Central America’s Deindustrialization

The paper assembles and harmonizes sectoral data from several sources to study the industrial trends in six Central American economies. The industrial employment share contracted by 2.5 percentage points on average over the past two decades. This deindustrialization was not trade-driven in which economies substitute domestic production of industrial goods via cheaper imports. Instead, an increase in barriers restricting the efficient flow of labor across sectors drives this decline. Adopting policies that target such barriers can potentially deliver considerable industrial expansion. But the economic impact of this policy is likely to be marginal, with aggregate output increasing by 3 percent or less if barriers are eliminated. At the same time, this approach also carries several risks, and rather than reining in inefficiency might introduce new distortions making the economy more inefficient. Perhaps a more prudent growth strategy will be to concentrate on boosting productivity, which, although challenging, has a direct effect on output.