NS4540 Winter Term 2019 Costa Rican Economic Model Federal Reserve Bank of Chicago, Strong Dollar Weak Dollar

Overview Robert Looney, Costa Rica’s Economic Model, World Politics Review, December 7, 2016 For years Costa Rica has been a Latin American Success story. Economy has thrived despite limited resources due to Democratic institutions Good Governance Country overachieves on various measures of prosperity considerably above the norm for countries at a similar level of development

Macroeconomic Trends

Costa Rica Strengths/Weaknesses

Costa Rica: GDP

Costa Rica: Per Capita Growth

Costa Rica: Recent Growth

Costa Rica: Population

Costa Rica: Demographic Profile

Costa Rica: Poverty

Costa Rica: Unemployment

Costa Rica: Income Distribution

Costa Rica: HDI

Costa Rica: Sector Growth

Costa Rica: Trade

Costa Rica: Governance Patterns

Costa Rica: Economic Freedom

Costa Rica: Competitiveness

Costa Rica: Minimum Wage

Costa Rica: Labor Productivity

Costa Rica: Doing Business

Costa Rica: FDI

Costa Rican Model I Much of the country’s success over the past several decades can be attributed to a development model focused on FDI and high tech exports Starting point was the mid 1990s when Indel made a $300 million investment in a chip-testing plant in San Jose. With this strategy, Costa Rica attempted to transition to a postindustrial economy focused on services but without developing a strong traditional manufacturing sector With Intel as centerpiece, strategy based on Michael Porter’s theory of clusters Called for the creation of a “Silicon Valley” to attract other waves of foreign high-tech export oriented firms Theory correct Soon high tech component accounted for 40% of total manufacturing exports

Costa Rican Model II Rude awakening in 2014 when Intel moved its operation to Asia Raised doubts about the future of the Costa Rican model Even before Intel’s departure concerns developing Inequality was increasing during past decade stemming from Higher wages associated with skilled labor in high-tech export sector and Absence of related industries that are lower in the value-added chain These factors helped widen the gap between highly profitable export sectors such as high-tech industries and lower-skilled sectors such as agriculture and tourism

Costa Rican Model III In effect strategy created a two-track economic structure with widening economic disparities Costa Rica has the fifth largest number of free trade zones in Latin America after: Colombia, Dominican Republic, Nicaragua and Honduras Workers employed in the zones earn on average 1.8 times more than average for private sector workers Few linkages with the rest of economy to pull up wages outside the zones Still Costa Rica around 20% more expensive than other Central American Countries Hurts the country’s competitiveness as an outsourcing destination

Costa Rican Model IV Other troubling trends pointing to economic model’s diminishing effectiveness While wages rose, unemployment rate increased from average of 6.1% in the 2000s to 8.1% from 2000 to the present Investment rate fell from 17.6% of GDP in earlier period to 15.5 in the latter period Government appears to have been unprepared for the way the economic model has played out. Budget deficit increased from average of 2.6% of GDP in 2000s to 5.2% from 2010 to present Government debt increased from 28.4% of GDP to 44.5% in 2016

Costa Rican Model V The government’s ability to finance deficits through debt may be constrained moving forward Costa Rica borrowed $4 billion from 2012-2015 in the Eurobond markets Failing to enact fiscal reforms has significantly reduced the market’s appetite for further issuance Costa Rica’s bonds are now in junk status Significantly increases the cost of borrowing

Assessment I Costa Rica’s current plight provides another reminder of the difficulties small countries face in today’s rapidly changing global environment Gone are days when small open countries like Singapore, Hong Kong and Mauritius could count on buoyant international trade and revenues to sustain growth of 7-8% annually While in the past, Costa Rica’s macroeconomic stability and its opening to international markets and FDI was necessary to bring prosperity It is no longer sufficient

Assessment II The dual economic structure created by Costa Rica’s economic model is still dominated by small, low productive firms in sectors outside of high-tech Economy linked to slower – growing U.S. economy These factors have not gone unnoticed The government and China have recently agreed to expand trade and investment Increased urgency to break the political gridlock to resolve the country’s fiscal crisis Government with World Bank assistance is attempting to addresse problems of small firms outside high-tech sector

Assessment III However for now country will face continued strains stemming from Slower world trade Reduced flows of FDI and An increasingly inward-focused U.S its largest trade partner.

EIU Forecast

EIU Risks