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In El Salvador, a glimmer of hope for a stronger economy

FORTUNE — Twenty-one-year-old Cesar Canas flashes a winning smile as he pitches his latest business idea: a shrimp farm that recycles its liquids rather than drawing daily on El Salvador’s limited water supply.

“You will hear about us in the United States,” he promises.  Canas is one of many young aspiring entrepreneurs packed inside an auditorium at the country’s largest private university, Universidad Technologica de El Salvador (UTEC). Across a brightly lit stage, television cameras spotlight the winners of El Salvador’s first-ever national entrepreneurship contest.

In stubbornly slow developing economies, like El Salvador, cultivating entrepreneurship is an essential ingredient for growth. With modest start-up costs, it is the small, even micro firms — from one to 50 employees — that generate most of the jobs. Yet, here, their emergence has been “absolutely stifled by the security situation,” says a seasoned diplomat in San Salvador.

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Real numbers are hard to come by, but it’s clear that criminal demands on the country’s commercial life stymy growth.

Last week, El Salvador’s National Council of Small Business (Conapes) reported that 84% of the organization’s nearly 12,000 members claim that they have been subject to extortion by gangs. This follows a long series of industry and chamber of commerce complaints about the uptick in crime. The insecurity is “testing the tolerance” of Salvadoran entrepreneurs, say business leaders.

Lissette Canales, UTEC’s business faculty dean, explains that the school co-sponsored the contest with the U.S. Embassy in an effort to empower “young people to improve their own quality of life.” Canales had no problem attracting hundreds of entrants, but she had to search for financial support to steward contestants, provide cash outlays, laptops, and two years of English classes for the winners.

The competition is a standout, says Canas. As he sees it, gangs’ grip on enterprise, the government’s pervasive abuse of power to wield influence and make money, and the public’s apparent resignation to the problems does not create much room for entrepreneurial spirit.  This week, the Seattle-based World Justice Project (WJP) released its 2014 survey of the rule of law in 99 countries, spotlighting Salvadorans’ belief that the worst corruption is in the government.

WJP Chief Research Officer Alejandro Ponce reports that when his team asked Salvadorans if a high-ranking government official exposed by the media for dipping into government coffers for personal gain would be held accountable, “33% responded that the most likely outcome would be that the accusation would be completely ignored by the authorities; 55% responded that an investigation would be opened, but would never reach any conclusions; and only 11% felt that the government officer would be prosecuted and punished through fines, or time in prison.”

Expectations are low and grounded in grim realities. For the eighth straight year, El Salvador posted the most anemic economic growth in Central America. Here’s why: gangs control streets, the rule of law is virtually absent, jobs are scarce, and a quarter of the population has already emigrated in search of a better life.

One step outside of UTEC University — in any direction — provides a clear picture of the challenges. Gang graffiti marks the walls along the streets; public transport comes in the form of repurposed old school buses from the U.S., battered and grossly overloaded with passengers; the grounds and entryways of the National Medical Center’s Rosales Hospital are thick with litter; and make-shift fences and barricades topped off by barbed wire protect stores, businesses, and living quarters from intrusion.

Cesar Canas confesses he is nervous about walking the two short blocks to his car on the sunny afternoon of the UTEC awards. Because he is well dressed for the ceremony, sporting a newly pressed shirt and slacks, he expects he’ll be a magnet for thieves. After showing off his J.C. Penny watch, he plans to put it in is pocket for the walk to the car.

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El Salvador’s statistics portend a tough future for the country’s next generation. Fifty percent of the population is under the age of 20. The real rate of unemployment is upward of 40% and heavily skewed to the youth. Next to Honduras, El Salvador ranks as the world’s second most violent country, according to the United Nations index. Impunity is the norm; to enforce the law is to invite more danger. With such risk factors, foreign direct investment barely trickles in at an official (and likely far lower than) $500 million. For the fifth year straight, it’s lower than the regional annual average of $1 billion.

The conservative private sector does not trust the government — the left-leaning FMLN party and the odds-on favorite in Sunday’s run-off election — which means El Salvador is hardly considered a nurturing place for new business.

Canas is acutely aware that the odds are against him. “I need to fight the reality of my country: violence, drugs, poverty, gangs, delinquency….” And then there are the specific stumbling blocks for a would-be entrepreneur: virtually no access to credit; the pre-occupation with security, or what Salvadorans have come to call weekly or monthly “rent” payments to gangs; and the general discouragement from society to be enterprising when it is much easier to be on the take.

Over two thirds of families in El Salvador draw support from people outside of the country. This is not new, of course — the U.S. has long benefitted from low-cost Central and Latin American immigrant labor to boost its industrial and agricultural productivity and business profitability while Central and Latin American countries soak up the flow of money transferred back home from their migrant workers. But in El Salvador, that reliance is ingrained, and the remittances are more than a cushion for Salvadorans. They have become replacement earnings for locals that dampen any incentive to work. The total reached almost $4 billion last year, 16% of the nation’s GDP. Economists expect a drop-off, pointing to huge Salvadoran migration waves that have already hit U.S. shores, and a tapering of remittances from established Salvadoran emigrants.

The Inter-American Development Bank cautions the Salvadoran government to be more prudent and less political in its spending. Subsidies for cooking fuel, electricity, transportation, school lunches, and school uniforms, for example, win voters’ hearts but do little for the economy. The IADB warns that spending is too high and unsustainable.

Government payment delays squeeze — and sometimes bankrupt — the tailors, cobblers, and other small tradesman who offer these products and services.

Canas says the biggest drag on entrepreneurialism is the mentality among people his age, who are either disengaged or idle, vulnerable to the gangs’ calling. They are the so-called nini’s — a term for 15 to 25-year olds who “neither study, nor work.”

“They don’t care anything about the economy. They don’t care about the country,” says Cana.

“Most Salvadorans search for an opportunity, they never think to create opportunities,” says Canas. “People always ask me, ‘why are you trying to start this [new business]? That will only give you more preoccupation with trouble, and you will live in danger of the gangs.’ We need people to stop living in fear, to stop being submissive. We need to do positive things. And to believe in ourselves.”