Envío Digital
Central American University - UCA  
  Number 423 | Octubre 2016



The Nica Act puts us at high risk but must we repeat the Myth of Sisyphus?

This up-to-date analysis of the country’s economic reality also looks at the dilemma facing the Ortega government’s alliance with the Superior Council of Private Enterprise’s business elite in light of the new political dynamic opened by the Nica Act and of the economy’s current strengths and vulnerabilities.

Arturo Grigsby

The Nicaraguan government’s urgent need to replace Venezuela’s collapsed cooperation with more fiscal resources for its social spending and public investment had already created a dilemma for the government’s corporative model in alliance with the Superior Council of Private Enterprise (COSEP): either the government eliminates at least part of the tax exonerations many large businesses have enjoyed for years or there will be some very serious belt-tightening. That dilemma has now been intensified by the shift in US policy toward Nicaragua, or at least by Congress’ move in that direction. The “Nica Act,” so far passed only by the House of Representatives on September 21, but with seldom-seen consensus, is creating uncertainty and could affect the credibility of the economic policy the Ortega government has followed since its return to office in 2007.

If also approved by the Senate, that bill will condition all loans Nicaragua requests from the international financial institutions on the holding of transparent, observed and competitive elections. What economic impact would that have on our national economy?

Is there reason to panic?

We heard presidential economic adviser Bayardo Arce quote the famous spoonerism of the late Mexican comic actor and director Roberto Gómez Bolaños in the guise of “El Chapulín Colorado,” his parody of a TV super-hero: “que no panda el cúnico” (which properly said, Que no cunda el pánico, means “Don’t spread the panic”). Comandante Arce reminded the population that the Senate has yet to be heard from, and it also remains to be seen whether the White House would in fact be willing to shift its policy priorities for Nicaragua— currently based on maintaining regional stability—to instead promote democracy should the Senate version of the bill turn out to be equally tough.

The business elite share his view, confident that Washington will continue to prioritize Central America’s geopolitical stability, as the instability of the three countries in the region’s Northern Triangle (El Salvador, Honduras and Guatemala), is, among other things, forcing thousands more of their citizens to emigrate to the United States. These business leaders believe Washington has no desire to see Nicaragua destabilized, turning the triangle into a rectangle…

Arce also said Nicaragua’s economy will keep growing in 2017, although perhaps not at the initially forecasted rate. Other voices close to the government second that assurance, claiming that a multilateral aid cut would only amount to some US$250 million, which they consider relatively insignificant.

That view doesn’t include the famous “business climate”

Those who remember El Chapulín Colorado’s garbled warning not to spread the panic are aware that it implicitly recognizes panic already exists. In that regard, Arce’s use of the phrase is more accurate than his appraisal, as the probable impact of the Nica Act isn’t limited to the low-interest loans Nicaragua receives from the World Bank, Inter-American Development Bank and International Monetary Fund. In an economy as fragile as ours, the unanimous signal sent by the House vote creates at least uncertainty, if not panic, and that alone will make investors think twice. COSEP leaders are well aware of that, as evidenced by their constant warning any time there’s the slightest blip on the “business as usual” radar, whether from disgruntled workers or economists who criticize their corporate tax exonerations, or even some outburst by their presidential ally himself that it threatens “the business climate.” The Nica Act is potentially more than just a blip and it’s very likely that investments will be put on hold until things are resolved one way or the other.

No investor wants to see another Nicaraguan conflict with the United States, no matter how low its intensity. For that reason, the Nica Act’s strongest impact will be on the credibility of the government’s economic policy and the influence any loss of that credibility will have on the expectations and decisions of both national and foreign private investors

We may even see capital flight

Independent Nicaraguan economists and opposition politicians see a different scenario than Bayardo Arce’s, believing that the signal the United States is sending with this bill, whatever course it takes, presages that loss of credibility for the government’s economic policy. They reason that if the Nicaraguan government is defying its main trading partner and that partner is now also proposing to cut access to multilateral financing for public investments, we shouldn’t kid ourselves: we’re heading for a period of economic stagnation or recession, particularly since Venezuela can no longer pick up the slack to protect us from such repercussions.

They even argue that we could find ourselves in a situation similar to the 1980s, when the blockade of the multilateral financing sources triggered a drastic drop in private investment and capital flight. In other words, the Nica Act would mean not only that new capital wouldn’t come in to the country, but also that much of what is here now could leave, as happened back then. In such a scenario, there’s very little likelihood of economic growth in the coming years.

Enter Sisyphus

This is where Sisyphus comes in, that figure of Greek mythology forced to push an enormous boulder to the top of a mountain again and again, only to see it roll back down each time. Between 1984 and 1993, the war and immediate postwar years, our national economy either didn’t grow or, far worse, grew negatively, as did the social indicators. There was such a fall in per-capita income that nearly 40 years later it has still not recovered its level of 1977, less than two years before the fall of the Somoza dictatorship.

Although the size of Nicaragua’s economy is significantly larger today than it was in 1977, the population has also doubled, so while the per-capita income has recovered from its lowest point of US$1,068 in December 1993, its current value of US$1,849 is still well below the December 1977 figure of US$2,577, according to World Bank inflation-adjusted figures in constant US dollars from 2000. So imagine the cost for Nicaragua if we enter economic stagnation or a recession again in the coming years for political reasons. It would severely affect the population’s wellbeing. The Sisyphean effort the country has made since the initial postwar years has been enormous. What would happen if we end up having to watch the boulder roll back down to the valley only to have to go through another stage of pushing it back up? Is that what awaits us in the coming years?

What does the economy’s behavior tell us about these opposing scenarios?

What we have before us are two extreme scenarios, both painted in vivid colors. The first is that of Comandante Arce and the spokespeople for the business elite, who say they don’t believe US policy is going to change fundamentally, and that both loans from the multilateral banks and economic growth will continue. The other is being pushed by those who take into account the uncertainty the mere signal sent from Washington is generating. How much uncertainty will the economy be able to absorb?Let’s see what light we can shed on both scenarios based on what has happened in the Nicaraguan economy in recent years and on the behavior of the country’s different economic actors.


Strong recovery from the global economic crisis.

The first thing that needs to be said is that Nicaragua’s economy has had an important recovery after the major recession the world experienced in 2008-2009. That global crisis affected the entire Central American economy, resulting in negative growth throughout the region, with increasing levels of poverty and unemployment affecting the governments’ capacity to respond to social needs. Despite everything, however, Nicaragua has had the most vigorous recovery of any country in the region, relatively speaking.

One of the two key factors of that recovery was the abundant Venezuelan cooperation, which helped stabilize the economy, finance new social programs and open a new market for Nicaragua’s traditional exports. The other was a period of very favorable international prices for the country’s main export products. We had years of an authentic export boom, in which the industrial exports from the free trade zones, mainly textiles, grew alongside the traditional exports such as sugar, coffee, dairy, peanuts, tobacco and gold.

Other factors contributing to the recovery were a sustained increase in remittances from our emigrant population and, more recently, a substantial increase in foreign investment, as well as an important expansion of bank credit to the private sector, mainly to finance commercial and consumer activities. The annual growth rate of bank credit has exceeded 20% since the start of this decade.


The collapse of Venezuelan cooperation and falling export prices.

This panorama underwent an important change starting in 2014, when oil prices began to plummet. One consequence of the low oil prices, which are still with us, was the collapse of Venezuelan cooperation. At the same time, the prices of our main export products also began to fall and have remained low. In short, two of the pillars of the vigorous economic growth we’ve been experiencing were seriously affected by changes not in Nicaragua but in the international context. Despite this, Nicaragua has maintained more or less similar growth levels in 2015 and so far this year. We didn’t see a recession or even economic stagnation, as would have happened in previous decades, when it was almost an iron law that Nicaragua’s economy would suffer a recession if both its traditional exports and its foreign aid dropped.


Increased foreign private investment.

The explanation for this has to do with a very significant increase in both foreign private investment and domestic consumption. In 2014, foreign investment reached US$800 million, the highest figure in our country’s history in absolute terms. Consumption has grown because the fall in oil prices has increased the disposable income of those who don’t live hand to mouth. In addition, both credit and remittances from family members abroad have continued to grow. All three of these factors—cheaper fuel, more remittances and easy credit—have stimulated both consumption and private investment, while a significant increase in public infrastructure investment has turned that investment growth into a real boom.

But what attracts significant foreign investors to Nicaragua in the first place? The main factor is that Nicaragua has the lowest salaries in Central America. Labor is so cheap here that it’s the only country in the region that can compete with the lowest salaries in Asian countries. El Salvador’s minimum wage is 50% higher than ours, Honduras’ is twice as large, Guatemala’s is a little higher than Honduras’ and Costa Rica’s is four times bigger, which of course is why so many of our people emigrate to Costa Rica.

Central American investors like Guatemalans Julio Herrera of the Pantaleón Group and Fernando Paiz—respectively awarded COSEP’s “businessman of the year” title in 2013 and 2016—or the Salvadoran economic groups that created and are now expanding Managua’s most important shopping malls, consider Nicaragua the ideal place to invest within Central America. This is not only because both land and labor are much cheaper here, but also because there are no strikes or social problems to interrupt economic activities and citizen security conditions are significantly better than in the Northern Triangle countries.


Nonetheless, a dicey business climate

. Despite these advantages, both the World Bank’s “Doing Business Index” and the Global Economic Forum’s “Global Competitiveness Report” define Nicaragua’s business climate as the worst in the region. What that means is that any analysis of our country’s property rights or juridical security using international criteria would leave one hard put to say there’s transparency in the handling of property or that the courts are unbiased adherents to the rule of law.


Personalized treatment of investors.

The explanation for this paradox is the government’s policy of direct and “personalized” treatment of investors, making for very different stories depending on the individual investor involved. Some openly admit you can resolve any problems that arise if you have good political connections. The Ortega govern¬ment’s negotiations with business magnates like Carlos Slim or Fernando Paiz are good examples of this.

The favorable conditions for foreign investors who know how to take advantage of them also work for national investors, who have additionally benefited from a generous tax exoneration policy. Even small and medium businesspeople have invested, particularly in cattle ranching, dairy and beef production, coffee and some agroindustrial sectors. There’s also national investment in tourism at all levels, from luxury resorts to small-scale rural tourism, and also in commerce. What’s happening with the new stage of uncertainty sparked by the Nica Act, however, is that all the investments these small, medium or large businesses had programmed for the coming year will be put on standby to see what happens.


An increase in open unemployment.

Another paradox is that despite the increased investment and economic growth, official figures show a rise in both open unemployment, calculated at 7% of the economically active population, and underemployment, i.e. informal jobs, which have grown enormously. Nicaragua has the highest rate of informal employment in Central America and one of the highest in Latin America. In 2009, the worst year of the global crisis, Nicaragua’s informal employment was around 60%, yet it has now climbed to nearly 80%. This expansion of the informal sector shows very clearly that our country has not grown enough to create the number of formal productive jobs needed to respond to the demand of the thousands of young people now entering the labor market.


Dropping productivity and little diversity.

This huge informal sector also reveals yet another paradox of Nicaragua’s economy: while there is economic growth, productivity is dropping rather than improving, particularly for small and medium agricultural production, small-scale manufacturing and services. No public policies are effectively promoting the adoption and adaptation of technologies available in our country for these sectors.

Moreover, Nicaragua’s economy isn’t very diversified, making it particularly vulnerable to falling prices for the products we’ve been exporting since the 19th century, including beef, coffee, gold and one or two others. Independent national economists, including José Luis Medal, Néstor Avendaño, Adolfo Acevedo and Juan Sebastián Chamorro, and more recently even Harvard economist Dani Rodrik have suggested public policies that promote diversification, modernization and the structural change of the national economy.

What can we do to diversify the productive structure and improve its environmental sustainability? Attempts have been made and there are currently initiatives, but they still aren’t anywhere near the scale or volume required to truly diversify our economy, thus reducing its extreme vulnerability and the risks we run as a result. An IMF investigation a couple of years ago that measured developing countries’ diversification levels showed that while Nicaragua ranked third in Central America with respect to diversification in 1977, it is currently in sixth place, in other words at the bottom. We have backpedaled while the neighboring countries have moved ahead.


The worst education in the region.

The gap with our neighbors has also widened in education. Improving the quality of and access to education is perhaps Nicaragua’s greatest development challenge. According to the latest UNESCO survey, from 2014, our education quality indicators are below the Latin American average and put us in last place in Central America. There has even been deterioration since the results of the previous survey in 2006. Approximately 10% of primary school-aged children don’t go to school, which means that right at the starting gate 10% of the children face a future as illiterate adults.


Contradictory figures on poverty reduction.

Although there has been little progress in resolving the country’s structural development problems, official data show significant progress in the fight against poverty. They indicate that between 2009 and 2014, the Nicaraguan population’s general poverty rate has dropped from 42.5% to 29.6% and that extreme poverty has fallen from 14.6% to 8.3%.

This is questioned by other figures, however. Annual surveys on poverty done during the same period by the International Foundation for Global Economic Development (FIDEG), an internationally recognized independent research center on this topic, show much more modest progress in the fight against poverty. Using a World Bank-endorsed methodology, FIDEG’s results show that the percentage of the Nicaraguan population below the poverty line only dropped from 44.7 to 40.5 in 2013, while extreme poverty remained almost stagnant, dropping from 9.7% to 9.5%, albeit starting with a lower figure than the government’s.

One possible explanation for the discrepancies was revealed by an analysis the World Bank itself did of the government’s official survey results, which reveals that the official poverty estimates in 2014 used a lower average number of members per household than the one used in the 2009 survey. The distribution of household income among fewer individuals obviously increases per-capita income. The analysis indicates that almost half of the poverty reduction the government registered was due precisely to this modification of the average household size.

Both the World Bank and FIDEG also underscore the key role of remittances in increased household consumption and hence poverty reduction. The impact of the govern¬ment’s anti-poverty social programs, in contrast, is quite limited despite their notably increased coverage.

The official discourse about progress in reducing poverty is also called into question by the government’s own data showing a widening rather than shrinking of the inequality of income distribution from 0.46 in 2009 to 0.48 in 2014, as measured by the Gini Coefficient. That may seem an insignificant fraction, but the Gini coefficient, which helps define the gap between rich and poor based on residents’ net income, only ranges between 0 (perfect equality) and 1 (perfect inequality), .


Wasteful inefficiency and corruption.

It must be said that the government’s financial problems aren’t only a product of the collapse of Venezuelan cooperation, which forced it to move the social programs onto the budget. There are also worrying trends in government spending, as reflected in the Nicaraguan Social Security Institute’s (INSS) deficit. Although the pension system was recently reformed, it wasn’t enough to adjust the INSS accounts, which have been running a deficit for the past two years, with insolvency projected for the coming years.

In theory, Nicaragua shouldn’t have a social security deficit because so many people of working age are now entering the labor force that their contributions and those of their employers should be expanding the pension coffers. But the vast majority of these people are only finding work in the informal sector, one of whose definitions is that it doesn’t pay in to social security, which of course also means that the 80% of workers in that sector have no access to health care coverage or a retirement pension.

It’s yet another paradox that the INSS budget has a deficit even though Nicaragua is now in the full-blown stage of what is known as the demographic dividend, with a high proportion of its total population of working age. This would never happen in developed countries. Instead of having only 20% of the working population insured, as we do, they would have at least 50% insured and thus paying in to the system. What this means is that despite all the forewarning about the need to prepare for this demographic change, it doesn’t amount to a dividend at all, but rather the waste of a great opportunity that only comes once. Both Nicaragua’s Adolfo Acevedo and the United Nations economists estimate that Nicaragua’s demographic dividend will only last roughly 30 years, which means that by 2045 it will be over. By then the 20% now formally employed will be reaching retirement age and behind them the shrinking work force resulting from a dropping birth rate will be even less able to cover these workers’ rightful retirement benefits.

Another worrying trend is the enormous deficit of Nicaragua’s water and sanitation utility (ENACAL). All evaluations indicate major levels of inefficiency in both INSS and ENACAL, both of which are critical to the population. Moreover, there is no evaluation of the economic cost of either the inefficiency or the corruption in these two public sector services, much less in other government institutions, although international indexes that measure such things show that Nicaragua is in a deplorable situation.


Threats to the stability of the Central Bank’s international reserves.

While the challenges posed by the fight against poverty and by Nicaragua’s development will require substantial improvements in both public policies and the efficiency of governmental administration, they also require significant financial resources. But the government is not currently in good financial shape to respond to these challenges. The collapse of Venezuelan aid has made it very difficult to maintain the stability of the Central Bank’s international reserves and also finance the social programs the government has been transferring to the national budget precisely because of the loss of that aid.

The drastic drop in the supply of Venezuelan oil this year has also increased the vulnerability of Nicaragua’s hard currency reserves because the country now has to pay promptly for around 90% of the oil it buys on the international market. That’s a significant change from a couple of years ago when it only had to pay Venezuela 50% of the oil bill within 90 days, while the remaining percentage not donated for social programs was due over a 25-year period with very low interest.

Concern over protecting its international reserve levels has led the Central Bank to contract the circulation of national currency over the course of this year. Independent economist Néstor Avendaño estimates that it took more than 2 billion córdobas (equivalent to over US$69 million) out of circulation between January and July.


A serious external debt level

. Not only is Nicaragua now paying cash for most of its current oil purchases, it is also amortizing its oil debt with Venezuela, contrary to there who insist we’re not going to pay it, The truth is we’re already paying and will continue to do so, and it’s having an impact on the economy.. If we add that debt to the rest of the public and private external debts, Nicaragua’s overall debt burden is 80% of its gross domestic product (GDP), the highest in Central America. El Salvador is closest behind us with a debt that’s only a little over 50% of its GDP.

This total is not officially provided because government statistics are presented separately and it only presents the traditional public debt, the one the country has with international lenders, which has remained stable. But the debt with Venezuela has been growing rapidly because that country’s oil assistance increased in 2011, 2012 and 2013.


A rush to attract investment.

To help calm the business sector’s uncertainty after the House vote on the Nica Act, the government sent the National Assembly a bill on Public-Private Associations, which will facilitate private investment in projects traditionally assumed exclusively by the public sector, and it was given fast-track approval in only a few days. The rush was particularly interesting given that for many years all World Bank reports recommended approval of a law of this type, but the government showed no interest in doing so, almost certainly because it wanted to maintain its discretionary assignment of the contracts for public infrastructure works. That discretionality will be harder to achieve now that this law has been approved, but at least in theory it will attract private resources for public investment in infrastructure projects.

Also to alleviate the business sector’s angst, within two weeks of the Nica Act vote the government announced a package of investment projects to be executed in the framework of these public-private associations or joint ventures. The combined total of the projects the government presented to the diplomatic corps was over US$5 billion. They include a Managua-Masaya-Granada railroad, the paving of the Pacific Coast highway, construction of an air terminal in Bilwi, installation of fuel supply systems for airports outside the capital, construction of interurban bus terminals in the municipality of Managua, building of a cruise ship terminal in San Juan del Sur, modernization of the port of Corinto, construction of a port in Bluefields, advances in the comprehensive water and sanitation program, a pilot program for a national irrigation plan to help resolve water supply problems in the country’s dry corridor and a program to improve production in isolated regions, among a host of others.

Most of these investments still only exist on paper and have been established as a complement to the simultaneously approved Law of Public Private Associations. At this particular moment it’s hard to imagine which private investors, either national or foreign, might decide to participate in them.


An increased need for fiscal income.

Even before the Nica Act, the government was already facing the need to increase tax collection to finance public spending. After the House approval of the Nica Act, Bayardo Arce said the government was going to go over the fiscal incentives favoring the business elite. It was an early warning that at least some if not all of the tax exonerations the government has maintained all these years will disappear or be drastically cut.

Even the International Monetary Fund (IMF) has more than once recommended reducing the high level of tax exonerations, pointing out that they are equivalent to 7% of Nicaragua’s GDP, while the education budget doesn’t even hit 4%.

It also needs to be taken into account that the uncertainty over the signal sent by the United States makes it very difficult, if not impossible, for Nicaragua to do what it was contemplating: issue bonds on the international market to finance public investments. The Nica Act has obviously increased the country’s risk factor.

The corporative model needs to be seriously reviewed

All these realities are evidence that the corporative economic growth model built on the government’s alliance with big business over these years, a model Ortega gave constitutional rank, has had its successes and its problems. Equally evident is that this model is now facing a serious dilemma over the next five years of a probable Ortega government, independent of any changes there may or may not be in US policy toward Nicaragua.

One of the main pillars of the alliance is the tax exonerations and exemptions granted to big business, which was equivalent to some US$850 million last year. Venezuela’s generous assistance from 2007 meant golden years for that alliance because that aid, rather than the taxes of Nicaragua’s wealthiest, financed a good part of the government’s social spending. But those golden years are over, so there needs to be an in-depth review of this corporative scheme; big business has to put its fair share into the nation’s development.

This dilemma was already on the table before House approval of the Nica Act, although the problem will definitely intensify if the Senate also passes it. If loans from the international financing institutions are blocked, it would mean lower growth rates for the country, which would also dissuade foreign investment. Both those factors would in turn shrink tax collection, reducing growth rates even more in a downward spiral.

There are predictions that 2017 will be economically better than 2016 for several reasons. First, the increased rains this year mean better harvests for both domestic consumption crops and export products. Second, there has been a partial recovery in international coffee and sugar prices. And third, the free-trade-zone assembly plants for re-export known as maquilas are beginning to recover after last year’s expiration of the 10-year fiscal exemptions popularly known by the initials TPL (Tariff Preferential Level) that CAFTA stipulated for Nicaragua’s garment assembly plants. Some thus see a more favorable scenario for next year, but these factors won’t improve the larger picture, which has already generated serious uncertainty.

Entering a radically different moment

The conjunction of adverse elements, particularly the collapse of Venezuelan aid and the signal from Washington, has put Nicaragua in the path of a “perfect storm.” But while we’re entering a radically different period, there are still many things the Nicaraguan government and the big business elite can do to avoid it.

The most serious problem is Ortega’s limited maneuvering room, which is currently so narrow it doesn’t allow him to adopt the extreme position of saying “I’m not going to do anything; we’ll go on with this model, confident that the population will tough it out.”

I don’t believe that will happen, because not only the interests of the poor are harmed by such a decision. So are those of Ortega and his partners in the current model.

We have to hope those partners will avoid the worst scenarios, because if the country’s exhausting and heartrending Sisyphean effort must be repeated yet again, the cost to the country’s development, not to mention the population’s welfare, will be extremely high. 
Arturo Grigsby is an economist and a member of envío’s Editorial Council.

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