A FORMAL AFFAIR

Costa Rica 2018 | INDUSTRY | FOCUS: SME INTEGRATION

Costa Rica has been plagued by high levels of informality that have contributed to rising inequality, but a number of recent government initiatives are working to reverse this trend.

Costa Rica has made a number of impressive economic and social gains over the past few decades, with quality of health, economic output, and quality of life metrics all rising to become among the best in Central and Latin America. In recent years, however, the government's focus has shifted to building an economy suited to long-term growth and innovation. The global financial crisis of 2008 served as a wakeup call, exposing the need for structural reform to increase competition, boost productivity, and decrease inequality. The formalization of Costa Rica's SME sector is one of the most important steps toward all of these goals, and as such has become one of the government's primary goals in recent years.

Costa Rica's informal SME sector is smaller than several other comparable Latin American countries but considerably larger than the norm in developed counties. Troublingly, however, it is actually trending upwards, in sharp contrast to global and regional trends. Informality as a whole has risen to 45% of the total workforce as of 2016, with the bulk of this concentrated in the agricultural, constriction, and domestic work services.
This has led to a bisected employment market that has become increasingly split between high-skilled formal jobs with international firms and low-skilled informal jobs with domestic SMEs. Further deepening the inequality is the fact that these informal SMEs contribute less in taxes and productivity growth, lessening the government's ability to fund public services that can raise innovation. A 2008 report of SMEs found that around 60% of the business in public registries were semi-formal and did not fully meet their tax obligations.
A number of efforts have been underway since the turn of the millennium to move SME industrial activity into the formal sector. In 2002, the Costa Rican government established the Program of Support for Small and Medium Enterprises (PROPYME), which awards grants to SMEs. PROPYME's focus has been innovation and skill development; the grants are designed for R&D spending and creating formal linkages with academic and corporate research sectors. The share of R&D coming from private firms is less than one-third in Costa Rica, compared to two-thirds in more developed countries, so part of PROPYME's mission was to transfer this innovation role from the government to the private sector. PROPYME's outcomes were mixed; the program saw fewer grant applications than expected in part because many SMEs were neither aware of the program nor able to navigate the application process.
In 2011, Costa Rica redesigned the program with the help of the World Bank to make it more accessible and add funding for human capital to give SMEs the base needed for innovation. This has increased the effectiveness of the program. Initiatives such as these and the Central Bank's Development Banking System have increased SME's access to funding, helping remove a major hurdle toward development and formalization. The Ministry of Economy, Industry, and Trade reported that SMEs accounted for 95% of all Costa Rican businesses in 2012, comprising 46% of total employment and 40% of GDP.
Industry leaders recognize, however, that there is still significant work to be done. The financial crisis and worsening fiscal situation that resulted has only shifted more of the poorest Costa Ricans into the informal sector in recent years; the poorest fifth of the population has around three-fourths of its workers in the informal sector. As this portion of the population further concentrates in the informal sector, the difficulty of integrating them into formal value chains, credit systems, and export markets only becomes harder. The government is hard at work though, and a recent set of policies have cut red tape, established tax exemptions for SMEs, and formed a National Network of Business Incubators and Accelerators to form new ties between groups in shared industries, striving for increasingly integrated innovation-based industry.