World Development, Vol. 23, No. 12, pp.

2079-2099, 1995
Elsevier Science Ltd
Pergamon
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Macroeconomic Policy and the Salvadoran Peace

Accords

ELISABETH WOOD*
Harvard University, Cambridge, Massachusetts
and
New York University, U.S.A.
and
ALEXANDER SEGOVIA
University of London, U.K.

Summary. - We analyze the relationship between macroeconomic policies and the implementation of
the peace agreement that ended civil war in El Salvador. We review recent stabilization and adjustment
policies and identify potential impediments to sustained growth. We observe that the agreement man-
dated thorough-going democratization of political institutions, but its socioeconomic reforms promised
little more than excombatants’ reintegration into civilian life; the poverty and inequality impelling the
war were not addressed. We analyze the political bargaining governing the agreement’s uneven imple-
mentation, and conclude that the macroeconomic policy environment of austerity, rather than resource
constraints per se, impeded its timely implementation.

1. INTRODUCTION The separation between economic policy and the

In an influential contribution to the debate about
postwar reconstruction and macroeconomic policy in
El Salvador, de Soto and de1 Castillo decried the lack
of coordination between the United Nations on the
one hand, and the International Monetary Fund (IMF)
and the World Bank on the other. They likened El
Salvador to a patient lying “on the operating table with
the left and right sides of his body separated by a cur-
tain and unrelated surgery being performed on each
side” (1994a, p. 74).
The metaphor is a dramatic depiction of the diff-
cult challenge of achieving both the consolidation of
peace and economic growth following civil war. If
efforts at policy reform - economic and political
alike - are not coordinated, either “operation” may
undermine the other. Yet the surgical image, with its
sole emphasis on the role of the international agencies,
does not capture important aspects of the political
dynamic of peace-building in El Salvador. Far from a
passive individual patient undergoing surgery, El
Salvador is made up of divergent groups whose evol-
ving interests and shifting alliances not only fueled the
war but continue actively to shape the peace.
peace process in El Salvador thus results from domes-
tic political dynamics as well as inadequate coordina-
tion among international agencies. From the begin-
ning of the peace negotiations, the Salvadoran
government successfully insisted that the macroeco-
nomic stabilization and adjustment policies begun in
1989 were not on the table for discussion. At the same
time, the leadership of the Farabundo MartI National
Liberation Front (FMLN) emphasized pressing mili-
tary and political rather than socioeconomic issues in
their negotiating agenda. As a result, economic issues
were not discussed until the 11th hour of the peace
negotiations, and even then the discussion centered on
the narrow questions of devising channels for postwar
reconstruction assistance which would not exclude the
opposition and of creating conditions which would
facilitate the reintegration of excombatants into civil-
ian life.
*The authors would like to thank James Boyce, Colin
Danby, Richard Fagen, Francesca Jessup, Terry Karl and
Manuel Pastor, Jr. Elisabetb Wood would like to acknowl-
edge the support of the Harvard Academy for International
and Area Stndies.

2079
2080 WORLD DEVELOPMENT
Two broader issues were therefore neglected. The
first is the short-run question of how to finance the
implementation of the programs mandated by the
Peace Accords signed in January 1992. The second,
raised by the apparent tension between macroeco-
nomic objectives of fiscal austerity and the expendi-
ture requirements of peace-building, is the longer run
question of how economic policy might be recast to
undergird the consolidation of peace in postwar El
Salvador.
This paper focuses primarily on the former ques-
tion. The agenda of reforms, which included the
founding of new institutions, the reconstruction of
war-tom areas, and the development of reintegration
programs including the transfer of land, required a
substantial commitment of resources. The Salvadoran
government called on international donors to finance
the implementation of the peace agreement, arguing
that its commitment to fiscal targets under agreements
with the international financial institutions pre-
cluded a significant change in the size or orientation
of the national budget. While international donors
did provide significant funding, programs essential
to the peace agreement were delayed or scaled
back.
In section 2, we review the macroeconomic poli-
cies pursued since 1989 and the bases for the signifi-
cant expansion of the Salvadoran economy after the
beginning of peace negotiations. Given the extraor-
dinary inflow of remittances and the beneficial conse-
quences of the resolution of the regional political cri-
sis over this period, the causal contribution of the
stabilization and adjustment policies to the resump-
tion of economic growth can be easily exaggerated,
and frequently is. We analyze three characteristics of
the economy that may undermine both economic
growth and political stability: vulnerability of foreign
exchange earnings to changes in US immigration pol-
icy, the weakness of export performance resulting
from the overvalued exchange rate, and continuing
high rates of poverty inadequately addressed by social
programs.
In section 3, we discuss the key elements of the
peace agreements, particularly its core agenda of
reform of the coercive institutions of the state and its
meager agenda of socioeconomic reform (including
some land transfer) limited primarily to facilitating the
reintegration of excombatants into civilian life. We
describe the postagreement bargaining that defined
reconstruction and reintegration policies, as well as
their costs. In section 4, we describe how the macro-
economic policy environment with its emphasis on
fiscal austerity resulted in delays in needed public
investment and legitimated deferral of expenditures
essential to the peace agenda. We suggest that the
international financial institutions might have con-
tributed more to postwar reconstruction had their dis-
cussions of conditionality given as much attention to
the implementation of the peace agreement as they did
to the implementation of economic reform. In section
5, we analyze the uneven implementation of the peace
agreement to date, and the social costs of deferral of
the peace agenda. Some concluding remarks are
offered in section 6.
2. MACROECONOMIC POLICY SINCE 1989
In 1989, the newly elected government of Alfred0
Cristiani embarked on a new set of stabilization and
adjustment policies. The government’s program,
which included a major reform in the trade and tax
regimes as well as a general thrust toward privatiza-
tion and liberalization, was backed by all the relevant
international institutions. The World Bank played a
particularly key role, substituting for the role USAID
had previously played in directing and supervising the
Salvadoran economy in the 1980s (Rosa, 1993). The
program was, moreover, generally supported by the
private sector, easing the tense business-government
relations that had characterized the previous presi-
dency.
During the period of the adjustment program’s
implementation, the economy has experienced rela-
tively high rates of growth (reaching 5% or more in
recent years) and the rate of open unemployment has
diminished, albeit marginally. While poverty indexes
have remained high, they do not appear to have grown
worse; and inflation has been controlled. International
institutions have thus judged the program as both
highly successful on its own terms, and important as a
supportive economic basis for the peace process
(USAID, 1994b, p. 3).
This period of macro-management has, however,
not been an unqualified success. Stability and growth
have depended heavily on a very large and increasing
influx of remittances from Salvadorans residing over-
seas. This influx has financed - and indeed can be
regarded as the principal cause of - a large and
widening trade deficit. Growth in nontraditional
exports to countries outside the Central American
Common Market (CACM) has been quite sluggish, in
part due to the appreciation of the real exchange rate
driven by remittances.
At the same time, remittances have mitigated tbe
social costs of adjustment, not only by sustaining
growth and checking inflation, but also by directly
augmenting the incomes of poor and middle-class
households. The fact that poverty has remained so
high despite these inflows is therefore quite troubling.
Moreover, the long-term future of the flows is uncer-
tain, particularly given recent changes in US immigra-
tion policy. The policy “space” provided by the cur-
rent foreign exchange bonanza could have been used
to develop the infrastructure for competitive exports
and to repair the poor distribution of assets and
 MACROECONOMIC POLICY AND THE SALVADORAN PEACE ACCORDS
income that was a fundamental factor in causing the
war. Instead, the government chose to push a neo-
liberal model of economic adjustment that may even-
tually worsen equity and increase macroeconomic
fragility.
The new government which took power in June
1994 has chosen to deepen this neoliberal restructur-
ing and has recently announced a new program aimed
at turning El Salvador into a large free-trade zone. The
program, which has as its central pillar a fixed
exchange rate and convertibility of the col6n (along
with further market liberalization), has generated
much debate in El Salvador and in Central America.
In contrast to the previous reforms, this new proposal
has neither the unconditional backing of the private
sector nor the formal approval of the international
financial institutions.
(a) General context of the reform program
Macroeconomic policies are never implemented in
a vacuum. Negative trends and external factors can
often make a coherent adjustment fail while positive
trends can give flawed approaches the aura of success.
In our view, at least three background factors are key
to evaluating the adjustment program initiated in
1989. The first is the reduction in regional and internal
political and military tensions, a trend which
enhanced social stability and raised private invest-
ment because of the attendant reduction in risk. The
second factor was the restoration of the alliance
between the government and the private sector, a phe-
nomenon which also aided the process of private cap-
ital formation. The final factor was the massive
increase in the flow of foreign exchange coming from
remittances, a trend which produced a more favorable
growth-inflation tradeoff.
(i) The amelioration of the politico-military crisis
After the guerrilla offensive of November 1989, El
Salvador entered a period of relative socio-political
stability. Peace negotiations began in 1990 and culmin-
ated in the signing of the Chapultepec Accords in
January 1992. The signing of the Peace Accords lifted
a principal obstacle to economic management of the
country - that is, the war - and the relative (and
growing) tranquility improved the investment climate
and helped to reactivate some sectors and activities
that were depressed during the conflict.
The end of the war and the subsequent reconstruc-
tion phase also had a favorable direct impact on the
economy. The peace effort has some required expan-
sion in public spending; while we would argue that
even more “investment” in consolidating the peace
would have been desirable, large sums have indeed
been expended and this has had the usual multiplier
2081
impacts. Moreover, the end of the war permitted the
government, particularly after 1992, to redirect
resources that were dedicated to the war effort toward
social sectors. Again, more could have been done, but
this spending shift toward nontradable services also
helped domestic employment and income.
The positive economic effects of this domestic peace
process were reinforced by successful peace negotia-
tions in other areas of Central America. In Nicaragua,
for example, the electoral defeat of the Sandinistas
helped to usher in an era of detente in the region and of
slow but sustained recovery of the regional market. El
Salvador has particularly benefited from this and
demand from the Central American Common Market
(CACM) has been one of the principal sources of growth
in recent years. Thus, the resolution of both the domes-
tic and regional crises had positive externalities which
helped the post-1989 Salvadoran reform program to
achieve better economic results.
(ii) Reestablishment of the private sector-government
alliance
The coming to power of the ARENA party in June
1989 also brought a warming of business-government
relations, in contrast to the various tensions that had
characterized the decade of the 1980s. In a country in
which the private sector has the power to make any
economic strategy unviable, its almost unconditional
support for the government was decisive in imple-
menting the adjustment program, which by its nature
involved changing the existing economic rules of the
game with sometimes negative effects - at least in
the short term - for certain sectors (particularly agri-
culture and certain manufacturing firms). That busi-
ness was willing to go along with such short-term sec-
toral pain suggested the depth of the new alliance.
While private sector support for the government
and its program was partly driven by ideological con-
siderations, it also reflected the impact of US efforts to
“modernize” the business community. US efforts over
the 1980s had created a social base for support of the
export model, much of it centered in the new business
institutions such as the Foundation for Economic and
Social Development (FUSADES). Indeed, FUSADES
played a leading role in the design and promotion of
the adjustment program and at least 17 business lead-
ers and others linked with that institution became part
of the new government. Other factors that contributed
to business modernization and support for the new
government were: the crisis of traditional export agri-
culture, which forced many business people to explore
new opportunities in other areas and economic sectors;
the internal political crisis which had spurred an emer-
gent process of internationalization of Salvadoran cap
ital; and generational change in some of the most
important economic groups in the country (Johnson,
1993; Segovia, 1994a; Wood, 1995).
2082 WORLD DEVELOPMENT

(iii) The massive growth in theflow of remittances
During most of the 198Os, remittances bypassed
official channels. After the post-1989 government
opened currency exchange shops and established a
single exchange rate, a move intended to eliminate the
black market, recorded remittances soon took the
place of official transfers as the largest single source
of foreign exchange, increasing from 3.5% of GDP in
1988-89 to more than 8% in 1992, exceeding for the
first time the total earnings from exports (see Table
l).’ By 1993, remittance inflows were double the vol-
ume of official external assistance, and in 1995 they
may surpass 10% of GDP.
Perhaps the most important impact of remittances
was that they allowed the government to focus on
economic restructuring and not simply stabilization.2
Remittances allow the country to live “beyond its
means,” importing more than it exports (that is, aside
from labor). The large volume of remittances provide
sufficient foreign exchange to finance the trade gap
and maintain a stable exchange rate, making it easier
to maintain growth and control inflation.
Remittances have been the key factor preventing the
adjustment process from producing recession, as
internal investment as well as domestic consumption
have been financed with external savings (ANEP,
1992, p. 52).
With the problem of short-run stabilization more
or less solved, the government concentrated its atten-
tion on the task of structural adjustment, understood as
a general process of economic liberalization. Indeed,
the greatest achievements of the adjustment program
from the point of view of its designers and backers,
were advances in installing in the country an eco-
nomic system based increasingly on market forces.
The problem, as we will note below, is that the inflow
of remittances has resulted in an overvaluation of the
Salvadoran currency, which strongly militates against
the success of the government’s export- oriented
growth model3
Remittances also played a fundamental role in
cushioning the social costs of adjustment and stabi-
lization. As several studies point out (Montes, 1987;
CEPAL, 1993; USAID, 1993), remittances have had a
strong redistributive effect, as they often represent a
direct transfer to the poor sectors of the society.
Montes (1987) estimated that one-third of Salvadoran
families have at least one relative in the United States,
and that the remittances received by each family rep-
resent on average 47% of their income; USAID (1993,
p. 31) cites studies showing that remittances increase
the income of poor urban and rural families by one-
third. Thus for many poor families remittances play a
crucial role in subsistence.4 Given the close relation-
ship between worsening income distribution and ris-
ing social tensions, remittances have played a crucial,
albeit not consciously orchestrated, role in the
Salvadoran peace process, and certainly helped to
reduce political opposition to the post-1989 economic
restructuring.
In addition to direct effects, remittances indirectly
affect the income distribution in several ways. Most
obviously, emigration reduces the supply of labor,
putting some upward pressure on employment and/or
wage rates within the country. A substantial fraction
of remittance income undoubtedly translates into
demand for food, helping to boost basic grain prices,
thereby benefiting net sellers of grain, some of whom
are poor. Some remittance income also provides
working capital for small businesses (Lopez and

Table 1. Macroeconomic significance offamily remittances, 1979-94

Remittances Remittances Remittances Remittances

(millions as a % of as a % of as a % of
Year of us $) Exports Net Transfers GDP

1979 49.2 4.4 95.7 1.4

1980 59.6 5.5 86.5 1.7
1981 74.7 9.5 92.4 2.2
1982 87.3 12.5 42.0 2.4
1983 97.0 12.8 35.7 2.4
1984 121.0 16.7 38.4 2.6
1985 101.9 14.7 31.9 1.8
1986 134.5 17.8 35.0 3.4
1987 168.7 28.5 29.4 3.6
1988 194.0 31.9 38.1 3.5
1989 203.7 41.0 39.2 3.5
1990 322.1 55.4 56.6 5.9
1991 518.0 88.1 94.6 6.8
1992 686.0 114.7 91.7 8.1
1993 789.0 107.8 89.4 8.1
1994 870.0 104.7 NA 9.7

Sources: PUSADES; BCR.

 MACROECONOMICPOLICYAND THE SALVADORANPEACEACCORDS 2083

Seligson, 1989).5 Despite these ameliorative effects,
poverty rates in El Salvador remain extremely high, as
we shall see below.
(b) Logic and content of thepost-1989 adjustment
program
While the adjustment program initiated in 1989
had the usual goals of inflation reduction and macro
stability, its more fundamental objective was to install
an economic model based on private enterprise. This
implied eliminating all restrictions and controls on
markets (i.e., liberalization) as well as opening the
greatest possible space for accumulation of capital by
business sectors, principally through privatization and
reducing the size of the state. It was assumed that the
external sector would be the new axis of accumula-
tion, with exports providing the foreign exchange nec-
essary to maintain short-run financial and exchange
rate stability. In contrast with the long-standing
agroexport model, where the bulk of exports consisted
of a few primary commodities facing unstable prices
on the world market, the new model was to rely on
nontraditional agricultural and industrial exports to
markets outside the region.
The government moved quickly to implement the
program. In mid- 1990 the single rate of exchange was
established and a “dirty float” system was put in place
to promote exports while maintaining a flexible and
realistic exchange rate. profound tariff reductions
were carried out in little more than two years, with a
significant impact on the real level of protection.6
Interest rate restrictions were relaxed and price con-
trols were eliminated on approximately 200 products.
An accompanying fiscal reform eliminated export
duties, reduced and simplified direct taxes, and intro-
duced a value-added tax (VAT). Partly to reduce pres-
sure on the spending side, steps were taken to restruc-
ture the public sector, particularly the education and
health ministries. In addition, a privatization program
was designed which included the sale of some state
property, the privatization of public services, and the
privatization of the financial system which had been
nationalized in the 1980s.’
The adjustment program did not undergo substan-
tial changes as a result of the signing of the peace
agreements, as we shall see below, despite the need to
dramatically increase expenditures to implement the
agenda of reform and reconstruction.
(c) Progress in stabilization
One of the successes of the program is the progress
achieved in stabilizing the Salvadoran economy.
Annual inflation slowed to 15% in 1990-93, versus
25% in the preceding five years. In our view, this is
due principally to the availability of foreign exchange
from remittances and international aid.8 Moreover,
this inflation success has been “purchased” with an
increasingly overvalued exchange rate, as the Central
Bank has sought to essentially fix the nominal
exchange rate in the face of modest price increases

Table 2. Basic economic indicators, 1990-94

Average Average
1990 1991 1992 1993 1994* 1985-89 1990-94

Real growth of GDP (%) 3.4 3.5 5.3 5.1 5.5 1.6 4.6
Real GDP per capita6 (1962 colones) 635 644 663 672 n.a.t 624 654
Gross Domestic Investment (% of GDP) 11.9 14.0 16.9 17.1 18.5 13.3 15.7
Private investment (% of GDP) 8.9 10.3 11.5 12.4 13.5 9.4 11.3
Public investment (% of GDP) 2.9 3.2 4.6 4.6 4.6 3.8 4.0
Deficit in non-financial public sector
(% of GDP) 2.5 4.5 6.3 4 3.4 3.6 4.1
Deficit of central government (% of GDP) 3.2 4.5 4.8 3 n.a. 3.7 3.9
Public saving of non-financial public
sector (% of GDP) -0.3 -0.1 0.2 0.8 n.a. 0.6 0.0

Exports (millions of US$) 582 588 597 122 797 629 658
Non-traditional Exports 285 316 380 450 540 199 394
Imports (millions of US$) 1262 1406 1900 2067 1012 1667
Trade deficit 680 818 1101 1177 1270 382 1009
Deficit in current account (millions of US$) 330 292 338 266 234 306
Net international reserves (millions of US$) 463 471 587 714 ;;“d 252 605

*Estimates.
tn.a. = not available.
Sources: FUSADES, BCR, IMF, USAID.
2084 WORLD DEVELOPMENT
ao’l”““““““““““’
70 72 74 76 76 90 82 04 96 86 SO 92
Figure 1. Real exchange rate, 1970-93. Index 1980 = 100
(n’se corresponds to depreciation). Calculated from
Salvadoran consumer prices and U.S. Wholesale prices.
Source: IhfF, International Financial Statistics.
(see Figure 1). The col6n rose in price by 31%
between the end of 1990 and May 1994. The result has
been a dramatically widening trade deficit, notwith-
standing strong growth in exports to the CACM, rais-
ing worries for a model supposedly built on export
growth and a “realistic” exchange rate policy (see
Table 2).
How best to resolve the contradiction between a
highly valued currency and an export-oriented accu-
mulation model remains a topic of ongoing debate.
Both Harberger (1993) and Hinds (1994) suggest that
remittances will continue in the long run and that the
current real exchange rate is therefore market-appro-
priate; in this view, nominal devaluation would sim-
ply translate quickly into inflation. Other authors,
including Gonzalez Orellana (1994), argue that appre-
ciation of the real exchange rate has come at the cost
of a severe deterioration in export competitiveness,
and that a real devaluation is needed to promote com-
petitiveness. Forcing a real devaluation is sensible
only if remittances are viewed as a short-run phenom-
enon, as the devaluation would simply adjust the
exchange rate to where the market itself will be in few
short years, thereby sending the right signal to
investors.
Ultimately, what exchange rate policies should be
adopted thus depends on the permanence of the cur-
rent remittance flows. An IMF official interviewed for
this study took an optimistic view, suggesting that in
future years remittances are likely to grow at the same
rate as host-country (that is, US) GDP. While this
would represent a somewhat lower rate of increase
than in previous years, it would imply that current lev-
els would be maintained for the foreseeable future.9 In
a less optimistic scenario, a “soft landing” predicted
by some observers, remittance inflows will gradually
decline in coming years as the ties between emigre
Salvadorans and their homeland grow weaker.
A more alarming possibility, a “hard landing,”
would be a sudden drop in remittances, perhaps pre-
cipitated by a change in US immigration policy.
Officials at international financial institutions inter-
viewed in November 1994 tended to discount this
possibility, but later that month the US announced
plans to terminate the Deferred Enforced Departure
program under which some 180,000 Salvadorans
lived in the U.S. without immigrant visas.‘O Although
the affected persons will be able to delay their depar-
tures, the termination of the program could affect
large numbers of Salvadorans in the next few years.
Other anti-immigration measures in the US could also
lead to repatriation of Salvadorans residing there ille-
gal1y.l’ Repatriation in large numbers could lead to a
sharp contraction in remittances, and thus to shortages
of foreign exchange, severe income losses for remit-
tance recipients, and great pressure on labor markets.
In such a case, the stabilization success since 1989
would be exposed as resting on fragile pillars, a result
foreshadowed by the recent Mexican collapse.
(d) Progress in structural adjustment
If structural adjustment is understood simply as the
process of installing a neoliberal economic model,
then El Salvador’s post-1989 experience may be con-
sidered a great success. ‘* The Salvadoran economy is
now less protected externally and more reliant on mar-
ket mechanisms and the role of the private sector has
been expanded through privatization and the reduc-
tion in the size of the state. In addition to consolidat-
ing the support of international financial institutions,
this structural change has generally reinforced the
confidence of the private sector, reflected in the mod-
est but sustained recovery of private investment.
This process of “modernizing” the market econ-
omy has not, however, been free from difficulties and
problems. Some of these clearly contradict the overall
goal of a competitive economy. For example, irregu-
larities in the privatization of banking have produced
oligopolization in the financial sector, hindering fair
competition and raising real interest rates (including
commissions) to borrowers. As a result, the banks
have become the defacto financial arms of major eco-
nomic groups, reflecting and reinforcing the concen-
tration of wealth with negative effects on the
prospects for sustainable economic growth and the
strengthening of new economic actors.13
Perhaps the biggest conflict, however, is the afore-
mentioned contradiction between the use of the
exchange rate as an inflation-fighting tool and the
objective of creating a strong and diversified export
sector. Despite the export-promoting policies
described above, nontraditional exports outside the
region remain weak. The only nontraditional exports
that have shown dynamic growth in recent years are
those goods directed to the CACM, and assembly ser-
vices, a category which generated more than 40,000
jobs in 1985-93 (Paus, 1995). Impressive performance
 MACROECONOMIC POLICY AND THE SALVADORAN PEACE ACCORDS
in the assembly industry is not, however, likely to
make up for generally slack growth: local value-added
represents only about 30% of gross value, and the pos-
sibilities for future growth have been reduced after the
US Congress blocked financing for free-trade zones
(GAO, 1993). Nor is it likely that the CACM will fuel
ongoing high growth of Salvadoran exports.
While a key barrier to a new dynamic pattern of
export growth is the appreciated colbn, Hinds (1994)
and the National Association of Private Enterprise
(ANEP, 1993) have also stressed the lack of produc-
tive investment. Hinds (1994) attributes this to high
interest rates, high operating costs (due to deficient
infrastructure, taxes on inputs and capital goods, etc.),
the low national savings rate, and the mentality of
many business enterpreneurs, who expect high returns
without large risks. I4 ANBP (1992, 1993) has repeat-
edly argued that the weak showing of exports is due
not only to exchange rate overvaluation but also to
economic incentives which encourage speculative
investment and investment in the commercial and ser-
vice sectors, rather than in the production of tradable
goods.
There indeed has been an increasing orientation of
the economy toward the tertiary or service sector: the
share of agriculture in GDP has declined dramatically
in recent years, while the share of commerce and ser-
vices has increased considerably.i5 This shift is not
surprising, however, given the real exchange rate
appreciation and the direct boost to consumption due
to remittances. In short, the exchange rate policy and
the lack of productive private investment are closely
linked. A successful macroeconomic alternative
would have to both depreciate the currency in real
terms and increase investment.
Finally, the adjustment of 1989-94 was not able to
decrease poverty significantly (nor did this goal figure
prominently in its intentions). Indeed, urban surveys
conducted by the Ministry of Planning indicate that
the number of people living in “extreme poverty” rose
from 23.3% of the urban population in 1988-89 to
29.6% in 1992-93. That the increase was not greater
was due to governmental compensatory programs -
mostly financed with external resources - as well as
economic growth and the redistributive effect of
remittances. The positive impact of remittances, prob-
ably the main factor in limiting poverty and ameliorat-
ing distributional inequities, can hardly be viewed as a
deliberate result of government policy, except to the
extent that the government helped to persuade the US
government to allow emigres to stay in that country
after the negotiated conclusion to the conflict. Both
real wages and basic grain prices have fallen sharply
in recent years, demonstrating that whatever their
favorable effects, emigration and remittances have
been insufficient to counter unfavorable trends in the
current macroeconomic environment. The continuing
high level of poverty in El Salvador is widely recog-
2085
nized as the most serious threat to the consolidation of
peace (see, for example, USAID 1994b and World
Bank, 1994).
The lack of major progress in the social sector -
not withstanding the positive impacts of the large
inflows of remittances - is related to two factors.
First, the government placed a much higher priority on
structural adjustment than on social policy (Belt and
Lard& 1994). The trickle-down vision underlying the
program accepted the old premise that growth and dis-
tribution are incompatible in the short term, and there-
fore emphasized growth first and redistribution of the
fruits of growth later. I6 This is hardly an auspicious
framework for making significant dents in poverty
rates.
A second reason for slow progress on poverty and
inequality was the institutional and financial weaken-
ing of the state as a result of the war, economic crisis,
and fiscal adjustment. On the administrative side,
many social policies were impeded by the lack of
qualified personnel and institutional resources; those
policies that were implemented often lacked adequate
control mechanisms. This institutional weakness has
been exacerbated by the emphasis on privatization and
decentralization, which accorded with the US-sup-
ported strategy of building up institutions that were
parallel to the state. On the fiscal side, revenues have
increased only moderately (see section 4). As a result,
social programs were heavily reliant on external fund-
ing, suggesting a lack of a deep governmental com-
mitment to building appropriate social safety nets.
In sum, the Salvadoran economy has been substan-
tially restructured-the market plays a larger role, the
state has less power, the private sector has more prop-
erty, and agricultural exports play a much smaller
role. But progress toward a diversified export strategy
and sustainable growth has been frustrated by an over-
valued exchange rate and the lack of productive
investment. Progress on the social front meanwhile
has been very slow and largely inadequate to the task
of meeting the demands of a deeply frustrated society.
These shortcomings point to the need for a new
strategy - one which would consciously depreciate
the real exchange rate to foster a shift to tradables,
encourage more productive private investment (in part
through enhancing public investment), and pay far
greater attention to the lot of the poor.
(e) The reform program announced by the new
government
In early 1995, the government which took office in
June 1994 announced its intention to carry out a new
economic reform program whose underlying goal
appears to be a total dollarization of the economy. The
centerpiece of the program is the proposal to fix the
exchange rate at a level of 8.75 colones to one dollar,
2086 WORLD DEVELOPMENT
with total convertibility. This would entail the cre-
ation of a Currency Board, which would eventually
take the place of the Central Bank, as exchange rate
policy would disappear and credit policy would
effectively be ceded to Washington. The designers of
the program anticipate that this policy would have a
series of short-term benefits for the country. First, it
would increase the confidence of national and foreign
investors due to the final elimination of the exchange
rate risks associated with devaluation. Second, fixing
the exchange rate and forcing the dollarization of the
economy would hold inflation to levels prevailing in
the United States and reduce the quasi-fiscal deficit
which arises due to the exchange rate losses of the
Central Bank. This, it is argued, would increase El
Salvador’s competitiveness, promote saving, and
contribute to raising real wage levels. Third, the new
exchange rate policy would cause interest rates to
drop substantially, hopefully close to international
rates, which would aid in increasing levels of produc-
tive investment.
Accompanying this fixed exchange rate policy
would be a dramatic reduction (over five years) in
tariff rates, cutting the current ceiling from 20 to 6%
and the new floor from 5 to l%.*’ As fiscal revenues
would decline, the government proposes to increase
the value-added tax, to step up measures to combat tax
evasion, to accelerate privatization, reduce public
employment, and to reform pension schemes. The
immediate impact on income distribution, particularly
on the tax side, is likely to be regressive.
Announcement of the program set off intense
debate in El Salvador and in Central America. As of
this writing, the principal business organizations have
given it conditional support (expressing concerns
about higher taxes and the fixed exchange-rate), while
the opposition parties and the trade unions have
declared their opposition to the proposals. Other
Central American countries have reacted cautiously,
partly because the plan would reorient El Salvador
away from the Central American market toward the
larger world economy and because the proposed tariff
changes would violate current subregional agree-
ments. El Salvador has formal commitments to the
CACM which it cannot abandon lightly. Nor should it
do so, for intraregional trade is currently the most
dynamic component of the country’s export sector. In
light of these reactions, the specifics of the plan
remain highly tentative.
Regardless of its final content, the proposal repre-
sents a unique opportunity to open a serious debate
about what kind of economy is most desirable for El
Salvador. This is particularly the case because the pro-
gram seeks to respond honestly to three fundamental
problems. First, it attempts to respond to the deli-
ciency of productive investment, by reducing risk and
thereby, it is argued, attracting foreign and increasing
domestic investment. Second, it attempts to discipline
a domestic business class accustomed to extraordin-
arily high rates of profit by tightening competition and
financial oversight. Finally, it recognizes the need to
incorporate the Salvadoran economy into the world
economy in a different way, recognizing that present
demand originating in the internal and regional mar-
kets will not sustain high growth rates and reorienting
the economy toward the world market, particularly the
North American market.
But while the new program is a welcome opening
for debate, it offers the wrong policies at the wrong
time. One key premise of the program is that remit-
tances from Salvadoran labor are akin to having an
assembly zone located in the United States: these
earnings will continue in the medium-term and thus
attempts to lower the real exchange rate will only gen-
erate exchange losses and reduce the real credit avail-
able to the private sector.
But declaring defeat in the face of the “Dutch dis-
ease” may prove to be a recipe for long-run disaster, if
remittances decline, particularly if this were to occur
quickly as in the “hard-landing” scenario.18 Sooner or
later, El Salvador will have to fall back on exports -
and the export infrastructure will only be there if the
government combines the right policies (i.e., public
investment) with the right prices (i.e., a less highly
valued colon). Freezing the exchange rate now against
the dollar would instead lay the groundwork for a
financial explosion h la Chile in 1982 or Mexico in
1994: bad news or external shocks could then trigger
an economic meltdown.
The key shortcoming in this new program is its
failure to incorporate a serious effort to reduce poverty
directly and to redistribute assets, opportunities, and
income. Poverty reduction is crucial as an end in
itself. But the evidence clearly shows also that market
economies work best when they start from a precondi-
tion of relative equality. Among other benefits, greater
equality reduces rent-seeking and induces a willing-
ness to share burdens, both of which makes it easier to
achieve stabilization and adjustment. For El
Salvador’s new market-oriented strategy to work, it
must now (and not later) launch a committed redistri-
butional and anti-poverty program.
This is particularly important in a country trying to
fulfill the obligations of a peace accord. The success of
any economic program depends on creating a climate of
stability which gives confidence to national and foreign
investors. In El Salvador this presumes the consolida-
tion of democracy and the full implementation of the
Peace Accords: the country cannot subordinate peace to
economic restructuring. Moving ahead with both
processes simultaneously is the only viable option for
attaining the goals of development and democracy. The
best way to insure such compatibility is to make the
more general guarantor of social peace-distributional
improvement and the elimination of poverty -the cen-
terpiece of a new economic strategy.
 MACROECONOMIC POLICY AND THE SALVADORAN
3. THE PEACE ACCORDS AND POSTWAR
RECONSTRUCTION
On January 16, 1992, the Salvadoran government
and the FMLN signed a peace agreement that ended
more than a decade of civil war. In essence, the agree-
ment laid out a political compromise in which the left
agreed to a democratic political regime and a capital-
ist economy with only very limited socioeconomic
reform, and the right agreed to participation by the left
in a democratic political regime with some degree of
socioeconomic reform. The Peace Accords enshrine a
democratic bargain: the two sides agreed to resolve
their future differences through a democratic political
process (Karl, 1992; Vickers, 1992; Munck, 1993). If
fully implemented and consolidated, the Peace
Accords will lay the institutional foundations of polit-
ical democracy in the postwar period.
The principal impediments to full implementation
of the peace agreement have been domestic political
obstacles, not economic constraints. To the extent that
a lack of economic resources constrained some
aspects of the peace process, the shortfall itself
reflected a lack of political commitment. International
actors, although they contributed significant financial
resources and political pressure at key moments, did
not compensate fully for inadequate political commit-
ment by Salvadoran actors, particularly the
Salvadoran government.
(a) Political reforms
The core of the peace agreement-the axis around
which its democratic promise revolved - was the
agenda of extensive reforms of the coercive apparatus
of the state. The agreement reaffirmed previously
negotiated agreements institutionalized in the April
1991 reforms to the Constitution, particularly the nar-
rowing of the Armed Forces’ role of defense (not pub-
lic security, except under particular emergency condi-
tions). A commission of civilians, the “Ad Hoc
Commission,” would review the human rights records
of the officers of the Armed Forces and issue recom-
mendations, and a Truth Commission would investi-
gate a range of human rights violations by both sides.
The Accords mandated a set of key institutional
reforms to reduce the military’s historical control over
rural areas, including the dissolution of the civil
defense patrols, the Treasury Police and the National
Guard, the institutional separation of intelligence ser-
vices from the Ministry of Defense, and the suspen-
sion of forced conscription.i9
The Peace Accords provided for the founding of
a new National Civilian Police (PNC) under the
Ministry of the Interior, separate from the Armed
Forces chain of command, and a new National
Academy of Public Security (ANSP) for its training.
PEACE ACCORDS 2087
Both exguerrillas and ex-National Policemen would
participate in the new force (not to exceed 20% of the
new force in either case) after attendance at the
Academy.
The Peace Accords also reaffirmed earlier agree-
ments on judicial and electoral reform. Most impor-
tant of these was the founding of a new investigative
and prosecutorial body, the National Counsel for the
Defense of Human Rights (Procuradurfa de Derechos
Humanos). Earlier reform of the Constitution had
changed procedures for the selection of Supreme
Court magistrates, a step toward breaking the tradi-
tional dominance of the judicial system by the ruling
political party. *OThe Accords also included provi-
sions to strengthen the independence of the National
Judicial Council and founded a new institution for the
training of judges and other judicial personnel. The
Peace Accords also extended earlier reforms to
broaden political party representation in the supervi-
sion of elections. The agreement mandated the legal-
ization of the FMLN as a political party, recognizing
its right to meet, to mobilize, to publish and to hold
licenses for communication (to legalize the FMLN’s
two clandestine radio stations).
(b) Socioeconomic reforms
The section of the Peace Accords concerning
socioeconomic reform was in places both vague and
ambiguous - in sharp contrast to the detailed agree-
ments on military reform and public security. While
the Accords explicitly declared any consideration of
the “philosophy and general orientation” of the gov-
ernment’s economic policy as beyond the scope of the
agreement, the government agreed that postwar stabil-
ity depended on the transfer of some resources to for-
mer guerrillas and their supporters. Principal elements
of the agreement’s limited agenda of socioeconomic
reform were limited land transfer to excombatants and
civilian supporters of the FMLN, channels for the
flow of external aid to communities in the former con-
flicted zones, the founding of a forum of labor, busi-
ness and government for further negotiations, and a
National Reconstruction Plan targeted on the excon-
flitted zones with programs to facilitate the reincorpo-
ration of excombatants of both sides into civilian
life.2’
The peace agreement thus did not include a redis-
tributive agenda, a troubling omission in view of the
sustained fall in real wages during the war and the
contribution of social and economic inequality to the
emergence of civil war. No agreements on wage
increases or even the right of unions to organize were
included. Notably absent was any significant exten-
sion of existing agrarian reform legislation; indeed,
the agreement indirectly affirmed the existing consti-
tutional ceiling on landholding (245 hectares). Nor
2088 WORLD DEVELOPMENT
was poverty directly addressed outside the areas tar-
geted by the PRN except in the vaguest of terms
(Vickers, 1992).
Redistribution was thus limited to the transfer -
more precisely, the purchase - of land to excombat-
ants and supporters of the PMLN as part of the rein-
corporation measures. There are perhaps two princi-
pal reasons (Wood, 1995). Fist, as described above,
the government’s economic policy emphasized diver-
sification away from a narrow dependence on agricul-
tural production and integration into regional and
international markets - a policy that would be more
threatened by wage and labor policies favorable to
workers than by the limited transfer of land. That is,
for ARENA modernizers, the price to be paid in land
for peace did not look steep-if it could be limited to
the conflicted zones and did not threaten the political
and economic base of the party in the western coffee
areas. Second, land transfer was critical for the
FMLN’s internal political cohesion: given the peasant
origins of most of its combatants, to negotiate an end
to the war without some transfer of land would have
led to traumatic internal difficultiesz2
The agreement defined the categories of land to be
transferred, including some state properties and pri-
vate properties in the “conflicted zones” subject to the
landlord’s agreement, but contained few details and
many ambiguities. There was no attempt to estimate
how much land would fall into any category, and ini-
tial estimates varied widely. Nor did the Accords
define the boundaries of the “conflicted zones,”
despite several references to programs particular to
those areas. Within 30 days of the signing, the FMLN
was to present an inventory of properties claimed in
the conflicted zones; the government was to legalize
tenure definitively within six months and extend
credit for land purchase on the terms of the 1980
agrarian reform. The agreement stated explicitly that
the current landholders (tenedores) would not be
evicted, but would eventually be resettled if the land-
lord chose not to sellz3 Landlords were to be paid mar-
ket prices, but what that would mean in areas where
the civil war had raged was not spelled out. Nor did
the agreement clearly define a process by which these
issues would be resolved and the transfer imple-
mented.
The Accords stated that the government would
present a draft of the National Reconstruction Plan
(PRN) to the FMLN within a month of the signing of
the agreement. While the FMLN’s recommendations
and requests would be “taken into account,” its role
was clearly secondary; there was no provision for the
participation of the beneficiaries in the development
of the PRN (except in the case of credit policy). The
principal goals of the plan were the integrated devel-
opment of “areas affected by the war,” attention to
basic needs of the population most affected by the war
and the excombatants of both sides, and the recon-
struction of damaged infrastructure. Policies facilitat-
ing the reincorporation of the Fh4LN were to include
programs such as scholarships, jobs and pensions,
housing projects and business promotion. Appealing
to the international community for support, the
Accords assigned to the United Nations Development
Programme (UNDP) the role of consultant in
fundraising, project design, and coordination with
nongovernmental organizations.
While the balance of political forces in the country
had been sufficient for the reaching of the commit-
ments enshrined in the Peace Accords, at the war’s
end it remained an open question whether the evolv-
ing balance of power in the postwar period would be
sufficient for their realization. The calendar of imple-
mentation of the socioeconomic agenda was defined
by the political logic of the peace process, not by an
analysis of its feasibility, an aspect of the agreement
that would complicate its implementation.
As the two armies separated to their designated
“points of concentration” after the signing of the
Peace Accords on January 16, 1992, both domestic
and political actors became increasingly aware of the
challenge of peace-building after more than a decade
of civil war. Beyond the immediate issue of the effec-
tiveness of the monitoring of the cease-fire by the
United Nations Observer Mission (ONUSAL),
loomed two key issues. First, would the calendar of
staggered implementation of the Accords together
with the attention of the international community pro-
vide mutual confidence sufficient to engender on-
going compliance? Second, who would pay the costs
of peace, given the significant resources required for
the implementation of the peace agreement? These
two issues were inextricably related: the political
implications of the amount and modalities of funding
could either reinforce or undermine the political will
and capacity of one or both parties to carry out the
terms of the peace agreement.
The fundamental challenge was to translate the
political commitments of the Peace Accords into ade-
quately-funded programs and policies that would
institutionalize the democratic bargain that resolved
the war. At the time of the signing of the Accords, no
overall assessment of the cost of the implementation
of the agreement existed; only initial estimates for
reconstruction based on a preliminary version of the
PRN existed.24
Planning for postwar reconstruction began in mid-
1991, half a year before the signing of the Peace
Accords, with an initial Consultative Group (CG)
meeting of donors and government representatives
(MIPLAN, 1991d).= Between that meeting and the
second CG meeting in March 1992, the Ministry of
 MACROECONOMIC POLICY AND THE SALVADORAN
Planning and Coordination of Economic and Social
Development (MIPLAN) issued a series of increas-
ingly detailed documents describing what was to
become the National Reconstruction Plan (PRN)
(MIPLAN, 1991a, 1991b, 1991~). Asaresultofcrit-
icism and debate, some changes were made but the
broad outlines of the plan remained essentially the
same. At the March 1992 CG meeting, the govem-
ment presented three documents outlining programs
and budgets for the PRN, the strengthening of demo-
cratic institutions, and technical assistance
(MIPLAN 1992c, 1992b, and 1992a, respectively).
The PRN was to cover approximately 40% of the
country, including the 20% of the population most
affected by the war. Investments and current expen-
ditures within the scope of the plan was to vary
between $1,200 and $1,600 million over a five-year
period. The average expenditure in each of these
years was equivalent to between 4 and 5% of GDP
(IDB, 1993, pp. 3-4).
The government appealed for international assis-
tance, arguing that it faced very serious fiscal con-
straints as a result of its commitments under the sta-
bilization and adjustment programs and the absence
of a peace dividend given the degree of external
financing of the war (MIPLAN, 1992a). The intema-
tional community pledged some $600 million in
response ($800 million if previous commitments are
included).
In the months after the CG meeting, two issues
dominated debate on reconstruction: the reintegration
of excombatants in general, and the transfer of land in
particular. Negotiations between the government and
the FMLN collapsed in mid- 1992 over the amount of
land to be transferred, the number of beneficiaries, and
the application of “market prices.” Nor were the
promised training and credit programs - the neces-
sary complements to land transfer - in place.
The impasse threatened the peace process itself as
the FMLN suspended its demobilization process and
political tensions increased. In an extraordinary
instance of its “good offices” mandate, the UN sent a
team of agrarian specialists to evaluate the situation
and then offered the two parties a take-it-or-leave-it
settlement. The proposal, subsequently considered by
the UN as an addendum to the Peace Accords, defined
the scope of the transfer in terms of both the number of
beneficiaries - 7,500 excombatants of the FMLN,
15,000 excombatants of the Armed Forces, and
25,000 tenedores - and the amount of land per bene-
ficiary. If the agreement had been fully funded and
fully implemented, the transfer of land would have
amounted to 12% of Salvadoran farmland (a bit over
half of the amount distributed under the 1980 agrarian
reform). Subsequent agreements, however, pared
down the amount to be transferred.
Development of other reinsertion programs trailed
the negotiations over land. Representatives of the
PEACE ACCORDS 2089
FMLN and the government began negotiations over
other reinsertion programs for excombatants by mid-
1992, with the UNDP acting as an observer.26 After a
series of discussions, facilitated and coordinated by
the UNDP, three tracks for reinsertion were defined
(in addition to the PNC track for those excombatants
who joined the new police force). For those pursuing
agriculture, training programs by nongovernmental
organizations were to begin immediately; once in pos-
session of land through the land transfer program,
agricultural credit, including a five-year loan to capi-
talize the farms, was to follow (UNDP, 1993).
Excombatants who preferred a nonagricultural future
would have access to credit for the founding of
“microenterprises” after technical-vocational train-
ing; university scholarships were also available if
appropriate. The approximately 600 mandos medios y
Zideres (mid-level commanders and leaders) of the
FMLN would participate in a program of business
training and credit to start their own enterprises or to
join existing ones with adequate technical and admin-
istrative skills. Under UNDP coordination, three sub-
tracks of this last track were developed: technical-
vocational training (33% of the participants), business
administration (58%), and executive training (9%)
(UNDP, 1994).
Throughout the negotiations, the government
maintained that the programs should be equally avail-
able to excombatants of both sides. Parallel programs
for excombatants of the Armed Forces were devel-
oped for the agricultural and technical-vocational
tracks (but not for the mandos medios program, for
which there was no parallel group). In both their
design process and implementation the programs were
quite separate although the opportunities were
roughly similar.
In April 1993, a third Consultative Group meeting
of international donors was convened by the World
Bank. The government presented a revised proposal
that emphasized the reinsertion programs and poverty
alleviation, with updated figures of estimated needs,
existing government and donor commitments, and a
substantial “funding gap” of still unfinanced programs
(summarized in Table 3).
Troubling to many observers was the continuing
inadequate funding of many programs judged essen-
tial to the consolidation of the peace process - partic-
ularly the new public security institutions and the rein-
tegration programs. The discrepancy intensified the
debate about the relationship between economic and
political reform (de Soto and de1 Castillo, 1994a;
Segovia, 1994b). Moreover, progressive lack of con-
fidence by donors in the National Reconstruction
Secretariat resulted in its programs being almost
exclusively funded by USAID, with other donors opt-
ing to channel bilateral assistance through other min-
istries and through the UNDP (Boyce, 1995; Murray
Coletti and Spence, 1994).
2090 WORLD DEVELOPMENT

Table 3. Fundingpriorities and shorrfalls, 1993-96: 1993 Consultative Group budget (millions of US dollars)*

GOES Expected international Shortfall, Shortfall

commitment contribution, (April 1993 (January 1994
PrOgKilllS Requirements (April 1993) (April 1993) est.) est.)

Priority Programs
National Civilian Police 173.0 35.4 6.0 131.6
Public Security Academy 104.7 28.0 9.9 66.8 182.0
Judicial Reform 219.8 162.3 15.0 42.5
Human Rights Ombudsman 16.8 6.4 1.1 9.3 66.6
Elections Tribunal 20.0 0.6 4.0 15.4
Reintegration (PRN) 316.8 26.6 80.0 210.2 177.8
Pensions for disabled 8.2 0.7 0.0 7.5
Land transfer 142.5 23.3 47.5 71.7 62.7
Housing 77.1 2.6 12.5 62.0
Agricultural credit 62.0 0.0 10.0 52.0
Microenterprise credit 27.0 0.0 10.0 17.0
Poverty alleviation (PRN) 310.2 57.2 147.7 105.3 93.7
Subtotal Ll61.3 316.5 263.7 581.1 520.1

Other Programs (PRN)

Social and productive sector 120.0 10.9 55.6 53.5 -14.6
Infrastructure 530.1 78.3 281.3 170.5 161.0
Environmental sector 17.5 1.9 0.0 15.6 15.4
Total 1,828.9 407.6 600.6 820.7 681.9

Sources: MIPLAN 1993a. GAO 1994.

*For further details, see Boyce (1995), Table 2. A negative shortfall indicates a surplus. The report to the 1993 CG meeting
also included a priority request for poverty alleviation funds for non-PRN areas ($372.32 million). As these figures are not
included in other documents, they are here ignored as well. In addition, a separate document requesting $20.4 million for tech-
nical assistance (MIPLAN, 1993b) accompanied the principal document; this request is treated in the text but is not included
in the table.

4. DOMESTIC RESOURCE MOBILIZATION
With the signing of the peace agreement, the need
to mobilize domestic resources has grown. While
international agencies and foreign governments wel-
comed the end of the war, external aid has, nonethe-
less, fallen. Domestic savings remain low, as does
government revenue. Given the rigidity of public
spending, there has been a constant potential conflict
between the need to fulfill the commitments contained
in the peace agreements and the need to maintain and
strengthen macroeconomic stability. The threat that
the “adjusting variable” would be peace expenditures
has been raised in requests for external assistance.
Indeed, key programs were delayed or scaled down as
a result of funding constraints, as we shall see. below.
Yet it is by no means clear that the scope for the mobi-
lization of domestic resources for peace through
expenditure shifting and increased tax revenues has
been exhausted.
While the foreign exchange gap has been filled by
remittances from Salvadoran emigrants as noted
above, it cannot be assumed that this windfall will be
permanent. In this context, a crucial task for
Salvadoran policy makers is to devise mechanisms
that will allow the economy increasingly to use
domestic resources to finance the costs of peace and to
achieve economic growth with social justice. The
government’s tax reform initiative (Gallagher, 1993)
has produced some favorable results in terms of
simplification and improved efficiency of the tax
system, but has not fully yielded the expected increase
in fiscal receipts.
(a) The principal features and results of the tax
reform
Recognizing the need to both enhance and stabilize
tax revenue, the adjustment program implemented in
1989 attempted to establish a more modem tax system
and to reduce the state’s reliance on volatile export
income.27 Among the most important measures imple-
mented were: (i) a total overhaul of the tax system,
including the elimination of all taxes on exports, of the
tax on net worth, and of the majority of tax exemp-
tions; simplification of personal and corporate income
taxes; reduction of the top income tax rate from 60%
to 25%; and replacement of revenue stamps by a
value-added tax (VAT); (ii) a variety of policies to end
widespread tax evasion28; and (iii) the simplification
and reduction of taxes on imports.
This reform in the structure and composition of tax
revenues has had a profound impact. First, the elimi-
 MACROECONOMIC POLICY AND THE SALVADORAN PEACE ACCORDS 2091

g ;r;;;ltandpropertvtrenefers
sive, worsening the already severe inequality of
incomes. Second, the reform has not had the expected
R Domestic transactions results in terms of increasing revenues, partly because
of an extraordinarily high degree of tax evasion.30
While the tax ratio (ratio of tax revenues to GDP) did
increase by two percentage points during 1989-93,
rising from 7.6% of GDP in 1989 to 9.7% in 1994, it
continues to be very low in comparison to that of other
underdeveloped countries,31 and low even in compari-
son to prewar levels (see Figure 3).
The low level of tax revenues has been largely
0 responsible for the government’s failure to achieve its
1985 1987 1989 1991 1993 prel
1986 1988 1990 1992 1994 est original goal of eliminating the fiscal deficit by 1994
(BCR, 1989,p.20).Infact,thedeficitduring 1989-94
Figure 2. Composition of tax revenue, 1985-94. Source:
USAID,from BCR. was higher on average than during the preceding five
years. Partly as a result, the state has become increas-
ingly reliant on external resources to finance social
nation of export taxes - which had traditionally spending, especially for programs related to poverty
been the most significant source of government rev- alleviation and investment in human resources. This is
enues - and the introduction of the VAT has indeed particularly worrisome as external assistance is
made the tax system more stable (see Figure 2). expected to decline in coming years.
Second, the bulk of state revenues now come from Rivera Campos (1994, p. 11) suggests that
three taxes: the VAT, the income tax, and the tax on “official transfers [of foreign savings] are allowing a
imports. The tax system is now much easier to lower tax burden.” In other words, while the formal
administer and control, particularly because of the conditionalities and less formal policy dialogue of the
tremendous enhancement in computer, auditing, and international donors have sought to encourage an
control systems.29 increased tax effort, the financial resources they pro-
Despite the merits and achievements of the reform vide may, in and of themselves, have had the opposite
there are problems. First, the new system, by reducing effect. In such a context, the strength with which con-
direct taxes and increasing reliance on indirect taxes, ditionality is exercised becomes critical (see Boyce,
has made the overall taxation structure more regres- 1995).

7970 1972 1974 1976 1978 1960 1982 1984 1986 1968 1990 1992
1971 1973 1975 1977 1979 1981 1983 1985 1987 1969 1991 1993

Figure3 Tax coeficient 197693. Source: IMF, International Financial Statistics and Government Finance Statistics; 1993
tax revenue drawnfrom USAID.
2092 WORLD DEVELOPMENT
(b) Fiscal targets and the Peace Accords
Public finances were in a precarious state in 1992,
when the peace agreements were finalized and
sigmd3* The fiscal deficit of the nonfinancial public
sector (NFPS) had climbed to 4.4% of GDP in 199 l-
much higher than the figure for 1990 (2.5%) and the
1991 target of 2.6%. The central government’s fiscal
deficit had risen from 3.2% in 1990 to 5.1% in 1991,
again above the targeted goal of 2.5%.33 Alarmed by
the fiscal imbalances, the IMF insisted on greater fis-
cal stringency, including a reduction in the general
NFPS deficit by over 2% of GDP.34 The central gov-
ernment itself was to adjust revenue and expenditure
by close to 1% of the GDP, with expenditure reduc-
tions leading the way.35
The spending projections were discussed by the
IMF’s Executive Board on January 6.1992 - a week
after the initial signing of the peace agreement and two
weeks before the signing of the formal agreement.
Although the Fund recognized that expenditures on
demobilization, reintegration and reconstruction would
far exceed the amounts that could be reassigned from
the existing 1992 budget (IMF, 1991b, pp. l&19), the
projections made no allowance for the financial impli-
cations of peace. Additional outlays beyond the redi-
recting of existing expenditures would have to be
financed entirely by foreign resources “in order to pre-
serve the price and balance of payments objectives of
the program for 1992” (IMF, 199 1a, Attachment III, pp.
59-60). Evidently the assumption was that the expenses
associated with the peace agreements and national
reconstruction would be financed entirely through for-
eign resources, in addition to some transitory financing
from the Central Bank (see also USAID, 1993, p. 25).36
When peace did come, the failure to account fully
for its financial implications produced a worsening of
the country’s fiscal situation. The NFPS fiscal deficit
rose from 4.4% of GDP in 1991 to 5.9% in 1992 (as
contrasted with the target of 2.3%). The central gov-
ernment also failed to meet its targets for current sav-
ings and expenditures.
In mid-1992, the World Bank recommended that
“the authorities should formally incorporate the
‘peace’ impact into [the] monetary program without
Table 4. Planned and actual capital expenditure by the nonfinancialpublic sector, 1992-94
Planned expenditure
Millions of Percentage of
colons GDP
1992 2,214 4.1
1993 4,145 6.2
1994 4,013 5.3
Source: BCR.
further delay” (World Bank, 1992, pp. i, 1.) The IMF,
however, continued to insist that tight fiscal and mon-
etary targets were still achievable. A July 1992 mis-
sion held to the original objectives for the overall pub-
lic sector and central government deficits, even
though the mission foresaw a significant increase in
peace-related expenditures during the second half of
the year, 45% of which could not be covered by for-
eign resources. The mission suggested that the gov-
ernment adopt a series of fiscal measures aimed at
raising an additional 1% of the GDP.37 Many of the
Fund’s suggested revenue enhancements were never,
however, implemented and others were not put into
effect until September 1992 (introduction of the VAT
and increase in electricity rates). As a result, the fiscal
goals for the year were not attained.
Thus the Salvadoran government and the intema-
tional financial institutions did not really “plan for
peace.” Even as rising peace-related expenditures
derailed fiscal targets, the &IF’s macroeconomic pri-
orities remained firm. While economic stability and
inflation reduction were worthy and shared goals,
unrealistic assessments which failed to incorporate the
costs of peace threatened to make peace the adjusting
variable. The international financial institutions did
not themselves fund high-priority programs mandated
by the peace accords, nor did they condition agree-
ments and loans to encourage the government to
increase further its domestic resource mobilization for
peace-related needs. The peace process thus remained
largely tangential to fiscal policy, rather than becom-
ing integral to it.
The failure to make fulfillment of the accords a pri-
mary economic as well as social objective was com-
pounded by a tendency to achieve fiscal balance
through short-sighted reductions in public investment.
While the 1993 tax-to-GDP ratio rose to 9.3%, and the
NFPS and central government deficits were reduced,
these levels were largely achieved because capital
spending - particularly that associated with the
National Reconstruction Program - was lower than
planned.38 As can be seen from Table 4, public sector
investment was substantially below projected levels in
1993, a trend which continued in 1994. The principal
mechanisms for public investment cutbacks were:
Actual expenditure
Percent of planned
Millions of Percentage of expenditure
colones GDP realized
2,856 5.7 129
2,767 4.6 67
2,844 4.0 71
 MACROECONOMIC POLICY AND THE SALVADORAN PEACE ACCORDS
execution of programs on a smaller scale than
planned, and deferral of program execution until suf-
ficient funds from the international community were
available. Among the programs affected were some
central to the peace process.
International financing agencies accepted the con-
ditioning of capital spending on the availability of for-
eign funds in the interest of maintaining macroeco-
nomic stability. Yet even the IMF’s Executive Board
has recognized that cutbacks in public investment may
have jeopardized the achievement of long-term devel-
opment objectives at a time when the country is in the
midst of rebuilding (IMF, 1994a, 1994b). As with the
failure to take account of peace-related current expen-
ditures, this acceptance of delays in public investment
may ultimately harm macroeconomic stability itself,
by undermining growth, improved income distribu-
tion, and the consolidation of peace.39
5. THE UNEVEN IMPLEMENTATION OF THE
PEACE ACCORDS
In the three years since the signing in Mexico City,
remarkable progress has been made in some aspects of
the Peace Accords. The FMLN participated in the
general elections of March 1994, making a To date the investigative capacity of the National
respectable showing at the presidential and legislative
levels. The military has been restructured, purged and
reduced in size; the new civilian police force has been
deployed throughout the country. Various reconstmc-
tion programs have been designed and implemented.
Implementation of the peace agreement, however, has
been incomplete and uneven in several areas, a num-
ber of which remain essential to the consolidation of
peace in El Salvador.
The founding of the new civilian police force
(PNC) has been one of the most problematic aspects
of the peace process. The decision to start a new force
made a new “organizational culture and adequate
guarantees for civilian rights” more likely, yet posed
significant obstacles as well (Stanley, 1995, p. 8).
Among those obstacles were the financial challenge of
building a new institution from scratch, the reluctance
of the National Police (PN) to cooperate with the PNC
in the transition period, and the crime wave fueled in
part by delays in the reinsertion programs (Stanley,
1993, 1995; UN Security Council, 1994a, 1994~).
As a result of these difficulties, the training and
deployment of the PNC were subject to very serious
delays and problems. One factor was the lack of ade-
quate initial funding.@ Facilities and equipment
belonging to the former security forces were retained
by the Armed Forces and the PN, forcing costly delays
as the PNC was built from scratch. While the UNDP,
Spain and the United States participated in the
development of curriculum and organizational plans,
adequate international funding was not forthcoming.
2093
Stanley (1995) suggests two reasons to account for the
reluctance to fund an institution so obviously key to
the peace process: the lack of international interest in
funding police in general, and the reluctance in partic-
ular to fund an institution to which the government
seemed inadequately committed.
One reason for donor skepticism about the govem-
ment’s commitment to the new force was its reluc-
tance or inability to end ongoing efforts by the former
security forces to undermine the PNC’s autonomy,
efforts that outlasted frequent ONUSAL attempts to
enforce the letter and spirit of the Accords.41 For
example, two units of the National Police were trans-
ferred in their entirety into the PNC in 1993 with
neither the evaluation nor the retraining specified in a
previous agreement. Nor were they integrated into the
new civilian line of command (Washington Office on
Latin America, 1994). Moreover, the training center
for the National Police continued to produce new
recruits well after the opening of the ANSP, a clear
violation of the spirit if not the letter of the Accords. In
late 1994, the newly elected President Calderon Sol
decided to dissolve the PN by the end of the year, a
move that some observers attributed to involvement of
high-level PN officers in organized crime, and
announced increase funding for the PNC.42
Civilian Police remains inadequate, contributing to
the general insecurity and rising crime. The judicial
system, including the new National Counsel for
Human Rights, remains extremely weak, although
reform programs are now in place (Popkin, 1994). As
a result, the authorities have been unable to curb the
activities of organized crime with increasing insecu-
rity the result (Spence, Vickers and Dye, 1995).
Ongoing and to date unresolvable delays in the
transfer of land - an essential aspect of reintegration
of excombatants into civilian life - continue to pre-
sent serious threats to the consolidation of the peace
process. The key problem has not been lack of funding
for the implementing agency, the Land Bank, but
rather lack of political will. The Land Bank has had
adequate interim funding from USAID; the bottle-
neck from month to month in the transfer of land has
not been a shortage of cash (interview with senior
USAID official).
Rather, the recurrent delays are due principally to
two factors (Wood, 1995). First, the titling process
remains remarkably cumbersome, despite repeated
agreements to streamline it (which could have been
readily accomplished by Presidential decree). The
government has taken a bureaucratic approach to the
process, originally insisting that only those on initial
lists would receive land and refusing to extend credit
until legal title was transferred. Second, the FMLN
and its allied peasant organizations have found it
extremely difficult to construct a stable list of benefi-
ciaries for each property to be transferred. In part this
2094 WORLD DEVELOPMENT
reflects the substantial mobility in the countryside in
the aftermath of the war and in part the FMLN’s inad-
equate organizational resources. The instability in the
lists of beneficiaries was reinforced by the delays in
titling, leading to a vicious circle fueled by insecurity
as some beneficiaries decided the delays and terms of
transfer were too hard a bargain.
As a result of the ongoing delays and problems,
representatives of the government and the FMLN
agreed in mid- 1994 to scale back the number of bene-
ficiaries of the land transfer from 47,500 to just over
40,000. In May 1994, the government introduced a
number of measures intended to streamline the
process and announced that adequate funding for the
scaled-down program had been secured (UN Security
Council, 1994b). But as yet little acceleration of titling
has resulted; as of March 16, 1995, less than 50% of
the reduced number of beneficiaries have received
land.
Reinsertion benefits remain a hotly contested issue
as excombatants and demobilized members of the
National Police, security forces, civil defense patrols
have paralyzed government on a number of occasions,
most recently in January and February 1995 when
thousands of protestors occupied governments build-
ings demanding land and indemnity payments. Many
of the demands clearly exceed the provisions of the
Peace Accords (in particular, civil defense patrol
members were never considered eligible for reinser-
tion benefits). Under the mediation of ONUSAL, the
government agreed to a compromise set of programs
to be implemented in early 1995.43 The specter of
ongoing unrest caused by excombatants of both sides
in neighboring Nicaragua offers a cautionary lesson to
Salvadoran observers, many of whom associate the
increasing crime rate with the inadequacy of the rein-
sertion programs.”
While the completion of these programs is neces-
sary, it will not be sufficient for successful reintegra-
tion, as the sustainability of the excombatants reinser-
tion into civilian life remains precarious (see for
example, UNGA, 1994, p. 6). As international donors
turn their attention increasingly to other postconflict-
ual situations, the funding for reintegration and recon-
struction in El Salvador will have to come increas-
ingly from domestic resource mobilization. While
there is significant scope for such mobilization, as we
saw above, present policies are undermining the con-
ditions for stable and equitable economic growth.
6. CONCLUSION
El Salvador’s stabilization and adjustment pro-
gram begun in 1989 was undertaken in a highly favor-
able context - its implementation coincided with the
beginnings of peace, the growing closeness of busi-
ness and government, and the increasing flow of
remittances. These advantageous conditions may not
endure: the domestic costs of implementing the peace
are growing, business may be less enthusiastic as the
government attempts more direct measures to
improve the private sector’s tepid response to market
incentives for productive investment, and, most
importantly, the flow of remittances may taper off. In
this sense, the adjustment process is entering a new
and more difficult stage.
So too is the peace process, following the depar-
ture of the UN Observer Mission in April 1995. While
significant reform of key institutions has been
achieved, the implementation of some aspects of the
peace agreement remains incomplete and in some
cases precarious. We have argued that the fundamen-
tal problem has not been funding constraints but rather
a lack of commitment on the part of the government at
crucial stages of the peace process. Thus, as we have
seen, a lack of political commitment, not financial
shortfalls, resulted in ongoing delays in the transfer of
land to excombatants and consequently in other rein-
tegration programs as well. Further, the government’s
apparent tolerance of repeated efforts by the super-
seded security forces to undermine the new public
security institutions signalled a lack of commitment to
key aspects of the peace agreement. The govem-
ment’s at-best lukewarm support-both political and
financial - also discouraged international financial
support. The delays affecting the new police force and
the land transfer program appear particularly threaten-
ing to the peace-building: according to de Soto and de1
Castillo (1994b), “on their success rests the entire
peace process” - and its sustainability in the long
run.
The rhetoric of austerity stemming from the
macroeconomic policy environment, not domestic
resource mobilization constraints per se, apparently
legitimated delays and the scaling down of these and
other programs. A greater interest on the part of the
international financial institutions in the implementa-
tion of the Peace Accords rather than a dominant
emphasis on economic reform might have contributed
to the reconciliation of the apparently conflicting pri-
orities of macroeconomic stabilization and peace-
building.
With the declining presence of the international
institutions, the implementation of the remaining
agenda of the Peace Accords depends primarily on the
willingness of the government to shoulder the costs of
peace. Scope for significant increase in the mobiliza-
tion of such resources exists.45 Tax reform has pro-
duced rising and more stable revenues and advances
have been made in improving the auditing capability
of the relevant ministries. Nonetheless, the tax-to-
GDP ratio remains very low by both historical and
comparative standards, the tax structure is quite
regressive, and the government faces a significant
problem of tax evasion. Most domestic actors recog-
 MACROECONOMIC POLICY AND THE SALVADORAN
nize the latter problem, and there is a broad consensus
in the country on the need to raise revenue.46
Macroeconomic stability and growth will prove
short-lived in the presence of political turmoil. Given
the potential for further unrest on the part of excombat-
ants and others and the continuing high rates of poverty,
political stability considerations strongly support a
transfer of fiscal resources from military spending (as
yet well above prewar levels) to re- integration and
poverty alleviation programs. This implies the need to
continue to reduce military expenditures and a need for
active “peace conditionality” on the part of intema-
tional lenders. Further substantial reductions would
allow both social spending and public investment to
rise, even if tax revenues lag, thus contributing to both
NOTES
1. Orellana Merlos (1992, pp. 5-7) reviews official esti-
mates for 1979-91 and their problems. He estimates the
remittance inflow in 1987 at $504 million, compared to the
official estimate of $169 million and Montes’s (1987) esti-
mate of $1.3 billion. Table 4.3 reports the official estimates
which seem to be relatively accurate in the most recent years.
2. Moreover, the government’s latitude for defining poli-
cies was augmented considerably once it had access to these
remittances precisely because they were autonomous - and
as such not subject to the usual conditionalities attached to
foreign aid and international assistance. For example, the
government did not have to rely on funds from the IMF,
despite having signed four Stand-By Agreements (these
Agreements were considered precautionary).
_3 While appreciation of the real exchange rate does not
have strong adverse impacts on traditional exports or on
exports to the CACM, it is of major importance for the com-
petitiveness of nontraditional exports outside the region.
4. A national household survey, conducted by the
Ministry of Planning in 1991-92, found that 7.1% of
“extremely poor” and 12.4% of poor households received
remittances, on average $36 per month and $61 per month,
respectively. Remittance income is greatly understated in the
survey, however: total remittances extrapolated from the sur-
vey were only $149 million/year, compared to the officially
registered inflow of $690 million for 1992. Siri and Abelardo
Delgado (1995, p. 6) note that understatement is likely to be
especially significant for poor households.
5. On the other hand, emigration that has produced remit-
tances has also had some negative distributional conse-
quences. Survey data indicate that emigrants tend to have
“above-average labor force characteristics” (Funkhouser,
1990, p. 23) and the country is now deprived of their human
capital. The positive income effects of emigration must also
be weighed against the social costs of the disruption of fami-
lies and communities. Perhaps most troubling, El Salvador’s
heavy dependence on remittances renders the economy in
general, and the poor in particular, vulnerable to an adverse
PEACE ACCORDS 2095
the country’s peace and its economic future.
Hence the Peace accords should no longer be
treated as an afterthought or a “remainder”; instead,
macroeconomic strategy must be designed to support
the goal of consolidating the peace. Moreover, the
importance of the political reforms mandated by the
Accords goes well beyond the desirability of democ-
ratic objectives and ending the civil warper se. While
the peace agreement did not directly address the pro-
found economic and social inequalities that fueled the
civil war, the consolidation of the political reforms is
both necessary and urgent if a future process of politi-
cal bargaining is to define a more equitable model of
economic development and a durable peace in El
Salvador.
shock from their sudden contraction, a topic to which we
return below.
6. The reforms reduced tariffs from a range of O-290% to
a range of 5-20%. There was much “water” in the earlier tar-
iffs, thanks in part to competition within the CACM; hence
the lowering of tariffs did not result in a wave of bankrupt-
cies.
7. For a detailed analysis of the process of privatization in
El Salvador, see Segovia (1994~).
8. In fact, the only times when the government had prob-
lems in controlling inflation were precisely those in which the
exchange rate underwent strong fluctuations (as happened at
the end of 1989 and beginning of 1990 due to the November
guerrilla offensive) or when measures were applied that
impacted directly on costs and inflationary expectations, as
was the case in 1992, when the introduction of VAT and other
fiscal measures led to significant price increases. The infla-
tionary spiral of 1992 was particularly serious because the
introduction of the VAT coincided with a serious shortage of
basic grains (beans) due to the drought that afflicted the coun-
try that year.
9. Similarly, Harberger (1993, p. 17) predicts that the
influx of remittances will continue “as long as more than a
million Salvadorans live abroad,” and that they will probably
grow over time, “particularly if those Salvadorans share in
the economic growth which is occurring in the United
States.”
10. The DED program was established to provide tempo-
rary protected status in 1990, and was extended on three
occasions “based largely on Salvadoran government con-
tentions that the country was not able to assimilate large num-
bers of its citizens now living in the United States.” In decid-
ing to terminate the program, the Clinton administration
ignored “strenuous appeals by Salvadoran authorities”
(Associated Press, 1994).
2096 WORLD DEVELOPMENT
11. For example, California’s Proposition 187, passed by
voters in November 1994, seeks to deny public education and
health care to illegal immigrants, and requires teachers and
health-care providers to report illegal immigrants to immi-
gration authorities.
12. These advances have been highlighted by international
institutions as one of the most important achievements of the
adjustment program. See USAID (1994b, p. 3) and World
Bank (1993, p. 2).
14. For a critical analysis of the process of privatization in
banking, see Sort0 and Segovia (1992) and Sort0 (1995).
14. Harberger (1993, p. 16) reports that, with the important
exception of agriculture, real profit rates in El Salvador are
very high, in the neighborhood of 2630% per annum.
15. Changes in relative prices have played the major role in
this shift (Acevedo, Barry, and Rosa, 1995).
16. For example, FUSADES (1993) suggests that:
“Experience shows that the sequence which eventually
makes it possible for a country to eliminate extreme poverty,
while at the same time attaining a condition of solvency (i.e.,
without significant macroeconomic disequilibrium), consists
of sustained growth first in order to distribute the fruits of
growth later” [emphasis in the original].
17. With the goal of giving businesses time to adjust, the
government is considering reducing tariffs by stages (rather
than a full and immediate cut) and allowing the pace of tariff
reduction to differ by sector; agricultural and animal hus-
bandry sectors, for example, would receive special treat-
ment.
18. The “Dutch disease” refers to the adverse impact of a
foreign exchange bonanza on the competitiveness of other
industries in the tradable goods sector (Corden, 1984).
19. Irregular Batallions were to be reabsorbed into the
army and civilians would participate in curriculum develop-
ment in the military academy.
20. Magistrates are now selected by a two-thirds majority
of the National Assembly and serve staggered nine year
terms (Popkin, 1994).
21. Other elements included but never adequately imple-
mented were the extension of credit for agriculture and for
small business and measures to alleviate the costs of struc-
tural adjustment.
22. One indication of the depth of conviction on this issue
is that FMLN field commanders in Usuluti - many of
them of peasant origins - repeatedly conditioned the con-
centration and demobilization of their forces on progress in
the transfer of land, at times without authorization from their
central command (Wood, 1995).
23. Because tenedores thus did not necessarily
occupy property, we use the Spanish term rather than the lit-
eral translation “holders.”
24. During the negotiation of the Accords, no attempt was
made to estimate its financial implications, a process which
would probably have impeded reaching an agreement by the
endof 1991.
25. USAID contributed importantly to initial aspects of the
government’s reconstruction planning. Two teams of consul-
tants to USAID carried out assessments of two aspects of the
reconstruction, defining possible priorities and estimated
costs for programs of physical infrastructure (Jones and
Taylor, 1991a, 199lb) and reintegration of excombatants
(Creative Associates, 1991).
26. In order to address the immediate needs of the FMLN
combatants confined to certain areas during the cease-fire,
the UNDP coordinated an emergency appeal to international
donors for resources (Weiss Fagen, 1995).
27. The most important measures included under this
reform were instituted over a period of slightly more than
two years, making El Salvador one of few countries in the
world to have executed such extensive tax reform so quickly
(Gallagher, 1993).
28. Policies to rein in tax fraud included the enactment of a
new law on tax fraud, creation of a new unit to focus on col-
lection of taxes from large taxpayers, improvement of the
computer, auditing, and control systems.
29. Under the joint sponsorship of USAID, the IMF, and
the IDB, a tax system modernization project, known as
MOST, was implemented in 1991. According to USAID
(1994b), the Ministry of the Treasury now has “a state-of-
the-art tax information system and enhanced administrative
capabilities.”
30. CENITEC (1993) and Mtndez and Abrego (1994)
report that tax evasion may be as high as 50%, with evasion
of the VAT running near 57%.
31. The World Bank (1994, p. 39) observes that El
Salvador’s tax-to-GDP ratio “remains one of the lowest in
the world.”
32. In part this reflects increased costs to the hydroelectric
authority during the 1991 drought. In addition, consolidation
of the internal public debt in 1989 and 1990 provoked a sub-
stantial increase in interest payments in 1991. The situation
was further aggravated by the increase in interest payments
on the external debt that resulted from the finalization of the
debt restructuring period provided for under the Paris agree-
ment of 1990.
33. In September the government, in conjunction with the
IMF, revised the original goals, raising the target fiscal
deficit for the nonfinancial public sector from 2.6% to 3.4%
and that of the central government from 2.5% to 3.8%. The
final results proved that these targets were too ambitious.
34. The government was also supposed to reduce the total
public sector deficit (including BCR losses) from 4.3% of
GDP in 1991 to 3.0% in 1992, and generate positive savings
of 1.5% of GDP in the current account of the NFPS. For
 MACROECONOMIC POLICY AND THE SALVADORAN
details see “Memorandum on the economic policies of El
Salvador” (IMF, 199lb. Attachment III).
35. The program also envisioned a shift in the composition
of spending, with military spending declining and spending
on education and health rising.
36. The economic program of 1992 assumed that the coun-
try would receive US$ 160 million in gross loan disburse-
ments from multilateral institutions and US$ 320 million in
loans and grants from bilateral sources (IMF, 199lb, p. 42,
Appendix VI).
37. The mission offered a positive assessment of the
macroeconomy and attributing fiscal shortfalls to the gov-
ernment’s delay in implementing planned measures (the
VAT, an increase in electricity rates, and the establishment
of the large taxpayers unit), as well as to the effect of the
drought on the electric company’s deficit and the impact of
the drop in coffee prices on fiscal revenues.
38. In 1993. the Salvadoran government achieved the
majority of fiscal targets specified in yet another stand-by
arrangement with the IMF, this one also supported by the
World Bank and USAID. The tax-to-GDP ratio, for example,
rose to 9.3%. the highest achieved during the government’s
term in office. The NFPS and central government deficits
were reduced to 3.9% and 1.4%of GDP, respectively, and
NFPS current savings improved compared to 1992.
39. Although the “peace dividend” has yet to materialize
fully, there has been a notable shift in the composition of
government expenditures. Since 1991 the defense budget has
declined in real terms and as a proportion of GDP; since 1993
the defense budget has been frozen in nominal terms at 866.5
million colones (roughly $100 million). This has been
accompanied by an increase in allocations for the social sec-
tors and for activities related to the strengthening of democ-
ratic institutions. Further progress in these directions is criti-
cal for the consolidation of the peace.
40. A US State Department official argues that the early
deployment of the PNC, despite inadequate training and
equipment, was important to capitalize on the euphoria of the
signing of the Accords (interview, December 1994).
41. The issue was complicated by high and rising levels of
crime, attributed by many to excombatants of both sides,
which led to an agreement in December 1992 to increase
REFERENCES
Acevedo, C., D. Barry and H. Rosa, “El Salvador’s agricul-
tural sector: Macroeconomic policy, agrarian change,
and the environment,” World Development, Vol. 23,
(1995), pp. 2153-2172.
Asociacion National de Empresa Privada (ANEP),
“Reflexiones sobre la intermediaci6n y politica
financiera,” Chidad Empresarial, (July-August, 1993).
Asociacion National de Empresa Privada (ANEP), “Tres
aiios de gesti6n macroecomjmica: logros y dificultades”
Rev&a Unidad Empresarial (May-June 1992).
PEACE ACCORDS 2097
the number of PN agents admitted to the PNC provided they
were evaluated and attended the Academy (UN Security
Council, 1994b; Spence, Vickers and Dye, 1995, p. 7). The
number of former National Policemen to have joined the
new force may well have exceeded those agreed levels; the
government’s long-standing refusal to supply ONUSAL
with lists of former combatants has made enforcement of
the agreements extremely difficult. An attempt to imple-
ment ONUSAL’s recommendation that all those trans-
ferred in excess of the December 1992 agreement be dis-
missed led to a month-long strike by one of the units in
early 1995. The situation was eventually resolved: over 150
members of the unit will retire with a year’s severance pay
(Spence, Vickers and Dye, 1995, p. 7; El Salvador
Information Project, 1995).
42. In June 1994, the lieutenant in charge of the criminal
investigations division of the PN was identified on a video-
tape of a bank robbery in San Salvador (Popkin, 1994). The
PN was disbanded on December 31, 1994 and its facilities
turned over to the PNC in mid-January 1995.
43. Proceso (El Salvador), February 1, 1995.
44. See Collier (1994) for evidence linking rising crime
rates in some districts of post-civil war Uganda with land-
lessness of excombatants.
45. Various studies have concluded that given the
prospects for economic growth over the next few years and
the changes in the tax system, it is feasible to raise tax rev-
enues as a fraction of GDP by between 0.5% and 1% each
year for the remainder of the century, resulting in a tax ratio
of 14% by the year 1999. Yet the government and FUSADES
have projected a tax ratio of only 10 to 11%. In addition to
vigorous implementation of existing tax reforms, the tax
ratio could be raised by further taxes on the nonproductive
transactions of high-income individuals, such as purchases
of luxury goods and high-value property transfers, which
would also improve the distributional incidence of the tax
system.
46. Indeed during the 1994 electoral campaign all the pres-
idential candidates - including Dr Armando Calder6n Sol,
who won the election - signed a document drawn up by
UNICEF in which they agreed to raise the tax ratio to around
15% during 1994-99 in order to be able to increase social
spending.
Associated Press, “U.S. to ax Salvadoran program,” wire
story, (November 28, 1994).
BancoCentral de Reserva (BCR), Memoria annual de
labores (San Salvador: BCR, 1989).
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