Multi-dimensional Review of Panama

Executive Summary

This second volume of the Multi-dimensional Country Review (MDCR) of Panama builds on the results of the first one, which identified the main constraints to advancing citizens’ well-being and achieving more sustainable and inclusive development. It provides recommendations in three key areas to address these constraints: skills and jobs, territorial development, and financing for development. A third volume will propose a way of prioritising policy interventions and a framework for measuring policy implementation.

Panama has experienced considerable socio-economic progress and improved well-being in recent decades. However, not all sectors, regions and people benefitted at the same level, resulting in a dual economy. Progress stemmed mostly from economic growth and improvements in labour productivity in the modern tradeable service sector – mainly financial intermediation and trade, logistics and communications activities. The Canal and the Special Economic Zones have played a considerable role in the country’s economic performance. Although the country has a formal sector with high wages in specific activities linked to global trade, export capacity and productivity remain low in the rest of the economy. The industrial and agricultural sectors only offer subsistence and informal jobs to most workers, thereby enhancing income inequality among Panamanians. This explains why Panama is considered as a dual economy.

Panama’s inclusive and sustainable development will largely depend on the ability to achieve three main objectives: building better skills and formal jobs; promoting the catching-up of lagging regions and reducing territorial disparities; improving the taxation system and enhancing the contribution of the private sector in financing for development.

Building better skills and creating formal jobs for all Panamanians

In Panama, workers’ skills remain poor and informality is high, challenging both social inclusion and productivity. Three quarters of the Panamanian workforce is low to medium-skilled and informality affects 40% of total workers. Informality poses a double threat: large losses for workers in the form of low savings and inadequate social protection, as well as a lack of upskilling opportunities; and low productivity and loss of revenues for firms and the wider economy.

To promote better skills and more formal jobs, Panama should implement an integrated package of socio-economic policies. First, Panama needs to create better conditions for productive development by increasing export diversification in agro-industry and upgrading existing services. Second, investment is required to increase access to and the quality of secondary and technical education. These measures should be accompanied by stronger active labour market policies, with the effective participation of the private sector. Third, an integrated pension system should be designed to increase the incentives to be formally employed and mitigate the pervasive impact of informality. Fourth, the skills and formalisation package should generate greater incentives for employees to formalise workers, for example by partially subsidising the social contributions of low-income workers and establishing a simpler scheme to determine minimum wages. Fifth, the formalisation of small and medium-sized enterprises (SMEs) and independent workers will require greater efforts to reduce red tape and administrative costs associated with formal status. Finally, more resources should be devoted to enhance supervision and enforcement of labour laws, including through greater inspection efforts to supervise informal workers in formal firms.

Strengthening regional development policy to boost inclusive growth

Regional development policy is an underutilised lever that would help Panama continue on its growth trajectory and achieve more inclusive socio-economic outcomes. Regional disparities across provinces and comarcas in terms of productivity, social cohesion and well-being outcomes are persistent in the country. Better strategic planning and implementation frameworks across different levels of government are necessary to support regional development and boost well-being and prosperity. The state should design policies and create conditions to catalyse greater investment across all regions, especially in the lower-performing ones, and invest more and more effectively at sub-national level.

To design and implement a regional development agenda, policy action in several domains is necessary. First, such an agenda must strengthen multilevel governance practices. This requires adjusting normative and institutional frameworks for regional development and building greater capacity and resources at sub-national and especially municipal levels. Second, it should support a new paradigm approach to regional development that introduces regional development plans, creates regional development funding mechanisms and builds performance measurement systems. Finally, it must enhance horizontal and vertical co‑ordination capacity by creating a high-level inter-ministerial body and a dedicated unit for regional development policy. This presupposes the need to build vertical dialogue mechanisms and promote inter-municipal co‑operation.

Improving the taxation system and promoting private sector involvement

Panama’s total tax revenues have remained stagnant during the last two decades at close to 16.6% of GDP (vs. 22.7% in Latin America and the Caribbean and 34.3% in OECD economies in 2016). Revenues from the Canal – at 4% of GDP – and other state-owned enterprises have partially compensated for low levels of public revenues. Improving the prospects of tax revenue collection would provide a stable long-term source of income to finance key social and productive policies. Revenues should be increased by improving the tax collection system rather than by raising rates. Likewise, mobilising private sector investment through a sound regulatory and institutional public-private partnerships system is an additional source of effective financing for development.

Policy actions are needed to improve the taxation system and encourage private sector investment to support financing for development. First, promote further compliance, transparency and accountability within the fiscal framework by establishing an independent fiscal council. Second, enhance the tax system’s efficiency by adopting a methodology to measure and report tax expenditures on an annual basis; by revising benefits provided to economic sectors, as the tax system might be subsidising otherwise unprofitable businesses or firms within these sectors; and by broadening the tax base by scaling back tax benefits provided to well-established and consolidated industries within Special Economic Zones. Third, increase the redistributive power of the tax system for instance by including the currently exempted “13th wage” and turning personal income tax allowances into tax credits. Fourth, modernise the tax administration by integrating critical processes to improve efficiency and reduce administrative costs, as well as by continuing the development of electronic invoicing to fight fraud and tax evasion. Finally, adopt and implement norms for public-private partnerships with sound regulatory and institutional frameworks.