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Determinants and Assessment of Political Risk in Central America.


Political and social change can produce rapid and unexpected problems for companies operating internationally. Social turmoil, war, revolution, and changes in public politics are often difficult to predict. Global managers need to assess the political environments in which they operate and take action to protect company assets. This paper explores possible predictive determinants of social instability and provides a comparative assessment of the often troubles countries of Central America. In particular, the unstable countries of Nicaragua and El Salvador are compared with the peaceful democracy of Costa Rica.

Political Risk

Political risk comes in a variety of forms and can be minimized by avoiding investment in potentially risky countries. Although entry into sometimes volatile markets may produce additional risks for the multinational corporation, the potential profitability of these markets can make them attractive alternatives supplements to domestic transactions (Abbass, 1995, Johnansson, 1997). Such a strategic move necessitates additional analysis and understanding of the various parameters of political risk. Recent research indicates that most U.S. businesses perceive the main risk of Latin American market penetration to be monetary, such as currency devaluation and inconvertibility (Trivoli, Graham, & Herbig, 1998). There are, however, additional risks that should be explored. Political risk can be segmented into a matrix based upon whether the contingency is initiated by government or nongovernment forces and the extent to which the contingency is unplanned or expected. For example, terrorism would be classified as a c ontingency caused by factors outside government control (not true in all countries) and producing involuntary and unexpected loss. On the other hand, export controls may be expected and are almost always initiated by governments. Torre and Heckar (1990) provide the classification found in Figure 1. Such a typology helps to explain the multidimensional nature of political risk.

Determinants of Political Risk

To assess the political instability of a country or region one must first establish determinants of stability and instability. One factor often assumed to cause discontent is the unequal distribution of income. The empirical evidence seems to show that inequality is a factor in socio-political instability (Park, 1996). The larger the gap between rich and poor, the higher the probability of political and social turmoil.

Unfortunately income equality in many Latin American countries seems to be decreasing, according to recent research (Berry, 1997). Recent economic prosperity has not been widely distributed, resulting in even greater polarization of the income extremes. Economic growth overall (measured in per capita GDP) acts as a mitigating factor, however (Park, 1996). Therefore, it could be hypothesized that political stability could be maintained as lone as economic growth continued, even if the distribution is skewed.

Social scientists have long theorized that economic disparity among differing ethnic groups produces social unrest. Based on research in the U.S., it appears that income inequality coupled with ethnic group size better predicts social conflict (Olzak & Shanahan, 1998). Therefore, another factor to consider in assessing political risk is the homogeneity or heterogeneity of the population and the relative composition of the various ethnic groups. Evidence from research on American riots points to the positive effects of such behavior gained by insurgent groups (Fording, 1997). It is hypothesized, therefore, that insurgent group activity in unequal societies will produce positive gains for the rebelling groups and result in increasing rebellion. Such factors are of interest to the countries of Central America.

History of Conflict in Central America

Central America was colonized by the Spanish who were seeking gold in the New World. Central America has a long history of political turbulence and violence. Unlike the development efforts of the early settlers in North America, the European settlers in Central America sought to retain the colonial nature of the relationship, often in a very exploitative fashion. Spaniards arrived in Central America in the 1520s and defeated the Indian populations by 1540 (Berryman, 1985) Because Central America did not possess the precious metals the Spaniards sought, the area was seen as little more than a backwater. The Spanish rulers sought to exploit the territory for whatever resources it possessed (primarily agricultural) and to convert the natives to Christianity. Tyrannical Spanish rule established a tradition of nondemocratic governance (Markun, 1983). The Church was also responsible for some of the political and economic repression. With the conversion of the indigenous peoples to Catholicism, the Spanish rulers we re able to maintain the power they enjoyed through Church teachings.

The influence of the Church took a different direction in the 1960s. Papal encyclicals in 1961, 1963, and 1965 declared the absolute right of political and economic freedom. The Medellin Conference of Bishops denounced "institutional violence" and the "international imperialism of money" (Cheney, 1989). This conference and the previous pronouncements of the Church inspired some clergy to adopt what was referred to as Liberation Theology. Nevertheless the region possessed an underlying basis for violent change, and the 1970s and 1980s were a time of major political upheaval in the region. The following country-by-country sketch provides historical information and an assessment of political risk in each country.

The Countries of Central America


One of the most troubled countries in Central America today is Nicaragua, which fought a bloody civil war that stands out even in Central America history. Civil war, foreign intervention and domination, and political repression were not new to Nicaragua. However Nicaragua gained its independence from Spain in 1821 and became part of the Mexican empire, but soon left this association to join the United Provinces of Central America, which was ruled from Guatemala. In 1838, Nicaragua established itself as an independent republic (Kott, 1995).

As a republic the young country experienced political conflict. Two groups sought to determine the destiny of the country. The "liberal" party based in Leon wanted political freedom and change. The "conservative" party based on Granada wanted Nicaragua to run itself much as it had under Spanish colonial rule. An American mercenary named William Walker was hired by the liberals to help in their fight with the conservatives. Instead, Walker declared himself president of Nicaragua and sought a political agenda beneficial to himself and American companies doing business in the country (Kott, 1995). Eventually Walker was ousted by the people and later killed in Honduras. A centralized government was formed.

Conflict with the United States followed as the new government of Nicaragua refused to grant concessions requested by the Americans in building a canal in the isthmus. The United States reacted by sending troops to settle the social conflict created by the canal proposal. The marines were sent to Nicaragua three times in the early 1900s.

Although the United States decided to build the canal in Panama, American troops remained in Nicaragua. A revolutionary named Augusto Cesar Sandino led a small band of guerrillas against the foreign invaders. This group referred to themselves as "Sandinistas" and staged attacks from 1927 to 1933 (Kott, 1995). The marines reacted to the insurgents by creating a national armed forced called the National Guard lead by Commander Anastasio Somoza Garcia. After the departure of the Marines, Somoza eliminated the rebel threat and installed himself as president of Nicaragua. He and his two sons ruled Nicaragua for 43 years and amassed enormous wealth. The Somoza dynasty controlled a high percentage of business interests in Nicaragua, while most of the country lived in poverty.

During the 1970s social unrest began to grow. The Sandinista National Liberation Front (FSLN) began a campaign to oust Somoza. Two events brought the underlying tension to the surface. In 1972, an earthquake caused massive destruction to Managua and although international relief efforts were generous, little of the funding filtered down to the citizens. The people of Nicaragua believed that President Somoza had confiscated the funds for his personal benefit. In addition, the editor of a popular opposition newspaper (LaPrensa) was killed, and Somoza was believed to be behind the murder. The FSLN gained support and social unrest grew. Somoza responded and National Guard soldiers killed suspected rebels and tens of thousand of citizens (Cheney, 1989).

Somoza fled the country in 1979, when the Sanadinistas took over the government and attempted to rule with a junta composed of various Nicaraguan leaders. The junta nationalized some industries and established land reform, but ruled in an authoritarian fashion and made little economic progress. Reacting to the rapid build-up of military strength and close ties with the Soviet Union, the U.S. embarked on a campaign to establish democracy in the country. The contras, a group of U.S.-supported counterrevolutionaries began a campaign to destroy Sandinista control. In response to the contra pressure, the Sandinistas entered into negotiations with the rebels and, in 1990 elections were held in Nicaragua. Violeta Barrios de Chamorro, wife of the slain newspaper editor, was elected president. President Chamorro's government made significant economic progress and brought democracy to this war-tom nation. In 1997, Arnoldo Aleman took office representing the first time in Nicaraguan history that democratic power was tr ansferred from one elected official to another.

Today Nicaragua remains unstable. Total support of elected officers is lacking, and bands of FSLN members roam the countryside. With the reduction of troops, many people remain unemployed. Criminal activity has increased as the standard of living decreases. Nicaragua is the poorest country in Central America, with high unemployment, large external debt, low adult literacy, poor health care and education, and a growing population (Table 1).

El Salvador

Another country with a much troubled past is El Salvador. This tiny nation is the most densely populated. It has been estimated that over 70,000 people lost their lives in the civil unrest that has plagued this small nation (Cheney, 1990). Mass killing of the peasant populations, political and social repression, the murder of an outspoken Archbishop, and the seemingly endless cycle of violence between ruling party and the citizenry mark the political landscape of El Salvador.

After declaring its independence from Spain in 1821 and resisting incorporation into the Providences of Central America, El Salvador sought statehood from the United States. When this failed, El Salvador achieved complete independence and established its sovereignty in 1823. Over the years, a small group of families amassed great wealth. Known as The Fourteen Families, they acted as the ruling elite and developed large planations growing cash crops for export (Foley, 1995).

The Great Depression of the 1930s significantly reduced the exporting of cash crops and forced many off the land. During this time, Agustin Farabundo Marti began organizing a peasant revolt. The Salvadoran military began a campaign to crush the rebellion, and an estimated 15,000 to 30,000 peasants were murdered (Cheney, 1989). In 1932 General Maximiliano Herandez Martinez took control and the political repression and violence expanded. The La Matanza, or the slaughter of 1932, was one of the greatest atrocities committed in this region and set the stage for years of peasant repression by the ruling elite.

A turning point occurred in 1979. A military coup lead by young officers established a junta which promised an end to the repression and also major land reform. By 1982, Salvadoran banks and some agricultural, businesses had been nationalized and a civilian president installed. By 1984, El Salvador saw its first free election in more than a half century, and in 1989 elected power passed peacefully to another civilian president. The United Nations brokered peace talks in 1990, and by 1992 the civil conflict was officially ended.

El Salvador still represents significant risk of political turmoil. The main political parties -- ARENA, historically associated with the death squads, and FMLN, the former guerrilla organization -- have major differences. The economy has shown signs of improvement, but there is still a large un-or unemployment population. Crime is now a major problem but appears to be economic-based and not political in nature. With a relatively high birth rate, large foreign debt, and low GDP per capita (Table 1) economic development is crucial to political stability. Some progress has been made in recent years.


When the Spaniards conquered Guatemala, they exploited the large Indian population as forced labor. During the Spanish control of Central America, much of the region was ruled from Guatemala (Perl, 1982). Like many of its neighbors, Guatemala experienced much turmoil after its independence from Spain, with few periods of peaceful democracy.

In the 1950s, a Central Intelligence Agency supported coup established a military government that ruled in a repressive and violent fashion. By the 1960s, opposition groups developed, and an anned struggle resulted in major loss of life. An estimated 500 villages were completely destroyed, and thousands of civilians were massacred (Salinas, 1998). Three groups fought the military for control of the government.

In 1986 a civilian president was elected, but his administration did little to end the repression and violence. After 10 more years of conflict, a peace accord was signed between the government and the revolutionary groups, formally ending the fighting. A Catholic Church report concluded that over 100,000 civilians were either killed or "disappeared" during the conflict (Salinas, 1998). In 1996 President Arzu initiated a campaign to end human rights abuses and began an effort to purge the military and police of corrupt personnel.

Guatemala still has political problems, one of the most unequal distributions of income in the world (Saltz, 1995). With a large Indian population and land reform issues still unresolved, ethnic tension is palpable. Sporadic guerrilla attacks still occur and street crime is rampant. Recently kidnappings have increased as well as high-profile murders. Guatemala has a high population density and growth rate (Table 1). With the lowest literacy rate in Central America, most citizens have limited opportunities for educational and economic advancement. Although Guatemala is experiencing relative peace and democracy at the present time, underlying forces for change remain strong.


Like its neighbors, Honduras achieved independence from Spain in 1821 and affiliated with the United Providence of Central America. After the alliance failed, sovereign with rapid changes in government -- more than any other country in Central America. Civil wars, internal rebellions, political corruption, and dictatorial rule were characteristic of Honduran politics throughout most of its history.

Perhaps more than any other country in Central America, Honduras has been influenced by American business interest, the United Fruit Company in particular (Acher, 1988). American business interests also shaped the political agenda of the U.S. toward this "banana republic." Years of dictators made this country ripe for political change. Political repression and human rights violations have recently given way to democratic reform. The 1990s have seen progressive independence of political parties in Honduras, with the fifth democratically elected president in 1998.

The present political situation is relatively stable, but tensions exist between the executive branch and the military. Recently presidential campaigns against corruption have not been completely successful and political and military acts of violence remain a possibility. Recent anti-American sentiment is manifest in attacks on American franchise operations. A rapidly growing population coupled with a high inflation rate (Table 1) are also destablizing factors.


Originally called British Honduras, this small country is a member of the Commonwealth of the United Kingdom. First settled by shipwrecked British sailors who marveled at the quality of the timber. Belize is now inhabited by various ethnic groups including descendants of Jamaican laborers. Belize is a parliamentary democracy with a long tradition of political stability. Although the history of this nation has been described a "classic case of colonial exploitation" (Bolland, 1986, p. 69), recent attempts have been made to allow citizens to capitalize on their resources, especially sugar cane, bananas, and citrus. Belize has also begun to develop a light manufacturing base.

At present there are no internal nor external political threats, but Belize has the potential for instability because of its high fertility rate, significant ethnic concentrations, high unemployment, and stagnant growth (Table 1).

Costa Rica

Once an undervalued backwater colony of Spain, today Costa Rica provides of model of social and political stability for all of Latin America. Named the "rich coast" by Columbus, Costa Rica was of little interest to the Spaniards. With a small indigenous population to enslave and no precious metals, Costa Rica remained isolated in the isthmus. In fact, when Costa Rica gained its independence from Spain in 1821, it took two months for word to arrive from Guatemala.

Most settlers to Costa Rica came from Spain with the intent not of exploiting the land but rather farming it. The early immigrants established small independent farms. Large land holdings were uncommon and class differences rare. The population today is rather homogeneous with the exception of small Chinese and Jamaican populations. A long standing tradition of ethnic acceptance facilitates social harmony.

With the exception of one violent struggle in 1948, Costa Rica has been peaceful. With a constitution established in 1949, Costa Rica is the oldest democracy in Central America. The constitution abolished military forces, and the Costa Ricans directed their resources into education and medical care. Costa Rica enjoys the benefits of a middle class, something unique to the region. With a literacy rate that exceeds some industrialized countries, Costa Rica strives for equality in education and income. Citizens enjoy inexpensive and high-quality medical care and have the highest life expectancy in Central America. Population growth and density are moderate (Table 1). The two main political parties (PLN and PUSC) are considered politically moderate and, unlike other countries in Central America, are not polarized into extreme conservative and liberal camps.

Although Costa Rica is the region's most stable country there are some potentially destablizing factors. Economic growth has slowed considerably in recent years and overall performance has been weak compared to nearby countries such as El Salvador and Nicaragua. Costa Rica has been a holdout in Latin America in the movement towards privatization and free market economies. Street crime has risen and possible spillover of turmoil in Nicaragua is always a threat. Costa Rica still compares very favorably with the other countries in Central America and is one of the reasons that Intel recently selected it for its first Latin American manufacturing facility.

Summary and Conclusions

Although Central American history has been one of political instability, it appears that peace and prosperity are increasing in the isthmus. The entire region is currently enjoying democracy and economic progress. Unlike the 1970s and 1980s Central American countries have seen peaceful transfers of power. Inflation is relatively low and external debt is manageable in most cases. Nevertheless, Nicaragua, El Salvador, and Guatemala represent significant risks.

Political risk assessment is a dynamic and fluid concept. Stability today does not ensure stability tomorrow. Political risk assessment lacks the predictive capabilities of more advanced forecasting methodologies and still is immature as a "science." This paper has proposed that income equality, economic growth, democratic tradition, ethnic composition, and population growth/density can be used to predict political stability. Caution is required, however, in that more empirical work is needed in the social sciences and management to recommend with any confidence the ability of these factors to predict change.

Dr. Rarick, a certified senior professional in human resources, has published widely in the Journal of Business Ethics, Journal of Business Strategy and others, and has made professional presentations in all continents.


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Author:Rarick, Charles A.
Publication:SAM Advanced Management Journal
Geographic Code:20CEN
Date:Jun 22, 2000
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