Foreign investment in Central America has great potential, but also faces many challenges. The region’s small domestic markets, lack of integration, weak legal systems, corruption, and high crime rates give foreign investors pause. However, Central America’s proximity to the massive U.S. market, trade deals like CAFTA-DR, and lower wages have attracted some manufacturing FDI. If Central American countries can strengthen regional integration, improve education and infrastructure, combat corruption, and provide predictable legal frameworks, they may convince more foreign investors to enter.
Poor domestic market access and regional fragmentation
A major barrier for foreign investors in Central America is the small size of individual domestic markets. Most Central American economies are tiny apart from regional powerhouse Mexico. For example, the population of Nicaragua is only 6.6 million. Building a factory for domestic sales would not be profitable in such a small market. Furthermore, Central America suffers from weak regional economic integration. Differing regulations, tariffs, and transportation networks between countries limit the potential of the bloc as a unified market. However, CAFTA-DR has helped link some Central American economies closer to the U.S.
Weak legal systems and corruption
Foreign investors want their assets and profits to be secure. But Central America struggles with corruption, opaque regulations, and weak legal enforcement. For example, Guatemala ranks 96th out of 180 countries in Transparency International’s Corruption Perceptions Index. Arbitrary changes in regulations or unfair targeting of foreign companies have happened across the region. Even when laws clearly favor investors, court systems may move slowly. Contracts can be hard to enforce. All this uncertainty keeps risk-averse foreign companies away.
High crime rates
Some Central American countries suffer from epidemic levels of crime and violence, largely driven by organized crime. El Salvador has one of the world’s highest homicide rates, while Honduras has the second highest rate in Latin America. Gangs target residents and businesses with extortion. Criminals also commit highway robberies and cargo theft. These rampant security issues raise costs for foreign companies operating in the region.
Lack of developed infrastructure
Modern electricity, transportation, and telecommunications infrastructure is crucial for manufacturing and services FDI. But Central American infrastructure is underdeveloped outside major cities. Only around 30% of roads in Central America are paved, hurting logistics. Electricity supply can be unreliable. Internet and mobile broadband penetration lags behind wealthier regions. As a result, operating and distribution costs climb for foreign investors.
In conclusion, foreign investors hesitate to enter Central America due to small individual markets, limited regional integration, weak legal systems, corruption, high crime, and infrastructure gaps. However, the region’s proximity to the U.S. and free trade deals remain attractive. If Central American governments can address these investment barriers, they may attract higher quality foreign capital.