How global changes are putting Costa Rica’s economic model under strain

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For years, Costa Rica has been a Latin American success story. The country’s democratic institutions and attention to good governance have allowed its resource-poor economy to thrive in a dangerous part of the world. The country outperforms various measures of prosperity, with its ranking on indices such as economic quality, business environment, governance, education, health, personal freedom, social capital and natural environment above. above the norm for countries at a similar level of development and wealth — and often considerably.

In terms of overall economic growth, data from the International Monetary Fund shows that the economy grew at a constant rate of 4.7% in the 2000s and 4.3% between 2010 and 2015. Inflation, which had increased at an annual rate of 10.6% in 2000, fell to 3.9% between 2010 and 2015. Reflecting current drug-related problems in Central America, the only area of ​​quality of life in which the country is below is safety and security.

Much of the country’s success in recent decades can be attributed to a development model focused on foreign direct investment and high-tech exports. The starting point was the mid-1990s, when Intel invested $300 million in a chip testing facility in the nation’s capital. With this strategy, Costa Rica is attempting to transition to a post-industrial service-oriented economy, but without first developing a strong traditional manufacturing sector. With Intel as its centerpiece, the strategy, based on the cluster theory of Harvard’s Michael Porter, called for the creation of a “Silicon Valley”-type technology hub to attract new waves of foreign high-tech companies geared towards export. Porter’s theory proved correct, and the high-tech component of the export sector took off, with such exports soon averaging more than 40% of total manufactured exports.

However, a rude awakening came in 2014, when Intel decided to move most of its operations to Asia, although it retained some of its engineering and global services operations in Costa Rica. The decision was entirely out of Costa Rica’s hands, but not necessarily a reflection of a shortcoming on the part of the country. Intel’s adaptation to a rapidly changing global environment simply required cost reductions in multiple regions and countries. Yet Intel’s decision raises serious doubts about the future of Costa Rica’s business model.

Even before Intel’s departure, there were concerns about several trends in the economy. Costa Rica is one of the few countries in Latin America where inequality, measured by the Gini coefficient, has increased over the past decade. The factors behind the rise in inequality stem largely from the higher wages associated with skilled labor in high-tech export sectors and the absence of related industries that are more low in the value chain. This has widened the gap between highly profitable export sectors, such as high-tech industries, and less skilled sectors, such as agriculture and tourism.

The current plight of Costa Rica reminds us once again of the difficulties that small economies face in today’s rapidly changing global environment.

In short, the strategy has created a two-pronged economic structure with growing economic disparities. Costa Rica has the fifth highest number of companies based in free trade zones in Latin America, after Colombia, the Dominican Republic, Nicaragua and Honduras. Workers employed in the country’s free zones earn on average 1.8 times more than the average worker in the private sector, and there are few links with the rest of the economy to raise wages outside the free zones. Yet Costa Rica is about 20% more expensive than other Central American countries, a factor that hurts the country’s competitiveness as an outsourcing destination.

Other worrying trends point to the diminishing efficiency of the economic model. IMF data shows that the overall unemployment rate rose from an average of 6.1% in the 2000s to 8.1% between 2010 and 2015, even as wages rose. To date, the government has not proposed any major policies aimed specifically at targeting job creation or improving the quality of jobs. Similarly, there has not been the hoped-for generalized increase in aggregate investment, with the investment rate falling from 17.6% of GDP in the previous period to 15.5% in the period more recent.

The government appears to have been unprepared for how its economic model has unfolded. The budget deficit fell from an average of 2.6% of gross domestic product in the 2000s to 5.2% from 2010 to 2015. Rising deficits led to a significant expansion of public debt, with levels from 28.4% of GDP in 2010 to 44.5% in 2016.

But the government’s ability to finance deficits with debt could be limited in the future. Costa Rica borrowed $4 billion between 2012 and 2015 in the Eurobond markets, but failing to enact tax reforms will drastically reduce the market’s appetite for new issues. Currently, Costa Rican bonds are rated at junk status, which significantly increases the cost of future borrowing. Perhaps in a sign of desperation, the country approached China for the sale of a billion dollar bond, but was ultimately turned down. With domestic turmoil growing and the government crippled unable to resolve its budget issues, it’s no wonder that in early 2016 polls showed President Luis Solis to be Central America’s most unpopular leader. .

The current plight of Costa Rica reminds us once again of the difficulties that small economies face in today’s rapidly changing global environment. Gone are the days when small open countries and territories like Singapore and Hong Kong, or even Mauritius, could count on vibrant international trade and sufficient income to sustain annual domestic growth rates of 7-8%. While Costa Rica’s macroeconomic stability and openness to international markets and foreign direct investment were necessary in the past to bring prosperity, they are no longer enough.

The dual economic structure created by Costa Rica’s economic model is still dominated by small, unproductive businesses in sectors other than high technology. Against this backdrop, economic growth rates will not be as impressive as those seen in the more inclusive models developed by emerging East Asian economies at similar stages of development. In addition, Costa Rica’s close ties to a slower growing U.S. economy will weigh on growth relative to other Latin American economies that have stronger ties to Asia, particularly China, and other economies. more diverse.

These realities have not gone unnoticed in San José, as Costa Rica’s economic model is changing. The government and China recently agreed to expand trade and investment. Breaking the political deadlock is increasingly urgent to resolve the country’s fiscal crisis. And despite the shortfall, the government, with the help of the World Bank, is trying to solve many of the problems faced by small businesses outside the high-tech sector. Over time, these and similar initiatives will hopefully put the country on a path to more sustainable and inclusive growth. For now, however, Costa Rica, as a small, open economy, will face continued strains from stagnating global trade, reduced foreign direct investment flows, and growing state concentration. United States, its main trading partner.

Robert Looney is a distinguished professor at the Naval Postgraduate School in Monterey, California. He specializes in energy security and economic development issues in the Middle East, Africa, South Asia and Latin America.

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