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COSTA RICA
A brief study on public FDI facilitation by means of trade agreements and trade liberalization

Nguyen Phuong Khanh Tung

Student ID: 0951040062

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Costa Rica: A brief study on public FDI facilitation by means of trade agreements and future political adjustments.

Abstract
Being probably the most economically-advanced countries within the region of Central America, Costa Rica is a very interesting example of a how a developing country would manage and regulate its economic growth and stability, much thanks to its unique regime to attract and allocate FDI efficiently. Despite having little natural endowments and regional advantages, Costa Rica has ever since been the economic vanguard among the Latin America community for the last past half decade, with remarkable level of development within knowledge-intensive industries. Furthermore, the country’s early acceptance and adoption of various trade liberalization schemes have created a destination that a number of economists have been referring as ‘investment haven’ for exported products and services. The case of Costa Rica, henceforth, is exemplary for developing countries, not only in regard to attracting pure FDI, but also supervising its spillover effects as a means to stimulate the economy. This paper does not quantify in detail the effects, but rather focuses on a sweeping analysis on Costa Rica’s political historical and possible future approaches in FDI facilitation and administration.

I. Introduction
In term of historical economic development, Costa Rica started off as any third-world countries, being a major exporter of agriculture products, namely bananas, coffee and sugar. Following a period of internal turbulences and civil wars up until the end of 1940’s, Costa Rica exerted its effort on creating a sovereign and stable political condition, with the most notable feature being the total relinquishment of the standing military force along with strong emphasis on the development of education and welfare system.
The process of trade liberalization in Costa Rica started in the mid 1980’s and ever since has delivered positive results in terms of economic growth and a more robust and diversified production structure, particularly after the negotiation of several Preferential Trade Agreements (PTAs). This process has been complemented with a strategy to boost the attraction of FDI, thus allowing for further diversification of Costa Rica’s export portfolio, particularly of high-tech manufactured goods. In the last three decades, FDI has led to increased exports in knowledge-intensive sectors. The number of jobs created by FDI rose from 7 758 in 2003-05 to 34 385 in 2009-11. Costa Rica has also achieved exports’ sophistication, ranking today close to Croatia and Norway, but still below Malaysia.
FDI has also acted as a demand-push for improving education and training and has fostered knowledge adoption (at the level of workers, management and production), thus improving the business environment in the country. While the United States remains the most relevant investor for Costa Rica, the number of source markets for FDI rose from 8 in 2005 to 18 in 2009, including emerging markets such as China. Foreign companies in Costa Rica have recently been upgrading their business towards more knowledge-intensive activities, including software design and R&D. In order to accommodate this movement, the government is adopting a more selective approach to FDI attraction, with stronger focus on enterprise in the high-tech, high-grossing sectors. These two trends have contributed to creating incipient industrial clusters in business services, medical devices and advanced manufacturing.

II. Trade liberalization regime and trade agreements of Costa Rica and effects on the influx of FDI Thanks to a strong course of political leadership since the early 1950’s, Costa Rica has been trailing the right path towards creating a diverse and dynamic economy; with one of the first step being gradual phases of trade liberalization. Even before the WTO was established, Costa Rica has actively participated in both multilateral and bilateral negotiations, and actually one of the countries that sparked the idea on the important implications of these political mutual commitments. This proves that the Costa Rican government had an early intention of constructing a sustainable and ever-growing economy, as PTAs allow for a deeper and faster liberalization of trade with certain strategic partners, it is worth having and strengthening multilateral rules that provide for security and predictability to trade, an efficient and reliable dispute settlement mechanism to enforce such rules, as well as a forum for multilateral negotiations towards further trade liberalization. Starting from the mid 1980’s, the course of action for trade liberalization by Costa Rica was largely welcomed by a number of high-profile partnering countries, most notably the United States, Canada, Spain and most lately China and Singapore. The practice was seemingly immediately rewarded as Costa Rica witness a soaring six-fold increment in the volume of inward FDI following the next decade. Source: UNTAD Databank, compiled by Knoema.com One of the most outstanding milestone for Costa Rican history on foreign investment also took place during this course: the decision by Intel to conduct a major FDI package on manufacturing and R&D facilities in Costa Rica, an event regarded by a number of economists as the compass that helped propel the local investment climate away from the being a conventional FDI recipient towards a host of foreign investment on high-tech industries. Aside from being active and efficient in its effort to initiate economic liberalization, Costa Rica has also been renowned for being a diligent participant in bilateral and multilateral trade agreements and bilateral investment treaties, which passively enhanced the country’s competence to absorb FDI inflows. A detailed list of these agreements and treaties that are currently in force are populated in the Annex. Over the course of this paper, we do not directly quantify and scrutinize the effect of each agreement or treaty specified; however, the overall impacts of these events are comprehensible. The most outstanding aspects are interpreted into the aspect of economic determinants of FDI as below: * Over the years, these various agreements helped create a comparative advantage via the factor of regional & global access for Costa Rican investment environment, most noticeably among Latin American countries as Costa Rica is one of the first and the most active negotiators and initiators. This has resulted in a large volume of FDI inflow from strategic regional partners: the United States and later Canada, who would find exporting from Costa Rica manufacturing sites extremely easy to carry out. * With early and steadily progressive course of trade liberalization, the domestic market of Costa Rica, despite not being particularly inherently strong, managed to diversify its consumers’ taste as well as attain a stable rate of economic growth. This factor, coupled with the reduction of tariffs and other trade barriers, turns Costa Rica into an ideal haven for investors. * With early tendency towards an open market, Costa Rica took full advantage of its externalities: a well-structured and competitive local market, an advanced education system, capable basic infrastructure and a qualified workforce. It took Intel only approximately a year to complete their investment screening on Costa Rica and both their requirements and proposals met with instant approval and assurance from the local authorities. And Intel were able to keep their risk diversification regime in control while appropriately fulfilled their efficiency seeking rationale. III. Costa Rica’s approach in FDI administration and allocation ‘No society can surely be flourishing and happy, of which the far greater part of the members are poor and miserable’ – Adam Smith Adam Smith’s contemporary concern regarding a flourishing economy was limited to the scenario of social stability and class equality that are prone to side damages caused by an open, competitive market in the 18th century. Modern economists, however, are obsessed with a broader eco-sociological term: sustainable growth. Among the challenges that FDI presents, sustainable growth for host countries are unquestionably one of the most critical ones. Despite foreign investment being a powerful tool for developing economies to attain jumpstarts for their development, the spillover effects are a two-sided blade since it is sometimes problematic to convert FDI inflows into fuel for sustainable long-term growth. The consequences are already seen in several countries which are trapped within the medium income trap and struggling to emerge from the quicksand of being profit-reaping grounds for developed countries. This challenge has been undertaken by Costa Rican government through a ‘tri-component’ scheme that makes it very easy for foreign enterprises to conduct investments in the country and at the same time regulates the flow of FDI to ensure its positive influence on the economy in the long term. This system consists of 3 Investment Promotion Agencies (TPAs): Costa Rica Ministry of Foreign Trade (Ministerio de Comercio Exterior - COMEX), Costa Rica’s Trade Promotion agency (PROCOMER) and Costa Rican Investment Promotion Agency (CINDE). * First on the list, COMEX, technically still a governmental department, however, without the obligation to directly report to any Economy of Public Relations Ministry, is small but agile and historically has not been subjected by law to all the civil-service restrictions that afflict the rest of the state (for instance, it attracts better professionals, pays more, and can hire and fire at will). Despite its size and limited mandate, it is a politically influential institution, especially due to the public attention to the negotiations of international trade agreements. In addition to the negotiation, implementation and oversight of those instruments and of trade policy in general, COMEX is charged with promoting a competitive business climate for export promotion. * Second, and organizationally linked to COMEX, PROCOMER is funded by fees from administering the export-import process and the canon paid by Free Trade Zones (FTZs) companies, is in charge of fostering the quantitative and qualitative growth of exports through very varied activities. PROCOMER is exceptionally flexible within the usually rigid rules for the Costa Rican state (the law describes it as an institution of “maximum deconcentration”). Among its programs are training initiatives like the Creando Exportadores program, which teaches international marketing and logistics to the management of established domestic firms; market intelligence about specific products and places; advisory services for small exporting companies; events for potential buyers to see samples of Costa Rican products and even promotion of the “image” of Costa Rican output. It also runs a program (Costa Rica Provee) to promote linkages between large multinationals operating in the country and local small and medium enterprises that could be their providers. It has small offices in a few key capitals. * Third, CINDE is an NGO founded with formal support from United States Agency for International Development (USAID) in the 1980’s to help train and encourage small agricultural exporters of new products. As the years passed—and especially as Costa Rica ceased to be a natural target for foreign aid—the institution evolved into a small, local private organization funded through an endowment and the sale of services, whose main purpose is to promote high-tech greenfield FDI. It does this by acting as an informational bridge and informal competitiveness expert to potential investors by channeling their concerns and problems after establishment and advising or lobbying the government and congress on problems that the country encounters in the competition for FDI. Much smaller than other institutions of its kind, CINDE is almost always cited among the best promotion agencies in the world and is quite distinct from the others as it is not a part of government or funded by the Treasury. This institutional arrangement also has the benefit of avoiding certain conflicts of interest regarding FDI and the FTZ regime, since PROCOMER, the organization in charge of overseeing and collecting fees and canons from the companies, is separate from both the institution promoting their entry (CINDE) and the institution authorizing their participation in the FTZ regime (COMEX). The arrangement has also created an environment that is very welcoming to the potential FDI, by providing a predictable set of rules, plenty of information that facilitates decisions and reduces risks, a mediator than can help investor and regulator understand each other and, in general, a “voice on its side” that speaks its language and sees its points. Much to the fancy idea of pure theorists that entrepreneurs would instinctively seek for investing opportunities wherever they exist, even across the national borders and that government should limit their actions to general facilitation and administration; the reality seems to disagree, and the Costa Rica government certainly saw the necessity for such a small country to inject certain distortions in their national management of FDI in the form of an allocation mechanism. Traditionally, in Latin America (and even in other small developing economies across the world), policymakers tend to resolutely, yet disruptively, ‘pick the winners’, that is, to make extreme interventions by ‘select’ which industries to promote the entry of the private sector through privileges of taxation, subsidies and other ‘blunt’ policy mechanism. This type of industrial policy seemed to be based on a view that certain sectors and activities were desirable and part of a development process, even if their growth did not come from becoming better at producing in those sectors. It was also based on the notion that government has enough information and probity to make these policy decisions based on sufficient and efficient sources of information and transparency; factors that are incredibly hard to come by among these countries. Therefore, towards the end of the 1980’s , along with their new scheme of promoting trade liberalization, Costa Rican policymakers started to welcome neutrality across industries as the new concept in their institutional framework for FDI. How did Costa Rican export promotion and FDI attraction policies manage to drift away from fostering “picking winners” in specific industries? Perhaps the best way of describing the existing policy is that government does not ‘pick’ winners, but rather ‘follows’ them. That is, the Costa Rican state does not apply any blunt policy instruments (like credit restrictions differentiated taxes subsidies etc.) that are enforced selectively, discriminatingly or exclusively across sectors. However, the fostering institutions have plenty of ‘soft’ secondary instruments (like selecting in which activities to train labor, or to conduct research, or contact companies etc.) which strongly target specific industries, based on a the market evidence of existing entrants in those industries or in “similar” activities. It is unreasonable to assume that policies that caters to the growth of an emerging sector, take medical devices manufacturing for instance, would be equivalent to others—say, sewing cotton garments. Medical devices manufacturing is definitely an industry that the economy would benefit sizably from, as it requires higher technology, employs well qualified workers, and, most importantly, contributes to the diversification of national export portfolio. To the most down-to-earth policymakers, those factors are important because they are among ones of a developed economy. Source: WTO As observable from the diagram above, the allocation mechanism adopted by Costa Rica has proportionated the FDI inflow towards a more balanced, sustainable disposition for the local economy. For a small country like Costa Rica, the increase of foreign funds onto Agriculture is of dire importance since the sector provides enormous amount of necessities and primary commodities as well as serves as direct or secondary inputs for other sectors. To some people, it may sound strange to find out that financial and real estate are among the top departments on Costa Rican government’s ‘follow’ list; however, according to many analysts, those two are likely to be the propelling thrust that drives a tourism-friendly economy ahead in the future. IV. Conclusion: The applicability of this strategy to Vietnam The remaining question is the applicability of the Costa Rican story to the Vietnamese reality. Despite the fact that there were certain historical differences on how each country has been treating the concept of FDI, the goals are identical: taking advantages of FDI as a driving force for greater economic growth. Thus, Vietnamese policymakers and analysts are likely to find some points discussed above of great interest to them; and as a matter of fact, some of the steps have already been taken by the local government, especially in the aspect of strategic trade agreements and trade liberalization. However, other similarities and opportunities need to be further assessed, including a more detailed, quantitative comparison between the human capital endowment of the two countries, in order to evaluate the extent of application and to guess where the low-hanging fruits could be. The course, however, is not without any challenge. As Vietnam is amidst a ‘game-changing’ economy re-structure gearing towards the private sector, one can easily imagine that Vietnam could aim to attract similarly impressive multinational corporations as Costa Rica did. However, reality has proved that even though the country has welcome a number of TNCs over the last two decades, lack of foreign investment administration regime has induced remarkable pressure on the internal growth of the domestic economy, as local SMEs struggle to stand up against sizable ‘invaders’ that they were not ready for. Additionally, while the industrial and service sectors are enjoying increasing stream of foreign financing, Vietnamese farmers are yielding for significant technological development and financial prowess within the agriculture sector as they are struggling against the mounting figure of inflation – a ‘positive’ side effect of a booming economy. Breaking this vicious circle of sectoral complications might not only take extreme planning, but also active literature review of other countries’ cases and experience. Regardless, It is not within our objective or intention to recommend an appropriate economic design for Vietnam. The global economy is very different now from what it was in the early 1980’s and that Vietnam and Costa Rica does not necessarily have the same starting point on FDI. However, the similarities are, despite not being thoroughly disclosed over the course of this paper, present and comprehensible, most noticeably, but not limited to, the fact that both countries have certain strategic comparative advantages and are currently being regarded as ‘safe haven’ for investors as global economy are still shaking off the aftershocks of the 2008 financial crisis. Upon the conclusion of this paper, we are content that this analysis would, at least, serve as a purpose towards broader projects to which these pages belong.

Bibliography

Abrego, L. (1999). Trade Liberalization and Foreign Direct Investment: An Applied General Equilibrium Model for Costa Rica. Univesity of Warwick.
Bureau of Economic, Energy and Business Affairs - U.S DEPARTMENT OF STATE. (2014). 2014 Investment Climate Statement - Costa Rica.
Monge-Ariño, F. (2011). Costa Rica: Trade Opening, FDI Attraction and Global Production Sharing. Leibniz Information Centre for Economics.
Multilateral Investment Guarantee Agency. (2006). The Impact of Intel in Costa Rica: Nine Years After the Decision to Invest.
OECD Development Centre. (2012). Attracting Knowledge-Intensive FDI to Costa Rica: Challenges and Policy Options.
Trejos, A. ( 2013). Economic Growth and Restructuring through Trade and FDI: Costa Rican experiences of interest to Cuba.

ANNEX Trade Agreements in force | Multilateral Agreements | | Agreement/Partner(s) | Date of Signature | | WTO Members | 07 May 1995 (Contracting Party to GATT 1947 as of 22 May 1991) | | Customs Unions | | Agreement/Partner(s) | Date of Signature | | CACM Members | 13 December 1960 | | Free Trade Agreements | | Agreement/Partner(s) | Date of Signature | | European Free Trade Association (EFTA) – Central America | 24 June 2013 | | Central America – European Union (Costa Rica, El Salvador, Guatemala, Honduras, Nicaragua and Panama) | 29 June 2012 | | Central America – Mexico (Costa Rica, El Salvador, Guatemala, Honduras and Nicaragua) | 22 November 2011 | | Peru | 26 May 2011 | | China | 08 April 2010 | | Singapore | 06 April 2010 | | DR – CAFTA (Central America – Dominican Republic – United States) | 05 August 2004 | | CARICOM | 09 March 2004 | | Central America – Panama (Costa Rica, Guatemala, El Salvador, Honduras and Nicaragua) | 06 March 2002 | | Canada | 24 April 2001 | | Central America – Chile (Costa Rica, El Salvador, Guatemala, Honduras and Nicaragua) | 16 April 1999 | | Central America – Dominican Republic (Costa Rica, El Salvador, Guatemala, Honduras and Nicaragua) | 16 April 1998 | | Preferential Trade Agreements | | Agreement/Partner(s) | Date of Signature | | Venezuela (AAP.A25TM No 26) | 21 March 1986 | | Colombia (AAP.A25TM No 7) | 02 March 1984 | | Bilateral Investment Treaties | Agreement/Partner(s) | Date of Signature | Entry into Force | | Argentina | 21 May 1997 | 07 March 2001 | | Belgium/Luxemburg | 26 April 2002 | N/A | | Canada | 18 March 1998 | 25 May 1999 | | China | 25 March 1999 | | | Chile | 11 July 1996 | 23 March 1998 | | Czech Republic | 28 October 1998 | | | Ecuador | 06 December 2001 | 29 August 2002 | | Finland | 28 November 2001 | | | France | 08 March 1984 | 04 November 1997 | | Germany | 13 September 1994 | 05 November 1997 | | Korea | 11 August 2000 | 07 May 2002 | | Netherlands | 21 May 1999 | | | Paraguay | 29 January 1998 | 25 May 2001 | | Spain | 08 July 1997 | 09 June 1999 | | Switzerland | 01 August 2000 | 07 May 2002 | | United Kingdom | 07 September 1982 | 26 November 1997 | | Venezuela | 17 March 1997 | 02 May 2001 |