SAN MARCOS UNIVERSITY

MACROECONOMICS

BACHELOR'S DEGREE IN BUSINESS ADMINISTRATION

RESEARCH WORK

FOREIGN DIRECT INVESTMENT IN COSTA RICA

DURING THE PERIOD 2000 - 2019

STUDENT

ANGIE SOTO VEGA

TEACHER

MARCO ANTONIO ZUNIGA GOMEZ

SAN JOSÉ, COSTA RICA

DECEMBER, 2020
 TABLE OF CONTENTS

INTRODUCTION...............................................................................................................2
DEVELOPMENT................................................................................................................3
CONCLUSION..................................................................................................................11

INTRODUCTION

This paper studies the main determinants of foreign direct investment (FDI) in
Costa Rica and its effects on national development during the period 2000-2019.

To understand the subject, it is of utmost importance to recognize that FDI has

played a dual role of great importance in the country: on the one hand, it has been a
central element of the export promotion strategy and, on the other, it has compensated
to some extent the low rates of domestic investment, thus strengthening the weak gross
fixed capital formation and the generation of jobs.

It is interesting to analyze the background of the Costa Rican economy. Foreign

Direct Investment (FDI) in Costa Rica has been the subject of several analyses, both for
the impact it has had and may have on the economy, as well as for the application of
incentive schemes designed to attract foreign companies.

What is certain is that FDI has become an important generator of jobs and a
notable source of resources that complement domestic investment and at the same time
cushions our trade deficit. This paper compiles the main findings of studies on foreign
investment in Costa Rica and complements them with some recent data, in order to
show the main effects of FDI on some of our variables and indicators.

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 DEVELOPMENT

Costa Rica is one of the major competitors for the attraction of Foreign Direct
Investment (FDI) in Latin America, it is recognized for the excellence of its human
resources, for its image as a sustainable country, of peace, democracy and generation of
opportunities for the business sector. One of the administration's objectives was to
attract foreign investment flows in order to expand the possibilities for national
development, generate sources of employment and obtain additional resources for
investment projects, train the labor force and produce positive effects on other
companies that learn new technologies and ways of operating.

For many developing countries, foreign direct investment (FDI) has become the
largest source of external resources, far surpassing amounts provided for assistance
from multilateral agencies, remittances from nationals abroad and investment flows in
sovereign bonds. In 2016, more than 40% of the nearly US$1,750 billion of the global
FDI flow was received directly by developing countries, providing them with much of the
private capital their economies needed.

In Costa Rica, FDI inflows grew at annual rates above 5% in the last ten years
(data as of 2018), have financed almost the entire current account deficit and represent
about 6% of Gross Domestic Product (GDP).

However, what is more interesting to know is the multiplier impact of this capital
flow on exports (X) -see box on the other page- of goods and services, on domestic
product and, above all, on the creation of 13,754 formal jobs, at the close of 2017. To
this end, the first thing to understand is that not all investment of this type comes to
Costa Rica for the same reasons. The economic motivation of each foreign investment
project explains which factors of the host economies are more relevant in attracting this
sector.

There are in turn two general types of foreign direct investment, related to the
control exercised by the foreign company in the company of the country in which it is
located.

"Greenfield" or start-up, this type of investment occurs when the foreign company

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makes the investment to set up from a zero base and grows from there. The advantages
of this type of investment are that you have total control over all aspects of the business,
you can design better long-term strategies, and you have total control over your
personnel and brand in the destination country. Its negative aspect is that a higher
investment is required, as well as that it may take more years to generate returns, and
the investing company will have to deal with all the governmental regulations of the
country receiving the investment (Irwin 2013).

On the other hand, the investing company may choose to "Acquire" a foreign
company, in which case it buys an amount of shares equal to or less than 50% of the
company, which allows it partial control of the company, or it acquires more than 51% of
its shares, which would allow it majority control of the receiving company. The main
advantages of this model are that immediate access to the "local market" is obtained, a
series of links with customers and suppliers are already gained, new technology is
obtained, and less investment is required. The disadvantages are that there may be
"hidden surprises", with which the investing company would have to deal; in addition, it
does not have total control over its own brand, and it assumes the commitments that the
receiving company may previously have. (Irwin 2013).

Since the mid-1980s, Costa Rica has been making efforts to achieve greater
international insertion of its economy, mainly through export promotion and attracting
FDI. Actions in this regard have been many and varied: from structural adjustment
programs that have affected various areas of the real economy, to trade policies,
implemented through bilateral, multilateral and subregional negotiations, to improve
access to world markets and implement open regionalism in Central America.

Costa Rica, like the other Central American countries, created export promotion
regimes in parallel to the process of economic liberalization, with tax incentives such as
tax exemption on imports of machinery and equipment, raw materials and intermediate
inputs, and exemption from income tax linked to export performance: the tax credit
certificate (CAT).

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 Legislation was also enacted to create the free trade zone regime, a productive
development policy and their contributions to the national economy are significant (in
addition to being important generators of employment, in 2010 they accounted for 54%
of exports and were the fastest growing investments), their productive linkages are
scarce and show weak technology transfer effects. For this reason, the new Free Trade
Zone Law includes changes that seek to remedy these problems and, at the same time,
support relatively less developed zones, without renouncing the granting of tax
incentives.

With the reform of the Free Zones Law, the export requirement was eliminated in
order for the companies covered by this regime to obtain the tax incentives included in
the new regulations. In addition, restrictions were lifted on the sales that these
companies can make in the local market, which are now treated as any other import,
subject to the collection of tariffs on imported inputs contained in the products and other
payments, as well as normal import procedures.

Additionally, the Law restricts the type of companies that can benefit from the
regime, establishing strategic sectors (Illustration I) according to the following guidelines:

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 a. qualified projects with high contribution to social development and that
generate quality employment

b. projects that, through the incorporation of advanced technologies, effectively

contribute to the country's productive modernization.

c. projects that carry out research and development activities

d. projects that promote innovation and technology transfer, or the incorporation

of clean technologies, integrated waste management, energy saving and efficient water
management.

Illustration 1 Strategic sectors eligible to enjoy the benefits of the free trade zone regime

BOX 2

Strategic sectors entitled to enjoy the benefits of the free trade zone regime

a) Companies that each year, on average, advanced technologies, fuel cells, parts and • Research and development expenses:
employ at least two hundred workers duly components of wind and/or hydroelectric Include salaries and expenses for
reported on the payroll, as of the date of turbines). personnel and direct support services for
the beginning of their operations. the research itself, purchase of research
• Automation and flexible manufacturing and development-related activities (new
b) Companies located in any of the following systems (such as: computerized process machines, laboratory equipment,
industries: control equipment, process instrumentation, computer equipment and software
robotic equipment, computerized numerical licenses , other licenses, plant and
Advanced electronics (such as: computer control machining equipment).. buildings) and expenses that can be
and printing equipment, micropro- classified as related.
cessors, communication equipment, • Advanced materials (such as: polymers or d) Companies that have at least one of the
integrated circuits, cathode ray tubes, blopolymers, superconductors, fine or following certifications for their local
advanced connectors, digital sound and advanced ceramics, high strength operation: ISO 14001 (14004) or
video equipment). composites, pigments, nanoparticles and equivalent, LEED or equivalent.
their formulations).
• Advanced electrical components. There are other requirements in addition to
c) Companies that, in their local operations, the restriction to the strategic sectors
• Medical devices, equipment, implants and allocate at least the equivalent of 0.5% of described, as some benefits are targeted to
supplies (including orthopedics, their sales to research and development new investments. Likewise, the Law
orthodontics, dental and optometry) and expenditures, according to the following excludes those companies that are not
their highly specialized packaging or definitions: currently totally or partially exempt from
containers. income tax; this means that domestic and
* Research: original, planified inquiry that seeks foreign companies established outside of
• Automotive (devices and Insumes). to discover new knowledge and acquire a free trade zones are not eligible for the
superior understanding in the scientific and regime, even if they are located in the
• High precision machined parts and technological field. defined strategic sectors. At the same time,
components. the possibility was created for companies
• Development: application of the results of that are already in free trade zones to access
• Aerospace and aeronautics. research or any other type of scientific the regime under the new conditions-
knowledge for the manufacture of new provided that they make new investments.
• Pharmaceutical industry and materials or products, or for the design of
biotechnology. new processes or production systems, as
well as for the substantial technological
• Renewable energies (such as: improvement of pre-existing materials,
photovoltaic/solar cells, polymer batteries products, processes or systems..
or other materials)

According to the social development index (IDS) prepared by the Ministry of

Planning (Mideplan, 2008b), the regions with the greatest lags in the country are Huetar

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Atlántica and Brunca.

By cantons distributed in quintiles, the lowest IDS values (first quintile)

correspond mainly to the border areas and the Atlantic coast. In the Brunca region,
89.5% of the districts are located in the lowest ranges and there are none in the fourth
and fifth quintiles, while the Huetar Atlántica region has 85.7% of its districts in the lowest
quintiles and none in the highest groups. "The Central Region, which concentrates more
than half of the country's districts (57.7%), has a very favorable position, since most of
the districts belong to the highest quintiles" (Mideplan, 2008b).

The lag shown by the IDS is also reflected in foreign investment flows. Table 7
illustrates the FDI flows to Costa Rica between 2004 and 2010 and how it was
concentrated in some provinces, to the detriment of those belonging to the lagging
regions. In 2010, San José and Heredia absorbed 68.8% of FDI (73% in the 2004-2006
period), while Limón and Puntarenas received 0.4% and 10%, respectively.

Figure 2 Costa Rica: distribution of FDI flows by province, 2004-2010

Costa Rica: distribution of FDI flows by province, 2004-2010 (percentages)

Province Average 2010

Heredia 40,6 17,1
San Jose 33.7 31.7
Puntarenas 9,3 10,0
Guanacaste 9,2 8,6

Alajuel 3,3 5,
Lemon 0,4

Carthage 1.8 7.1

Source: Prepared by the authors with data from the Central Bank.
The services provided by investment promotion agencies are rated as "important"
by about 50% of efficiency-seeking FDI investors, while about 33% of investors in the
sector for other purposes rate them in the same range.

FDI seeking efficiency and market access in Costa Rica is positively sensitive to
tax incentives, the existence of a good local supplier base (linkages), our network of free
trade agreements and the services provided by the Costa Rican Coalition of
Development Initiatives (CINDE), the agency in charge of attracting foreign direct
investment to Costa Rica. This represents on average 33% of all FDI flows into the
country annually and has very significant multiplier effects on total exports, services

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exports and formal job creation.

Illustration 3 Impact of FDI on the Costa Rican economy

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 The data is the result of several econometric models with data series from 1991
to 2016 and was developed by CINDE in September 2017. It should be noted that for
each additional dollar of FDI from foreign companies that come to the country in search
of efficiency and access to markets, and whose economic determinant is the availability
of productive human capital, GDP grows by an additional US$5.1, total exports increase
by an additional US$13.6, and exports of services increase by an additional US$6.2.

In terms of formal employment created, FDI promoted in the country generates

10 new formal jobs for every US$1 million of additional FDI, which is 67% higher than the
employment multiplier effect of the rest of the foreign direct investment coming into
Costa Rica.

This sector has left an indelible mark on the country's development, progress and
well-being.

Illustration 4 Satisfaction of domestic and export demand for Natural Resources

TO MEET THE DOMESTIC DEMAND

AND TO EXPLOIT
NATURAL RESOURCES
For each new dollar invested, an average of
was generated:

5 Additional LO
Additional
in the X US$ total
Uses inGDP
Additional i Additional
,0 in the X of i I in the X 's of
US$ goods US$ served
For each new million dollars invested,
generates an average of 6 new jobs.
SOURCE: CINDE BASED ON DATA FROM BCCR, INEC AND FREO . 2017
However, the evidence also shows that we are losing that competitive advantage
over our competitors. The productivity of our human capital rises more slowly than its
cost.

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 It is increasingly difficult to find Science, Technology, Engineering and
Mathematics (STEM) graduates with English language proficiency and other skills
demanded by foreign companies.

CINDE has a 35-year track record thanks to the fact that Costa Rica was the first
country in Latin America to create a foreign investment promotion agency that today is
number one in the world (ITC, 2017), and also, it was the first to attract medium and high
technology FDI. Therefore, it is important to react to the aggressive competition for the
same foreign direct investment flows that Costa Rica attracts, in an international
environment that has fewer and fewer allies.

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 CONCLUSION

FDI in Costa Rica, as in most developing countries, has played a dual role: on the
one hand, it is a central element of the export promotion strategy and, on the other hand,
it has served to compensate to some extent for the low rates of domestic investment,
thus strengthening the weak gross fixed capital formation and employment generation.

It should be reiterated that in Costa Rica there is a high concentration of FDI

linked to exports, that is, the entry of transnational capital for the transformation of
products or services for subsequent export. This is normal, as the smallness of the
domestic market inhibits investments seeking new local markets.

However, this also suggests that the prevailing strategy among companies
setting up in Costa Rica is the search for efficiency through cost reduction. The
sophistication of FDI also indicates that the country has managed to improve its
international insertion by linking itself to global value chains in some segments with
higher knowledge and technological content (health services, professional back office
services, medical devices, capital- and technology-intensive manufacturing), which has
resulted in higher wages.

The linkage of some professional and productive segments to the international

economy has been a partial success of this development strategy; however, most of the
labor force and the productive sector continue to be disconnected from its benefits, and
an industrial policy, understood in a broad sense as a policy of productive improvements
and increased productivity in all sectors, should focus on correcting this imbalance.

In other words, modern industrial policy, in addition to seeking to change the

production structure, must ensure that the model is inclusive. The benefits that FDI can
bring to the productive sector depend to a large extent on the productive linkages and
spillovers it generates at the "micro" level, and not on its contribution to the balance of
payments equilibrium.

However, secondary sources indicate that FDI does not transfer technology motu
proprio, nor does it spontaneously transform the productive structure. For this reason,

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the FDI strategy can only be conceived as part of a more comprehensive productive
development policy that identifies and prioritizes the sectors to be strengthened and, at
the same time, is complemented by policies that seek to develop absorptive capacities in
local companies, improve basic and higher technical education, strengthen institutions
and broaden the scientific and technological base (ECLAC, 2006).policies that seek to
develop absorptive capacities in local companies, improve basic and higher technical
education, strengthen institutions and broaden the scientific and technological base
(ECLAC, 2006).

The modification of incentives in Costa Rica should be seen as an opportunity to

implement a policy for the development of the productive sectors, in the context of an
investment promotion scheme that encourages the transfer of technology and best
practices, upgrading in the value chain and the search for linkages with domestic
companies, as well as an increase in their competitiveness, so that they can participate
more in the export effort and become more involved in the export effort.The modification
of incentives in Costa Rica should be seen as an opportunity to implement a policy for
the development of the productive sectors, in the context of an investment promotion
scheme that promotes the transfer of technology and best practices, upgrading in the
value chain and the search for linkages with national companies, as well as an increase
in the competitiveness of the latter, so that they participate to a greater extent in the
export effort and generate spillover effects on national development.

The new incentives for FDI provide space to encourage investment in lagging
areas. However, given the strategy that explains the arrival of FDI in Costa Rica (search
for efficiency through cost reduction), companies have no reason to locate in places
where production costs will be at least equal to those they can obtain in other areas of
the country.

For this reason, in order to attract FDI to relatively less developed areas, tax
incentives are not enough, and it is necessary to offer other qualitative elements to turn
these areas into FDI attraction poles. In other words, FDI alone does not generate
development poles. Complementary productive development policies must create the
"environmental" conditions (basic infrastructure, telecommunications, education system

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and labor force capacity), such as the "micro" factors related to the absorption capacity
of spillover effects and externalities (spillovers) of FDI.

In addition, the benefits that FDI can bring to lagging areas of the country,
beyond jobs and training-related spillovers, require local capacities to be built.

As FDI is an important form of knowledge transfer between developing countries,

transnational corporations and some important actors in national innovation systems
(NIS), it is particularly relevant to understand the role of these firms in these systems and
how they influence the effects of FDI in a host economy.

Transnationals can be a source of access to technological competences

originating outside an NIS and offer the host economy the possibility of being part of the
global processes of knowledge creation and diffusion (Marín and Arza, 2009).

The indirect effects of FDI are heterogeneous and depend on the characteristics
of the transnational companies, especially with respect to the technological content of
their activities. Companies in high-tech sectors and with research and development
activities have, on the one hand, a greater impact on capacity building, technological
"spillovers" and productivity spillovers and, on the other, a positive effect on the
absorptive capacity of the host country and the strengthening of its innovation system
(ECLAC, 2011).

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