2009 Index of Economic Freedom

Quick Facts

Population:

• 6.8 million

GDP (PPP):

• $39.0 billion
• 4.2% growth
• 2.7% 5-year compound annual growth
• $5766 per capita

Unemployment:

• 6.2%

Inflation (CPI):

• 3.9%

FDI Inflow:

• $203.7 million

El Salvador's economic freedom score is 69.8, making its economy the 33rd freest in the 2009 Index. Its overall score is 1.3 points higher than last year, reflecting a substantial improvement in business freedom. El Salvador is ranked 4th out of 29 countries in the South and Central America/Caribbean region, and its overall score is well above the world average.

El Salvador boasts an impressive record of structural reforms in opening itself to global trade and investment, privatizing various state-owned companies, and implementing comprehensive tax reforms. These achievements are reflected in its performance in fiscal freedom, government size, investment freedom, and financial freedom: Its scores in these areas exceed world averages by more than 10 points. Tax rates are moderate at 25 percent, and the overall tax burden is moderate as well. Regulation of the free market is characterized by transparency and efficiency.

Freedom from corruption is the only area in which El Salvador scores below the world average. Inflation is moderate because the economy is now completely dollarized. Government price controls distort prices on certain staples.

Background Back to the top

It is estimated that as many as 75,000 Salvadorans died in their country’s civil war, which lasted from 1980–1992. Since the 1992 peace accord, El Salvador’s political parties have cooperated on political and economic reforms and the restoration of civil liberties and respect for human rights. A poor education system and rising gang violence are major problems. Steady economic growth and reduced poverty are due in part to the National Republican Alliance (ARENA) party’s free-market policies in the mid and late 1990s. Coffee exports remain significant, but much growth has come from maquila industries (e.g., textiles) and the services sector. Annual emigrants’ remittances of roughly $3 billion are also vital. El Salvador participates in the Central America–Dominican Republic–United States Free Trade Agreement.

Business Freedom 67.3 Back to the top

The overall freedom to conduct a business is relatively well protected under El Salvador's improved regulatory environment. Starting a business takes about the half the world average of 38 days. Obtaining a business license takes less than the world average of 225 days. Bankruptcy is somewhat lengthy but not costly.

Trade Freedom 81.8 Back to the top

El Salvador's weighted average tariff rate was 4.1 percent in 2006. Import restrictions and bans, some services market access barriers, some restrictive sanitary and phytosanitary regulations, export subsidies, and a few other discriminatory applications of standards add to the cost of trade. Ten points were deducted from El Salvador's trade freedom score to account for non-tariff barriers.

Fiscal Freedom 85.7 Back to the top

El Salvador has moderate personal income and corporate tax rates. The top personal income and corporate tax rates are 25 percent. Other taxes include a value-added tax (VAT), a tax on insurance contracts, and an excise tax on fuel. The VAT is the largest source of government revenue. In the most recent year, overall tax revenue as a percentage of GDP was 13.3 percent.

Government Size 87.9 Back to the top

Total government expenditures, including consumption and transfer payments, are low. In the most recent year, government spending equaled 20.1 percent of GDP. The share of state-owned enterprises in the economy has been diminishing with widespread privatization. Talk of decentralizing government-subsidized water services generated street protests in 2007.

Monetary Freedom77.4 Back to the top

Inflation is moderate, averaging 4.0 percent between 2005 and 2007, partly because the economy is now fully dollarized. The government controls the prices of some goods, including electricity, and subsidizes diesel, petroleum, and liquid propane gas. Ten points were deducted from El Salvador's monetary freedom score to adjust for measures that distort domestic prices.

Investment Freedom70.0 Back to the top

The law grants equal treatment to foreign and domestic investors. Investors who begin operations with 10 or fewer employees must present plans to increase employment to the Ministry of Economy. Investment in certain sectors faces additional regulation. Laws and regulations are relatively transparent and generally foster competition. Bureaucratic procedures are relatively streamlined for foreign investors, although commercial law enforcement remains inefficient and inconsistent. There are no controls or requirements on current transfers, access to foreign exchange, or most capital transactions. No single domestic or foreign entity can own more than 245 hectares of land. Rural lands may not be acquired by foreigners from countries where Salvadorans do not enjoy the same right.

Financial Freedom70.0 Back to the top

El Salvador's financial sector is one of Central America's most advanced. Banking is sound and relatively well managed, and credit for entrepreneurial activity is easily accessible. Following a decade of liberalization and consolidation, there has been robust growth in deposits and domestic assets. The banking system is now largely foreign-owned. By the end of 2007, there were 13 banks, two of them state-owned. The three largest banks were recently sold to international and regional banking groups. A wide range of financial services are available for financing, and non-performing loans account for only 2 percent of the total. Banking regulations are open and transparent. Non-bank financial institutions are limited by the lack of personal savings and low disposable income. Foreign investors have access to credit in the financial market under the same conditions as domestic investors.

Property Rights50.0 Back to the top

Property rights are moderately well protected. Lawsuits move very slowly and can be costly and unproductive. The legal system is subject to manipulation by private interests, and final rulings may not be enforced. Judicial inefficiency and crime are among the main constraints on doing business. Studies done after the 12-year civil war identified weaknesses in the judiciary and recommended that all competent judges be replaced, but this goal has not been fully realized.

Freedom From Corruption40.0 Back to the top

Corruption is perceived as significant. El Salvador ranks 67th out of 179 countries in Transparency International's Corruption Perceptions Index for 2007. It is against the law to solicit, offer, or accept a bribe. Most governmental corruption occurs at the lower levels of the bureaucracy.

Labor Freedom67.5 Back to the top

El Salvador's relatively flexible labor regulations enhance employment opportunities and productivity growth. Restrictions on the number of working hours are not rigid. The non-salary cost of employing a worker is low, but dismissing a redundant employee remains a burdensome process.