The Panama Canal Expansion: Changes Beyond The Waterway by Knowledge@Wharton
With the opening of the long-awaited Panama Canal expansion project this June, all eyes are on the impact the $5.25 billion engineering marvel will have on maritime traffic across the vital international lanes that link the Pacific, the Atlantic and the Gulf of Mexico. However, the transformation it will bring to Panama’s domestic economy and society have been largely overshadowed by the historic expansion.
The expansion has already bolstered Panama’s efforts to become the Singapore – or perhaps Dubai – of Central America. It also promises to help to transform the role that Panama is playing for many U.S. and other foreign firms that are doing business in Central and South America.
There are several factors that make Panama’s prospects promising for many multinationals. Blessed with a unique geographical position, Panama is one of the fastest-growing economies worldwide. According to the World Bank, between 2001 and 2013, its average annual growth rate was 7.2%, more than double the average in Central and South America. In 2014, growth slowed to 6.2%. It was 5.8% in 2015, a year in which virtually all the region’s economies either slowed down or contracted.
The growth rates in Brazil, Chile, Argentina, Venezuela and elsewhere were hit by commodity price declines. Among all the economies of Latin America, Panama has been least sensitive to commodity prices. It helps that “Panama made a very intelligent choice shortly after becoming independent from Colombia in 1903 to adopt the U.S. dollar as its legal tender,” says C.E. Maurice Belanger, executive director of the American Chamber of Commerce & Industry of Panama. Although Panama’s official currency is the balboa, it does not print any paper money and only has a small amount of Panamanian coins the same size and denomination as U.S. coins. Belanger explains that “this provides a very convenient base for international trade and tourism.”
“When there is a $25 million investment in New York, Buenos Aires or Mexico City, nobody sees it. In Panama, an investment of this amount, the restaurants, the stores and even the taxi drivers [feel] the impact.” –C.E. Maurice Belanger
Furthermore, the banking system has at times been compared to the Swiss banking system, and widely lauded by many for being very “conservative.” “Even during the last world financial crisis in 2009, Panama still had a positive GDP of 3.2%,” recalls Belanger. Panama managed to reduce its poverty rate from 39.9% to 26.2% between 2007 and 2012, despite the global financial crisis, notes the World Bank, while reducing extreme poverty from 15.6% to 11.3%.
Panama Canal – Attractive for FDI
In the 2015-2016 Global Competitiveness Report published by the World Economic Forum, Panama scored 4.4 points out of seven, slightly below South Africa but just above Turkey and Costa Rica, India and Mexico. In other key indicators, Panama’s unemployment rate is projected to drop from 2.88% in the first quarter of 2016 to 2.06% by 2020, according to government economists. Inflows of foreign direct investment (FDI) have also risen dramatically from an average of $1.258 billion between 1990 and 2012, to a total of $4.653 billion in 2013, according to the national census bureau. Reports the World Bank: “Panama continues to be an attractive country for FDI. The prospects of sustained high growth are also supported by emerging opportunities in transport and logistics, mining, financial services, and tourism.” Panama is a dollar-based economy, with no central bank of its own. Inventories in its warehouses are denominated in dollars, further simplifying the customs compliance process for companies when they export or re-export from Panama.
“Being a small country of just under four million inhabitants and about the size of the state of South Carolina contributes to our statistics,” says Belanger. “When there is a $25 million investment in New York, Buenos Aires or Mexico City, nobody sees it. In Panama, an investment of this amount, the restaurants, the stores, and even the taxi drivers [feel] the impact.”
That doesn’t mean that Panama has been completely immune to the ill effects of global financial contagion and the steep drop in global commodity prices over the past year. Henry Kardonski, managing director of London & Regional Panama, project leader of the huge Panama Pacifico development project, says that Panama has “not been directly affected” by the current global slowdown, but “the downturn in commodities affects the currencies of these countries” and changes in the value of currencies — such as the decline of the Colombian peso versus the U.S. dollar — “affect those countries’ ability to import and do other things.” However, the current crisis began last year, and “my clients have adapted to it. They’ve done their adjustments but it affects them because they are doing business regionally.”
The expansion of the Canal will enable longer, wider and heavier ships to transit; it is expected to open for commercial traffic on June 26. Although that’s far behind the original target date of August 2014, the delay has given U.S. East Coast ports and businesses more time to get ready. The expansion includes two larger sets of locks on both the Atlantic and Pacific sides, new access channels, dredging and improved water supply along the length of the 50-mile waterway.
Panama Canal – Natural Advantages
Observes Philip Nichols, professor of legal studies and business ethics at Wharton: “You can’t help but notice that the roads [in much of Panama] are very modern, and it’s a substantially different experience from driving around Honduras or Nicaragua. There is clearly something going on all over Panama, not just at the two cities at the terminus [of the Panama Canal].” More than ever, Panama is determined to exploit its natural advantage — the Canal. “The Canal is the advantage that Panama has over everyone — and it always will [have],” notes Nichols. “They know that they have an income, no matter what. It’s like having a good, solid lead tenant when you’re building a development.”
It’s not just the predictable flow of income from the Canal, says Nichols, a frequent visitor to Panama. “It’s the security that Panama is always a good bet” and that the Canal is “a resource that a lot of people with a lot of money are interested in. During World War II, the U.S. devoted considerable resources to protecting the Canal. It’s like oil, but it’s even better than oil.”
To be sure, there are competitors to the Canal — such as large container ships that operate on multi-modal supply chains. These ships dock in California, and then use rail to carry their goods across the U.S. Later, those vessels are picked up again in New Jersey or Florida or Georgia and then taken to Europe. There are also new competitors, adds Nichols: The trans-Arctic routes that are going to open up to traffic in response to global warming. “There are technologies that can compete with the Panama Canal but the Canal will always be important as long as we are moving things physically.
“The Canal is the advantage that Panama has over everyone…. It’s like oil, but it’s even better than oil.” –Philip Nichols
“Oil often has an adverse effect on governance,” adds Nichols. “There is an incentive for bad governance because, if a government can get a monopoly over oil, it pays off big. With the Canal, it’s kind of had the opposite effect in two ways: First, because the Canal is so important, the world has taken a stronger role in administering it. So, no matter what else was going in Panama, there was accountability and responsible administration of the Canal; there was a model for governance. People could just look over to the Canal Zone and say ‘our government should be working the way that’s working.’”
Panama Canal – Ties with Outsiders
The Canal has long provided huge opportunities for Panamanians to establish personal ties with outsiders that are rare in most of the region’s small, natural-resource poor nations. Says Nichols: “There were tons of relationships created. If an American had to choose between investing in Nicaragua and Panama, most people in the U.S. would think of things like the Sandinista-Contra civil war [in Nicaragua], and would think negative. Whereas with Panama, they might think, ‘My uncle lived there for 10 years while he worked in the Canal Zone.’” Indeed, U.S. Sen. John McCain was born into a U.S. military family at the Coco Solo Naval Air Station in the Panama Canal Zone, which was U.S. territory between 1903 and 1979. “You can’t underestimate the importance of those kinds of relationships,” Nichols says. “Economists are now looking at behavioral economics — and Panama had those relationships in abundance, unlike other countries in the region. Those relationships affect economic decisions just as much as numbers do.”
In part because of strong linkages between the U.S. and Panamanian private and public sectors, “innovation and entrepreneurship are currently playing a very important role in Panama,” says Nicolaj Siggelkow, management professor at Wharton. “The current government, through liberalization of immigration laws and low taxes, has created an environment very conducive to innovation and entrepreneurship.”
Siggelkow points out that one way to gain permanent residency in Panama is to start a new enterprise. “In addition, since the Canal became Panamanian property in 1999, the government has spent considerable resources in upgrading infrastructure. Given its central location, it has developed into a key mode of transport and logistics of goods and services.” This makes it easier for entrepreneurial startups to source and distribute their components and the products that they ship from Panama.
Panama Canal – Looking Inward for Further Growth
Given the Canal’s historic role as a critical pathway between the Pacific and the Caribbean, Panama has traditionally been a country that “looks from the coast outward,” says Kardonski, project leader of Panama Pacifico since it was conceived in 2005. Panama Pacifico exemplifies a growing awareness of Panama’s potential to change its mindset and “look inward,” Kardonski notes. Gradually expanding, Panama Pacifico’s 3,450 acres of land assets are home to the International Business Park and the PanAmerica Corporate Center, where 140 companies have a presence, including 3M, Caterpillar, Dell, Grainger, Cable & Wireless, Avon and BASF. There, and elsewhere in Panama, a total of 117 multinationals have established their regional headquarters for Central and South America.
“[Because of strong linkages between the U.S. and Panama], innovation and entrepreneurship are playing important roles.” –Nicolaj Siggelkow
Beyond using Panama’s convenient location for managing regional distribution, an increasing volume of manufacturing takes place here. At Panama Pacifico, 3M produces lines for its automotive division, including paint guns and plastic bottles. Other firms make diapers, and operate high-tech printing technology to turn out such magazines as Esquire, notes Kardonski. Because Panama is well-equipped with infrastructure, such firms now “have the ability to reduce their presence in Peru, Colombia” and other Latin American locations that lack Panama’s transportation, distribution and just-in-time manufacturing capabilities. It helps that Copa Airlines, the country’s national flag carrier, has been pursuing an aggressive expansion path, already operating direct flights to over 50 of the biggest cities across Latin America and more than a dozen cities in the U.S. and Canada, including a new direct service between Panama City and New Orleans. In an effort to facilitate trade between Panama and the oil-rich nations of the Middle East, Dubai-based Emirates Airlines recently began nonstop services from Dubai to Panama City; billing the flight as the longest nonstop in the world. “We have combined first-world infrastructure, first-world buildings and first-world services” in one convenient location, says Kardonski.
Tourism is another sector growing at a rapid rate. According to Panama’s comptroller general directorate, income from tourism is now nearly double what the country earns from the iconic Panama Canal itself. Much like their counterparts in Dubai, Singapore and Hong Kong, Panama’s high-end malls draw large numbers of fashion-conscious travelers to the country.
In 2015, the number foreigners who visited Panama grew by 10.7%, reaching 2.5 million, according to the Tourism Authority of Panama. Nearly half — 46.1% — came from South America, led by Colombia (288,569), Venezuela (260,145), Brazil (88,348), Ecuador (74,043), and Peru (50,275). Collectively, the three nations of North America (the U.S., Mexico and Canada) accounted for only 24.1% of all incoming tourists, followed by Europe with 13.6%, Central America 10.3% and the Caribbean with 2.3%.
The wide range of new initiatives demonstrates that the Panamanians are aware that the best way to take advantage of the expanded Canal is “to build around it; to complement it,” says David Lewis, a Latin American investment consultant, and vice-president of Manchester Trade in Washington D.C. “Over and beyond just ships coming in and out, there is going to be [further] growth of ancillary services.” He adds: “Companies are realizing that Panama is a very attractive location to set up America hubs, because of Panama’s [multiple] free-trade agreements that get you everywhere. And with its dollarized economy, they don’t have to worry about foreign exchange risk.” While Panama’s population is small, “what really counts is the companies coming in to do their operations” in the country.
Lewis notes that at least 75% of the capital that has left troubled Venezuela recently seems to have gone to stable Panama. (Within the Latin American market, the rest has largely gone to the Dominican Republic). A lot of foreign companies that once had successful operations in Venezuela have moved them to Panama. In uncertain terrain, it’s a better bet.