I put up my previous post on Chocolate Momotombo to show a great example of a Nicaraguan company engaging in value-added production.
In October of last year I was having a conversation with another volunteer (not Peace Corps) in Nicaragua. She works in English education through the US Embassy, and we got on to my favorite topic: Value-Added Production. She was working with English language learners in the Food Sciences and Engineering program at the local university, and was very interested in the topic as well. She asked me a very straightforward question: why is there a lack of domestic production in Nicaragua?
In addition to Nicaragua’s trade deficit, another indicator of a lack of a domestic production sector is energy consumption by sector. In Nicaragua, industrial demand for electricity comprises 20% of total demand. In the United States it comprises more than 30%, the largest sector in terms of energy usage. I’ve thought about why this could be thoroughly since my friend posed the question to me and I would like to present my hypothesis for why Nicaragua imports a lot and produces for itself very little:
- Education. The Nicaraguan education system does a poor job to prepare students to someday become value-added producers.
- Infrastructure. Nicaraguan infrastructure is poor and limits the ability of producers to reach manufacturers and also limits the possibility for exporting.
- Energy prices and availability. Electricity is extremely expensive in Nicaragua and it often goes out, making Nicaragua quite noncompetitive with other Central American products.
- Price cartels. The current structure of the economy allows price cartels to fix the price of primary goods about the market equilibrium price.
- Credit Availability. Lack of credit availability limits the ability of producers to grow their business.
- Arduous Regulatory Environment. Formalizing a business in Nicaragua is very arduous and expensive.
Each of these issues affects the value-added industry in different ways. One ways is to limit the ability of producers to produce. It stunts the generation of new ideas in the first place. Other issues raise costs, which raises the ultimate price to consumers. This reduces the quantity demanded domestically, which may not make the enterprise worthwhile in the first place, and secondly it makes the products less competitive in export markets.
Sourcing primary goods, coming up with a cost effective method to process them, preserve them, package, label, and commercialize them requires a lot of specialized knowledge. It is engineering plus business management. To be successful, the business needs to be run by people with a high degree of educational attainment. Plus, someone needs to come up with an innovative idea for a value added product in the first place. The Nicaraguan school system has certainly come a long way, but it is still deficient in many facets.
In Nicaraguan culture, people feel entitled to work. I’ve even heard that it is a right enumerated in the constitution. I am not sure if that is true or not, but it is a strong ideal in society. This ideal transfers over strongly to the school system. It does not educate students to innovate and to lead. They learn “stuff” in primary school and secondary school. They specialize in university. Then they are to seek work. There are certainly efforts to change this attitude, but for now the education system is not fostering a highly productive economy. Furthermore, various other issues in the school system leave students under-prepared and deficient in critical thinking, problem solving, quantitative reasoning, reading comprehension, and communication skills.
In order to produce a value-added product a producer needs access to quality primary goods as well as have access to distribution channels. Leaving aside electricity, this primarily means roads, and to a lesser extent trains, ports, and other types of infrastructure. If I am going to make vegetable oil I need corn to come into my factory and I need to get the finished oil out for distribution. Nicaragua has done a nice job expanding the road network, and from my trip to Honduras I can also attest that in some respects Nicaraguan roads are superior to others in Central America.
Nevertheless, in Nicaragua, the further you get from Managua and the further you get from other big cities, the worse the roads. Some towns are virtually inaccessible during rainy season by large vehicles, and still other towns are left stranded because there are no bridges over certain rivers. Wiwilí de Jinotega and Wiwilí de Nueva Segovia are separated by the Coco River. There is no bridge across the river at Wiwilí. If you want to get from one town to the other you have to hire a small boat to take you.
Furthermore, there is no deep water port in Nicarauga. This makes it more expensive to export products further afield than the rest of Central America, and if a producer needs specialty products imported, it makes them more expensive as well. Lastly, the poor roads not only make it difficult for further afield producers to distribute their products, it has a network effect. Every producer is a supplier for another producer, so the poor roads make primary goods more expensive or difficult to obtain, which depresses the entire Nicaraguan value-added industry.
Energy Prices and Availability
Energy prices are highest in Nicaragua among all of Central America. For commercial users it can be more than 10 times more expensive than electricity in the US. This makes operations very expensive, as well as refrigerated storage. In addition, it makes Nicaraguan products less competitive against products from other Central American countries. For some perspective, the average cost of kilowatt-hour of electricity for industrial use in the United States (March 2016) is 6.47 cents. In Nicaragua the average cost per kilowatt-hour is 24 cents, and it is even higher for industrial use.
Not only are prices high, but the electricity often goes out. For producers with large stocks of primary and finished goods that need to be refrigerated or frozen, they need to get generators. These machines and their diesel fuel is of course an additional cost that raises the sale price of their products and makes them less likely to be successful to a large swath of the domestic market or to export markets.
Ideally, a market will have lots of producers and lots of buyers, all of a relatively equal size. With this market structure the laws of supply and demand zero in on an equilibrium price that everyone will be happy with relatively quickly. Unfortunately, this is often not the case. Economists typically observe markets where there are only a few large producers or a few large buyers. When there are only a few buyers it gives them outsize pricing power, because the suppliers have nowhere else to dump their product, and likewise, when there are only a few small suppliers it gives them power because they can demand higher prices from the buyers. They do not have many alternatives.
Seeing this situation, many agricultural staples are not sold by producers on the free markets. Instead, producers sell their harvests to agricultural cooperatives (often owned by the farmers themselves). This food markets structure gives power to the large-time producers and the cooperatives, and they can set prices above supply and demand equilibrium, especially since there are not a lot of producers demanding agricultural staples for value-added production around the country.
This entire issue warrants an economic study (for all I know it has already been researched and written). Personally, to allow for the development of value-added production, I would prohibit agricultural producers from selling their goods to cooperatives of which they are members. Nothing ever goes wrong when you intervene in agricultural markets in Nicaragua. Nothing ever.
It is not easy to get a conventional loan in Nicaragua. Nicaragua has a history of financial crises and very high default rates. Interest rates are high even from the major banks that operate in Nicaragua. It is also difficult to get a business loan. At the very least a business needs to be in existence for a year. Then the banks request financial statements and like to see a “flow” of funds in and out of a bank account. For newly formed small businesses that need credit it is very difficult to get a formal bank loan.
There are many micro-financiers that offer loans to businesses and individuals. They have varying degrees of prerequisites and requirements. However, in general, they have very high interest rates. Interest rates approaching the rates that payday lenders in the United States charge. This financial situation makes credit extremely limited, and businesses that need equipment to process primary goods or businesses that need to produce at scale to turn a profit are prevented from growing. There are alternatives to this system, and many businesses have been successful maneuvering this system, but nevertheless the difficulties depress the value-added production sector of the economy.
Arduous Regulatory Environment
The Nicaraguan government blows a lot of smoke about supporting small businesses, but truly they do not do a very good job. Most businesses get started informally and then sometimes they grow. As they grow they catch the attention of government agencies who demand more and more of the business’ time. This takes the form of licenses and taxes. Nearly everything has to be done in person in major cities. Taking the trips to the cities can be expensive and arduous. A fish processing cooperative that I worked with was constantly being called in to the Nicaraguan Small Business Administration. A trip could easily cost them more than C$ 100. Their margins are razor thin. They would have to sell at least twenty trays of their fish cakes to cover one C$ 100 trip into town.
I’ve also observed that the government agencies are not well coordinated and they often contradict each other. I know a non-profit tour operator that was taking heat from the Institute of Tourism for not being registered as a tour operator. They wanted to get registered, but another government agency would not give them the prerequisites because they are a non-profit. It took them a few years to favorably resolve the situation. With a tourism cooperative that I worked with, they had to submit their tax ID number to the agency overseeing cooperatives to formalize their business. However, the tax authority was delayed in issuing them their tax ID number. The agency overseeing cooperatives then assessed a fine. This type of environment is not conducive to small business growth, regardless of the type of business, whether it be production or commercial.
Furthermore, many small business owners are under-educated and not very adept at bookkeeping which makes doing their taxes very difficult. I suppose that an overarching small business “czar” needs to streamline the small business licensing process in Nicaragua. In addition, online systems need to be introduced for business owners with internet access.
A small gallery of student-made value-added products in Nicaragua:
Every country struggles in some way or another with these issues and others. However, the issues are particularly debilitating in Nicaragua, leaving the country with a relatively small value-added production industry.