_Recuperation and stagnation, 1985-2002._ A third episode of growth begins approximately in 1985 when democracy was restored, albeit with civilian governments patronized by the generals. Although growth rates recovered, they have ever since followed a more or less stagnant pattern. A cornerstone in economic and social development in history was the signing of the Agreement of a ‘Firm and Lasting Peace’ in December 1996, the formal end to the civil war. Since the signing of the UN-sponsored Peace Accords, Guatemala has made progress by increasing investments in infrastructure and human capital. It has also made some efforts to improve public financial management, and in the area of tax revenues. However, UNDP (2003a) finds that the implementation of the Peace Accords has been uneven. Moreover, in particular during the past decades, Guatemala seems to be affected by electoral cycles. This issue has been investigated by López-Cálix (2002) who indeed finds weak empirical evidence supporting this hypothesis.

# **Box 2. Social Conflict and Guatemala’s Growth Collapse**

A key study for understanding the Guatemalan growth collapse after 1975 is Rodrik (1999). His core idea is that the effect of the external shocks on growth is increased within the context of ‘social conflict’ and weak institutions for ‘conflict management.’ The term social conflict refers to the depth of social inequality and ethic fragmentation. Conflict management refers to democratic institutions, an effective judiciary and a non-corrupt bureaucracy. All of these adjudicate distributional competition within a framework of rules and accepted procedures. However, as in the case of Guatemala, the economic costs of shocks can be magnified by the associated distributional conflicts. These are triggered because social divisions run deep and governmental as well as democratic institutions are weak. Consequently, the productivity of resource utilization can be diminished in a number of ways. For example, by delaying adjustments in fiscal policies and key relative prices, including the real exchange rate and real wages. In addition, these adjustments may generate uncertainty in the economic environment and paralyze the economy for years. Cross-country econometric evidence supports this hypothesis. Rodrik finds that countries experiencing the sharpest drops after 1975 were those with divided societies and weak institutions. This seems indeed to be the case for Guatemala, and is an important finding not only in retrospect but also for the future.

Finally, GDP growth has declined continually since 1999. The processes behind this decline are not exactly understood. It is uncertain whether this represents a decrease in Guatemala’s trend growth or a prolonged cyclical downturn. However, it is not unreasonable to argue that this decline is partly associated with high levels of violence, kidnappings (including the central bank governor) and social unrest. In addition, Guatemala scores poorly on most governance indicators, particularly those for corruption, the rule of law and the justice system, and political stability. The culmination of these factors ultimately seems to damage the climate for growth and investment.<sup>6</sup>

> 6 Larrain (2004) analyses these issues in more detail. Hypotheses for the recent growth slowdown can be found in World Bank (2003b). These include restrictive macroeconomic policies, unfavorable external developments, the ending of the economic model relying on traditional agro-exports, and several political factors. As of June 2000, Guatemala is listed as noncooperative country in the OECD-backed ‘Financial Action Task Force on Money Laundering.’

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