Since the early 1500s, Panamanians have relied on the country's comparative advantage--its geography. Exploitation of this advantage began soon after the Spanish arrived, when the conquistadors used Panama to transship gold and silver from Peru to Spain. Ports on each coast and a trail between them handled much of Spain's colonial trade from which the inhabitants of the port cities prospered. This was the beginning of the country's historical dependence on world commerce for prosperity and imports. Agriculture received little attention until the twentieth century, and by the 1980s had--for much of the population--barely developed beyond indigenous Indian techniques. Industry developed slowly because the flow of goods from Europe and later from North America created a disincentive for local production.

Panama has been affected by the cyclical nature of international trade. The economy stagnated in the 1700s as colonial exchange via the isthmus declined. In the mid-1800s, Panama's economy boomed as a result of increased cargo and passengers associated with the California gold rush. A railroad across the isthmus, completed in 1855, prolonged economic growth for about fifteen years until completion of the first transcontinental railroad in the United States caused trans-isthmian traffic to decline. France's efforts to construct a canal across the isthmus in the 1880s and efforts by the United States in the early 1900s stimulated the Panamanian economy.

The United States completed the canal in 1914, and canal traffic expanded by an average of 15 percent a year between 1915 and 1930. The stimulus was strongly felt in Panama City and Colón, the terminal cities of the canal. The world depression of the 1930s reduced international trade and canal traffic, however, causing extensive unemployment in the terminal cities and generating a flow of workers to subsistence farming. During World War II, canal traffic did not increase, but the economy boomed as the convoy system and the presence of United States forces, sent to defend the canal, increased foreign spending in the canal cities. The end of the war was followed by an economic depression and another exodus of unemployed people into agriculture. The government initiated a modest public works program, instituted price supports for major crops, and increased protection for selected agricultural and industrial products.

The postwar depression gave way to rapid economic expansion between 1950 and 1970, when GDP increased by an average of 6.4 percent a year, one of the highest sustained growth rates in the world. All sectors contributed to the growth. Agricultural output rose, boosted by greater fishing activities (especially shrimp), the development of high-value fruit and vegetable production, and the rapid growth of banana exports after disease-resistant trees were planted. Commerce evolved into a relatively sophisticated wholesale and retail system. Banking, tourism, and the export of services to the Canal Zone grew rapidly. Most importantly, an increase in world trade provided a major stimulus to use of the canal and to the economy.

In the 1970s and 1980s, Panama's growth fluctuated with the vagaries of the world economy. After 1973, economic expansion slowed considerably as the result of a number of international and domestic factors. Real GDP growth averaged 3.5 percent a year between 1973 and 1979. In the early 1980s, the economy rebounded with GDP growth rates of 15.4 percent in 1980, 4.2 percent in 1981, and 5.6 percent in 1982. The acute recession in Latin America after 1982, however, wreaked havoc on Panama's economy. GDP growth in 1983 was a mere 0.4 percent; in 1984 it was negative 0.4 percent. In 1985 Panama experienced economic recovery with 4.1-percent GDP growth; the corresponding figure for 1986 was estimated to be 2.8 percent.

Changing Structure of the Economy

The structure of Panama's economy in the twentieth century has been characterized by the dichotomy of a large internationally oriented services sector and a small inward-looking goods sector. The major change in that structure has been the rapid growth of the services sector. In 1950 services accounted for about 57 percent of GDP; that share rose to 63 percent in 1965 and to over 73 percent in 1985. Given Panama's geographic location, modern infrastructure, and an educated population trained in commercial and financial activity, services will likely remain the leading sector of the economy.

In contrast, the goods sector has declined in relative terms. Although efforts have been made to stimulate agriculture and industry--and both registered substantial growth--their share of GDP has fallen as that of the services sector has risen. In the late 1980s, one of the greatest challenges facing Panamanian policymakers was that of using the services sector as a springboard for growth, primarily in industry but also in agriculture.

During the Torrijos administration, the economy was stimulated in several areas. The principal stimulus to the services sector was banking, articularly offshore banking. Transportation also increased rapidly, along with expansion of the road network. Substantial investments were made in the communications system in an effort to meet international standards expected by the extensive network of foreign businesses. Storage and warehousing grew rapidly in response to the economy's own needs and particularly to the foreign business conducted in the CFZ.

Industrialization progressed rapidly after 1950, with industrial production rising from 10 percent of GDP in 1950 to 19 percent in 1965. This expansion was based primarily on import substitution. Industry continued to grow at an average annual rate of 5.9 percent from 1965 through 1980, but registered negative 2.2- percent average annual growth between 1980 and 1985.

As a result of the lack of growth as well as the rapid rise of the services sector, industrial production had dropped slightly as a percentage of GDP in 1985--to just under 18 percent. Manufacturing accounted for about half of the industrial sector, followed by construction, energy, and mining. Given the small size of the domestic market, observers believed that future industrial growth would rely primarily on foreign markets. Success, therefore, would depend to a large extent on Panama's ability to make its industry internationally oriented and competitive.

Although the agricultural sector continued to expand and to employ the largest number of workers, its share of GDP declined substantially, from 29 percent in 1950 to 18 percent in 1965 and about 9 percent in 1985. This sector grew at a respectable average annual rate of 2.4 percent between 1965 and 1980, and 2.7 percent between 1980 and 1985, but it could not keep pace with the rapid growth rate of the services sector. Bananas, shrimp, and sugar continued to lead the list of export items. The expansion of the agricultural sector hinged on exports and product diversification.

Recent Economic Performance

The Torrijos era (1968-81) stands as a dividing point in Panama's economic history. Under Torrijos, the state took a more active role in the economy and initiated ambitious social projects. The public sector expanded to an unprecedented degree, as did the fiscal deficit and the external debt. In the 1980s, Panama was forced to address some of the excesses of the 1970s, and to adjust its policies, often under the aegis of the International Monetary Fund (IMF) and the World Bank.

In the 1960s, Panama experienced buoyant growth in virtually all areas of the economy as a result of the boom in canal-related activities and the growth in private investment. GDP expanded at an average of 8 percent per year. Employment grew at 3.5 percent per year, well above the population growth of about 3 percent a year. Most of the new jobs were generated by the private sector.

In the 1970s, Panama's average annual growth rate of GDP fell to 3.4 percent. Many factors contributed to the decline. In the international arena, reduced canal use (especially after the Vietnam war), rising oil prices, international inflation, and recession in the major industrial countries had a negative impact on Panama's economy. Domestically, investment fell in response to government policies of agrarian reform, expropriation of private power companies, creation of state industries, protection of labor, controls on housing, subsidies, and high support prices. In addition, the prolonged negotiations between the United States and Panama over the canal adversely affected investor confidence. The government sought to regain private investment by investing in large infrastructure projects and by expanding or acquiring productive enterprises. Two-thirds of the new jobs created in the 1970s were in the public sector. The public-sector deficit expanded, and the government was forced to borrow money from abroad. By 1980 the external debt had reached 80 percent of GDP.

In 1982 Panama, like most of Latin America, felt the impact of the world recession. Once again, the government sought to remedy the declining private-sector investment through increased public expenditures. In the same year, the public-sector deficit reached 11 percent of GDP. In 1983 and 1984, the government imposed a severe austerity program, which had the imprimatur of the IMF. Public investment was reduced by 20 percent in 1983 and by a further 8 percent in 1984. The public deficit was also cut, to about 6 percent of GDP in both years. In addition, the government undertook structural adjustment measures in the areas of industry and agriculture and instituted changes to streamline the public sector. The simultaneous recession and reduction in public expenditures caused GDP to fall in 1984, the first decline in more than twenty years. In the following years, however, Panama, avoiding the economic slump that plagued most Latin American countries, experienced moderate growth.

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Source: U.S. Library of Congress