done simultaneously: first, it grew the economy and boosted productivity; second, it created a welfare state; and third, it consolidated a political democracy, something which at the time was considered a rich country ‘luxury’. Now, however, Cullell argues that there are important imbalances. One is that the export sector has diversified and modernised but has failed to transform sectors focused mainly on the internal market. In some ways there is a dual economy. He describes the export sector as a locomotive that has not been securely fixed to the train carriages representing the domestic economy. The resulting imbalances have led to a widening fiscal deficit and higher debt. Just as in the 1950s, he argued that Costa Rica must now try and do things that few believe can be done simultaneously: reducing spending and boosting growth.

• Uruguay background

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  Compared with the rest of the region, Uruguay stands out as an egalitarian society, with low levels of poverty and low inequality. Relative to the overall size of its population Uruguay has the largest middle class in Latin America. Confidence in the government is comparatively high, a reflection of low levels of perceived corruption. The World Bank says the country has attained a high level of equality of opportunity in terms of access to basic services such as education, running water, electricity and sanitation. Moderate poverty dropped from 32.5% of the population in 2006 to 9.4% by 2016, while in the same period extreme poverty was almost eradicated – down from 2.5% to 0.2% of the population. Income levels of the poorest 40% of the population have increased more rapidly than the average for the population as a whole. The proportion of the population over the age of 65 that receives a pension has grown to 87%, one of the highest coverage rates in the region. The World Bank attributes the reduction in poverty to two main factors, “a solid social contract and economic openness”.

  Unemployment has traditionally been low: 6.6% in 2014, although it has edged up (to 7.8% in mid-2017) after a period of lower economic growth. Export markets have been significantly diversified, reducing dependence on traditional trade partners such as Argentina and Brazil. At present 77% of exports go to 15 different destination markets.

  The IMF concluded an Article IV consultation with Uruguay in January 2018. It noted that 2017 had been a good year for the country’s economy, with growth of over 3%, unemployment stabilising, and inflation coming down to around 6.5%. Fiscal policy was described as being on track, following a counter-cyclical pattern as higher-income tax receipts were partly offset by rising pension and healthcare costs. The overall fiscal deficit was estimated at around 3.3% of GDP. The current account balance had been improving, reaching a surplus equivalent to nearly 2% of GDP. The exchange rate had become more competitive in relation to neighbouring Argentina (attracting a big increase in tourism inflows) but the peso had appreciated against other currencies, weakening export competitiveness for agricultural and manufactured goods.

  The IMF mission identified an important upside risk for the economy – a potential investment in the country’s third pulp-processing plant, which would be the largest FDI project ever materialised in Uruguay, and would boost confidence and growth. Downside risks related to a slowdown in the world economy, a general loss of investor confidence in emerging markets, or a reversal of economic recovery in neighbouring Brazil or Argentina. That said, attention was also drawn to the country’s “large buffers” (high foreign currency reserves and liquid financial assets), which would allow it “to weather potential short-term shocks relatively unscathed”. Broadly speaking, the Fund said the major challenges facing the country lay in the medium term. Despite widespread recognition of the country’s strong institutions and hard-won economic stability, the Fund said “there is scope to address weakness in transport infrastructure, education and skills formation, labour market flexibility, and access to foreign markets”. It also called for action to improve the business climate.

  Uruguay Key Indicators (IMF Article IV, January 2018)
  Annual % change, unless otherwise indicated
  	2014	2015	2016	2017	2018f	2019f
  Real GDP growth	3.2	0.4	1.5	3.1	3.4	3.1
  Consumer prices eop	8.3	9.4	8.1	6.4	6.7	6.5
  Unemployment (%, eop)	6.6	7.5	7.9	7.4	7.1	7.1
  Current account balance (% of GDP)	-2.8	-0.7	1.7	1.9	1.3	0.6
  Foreign Direct Invesmtent (% of GDP)	4.1	1.6	-1.5	1.4	1.3	1.2
  Overall balance of payments (US$bn)	1.357	-1.867	-2.190	2.000	0.340	0.340
  Public Sector fiscal balance (% of GDP)	-3.5	-3.6	-4.0	-3.3	-2.7	-2.5
  Total external debt (% of GDP)	74.9	89.5	74.8	68.5	70.1	70.4
  of which External public debt	33.7	37.1	31.8	30.6	32.3	32.6
  Memo Item: GDP (US$bn)	57.2	53.3	52.4	58.6	63.6	67.2
  Source: IMF

• Uruguay’s political context

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  Of our ‘small and successful’ country group composed of Costa Rica, Panama, and Uruguay, Uruguay did best of the three in the 2017 Democracy Index prepared by the Economist Intelligence Unit (EIU), coming in 18^th out of 167 countries (ahead of the United States which was ranked equal 21^st with Italy). Uruguay was ranked as a “full democracy”. This category is defined as gathering those nations where civil liberties and basic political freedoms are not only respected but reinforced by a political culture conducive to the thriving of democratic principles. These countries have governmental checks and balances, an independent judiciary, adequately functioning governments, and a diverse and independent media. Uruguay got its highest scores for electoral process and pluralism, civil liberties, and the functioning of government. Its weaker areas were political culture and political participation.

  Through much of the nineteenth century Uruguay experienced recurring civil wars which pitted rural against urban power groups. In the twentieth century a more stable political system came into being, with peaceful co-existence between the rural interests, represented by the Partido Nacional (or Blancos) and a more urban middle class, represented by the Colorado party. The Colorados successfully introduced basic features of a welfare state. While Uruguay benefited from strong economic growth and import substitution associated with the two world wars, its economy remained largely dependent on beef and wool exports. The prices of these commodities stagnated in the 1950s and 1960s, leading to a period of economic decline and eventually triggering a political crisis in the late 1960s and early 1970s. Amid left-wing guerrilla activity the armed forces took power in 1973 and imposed a repressive dictatorship which remained in office until 1985. Since then the country has returned to its democratic ‘norm’. There have been seven successive elected administrations over a period of 33 years.

  In this uninterrupted democratic period there have been two significant changes. First, the two party system, based on alternation between Blancos and Colorados, has been modified with the appearance of a strong left-wing coalition, known as the Frente Amplio (FA), which has ruled the country since 2005 – a total of 13 years. The FA has in fact been a moderate, centre-left force, which has introduced a number of market-friendly reforms. Second, the country is much less dependent on beef and wool prices than in the past: the economy has diversified in terms of overall trade and domestic sectors of activity, benefiting from the construction of large paper and pulp plants but also from the rapid expansion of software companies (including the gaming industry) and other services. By one reckoning Uruguay now has a US$1.2bn IT industry with 700 tech companies exporting software across 52 different markets.

• The performance debate about Uruguay

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  Various analysts have come up with different reasons for Uruguay’s relative success. Writing in the New York Times in 2016 journalist Uki Goñi claimed the country had a refreshing absence of the type of passionate nationalism that can be whipped up by populist leaders elsewhere in Latin America. He cited Uruguayan historian Gerardo Caetano, who said, “Nation is not a word we often use. We prefer republic.” Goñi also cited the trail-blazing reforms introduced by Colorado President José Batlle y Ordoñez in the early part of the 20^th century, pointing out that among many modernising steps, the country adopted a liberal divorce law in 1913, while it took Chile almost another 100 years, until 2004, to make divorce legal. In the same tradition he cited Uruguay’s legalisation of marijuana consumption in 2013. Caetano argues that Uruguay is set apart by a strong “social contract”, in effect a tacit agreement to resolve differences at the ballot box, not by mass street demonstrations and confrontations of opposing factions. In his Caetano’s words, “We don’t have that sense of epic politics, we just have a boring democracy. In Uruguay the political parties are more important than the social movements.” In Goñi’s opinion, “Uruguayans have a healthy mistrust of charismatic, messianic leaders, which preserves them from the bane of presidents dubiously extending their term limits, as we have seen in Venezuela, Ecuador and Bolivia in recent years.”

  In an article written in March 2018 London-based The Economist noted that after 2.7% GDP growth in 2017, Uruguay had achieved a 15-year uninterrupted growth streak, the longest in the country’s history. It credited the FA with seeking to reduce Uruguay’s dependence on its two large neighbours (Argentina and Brazil) and with setting up special tax regimes and economic zones to attract new industries such as software and audio-visual services. The share of exports going to Brazil and Argentina fell from 37% to 21% from 2001-2016. There have also been big increases in public spending on science and technology. FA governments took care to keep taxes low and strengthen an independent judiciary to keep the country attractive for foreign investors. The article noted, however, that the country is far from problem free, with growth still somewhat sluggish, inflation stubbornly high, and an ongoing fiscal deficit.

• The Competitiveness debate

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  One of the most widely accepted measures of country-level competitiveness is the Global Competitiveness Index (GCI) compiled every two years by the World Economic Forum (WEF). WEF defines competitiveness as “the set of institutions, policies, and factors that determine the level of productivity of a country”. Productivity is seen as determining the rate of return on investments in a given territory, which in turn drives growth rates. A more competitive economy is expected to be a faster-growing one. WEF compiles the GCI by assessing over 60 indicators divided up into 12 categories or ‘pillars’. These pillars are institutions, infrastructure, macroeconomic environment, health and primary education, higher education and training, goods market efficiency, labour market efficiency, financial market development, technological readiness, market size, business sophistication, and, finally, innovation. It is worth noting that under market size there is an assumption that a country with a larger market is likely to be more competitive; however, the way the GCI methodology works means it is possible for smaller countries to offset this negative factor with other positive ones.

  Of interest to the discussion is the WEF’s categorisation of three main stages of development. In the first stage of development, a country’s economic growth is assumed to be primarily factor-driven: therefore its competitiveness is assumed to depend primarily on well-functioning institutions (1^st pillar), infrastructure (2^nd pillar), macroeconomic management (3^rd pillar) and a healthy and educated workforce (4^th pillar). The next stage of growth is efficiency-driven, when productivity becomes more important. Here education and training (5^th pillar), efficient goods markets (6^th), well-functioning labour markets (7^th), financial markets (8^th), technology (9^th), and market size (10^th) become more important). Finally, in the third, innovation-driven stage, it is the last two pillars, business sophistication (11^th) and innovation (12^th) that come to the fore. Of the economies we are examining Honduras is classified as being in a transition between the first and second phases; Brazil, China, Guatemala, and Mexico are in the second, efficiency-driven stage; Argentina, Costa Rica, Panama, and Uruguay are classified as being in transition between the second and third stages; and Australia, Norway, Switzerland, and the United States are in the third, innovation-driven stage.

  One way of identifying what the ‘successful’ small counties are doing right in the field of competitiveness is to compare the highest-ranked in the GCI, Costa Rica, with the lowest-ranked among our ‘small and failing’ country group, which is El Salvador. Costa Rica is ranked 47^th in the world for competitiveness, while El Salvador comes in at 109^th. On the WEF’s scale of 1 to 7, Costa Rica scores 4.8. Its scores particularly well for the pillars relating to health and primary education (where it is ahead of the Latin American average), higher education and training, goods market efficiency, labour market efficiency, financial market development, and technological readiness. The three most-problematic factors for doing business are identified as inefficient government bureaucracy (23.1% of business respondents), inadequate supply of infrastructure (18.4%), and tax rates (10.4%).

  

  In contrast, El Salvador scores only 3.8 in the general index, and well below Costa Rica on most pillars. El Salvador’s best performance is also registered in health and primary education where it is close to the Latin American average, but it lags behind for the quality of its institutions, on higher education and training, on labour market efficiency, and on innovation. The most problematic factors for doing business are identified as crime and theft (19.5% of respondents), corruption (15.9%), and inefficient government bureaucracy (11.1%).

  

  One of the big contrasts between Costa Rica and El Salvador is only partially captured in the WEF data. Put simply, this is that for a variety of historical reasons, El Salvador has been, and continues to be, a much more violent society than Costa Rica, something which has a clear economic and social cost. El Salvador has a history of greater political instability and experienced a bitter civil war for over 12 years (1979-1992). Democracy was re-established in the 1990s, but continuing poverty and inequality led to the spread of violent gangs (known as maras) dedicated to drug and people trafficking and extortion. Because of this, El Salvador, along with its two ‘Northern Triangle’ neighbours, Guatemala and Honduras, has in recent years experienced some of the highest peacetime homicide rates in the world. In 2017 El Salvador had the second-highest homicide rate in Latin America, equivalent to 60 homicides per 100,000 inhabitants. The homicide rate in Costa Rica in the same year was only 12.1 per 100,000, placing it among the more peaceful and secure countries in Latin America.

• Doing business

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  One measure of how well an economy is likely to perform is the Doing Business survey carried out regularly by the World Bank. As the title suggests, the Doing Business (DB) index measures the ease of carrying out 10 business tasks in each country. These are: starting a business, dealing with construction permits, getting electricity, registering property, getting credit, protecting investors, paying taxes, trading across frontiers, enforcing contracts, and resolving insolvency. Each of these is measured in standard units (for example days or number of stages in an application procedure) and given a value that allows countries to be ranked. The World Bank also measures what it calls the “distance to frontier” – the distance between each economy and the highest performance in each category.

  The Doing Business survey has often persuaded governments to try and improve their procedures so as to support business efficiency and attract new investment. The World Bank keeps track of a number of these reforms. In the 2018 edition of Doing Business it noted that El Salvador had adopted four reforms in the preceding year, including improving the reliability of electricity supplies, and creating an online platform to make it easier to pay taxes. Other countries carrying out reforms in the preceding year included Jamaica, the Dominican Republic, Brazil, and Mexico. Latin America’s best-ranked countries for the ease of doing business are Mexico (49^th in the world), followed by Peru (58^th), and Colombia (59^th).

  Among the ‘small and successful’ country group we are examining, the best ranking was achieved by Costa Rica (62^nd in the world) followed by Panama (70^th) and Uruguay (90^th). For comparison the ‘small and failing’ country group performed less well on average. Guatemala was ranked 88^th, followed by El Salvador (95^th) and Honduras (105^th). For the purposes of comparison it is worth looking at the best performer among the ‘small and successful’ group, which was Costa Rica, and the worst performer from the ‘small and failing’ group which was Honduras.

  

  

  To give a sense of the business impact of these different procedures it is worth looking at an example – paying taxes. In Costa Rica taxes must be paid on average ten times year, and the process of filing the necessary information and paperwork takes companies around 151 hours every year. In Honduras on the other hand an average of 48 payments have to be made every year, taking up 224 hours of administrative effort.

• Corruption

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  Having low levels of corruption is clearly important for a successful economy: without that, resources are used inefficiently and development priorities are distorted. One widely used measure of corruption is the annual Corruption Perceptions Index (CPI) published by anti-corruption lobby group Transparency International (TI). The latest was published in early 2018.

  As in previous years, the report gives each of 180 countries a perceived public sector corruption score ranging from zero (very corrupt) to 100 (very clean). Globally TI is fairly gloomy about the progress that is being made. It says that the majority of countries are “moving too slowly in their efforts” to reduce corruption. Over two-thirds of the countries surveyed scored below 50: the global average was a score of 43. In 2017 the world’s least corrupt countries included New Zealand (with a score of 89) and Denmark (with a score of 88). The most corrupt were identified as Syria (scoring 14), Yemen (12), and Somalia (9).

  In Latin America and the Caribbean TI says that despite “great strides” in the battle against corruption, including high-profile investigations and pro-active civil society campaigns on the issue, most countries continue to score poorly. There were new anti-corruption laws in Chile, the Bahamas, Guyana, and Jamaica. Major anti-corruption investigations continued in Brazil, Ecuador, Peru, Guatemala, and Panama. Yet most of these countries still lacked what TI calls “overarching policies” to address the historic and structural causes of corruption. As a whole the Americas scored 44, just above the global average, but that included high scoring countries like Canada (ranked 8^th globally) and the United States (16^th). As might be expected the countries in the “small and successful” group scored well, led by Uruguay (23^rd in the world), Costa Rica (38^th), and noticeably lower down, Panama (96^th). The ‘small and failing’ group performed less well, led by El Salvador (112^th), Honduras (135^th), and Guatemala (143^rd).

  

• Conclusion

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  The basic conclusion of this report is that it is legitimate to talk about Costa Rica, Panama, and Uruguay as a group of small Latin American countries that have outperformed their peers in the region. As the table below shows, they can make a legitimate claim to being more competitive, more democratic, less corrupt, and easier places to do business. As we saw at the beginning of this report, they are also high-scorers in the human development index (HDI) and on the available data, have chalked up the highest rates of growth in GNI per capita. On all these criteria they outperform two other groups of their peers, those we have called the ‘small and failing’ (exemplified by El Salvador, Guatemala and Honduras) and those we have tagged as being ‘big and struggling’ (Argentina, Brazil, and Mexico).

  Latin America's small and successful country group does well in the tables
  Most Competitive		Most Democratic		Least Corrupt		Easiest for Business
  GCI Overall Ranking		EIU Democracy Index		Transparency International CPI Index		World Bank Doing Business
  Country rank out of 137		Country rank out of 167		Country Rank out of 180		Country Rank out of 190
  Swizerland	1	Norway	1	Norway	3	Norway	6
  United States	2	Australia	8	Switzerland	3	United States	8
  Norway	11	Switzerland	9	Australia	13	Australia	15
  Australia	21	Uruguay	18	United States	16	Switzerland	31
  China	27	United States	21	Uruguay	23	Mexico	47
  India	40	Costa Rica	23	Costa Rica	38	Costa Rica	62
  Costa Rica	47	India	42	China	77	Panama	70
  Panama	50	Panama	45	India	81	China	78
  Mexico	51	Argentina	48	Argentina	85	Guatemala	88
  Uruguay	76	Brazil	49	Brazil	96	Uruguay	90
  Brazil	80	El Salvador	65	Panama	96	El Salvador	95
  Guatemala	84	Mexico	66	El Salvador	112	Honduras	105
  Argentina	92	Guatemala	80	Honduras	135	Argentina	116
  Honduras	96	Honduras	82	Mexico	135	Brazil	123
  El Salvador	109	China	138	Guatemala	143	India	130
  Source: World Economic Forum, EIU, Transparency International, World Bank

  However, it is also important to make a number of qualifications. Firstly, there seems to be no standard recipe for success. We have assessed a whole range of factors but it is difficult to weight them in order of importance or to separate the one, or two, or three that are to be considered ‘critical’. Intangible, cultural factors and attitudes may also be important. The general proposition is that competitive, democratic, non-corrupt, and business friendly countries are likely to do better than others, and that small countries can benefit from that approach. But there are plenty of examples where countries that miss out on some of those attributes are still successful in economic terms. China performs poorly on corruption, but still has an impressive growth record. Countries like Singapore and the UAE have also grown strongly despite a strong authoritarian streak in their political systems.

  The second point is that relative success or failure is a fairly long-term thing. The factors that have boosted performance in Costa Rica, Panama, and Uruguay can all be traced back to things that have happened at least 10 years ago, and often much longer than that. This is particularly the case when discussing attracting new industries, infrastructure investment, education, and training where the benefits take a long time to materialise. The third and final point is that ‘nothing is forever’. Each of the three countries we have focused on face challenges amid their current success. To remain successful they will need to adapt continually: on the plus side, as small countries, they may be more acutely aware of that never-ending need than their larger neighbours.