Panama depends largely on its privileged geographical position: the economy is based on a well-developed services sector, including the Panama Canal, banking, insurance, government, the trans-Panamanian oil pipeline, and the Colón Free Zone. The Panama Canal and the monetary regime anchored in the use of the US dollar as legal tender spurred the rapid development of the service economy which offset markedly unfavorable terms of trade. The unique monetary system played a significant role in the creation of an International Banking Center and the Colón Free Zone.
Whereas many countries were characterized by a growing protectionism in the late 1940s, Panama launched the Colón Free Zone (the world's largest Free Zone, counting Hong Kong as the largest free port). Panama also earned substantial rents through the construction of the trans-Panamanian oil pipeline and by the licensing of the Panamanian flag to merchant ships from around the world. Another important, but shrinking economic sector is agriculture, which accounted for 7% of GDP in 2001. Main primary products include bananas, rice, corn, coffee, sugar, vegetables, meat, and shrimp.
The economy generated annual growth of more than 6% during the period 1950–81. However, economic growth stagnated to 1.9% annually over 1977–87, caused by the aftermath of the second oil shock and the debt crisis. In the early 1990s, Panama rebounded from an excruciating recession brought about by a US embargo and subsequent military invasion. The US objective was the capture of General Manuel Noriega, who had installed puppet governments and was responsible for an increase in drug trafficking and money laundering. After Noriega was captured, extradited and condemned at a Miami federal court, Guillermo Endara assumed office. Nevertheless, his administration was widely criticized for not fulfilling Panamanians' hope for a rapid and bountiful recovery.
In May 1994, Armando Perez Balladares was elected president. The economy continued to grow, but at a slower pace during the first half of the 1990s. Panama's main engines of economic growth (the Panama Canal, the Colón Free Zone, and International Banking Center) continued to lose competitiveness in the context of an open economy throughout the world. The Balladares Administration responded in 1996 with a solid program of economic reforms. These included the privatization of two seaports (Cristóbal and Balboa), the promulgation of an antimonopoly law, the renegotiating of foreign debt with commercial banks, the privatization of the electricity and water companies, and a banking reform law. These economic reforms were accompanied with the recovery of the majority of traditional sectors, with the exception of the construction sector.
Between 1988 and 1998, the economy grew at 5% annually. In 1999, Ms. Mireya Moscoso was elected to the presidency. She did not intend to privatize the few remaining state enterprises, and wanted to raise protectionist tariffs to help local farmers (but membership in the WTO forbade this action). In December 1999, in accordance with the 1977 Panama Canal Treaty, the Panama Canal and all American bases were returned to the Panamanian government, comprising 364,000 acres, and estimated to be worth $4 billion. Real GDP growth fell to 3.2% in 1999 (down from 4.4% in 1998) and then to 2.5% in 2000. A major cause of the slowdown was a decline in foreign direct investment (FDI), which had run at about $1.3 billion in 1997 and 1998, but fell to $.65 billion in 1999 and $.60 billion in 2000. Real GDP growth fell to 2.5% in 2000. In 2001, growth declined further as declining export demand and a dramatic drop in tourism following the 11 September 2001 terrorist attacks on the United States were added to declining domestic demand. Real GDP annual growth fell to 0.3% in 2001, and is estimated to have reached only 1.2% in 2002. Inflation has been held in control, falling from 1.5% in 1999 to 0.3% in 2001, and estimated at0.8% for 2002. Unemployment remains in double digits, reaching 14.4% in 2001. In 2001 Panama was removed from both the United States and the OECD lists of non-cooperating countries on money laundering, having been certified as compliant with 23 of 25 Basel Core Principles by the IMF Offshore Financial Center Module II assessment in August 2001. However, in 2002 and 2003, Panama remained one of 23 countries on the US list of major illicit drug producing and/or drug transit countries. Government plans are to make the Colón Free Zone, which accounts for about 10% of Panama's GDP, a multimodal logistics center for the Americas, but in the first quarter of 2003, sales and turnover were down about 20% over the year before.