LAND OF PLENTY

Costa Rica 2017 | ECONOMY | REVIEW

Costa Rica's political stability and regional integration have led to a rise in FDI and tourism, but continued work is needed to ensure the gains from trade reach all sectors of the population.

The Costa Rican economy has been built upon a foundation of political stability, strong human development, and high levels of foreign investment and trade liberalization. An uninterrupted democracy since 1953, it is the oldest working democracy in Latin America. It is well ahead of the rest of Central America when it comes to health benchmarks like access to clean water, infant mortality, and life expectancy. Further contributing to human development, most Costa Ricans are covered under the state's social security programs. The result has been the development of a population that has been able to shift and meet the growing demands placed upon workers in a global marketplace.

Costa Rica has taken advantage of its stable political situation and well-educated population to become one of Central America's most well-developed economies. After five years of average 6.65% GDP growth in the mid-2000s, the economy took a hit in the global financial crisis, contracting by 1.02% in 2009. It rebounded well in 2010 to post growth of 4.95% and has remained positive ever since, posting rates of 3.5% and 2.58% in 2014 and 2015, respectively. Costa Rica's GDP of USD51.107 billion equaled a per-capita GDP of USD10,629.8, above the Latin American average of USD 8,370.7 and well above every Central American country save Panama.
This GDP growth has been sparked by trade policies that have taken care to expand opportunities for domestic producers while sharing the gains among all Costa Ricans. It has long been a member of the Central American Integration System (SICA), an economic and political organization that aims to increase political cooperation and economic exchange between Belize, Costa Rica, El Salvador, Guatemala, Honduras, Nicaragua, Panama, and the Dominican Republic. Though at times a source of political conflict (Costa Rica briefly withdrew from the organization in early 2016 over a dispute about Cuban migrants), the organization has led to new levels of regional cooperation and stability. Perhaps Costa Rica's most important economic partnership is its membership in the Central America Free Trade Agreement (CAFTA-DR), which established new trade regulations between Central American and the US. Though controversial upon announcement in 2007 for ending government monopolies in the insurance and telecoms industries, it has spurred foreign investment and solidified the openness of Costa Rica's economy. Agricultural products remain key to Costa Rica's economy, but the growth of high-tech and high-skilled industries since in the mid-1990s has given the country new avenues for development.

Costa Rica's free trade zone laws were created in 1981, establishing a new model for manufacturing and laying the groundwork for increased FDI. The law targets export services, scientific research firms, strategic sectors, and significant suppliers by offering a 100% income tax exemption for the first eight years of the agreement, with the potential for additional eight-year renewals if significant reinvestment is made. In return, firms agree to invest at least USD10 million and locate at least 100 employees in the region, offering a new group of high-tech manufacturing jobs. The free trade zones grew steadily throughout the 1980s and early 1990s, but Intel's construction of a USD300-million assembly plant in 1996 was a key moment for the sector, signaling the region's ascension in the eyes of global multinationals. At one point, the plant had over 2,000 employees and was responsible for 20% of total exports and 4.9% of Costa Rica's GDP. In 2014, the company opened an R&D center that employed Costa Rican engineers to work on microprocessors for computers, smartphones, and tablets. After Intel's arrival, other electronics manufacturers arrived on the market as well. Hewlett Packard (HP), the world's second-largest provider of PCs worldwide, brought ITO operations to Costa Rica in 2003, growing from 123 employees to become the second-largest private employer in the country. HP's investment in the country includes both support services, R&D, and a supply chain laboratory in charge of developing manufacturing diagnostic tools for other HP factories. Other key companies active in Costa Rica include Zollner Elektronik AG, which has a manufacturing and engineering services faculty in Cartago, and medical supply company Boston Scientific, which opened manufacturing plants in 2003 and 2006 and employs over 2,200 Costa Ricans.

The impact on the Costa Rican economy has been tremendous, but there are troublesome signs for the long-term health of the economy. Exports grew by 2% in the first eight months of 2016, but free trade exports grew by 13%, leading some analysts to worry that the divide between free-trade and non-free-trade industries was widening to an unhealthy degree. While the foreign trade promotion agencies PROCOMER, COMEX, and CINDE report that each dollar of incentives granted to companies generates USD6.2 for the country, there are several indicators pointing to widening inequality. Average wages in FTZ firms grew at rates of 7% in the past year, a figure 1.8 times larger than the average for the rest of the country. These FTZs have created more than 82,000 direct jobs and 43,000 indirect jobs, but total poverty has been increasing slightly in recent years. More concerning in the long run, competition for global firms remains fierce, and Costa Rica's appreciating real exchange rate and rising labor costs mean that some companies are looking elsewhere. Intel's landmark assembly center, once the jewel of the FTZ, closed in 2014 as the company moved its operations to China, Malaysia, and Vietnam. Exports of electronic components dropped 16.7% in the first nine months of 2015, demonstrating the danger of overreliance on a single firm.

These same concerns about overreliance are present when it comes to Costa Rica's relationship with the US. CAFTA has strengthened the trade links between the two countries; exports to the US jumped from USD5.611 billion in 2009 to USD8.697 billion in 2010 and a high of USD12.046 billion in 2012. However, trade between the two countries has fallen for three consecutive years, culminating in Costa Rica exporting just USD4.488 billion to the US in 2015 and below that pace through the first eight months of 2016. While still up 13.5% from the pre-FTA era, this represented a 53% decrease from 2014. Optical and medical instruments (USD1.5 billion in 2015), fruit and nuts (USD892 million), and electrical machinery (USD667 million) represented the top Costa Rican import sectors. At its peak in 2013, US exports represented almost 20% of Costa Rica's GDP, making the nation vulnerable to shifts in US trade policy or economic standing.

The outlook is more positive in the services industry, where a well-established tourism sector has made positive contributions to the economy. Costa Rica saw a record 2.66 million tourists visit in 2015, generating more than USD2.8 billion in revenue—an increase of 9% over 2014. The tourism industry employs roughly 600,000 people through direct and indirect employment, making it the single-largest industry in the country. Unsurprisingly, the US is by far the single largest source of tourists, accounting for about 40% of all visitors with just over 1 million in 2015. ICT, Costa Rica's tourism board, reports that the average US visitor to Costa Rica stays for 11 days and spends an average of USD1,340. The country also saw increases of more than 20% in tourists from the UK and China, the result of new routes from British Airways and an emphasis on targeting the Chinese market.

Tourism will remain a key industry for Costa Rica because it takes advantage of its abundant and well-maintained natural resources, one of the nation's biggest comparative advantages. A recent World Bank report called Costa Rica “the only tropical country in the world that has reversed deforestation," noting that the area covered by forests has increased from 26% in 1983 to 52% today. Costa Rica's environmental successes have come about due to its Payments for Environmental Services (PES) program, which has contributed to the conservation and rehabilitation of an average of 310,000ha per year through incentives. A further 26% of land area in the country is made up of national parks and protected areas. In the medium term, Costa Rica looks primed to take advantage of the rise in eco-tourism and the growing number of tourists looking for unique environmental experiences. The World Travel & Tourism Council (WTTC) expects that tourism's role in the wider economy will only continue to increase, with a recent report projecting growth of 4.7% over the next decade. This would make tourism 13.2% of total GDP, up from 12.5% in 2015.

Moving forward, the Costa Rican government's role will be to navigate the shifting FTZ environment while continuing the strong growth in service sectors. Political gridlock and cumbersome regulation is a common complaint for foreign firms operating in Costa Rica, and streamlining these regulatory barriers should lead to increased investment in infrastructure and improved relationships with international investors. The continued development of the country depends on the successful utilization of Costa Rica's regional links and natural resources. With all the elements for success in place, there is plenty of reason for optimism.