El Salvador Attempts to Attract Foreign Direct Investment
“We did it with security, now we’re going to do it with the economy. We’ll prove them wrong…again” said President Nayib Bukele, emboldened after recent elections that provided him complete political control over the country – with questionable legality of the presidential election and gerrymandering of the electoral map aside. The centerpiece of President Bukele’s economic strategy is a new law that hopes to attract foreign direct investment (FDI) in light of a complete reduction of gang activity, an initiative that began in March of 2022 when President Bukele suspended all constitutional rights as part of a sweeping crackdown on gangs that led to the incarceration of 2% of the Salvadoran population – larger than that of the United States. As of result of the security plan, according to President Bukele, the gang problem has been solved; although, interestingly enough, the State of Emergency will continue.
The question now is: will the new FDI law bear its intended fruit? It seems unlikely. The main concern of the private sector, particularly international investors outside of the narrow category of Salvadorans living abroad who have been investing heavily in the country, may no longer be security-related but the opaque policy environment that has replaced the gang problem. In El Salvador, governance is dictated more by the President Bukele’s social media posts than by anything sanctioned by law, and the new FDI law does nothing to assuage the concerns of investors knowing that financial ruin is but a tweet away. This blog explores the importance of FDI, traditional causes for El Salvador’s lack of FDI, the narrow sliver of investors who are investing in the country, and how the new law does nothing to address overall prevailing concerns.
“We did it with security, now we’re going to do it with the economy. We’ll prove them wrong…again” – President Nayib Bukele
Understanding Foreign Direct Investment
There are a number of papers that support the benefits of FDI. For example, according to research cited by the World Bank, “an increase of a dollar in capital inflows,” as a result of FDI, “is associated with an increase in domestic investment of about 50 cents.” At the same time, FDI is not a panacea, the risks associated with these capital inflows were also documented in the same World Bank article. Still, the consensus is that FDI is largely positive: it can provide employment opportunities, increase technology transfer, boost individual buying power, and lead to boost the economy.
Imagine that you are a single parent responsible for two loving, yet demanding, children. Income from your job provides capital to invest in the livelihoods of your offspring and address other financial responsibilities to keep the household going. Your credit card, with a variable interest rate and late payment penalties, is another source of financing to address any immediate shortfalls that your paycheck can’t cover.
But what happens if your income isn’t enough to cover the necessities? Perhaps your place of employment has limited your hours, or worse, let you go? What if, as a result, you resorted to credit cards, opening various lines of credit and begin to accumulate debt that you can’t possibly repaid unless drastic changes are made.
This is what is happening in El Salvador. In this scenario, the single parent is the government. The “income from your job” are the tax flows accumulating in the federal coffers – far too low to keep up with with spending. The credit cards are the various loans that the government has obtained in order to continue everyday operations (see my previous post that talks about the governments accumulating debt).
In this simple example of the single parent, FDI can be seen as the larger community coming in and investing in you and your children where each partner seeking a profit on the productivity that your children create with an influx of fresh capital. Maybe the land you own has promising potential for a new hotel. Your children, confident and capable, could serve as managers of new enterprise. The benefits would be mutually-reinforcing: an influx of capital and a potential for increased productivity and associated living standards.
El Salvador – Lowest Recipient of FDI in LAC
Comprehensive FDI is lacking in El Salvador. According to the Economic Commission for Latin America and the Caribbean (CEPAL in Spanish), El Salvador holds the notoriety of being the lowest recipient of foreign FDI in Latin America. Of 29 countries, Bolivia comes in at a distant second. The U.S. State Department’s 2023 Investment Climate Statement agrees with CEPAL, “[f]or the last thirty years, El Salvador has lagged behind its regional peers in attracting foreign direct investment (FDI). This is attributed in part to widespread, gang-related crime and extortion.”
The gang problem has been an issue for decades. That changed in 2022. In what became the deadliest spike in violence in the country’s recent history, a gang-led killing spree, seemingly at random, took the lives of 92 individuals between March 24–27 of 2022. As of result those horrific events, the Salvadoran government passed a “state of emergency,” that suspended constitutional rights, including the freedom of association and assembly. Under the emergency law, freedom of association, the right to a defense, administrative detention timelines, the inviolability of correspondence, and interventions of telecommunications were suspended.
Police and military flooded the streets. With authorization to use deadly force and daily arrest quotas to meet, hundreds of thousands were rounded up and shipped to prison. According to Human Rights Watch (HRW), “Between March and November,” of 2022, “police officers and soldiers have conducted hundreds of indiscriminate raids, particularly in low-income neighborhoods, arresting over 58,000 people, including more than 1,600 children.” The report continues, “As of November 2022, judges had charged over 51,000 people arrested during the state of emergency with gang membership and sent them to pretrial detention, often appearing to apply a recent and abusive amendment to the Criminal Code that expanded mandatory pretrial detention.”
Despite the mass of human rights abuses, the intended target was achieved: a successful dismantling of the gangs. According to one report by Insight Crime, “the speed and scale of arrests made during the state of emergency have decimated gang ranks and sent scores of members fleeing abroad or into hiding in El Salvador.”
In 2024, the gang problem is now considered solved despite concerns that the Salvadoran government does not have a strategy to prevent further gang violence or address its root causes. Perpetual incarceration seems sufficient.
The country has now turned to promoting economic growth.
El Sal’s New FDI-focused Law
FDI is low in El Salvador, but current conditions have attracted a particular type of foreign investor: hermanos lejanos (far and away brothers), have returned to El Salvador in droves and are investing in their country. 2023 was a record-breaking year with 4.5 million visiting the country, more than the previous five years. While it’s difficult to discern how many were Salvadoran-American investors, what is clear is that many who did come were looking to buy. And according to a recent report by El Salvador’s Central Bank, and reported by one of large national media outlets, “remittances for investment experienced strong growth of 45% at the end of 2023 compared to the $72.6 million reported in 2022. This money is used for construction or purchase of property, as well as a business.”
Then on March 8, the Salvadoran Legislative Assembly, with a super majority faithful to the President, passed Ley de Impuestos sobre la Renta (Income Tax Law). The new law offers several tax exceptions, but perhaps that which has garnered the most attention has been the tax-free designation to remittances and investments in country. Such overtures, according to the Vice President of El Salvador’s Legislative Assembly Suecy Callejas, create the conditions where “investors can inject capital directly in El Salvador’s economy.”
Not all agree that the FDI law is made specially for those intentions. One of the few opposing legislators to President Bukele’s super majority in the Legislative Assembly warns of an ulterior motive. According to Claudia Ortiz, “it is an attempt by this administration to attract more money into the country’s economy so that there are more deposits in the banks. We already know, due to different measures that have been taken here and the closing of spaces to access financing that the government of El Salvador is financing itself with money from the national financial system.”
Representative Ortiz’s comments have merit. El Salvador, with little access to international markets to obtain loans, has resorted to syphoning market liquidity from local banks to provide short-term capital (see previous blog for more details).
Why El Sal will Continue to Have Low FDI: Legal Uncertainty
“The lack of a credible medium-term fiscal and financing framework, along with weak governance, undermine policy predictability and continue to weigh on creditworthiness.” – Moody’s
The true intentions of the new FDI law aside, the law is a best practice to bring in FDI; however, it does nothing to address the new prevailing concern: the risk to international investors may no longer be related to security but legal uncertainty. That same uncertainty is also driving money out of the country.
Moody’s recently reported that one of El Salvador’s challenges was its weak governance. “The lack of a credible medium-term fiscal and financing framework,” they report, “along with weak governance, undermine policy predictability and continue to weigh on creditworthiness.” Also, in a recent interview, Odalis Marte, Executive Secretary of Consejo Monitario Centraoamericano (SECMCA), a technical-administrative body of the Central Ameican Monetary Council, highlighted in a recent interview, “The private sector likes certainty, so to the extent that there is certainty, that will be good for the economy.”
That uncertainty is only compounded with recent government actions. A recent update to the anti-money laundering law largely seeks to provide more government surveillance of private sector, but mostly NGO activities. The Government has also expropriated of land for infrastructure works. But perhaps the most intimidating overture has come from the Salvadoran president himself. President Bukele’s antiglobalization speech at CPAC did nothing to invite investor confidence. The president, in a roaring crowd of allies, decried, “They say globalism comes to die at CPAC. I’m here to tell you that in El Salvador, it’s already dead.”
Conclusion
Without a doubt El Salvador needs to solve its financial situation. The foundations of the economy are weak and fiscal conditions continue to look bleak for the country, and of those tools at their disposal, the government is hesitant to pull the levels that would result in fiscal constraint (see previous blog for more details). El Salvador sees the FDI law as their opportunity to avoid the difficult decisions and, at the same time, bring in fresh capital. However, the new law will not address new concerns of investors; namely, the lack of a clear and predictable policy environment.
But Bukele feels that the economic miracle is possible. The man is so confident in his security policy that he offered to fix the Haitian problem. Now, in his bid to rebuild El Salvador’s economy, that same confidence will fall short of expectations as he tries to coax investors to bring their money to El Salvador. Why? Well before Bukele’s security plan, the Salvador President demonstrated a propensity to use the state’s security apparatus to intimidate his foes (both gangs and the opposition alike). Such top-down intimidation tactics serve no value to convince investors. Even with an overpowered propaganda machine, the hardline strategy that Bukele has employed and the total concentration of political power through questionable means has served only to sow doubt, and to some extent fear, in the minds of investors.