Panama - Role of Government in the Economy

More about the Economy of Panama.

Panama's financial stability and international credit standing were determined not by monetary policy, but principally by fiscal policy and balance of payments. Fiscal policy was thus more important for Panama than for most other countries, and as a result, public-sector deficits were especially problematic for the government.

From 1971 through 1975, the annual average for the consolidated public-sector deficit was 6.5 percent of GDP. That figure nearly doubled to 12.9 percent between 1976 and 1980, at the height of government spending on infrastructure and ambitious social programs. In the 1980s, the figure has declined, from 10.8 percent in 1982 to 5.8 percent in 1984. The 1982 figure represented an aberration, brought about by the political uncertainty and lack of fiscal restraint following Torrijos's death. Most impressively, the deficit was reduced to 2.5 percent of GDP in 1985, a figure even lower than the 3.5 percent targeted by the IMF. The reduction was brought about by increased revenues, reduced expenditures, and streamlined administration.

Panama's monetary system is unique. United States dollar notes serve as the paper currency and are legal tender in Panama. The local currency is the balboa, which, since its creation in 1904, has remained tied to and equal to the United States dollar. Panama issues only coins corresponding in size and metallic content to United States coins. No foreign exchange restrictions existed in Panama in the mid-1980s.

With no need for a bank to issue and protect the paper currency, Panama did not have a central bank. The National Bank of Panama (Banco Nacional de Panam�--BNP), a state-owned commercial bank, was responsible for nonmonetary aspects of central banking. The BNP was assisted by the National Banking Commission, which was created along with the country's International Financial Center, and was charged with licensing and supervising banks. In 1985 the level of M1 (currency and demand deposits) was US$410 million, while M2 (M1 plus time deposits) was US$1.95 billion.

In a sense, Panama could not have a monetary policy, because it lacked the instruments to implement such a policy, such as money creation and exchange-rate manipulation. In effect, Panama's money supply was determined by the balance of payments, by movements in interest rates, and by the United States, which controlled the number of dollars available for the country's international transactions.

Panama's monetary system has benefited the country in numerous ways. The country has enjoyed almost automatic monetary and price stability. International transactions have been facilitated by the use of the United States dollar. No short-term transfer problems are associated with the balance of payments. The foreign exchange constraint felt by most developing countries has been obviated by the dollars circulating in the economy and the ability to borrow.

In the late 1980s, the financial system consisted largely of banking. Panamanian businesses relied relatively little on public stock or bond issues. No formal stock exchange existed; supervised, independent brokers handled the limited trading in regulated financial certificates, stocks, and bonds. In addition, some insurance companies, savings and loan associations, and unregulated consumer-finance companies were formed. The country's social security fund invested in government bonds and various development projects.

Role of government

The government has played a limited role in economic matters throughout most of Panama's history, restricting its activities to infrastructural development and creating a climate conducive to private investment. The government's role expanded dramatically after 1968, when the National Guard, now called the Panama Defense Forces (Fuerzas de Defensa de Panam�--FDP), took control of the government under Torrijos's leadership. Members of the National Guard tended to be provincial, racially mixed, and lower- or middle-class in background and thus provided an outlook different from that of the urban-oriented elite that had dominated Panamanian politics in the twentieth century.

The National Guard implemented policies that attempted to reduce the most glaring discrepancies between the urban and rural economies. In 1968 economic activity was heavily concentrated in the two provinces of Panam� and Col�n, which accounted for over two-thirds of GDP, and an even larger share of the country's manufacturing, construction, trade, transport, and communications. Residents of the metropolitan areas had access to relatively well-developed education, health, and other services. Their consumption pattern was closer to that of affluent developed countries; they owned most of the country's cars, refrigerators, telephones, and television sets. Their tastes and aspirations were patterned on those of United States citizens in the Canal Zone and the many international visitors. In contrast, rural residents had access to far fewer services, and their living conditions were substantially below those of urbanites. The majority of the population in the countryside had incomes of less than one-third of those in Panama City and Col�n, and many had little more than one-tenth. The economic policies of the military leaders aimed at continued high growth of the urban economy, from which resources could be channeled to the poorer elements of the society to bring about greater economic and social integration.

High growth of service industries in the terminal cities was considered essential because of several constraints: canal-related activities were not expected to provide much of a growth stimulus; import substitution opportunities in manufacturing had been largely exhausted; and expansion of banana exports appeared limited by international conditions. Panama became a regional financial center after 1970, when the government created the International Financial Center. Tourism was bolstered by construction of additional airports, a convention center, new hotels, and resorts. The CFZ was upgraded, and transportation and warehousing facilities were also improved.

Under Torrijos the government became more active in the goods sectors. In agriculture, land reform was accelerated, and cooperative farming was promoted. In industry, state-owned companies expanded, most notably in sugar refining, cement production, and electric power. Torrijos intervened more forcefully in other areas of the economy, such as in the setting of wages and prices; a 1972 labor code increased job security and promoted union organization.

These measures created a more equitable society, but often at the expense of efficiency and overall growth. Government expenditure rose sharply, and the public sector became bloated with a proliferation of new government agencies. In the service sector, construction declined in the mid-1970s, in part because of the disincentive created by rent controls. In agriculture, considerable improvements in social conditions were not accompanied by increased incomes. Moreover, greater government participation and prolonged canal negotiations created difficulties and uncertainties for private investors, and private investment declined precipitously.

After 1975 the government became more pragmatic and modified its programs to stimulate economic activity. Incentives to investors were increased. The 1972 labor code was modified in 1976 to meet some of the objections by employers. A freeze on collective bargaining agreements was established that in effect prohibited wage increases. Government-set prices were raised to encourage production.

Under a structural adjustment program in 1983 and 1984, Panama reduced the scope of the public sector in the economy. In March 1986, and as preconditions for two structural adjustment loans from the World Bank, the government passed several major laws that revised its labor code, removed protective tariffs, changed the price structure for agricultural goods, and encouraged foreign investment. In August 1986 the government launched a privatization program and proposed the sale of state assets worth US$13 million.

Panama developed an efficient and centralized budgetary system in the mid-1960s. By law, the budget had to balance, so increasing recourse was made to handle some expenditures outside the budget. One such device was the creation of autonomous government agencies. These agencies increased in numbers and importance in the 1960s and 1970s. Their areas of operation included banking, the national electrical system, welfare, tourism, and gambling. Their budgets were excluded from that of the central government, although various transfers were made.

The collection of direct taxes (on income, businesses, and corporations) was relatively efficient in Panama. Direct taxes totalled 7 percent of GDP in 1983. Although this figure is high compared with those of other countries in the region, direct taxes have brought stability to Panama's budget system and avoided the fluctuations that occurred in neighboring countries, which were more dependent on import and sales taxes. In the late 1980s, only a fraction of Panama's revenue was derived from taxes levied on foreign trade.

Budget Process

Fiscal Policy

Monetary Policy

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