Obama’s surprise stop: El Salvador

President Obama’s Latin American tour is taking him to Brazil, Chile, and El Salvador. The first two destinations do not surprise. Brazil is Latin America’s largest economy (and the seventh-largest globally). Chile is Latin America’s most developed country, setting the regional bar for per capita income, poverty reduction, and Human Development.

El Salvador stands out as the tour’s third stop. It lacks Brazil’s size or Chile’s reputation. However, El Salvador has been a disciple of Chile’s free-market model. In the aftermath of a devastating civil war, Salvadoran governments rebuilt the country in the 1990s with free-market reforms targeted at opening the economy to foreign investment.

The economic reforms bore fruit in 1996 when El Salvador became the second country in Latin America (after Chile) to receive an investment-grade credit rating (since then, its rating has been downgraded several times, and now is classified as BB- by S&P).

In 2002, I was invited by the government’s investment promotion agency PROESA to tour El Salvador. During my visit I saw call centers, gleaming food processing and pharmaceutical factories, and new shopping centers. Each of these were evidence of the economy’s progress. It seemed El Salvador was firmly positioned on a path of steady development that would allow it to make a decisive break from its violent past.

Unfortunately, El Salvador’s path to development has not been as smooth as Chile’s. The Great Recession of 2008-09 devastated the Salvadoran economy, which is dependent on the US for trade and remittances. The US accounts for 80% of El Salvador’s exports and 33% of its imports (1, 2) and is home to some 2.5 million Salvadorans, who in 2008 repatriated $3.8 billion in earnings to El Salvador (home to 6 million Salvadorans).

Violent crime has surged and now poses a grave threat to the country’s political stability. The Maras (street gangs) initially formed among Salvadoran immigrant groups in California in the 1990s. They have since returned (or have been deported) to El Salvador, where they have focused on drug trafficking, extortion, and kidnapping.

The Maras have helped El Salvador achieve the world’s highest murder rate over the last five years. An average of just under 4,000 people have been murdered annually since 2006. These death totals even compare to those of the civil war of 1979-1992. That 13-year conflict consumed the lives of 75,000 people – a rate of 5,700 deaths per year. The chart below shows the severity of the violence. El Salvador’s murder rate is far above those of other Latin American countries with reputations for violence (sources here).

The good news is the country’s political leaders may pull yet another miracle. Elected in 2009, President Mauricio Funes maintains 70-80% approval ratings. Funes is the first president from the Farabundo Martí National Liberation Front (FMLN), a left-wing political party with origins as a Marxist guerilla force during the civil war.  

Some feared Funes would align El Salvador with Hugo Chavez’s Venezuela. However, Funes has followed the example of Brazil’s former President, Luiz Inacio Lula da Silva. Like da Silva, Funes has maintained pro-market policies while emphasizing anti-poverty programs. His policy achievements include making basic education free, providing poor children with school uniforms and shoes, and expanding public health programs.

The president has also prioritized combatting the violence, by deploying the army to participate in street policing. The murder rate dipped by 9% in 2009. However, a series of recent arrests are providing evidence that the local gangs are now partnering with Mexico’s powerful drug cartels, including the Zetas and the Sinaloa cartel. 

El Salvador is too small to win a battle of arms against the cartels. It lacks the population and tax base of Colombia or Mexico to fund a major anti-gang war. Instead, the government’s best long-term option is to create meaningful alternatives for its people.

So, what can El Salvador do? I offer three suggestions. First, continue with pro-business reforms. El Salvador still ranks 86th in the world in the World Bank’s Doing Business Index. By comparison, Mexico is 35th and Colombia is 39th. El Salvador should try to move to this range if it is going to be a competitive destination for foreign investment.

Second, use military and police resources to defend property rights. Some 5% of Salvadorans are victims of extortion from the Maras. The government must protect the interests of small and medium businesspeople from these parasitic mafias.

Third, focus on promoting foreign investment in industries that require less capital investment but which employ large numbers of people. Given El Salvador’s violent climate, it will be easier to attract ventures that involve fewer upfront fixed costs. 

One potentially attractive industry is call center services. About 25% of Salvadorans have lived in the US, so the country has a large population of English speakers.

Breaking the cycle of violence and poverty will not be easy, and it’s possible the government may be dragged into an unwinnable war against the gangs. However, further economic reforms do offer a potential pathway out of the current mess.

Written by David Gates for Emerging Markets Blog

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