Worldwide trade in services accounts for 63.5 percent of global GDP, surpassing industry and agriculture combined. Services are also the fastest-growing area of trade and they were the quickest to recover after the global financial crisis. With their growing importance to global trade, developed and developing economies alike are recognizing the need to ease trade in services. India, for example, is pushing for a trade facilitation deal in services at the World Trade Organization.
But, while global trade is now increasingly driven by services, Latin American and Caribbean exports are still concentrated in basic goods such as agricultural products, oil, copper, iron, and other commodities. If Central America wants to take part in this new global boom it will need to shift to a high-quality service-based economy.
Services: Room for future growth
Services and trade in services have grown significantly in Latin America and the Caribbean in recent years. They now account for 63 percent of the region’s GDP and 66 percent of Central America’s, according to the United Nations Conference on Trade and Development (UNCTAD), and they are also responsible for a similar share of total employment. Despite this, a closer look shows disparities between Central American countries’ share on services. First, there is size. In Panama, the service economy represents 77.3 percent of its GDP and Costa Rica follows closely with 75.2 percent—while other countries show smaller shares in the Central American service economy. (See chart.)
Countries’ share of Central America’s Service Sector (2015)
US$ millions and percentage structure (%)
Differences also persist in the types of services countries are engaged in. Panama and Costa Rica, again, have more successfully inserted themselves in some of the leading services subsectors, such as commercial services, including call centers and logistics, that have a 6 percent annual growth. Meanwhile, El Salvador, Guatemala, Honduras, and Nicaragua are still focused on less innovative services such as travel and transport.
What has worked in Costa Rica and Panama?
The policies implemented in each country have had a deep influence on the type of services they developed, their role in the economy and the country’s economy performance. Costa Rica is an example of moving beyond the traditional service model and transforming itself in a value-added and diversified service-based economy. The way it did that: investing in its people.
Costa Rica’s strategy focused on the development of its human capital. The country has the highest public spending in education and health services in Central America as a percent of GDP. The investments have transformed the country’s call-center industry into a more sophisticated, shared service-center industry. The centers help multinationals reduce transaction costs by consolidating business activities for 150 companies worldwide, at the same time that they provide approximately 55,000 jobs around the country. Additionally, the multi-sectoral nature of the centers has helped Costa Rica insert itself in more sophisticated global value chains, as companies outsource financial, engineering, human resources, IT and other types of services.
Panama’s model to become the leading country in the service sector in Central America followed a different path. Although the success of its service-driven economy is due to different factors, a key element is legislation that specifically aimed to develop a secure and welcoming financial environment to attract international investors. One of the keystone laws was the 2007 Regional Headquarters Law that gives economic, labor and residency advantages to enterprises seeking to establish subsidiaries in Panama. By the end of 2016, 134 companies—Dell, Sony, Caterpillar, Procter and Gamble, Huawei, Nike, Daewoo, among others—had a subsidiary in the country, accounting for $800 million on foreign direct investment and generating 5,000 jobs. The combination of legislation with the benefits of the Panama Canal and operations of international companies explains the successful development of its financial services and logistics sectors.
As these countries’ experience shows, Central America has the potential to become a more relevant player in the service economy. But doing so will require strategic and regional vision. The challenges are best tackled at the regional level by devising integration policies that support the strengthening of the service sector and higher value-added production and trade. Central America can do this by focusing less on its traditional exports and more on the service economy. To accomplish that, one of the regional service’s shortcomings must be addressed: properly and accurately measuring the sector with reliable updated data. These transformations and a sharp focus on value-added services will ensure Central America’s path toward a competitive economy and better opportunities for its people.