Costa Rica and the Costs of Foreign Direct Investment Led Development: A Look at the Limited Ability that Small, Dependent, Underdeveloped Countries have to Attract Foreign

Direct Investment.

By

Joseph Tutt

Submitted toThe Wilf Family Department of Politics

New York University

in partial fulfillmentof the requirements for the degree of

Master of Arts

Project Sponsor: Professor ___Muserref Yetim Signature __ _

(For Departmental Use Only)MA Project Committee: Professor ________________

Professor ________________

New York City, USA2009

Abstract: This paper investigates Costa Rica’s foreign direct investment attraction strategy

for the past thirty years. The literature on foreign direct investment led development mostly focuses

on the comparative effects of different domestic policies on attracting foreign investors and

increasing technological spillovers. The case of Costa Rica has often been held up as an ideal

example. However, examinations of Costa Rica’s have largely ignored the fact that their strategy

was heavily dependent on external resources, both monetary and technical, suggesting that the

process of investment attraction is more extensive and costly than the literature has previously

acknowledged. Specifically, overcoming the information inequality between transnational firms and

underdeveloped countries and adequately investing in public goods such as worker skills and

infrastructure, that are necessary to attract growth spurring investment requires resources that less

developed countries are not likely to be able to afford.

Acknowledgements – The author would like to recognize the great assistance provided by

Professors Muserref Yetim and Tony Spanakos in helping guide the construction of this paper. Their

revisions and critiques provided immeasurable help in completing this project. He would also like

2

to extend gratitude to the entire Wilf Family Department of Politics at New York University for its

excellent resources and assistance in writing this paper. Finally, he would like to thank his loving

family for their unending support.

Table of Contents

List of Tables and Figures

List of AbbreviationsCACM – Central American Common MarketCAFTA – Central American Free Trade AgreementCBI – Caribbean Basin IniativeCENPRO – Centro de Promociones de Exportaciones e Inversiones.CINDE - Coalición Costarricense de Iniciatívas para ed DesarrolloCRP – Costa Rican ProveéECLA- Economic Commission on Latin AmericaFDI – foreign direct investmentFUNDEX - Fundación de ExportacionesGDP- gross domestic product GNP – gross national productHDI- Human Development IndexIPA – investment promotion agencyISI- import substitution industrializationOECD- Organization for Economic Cooperation and DevelopmentPROCOMER- Promotora de Comercio ExterioLDC – less developed countryUSAID – United States Agency for International Development

3

Introduction

Over the last 15 years, Costa Rica has achieved strong growth rates in its overall

economy, and particularly in its nontraditional-export sector. Much of this growth has

been fueled by foreign direct investment (FDI) in the computer chip and medical

industries. Both of these industries are high value-added and involve high-skilled jobs.

Costa Rica is quite unique in the Latin American context, a region where most other

stories of economic growth are highly dependent on either commodity price booms or are

concentrated in industries of low value-added, low skill, and cheap labor.1 Costa Rica’s

1 Robert N. Gwynne and Kay Cristóbal, “Latin America Transformed: Globalization and Neoliberalism.” In Latin America Transformed: Globalization and Modernity 2nd ed., eds. Robert N. Gwynne and Kay Cristóbal, (London: Edward Arnold, 2004): pgs 7-18.

Thomas Klak, “Globalization, Neoliberalism, and Economic Change in Central America and the

Caribbean.” In Robert N. Gwynne and Kay Cristóbal, eds., Latin America Transformed: Globalization and

focus on high-value, high-tech industries, and its strong investment promotion strategy

appear to have Costa Rican growth isolated and cushioned from potential swings in

international commodity prices and labor competition from Asia, both of which have the

potential to derail other growing countries in the region.2

Most literature on FDI and export-led development have focused on comparative

domestic policies seeking to identify which investment attraction policies led to the

highest rates of growth, most technological spillovers, and strongest backwards linkages.3

While designing appropriate long-term-growth oriented investment strategies is certainly

vital, these studies have overlooked the important issue of the cost of the monetary and

technical resources that implementing these policies require and how under-developed

and peripheral countries are then supposed to afford or attain the resources that successful

investment-attraction policies require. Specifically, there are considerable information

asymmetries between potential investors and countries seeking their investment.

Overcoming these asymmetries requires more than just removing trade barriers.4 The case

of Costa Rica suggests that the cost of overcoming these asymmetries is considerably

high. Furthermore, attracting high quality, long-term-growth oriented investments often

require heavy investment in public education, worker skills, and infrastructure to attract

and support high quality firms. Finally, many consider a core component in attracting

Modernity 2nd ed. (London: Edward Arnold, 2004): pgs 77-84

2 Eva Paus, Foreign Investment, Development, and Globalization: Can Costa Rica Become Ireland? (New York: Palgrave Macmillan, 2005), 135-143.

3 For a review of the literature on and analysis of FDI led growth policies, see Theodore H. Moran, Harnessing Foreign Direct Investment for Development. (Baltimore, MD: Brookings Institution Press, 2006)

4 In a quantitative evaluation of FDI policy, Biglaiser and DeRouen, Jr. found that economic reforms and tax policy changes did not have a statistically significant effect on attracting more FDI.

Glen Biglaiser and Karl DeRouen, Jr., “Economic Reforms and Inflows of Foreign Direct

Investment in Latin America,” Latin American Research Review 41 No.1 (February 2006): pgs 51-75.

firms to be offering beneficial tax incentives. Thus, investment attraction requires

increased state capacity but no new way of funding the expansion of it.

The literature on Costa Rica has identified the political and institutional stability,

the successful use of free-trade zones, and successful use of a comprehensive investment-

promotion strategy as the key explanatory factors of Costa Rica’s growth.5 While these

endogenous factors have certainly played a key role in Costa Rica’s success, examining

endogenous factors alone do not tell the entire story. The United States Agency for

International Development (USAID) also played a vital role in the Costa Rican success

story, and was heavily involved in funding and planning the country’s investment

promotion strategy throughout the 1980s and early 1990s. Indeed, USAID primarily

provided the resources that allowed Costa Rica and Intel, along with other investors, to

overcome informational asymmetries. Furthermore, Costa Rica received additional

support through aid and preferential trade treatment. Foreign aid allowed Costa Rica to

maintain macroeconomic stability as well as allowed it to expend additional resources on

infrastructure and skill investments. Finally, preferential trade treatment greatly increased

the viability of many US firms investing in Costa Rica. Since the loss of US aid, Costa

Rica has seen its ability to afford its investment promotion strategy drastically decrease.

Without USAID involvement and highly preferential trade treatment that Costa Rica

5 See Paus, Foreign Investment, pgs 12-20, 155-172; Moran, pg 30; Dilip Mirchandani and Arturo Condo, “Doing Business In: Costa Rica,” Thunderbird

International Business Review 47 No.3 (May 2005): pgs 335-360.Lynn K Mytelka and Lou Anne Barclay, “Using Foreign Investment Strategically for Innovation.”

European Journal of Development Research 16 No.3 (Autumn 2004): pgs 531-560, Roy C. Nelson, “Competing for Foreign Direct Investment: Efforts to Promote Nontraditional FDI

in Costa Rica, Brazil, and Chile,” Studies in Comparative International Development 40 No.3 (Fall 2005): 5-16.

Eva A. Paus and Kevin P. Gallagher, “Missing Links: Foreign Investment and Industrial Development in Costa Rica and Mexico.” Studies in Comparative International Development 43 No.1 (March, 2008): pgs 531-555

Debora Spar, FIAS Occasional Paper 11- Attracting High Technology Investment: Intel’s Costa

Rican Plant. (Washington D.C.: World Bank, 1998): pg 13

received from the US government, Costa Rica’s successful investment strategy would

have, at the worst, never existed or, at least, not have been nearly as successful.6

In this paper, I argue that endogenous factors such as macroeconomic stability and

investment promotion strategy are necessary but not sufficient to achieve economic

growth through FDI, as the case of Costa Rica suggests. Successful investment attraction

is an extensive and costly process, and merely removing trade barriers is not sufficient. It

requires extensive information gathering and lobbying efforts to overcome information

asymmetries, which few under-developed countries are likely to be able to afford. The

main implication of the high costs of attraction and the experience of Costa Rica

suggests, I argue, is that external actors, and more specifically an interested regional

hegemon are the most likely source to provide the necessary funds and information that

are necessary to overcome information asymmetry and afford the necessary investments.

In other words, in the past 30 years, there has been more variation in outcomes than there

has been in liberalization reforms.7 Many countries in Latin America started from roughly

similar circumstances, followed roughly similar liberalization programs and have seen

booms in investment. Yet while Costa Rica has enjoyed the benefits of an Intel computer

chip factory, other countries have seen liberalization only lead to the privatization of

public utilities or devastating monetary speculation bubbles.8 Many countries in Latin

6 Mary A. Clark, “Transnational Alliances and Development Policy in Latin America: Nontraditional Export Promotion in Costa Rica.” Latin American Research Review 32 No.2 (1997): pgs 71-94.

7 For an overview of Latin America’s experiences with liberalization reforms see Robert N. Gwynne and Kay Cristóbal, eds., Latin America Transformed: Globalization and Modernity 2nd ed., (London: Edward Arnold, 2004), Chapters 1-4.

Gwynne and Kay, pg 12.8 Gwynne and Kay, pgs 12-13; Paus, Foreign Investment, pg 5, 143. William Assies, “Gasified Democracy,” Revista Europea de Estudios Latinoamericanos y del

Caribe 76 (April 2004): pgs 26-31Pilar Domingo, “Democracy and New Social Forces in Bolivia,” Social Forces 83 No.4 (June

2005): pgs 1727-1743 Robert Gilpin. The Global Political Economy: Understanding the International Economic Order.

(Princeton, NJ: Princeton University Press, 2001): pg 263

America were only able to liberalize their economies, Costa Rica’s massive inflow of

external aid money allowed it to construct a much more elaborate attraction policy.9

Costa Rica is an important case for two crucial reasons. First, it is small country

with a long history of dependence on agricultural exports, and therefore the Costa Rican

case holds many potentially important lessons for the many small, underdeveloped, trade

dependent countries (to provide some perspective, Costa Rica is near the global median

country size by population and area10) seeking to achieve developmental gains through an

FDI strategy (which remains the current paradigm for development for a majority of

developing countriesi).11 Considering the fact that around three quarters of FDI has

consistently flowed between developed industrial nations (See Table 1), instances of

successful FDI attraction and utilization by less-developed countries are important cases

to study.12

Table - Distribution of Global FDI Inflows, 1970-20001970 1980 1990 2000

Total In Millions of Current US Dollars (Percentages in Parentheses)

12,926(100)

54,932(100)

208,501(100)

1,392,957(100)

Developed Countries

US

EU

9,477(73.3)

1,260(9.8)

5,127(39.7)

46,530(84.7)

16,918(30.8)

21,317(39.7)

171,076(82.1)

48,442(23.2)

96,773(46.4)

1,120, 528(80.4)

314,007(22.5)

683,893(49.1)

Daniela Magalhâes Prates and Leda Maria Paulani, “The Financial Globalization of Brazil under Lula,” Monthly Review 58 no. 9 (February 2007): pg 36.

Susan Spronk and Jeffrey R. Webber, “Struggles against Accumulation by Dispossession: The

Political Economy of Natural Resource Contention” Latin American Perspectives 34 (2007): pgs 31-47

9 Clark, Transnational Alliances, pgs 71-94.10 Klak, pg 69.11 See Klak, pg 67-73 and Paus, Foreign Investment, pg 3-6 for a more thorough discussion of the

meaning and consequences of size and trade dependence in Central America.12 Gilpin, pgs 289-290; Klak, pg 78, Paus, Foreign Investment, pgs 3-5.

Developing Countries (China not included)

Central America and Caribbean

Costa Rica

3,449(26.7

1,063(8.2)

26(0.2)

8,301(15.1)

3,854(7.0)

53(0.1)

33,468(16.1)

4,826(2.3)

162(0.1)

205, 285(14.7)

38,110(2.7)

409(0.03)

Source: Modified from Paus, Foreign Investment, pg 4. Original data from UNCTAD Foreign Direct Investment Database <http://www.unctad.org/Templates/Page.asp?intItemID=1923>

Second, Costa Rica serves as a most-likely case for successful development

through an export-oriented, foreign direct investment approach due to its favorable

domestic political and demographic characteristics, history, and location. A better

understanding of the considerable information asymmetries that Costa Rica had to

overcome and investments and concessions it was required to make will better clarify the

true costs of FDI attraction policies. Furthermore, by investigating the manner in which

USAID and Costa Rica interacted in order to provide the necessary funds and

information to allow Costa Rica to attract FDI provides valuable insight into the

feasibility of other small, under-developed countries attracting the requisite money and

information. By further studying the entire costs of FDI attraction policies and strategies

scholars and bureaucrats will be able to judge how feasible an FDI led program is in

certain cases, and also will be better equipped to design foreign aide programs likely to

spur economic growth.

In this thesis, I shall analyze Costa Rica’s experience with FDI-led development.

The first section will provide a literature review, and I will look at the role FDI is

theoretically supposed to play in spurring development. The second section will provide

background on Costa Rica’s place in the broader scheme of Latin American development

and what makes it both unique and similar with the rest of the region. This will establish

both why it is a most-likely case, but also outline the considerable obstacles that stood in

the way of Costa Rica’s success. This will highlight Costa Rica’s strong need for external

resources in order overcome informational asymmetries and make public investments. In

the third section, I will look at Costa Rica’s implementation of the neoliberal reforms and

its growth through FDI in the 1990s. In the fourth section, I will examine the central role

that external actors and resources played in Costa Rica’s experience and its implications

on the broader FDI literature. Finally, I will offer a discussion section about aspects of the

world economy and under-developed countries that the current FDI literature has

neglected and that the experience of Costa Rica suggests needs to be incorporated into

models and theories on FDI-led growth.

The Link Between FDI and Development

The role that FDI is supposed to play in facilitating economic development has its

roots in theories on economic development and globalization. As far as developmental

theories are concerned, theories founded on FDI are best classified under the neoliberal

paradigm. Neoliberal theories have their roots in the 1960s and grew out of the critiques

of theories of the developmental state and import substitution industrialization (ISI).

Theories of the developmental state have their origins in Friedrich List’s studies on the

role of the German state in spurring Germany’s rapid industrialization in the late

nineteenth century. The ISI model has its origins in the 1940s and 1950s with authors

such as Albert Hirshmann, Gunnar Myrdal, Raul Prebisch, and Max Singer, who sought

to understand why the theories on advantages of late comers were not applying to least

developed countries (LDCs). These authors agued that LDCs had fundamental

characteristics that had thus far prevented economic development and would continue

prevent development in the future. They argued LDCs were burdened by excess labor and

low productivity in the agricultural sector, that their economies were based on

commodities that had unfavorable terms of trade, and that system wide market failures

locked LDCs into a vicious cycle of under-development.13 The ISI model became

particularly transcendent in Latin America under the influence of Prebisch and the

Economic Commission for Latin America (ECLA) who studied the dramatic effects that

the Great Depression and the collapse of primary commodity prices had on Latin

America. Prebisch argued that in Latin America the great disparity in capabilities between

Latin American firms and international firms and the disparity between the types of

goods being traded was so great that international trade and openness only exacerbated

Latin America’s problems. Prebisch argued that the solution was for Latin American

economies to become more inward-oriented— only through restricting the entry of

foreign goods and technologies would domestic actors be forced to innovate on their

own.14 A strong, interventionist state was envisioned to protect infant industries, guide

investment, overcome persistent market failures, and generally speed up the process of

domestic economic development. The goal was for the state to develop the industries

quickest that it was most dependent on imports for, hence ‘import substitution.’ By the

late 1970s, the widespread failure of Latin America’s inward-oriented ISI modelii and

major market distortions that the model itself had created, evidenced by widespread

balance of payments crises and the uncompetitive firms in many Latin American

countries lead to the widespread rejection of the inward-oriented ISI model.15 Neoliberals

criticized the ISI model for creating widespread market distortions through high levels of

inflation and government debts and for theorizing that the economics operated

13 Gilpin, pgs 306- 309. 14 Gilpin, pg 308;

Robert N. Gwynne, “Structural Reform in South America and Mexico: Economic and Regional

Perspectives,” in see Robert N. Gwynne and Kay Cristóbal, eds., Latin America Transformed:

Globalization and Modernity 2nd ed., (London: Edward Arnold, 2004): pgs 43-46

15 Gilpin, pgs 309-312; Gwynne, pgs 43-46.

fundamentally differently in LDCs than in developed countries.16 In short, the inward-

oriented ISI model had created a serious predicament for many LDCs. The use of heavy

subsidies to create and heavy tariffs to then protect national industries led to the

development of highly inefficient industries. The isolation of ISI industries both removed

incentives for innovation through the absence of competitive pressures as well as

removing needed interaction with other firms that possessed more efficient technologies

and methods. The inefficiency and heavy protections of these industries both made them

expensive and unable to compete on the international market.17 Thus, ISI model’s heavy

use of protections only led to increasing the price of domestic consumption, not spurring

economic growth. Thus, even though industries had been created, many LDCs remained

highly dependent on the export of primary commodities to bring in new capital. In

essence, this led to huge new expenditure commitments by the state, but no real new way

of funding them. Indeed, much of the ISI model was funded by heavy external credit.18

When the credit became more scarce and expensive due to the Oil Shocks, and the global

economy took a down turn in the late 1970s, states that had followed the ISI model were

thrown into a balance of payments crisis as the price on their debt rose rapidly, their

internal commitments (both welfare spending and propping up slowing industries) grew

rapidly, and their ability to pay rapidly decreased.19

The neoliberal solution to balance of payments crises was simple, remove the

government distortions and ‘get the prices right.’ The seminal understanding of the

neoliberal development model is in a paper by John Williamson called the Washington

Consensus (WC).20 The three main points of the WC are for the state to embrace

16 Gilpin, pgs 309-312.17 Paus, Foreign Investment, pgs 16-17; Moran, pgs 18-19. 18 Gwynne, pgs 45-46.19 See Gilpin, pgs 312- 315; Gwynne, pgs 45-47; Klak, pgs 76-77; Moran pgs 7-21, 20 John Williamson, “What Washington Means by Policy Reform,” in Latin American

Adjustment: How Much Has Happened, John Williamson, ed. (Institute for International Economics, 1990).

macroeconomic discipline, embrace market principles, and maintain openness to the

international economy.21 The goal of the reforms was to remove the highly inefficient

state protections from industries, allow competition to improve productivity and reduce

prices, open up markets to allow entry of much needed foreign capital, technology, and

innovation. The role of the state was reduced to maintaining stable markets.22

Spillovers, Linkages and Development

In the neoliberal model, the opening of markets and entry of FDI was to play a

primary role in spurring economic growth and development through providing three

essential goods—technology spillovers, backwards linkages, and the establishment of an

internationally competitive industrial base.23 Technology spillovers occur whenever

transnational firms introduce cutting edge technologies, production, and management

techniques into an underdeveloped economy. Ideally, local workers who were trained in

these skills spread them throughout the country as these workers eventually moved to

other local firms and as local companies interact with the foreign firm. Backwards

linkages occur whenever local companies and entrepreneurs seek to fill sourcing needs of

the foreign firm. Backwards linkages accelerate spillovers, create domestic jobs, and can

create new exports. The theoretical goal of FDI-led development is for spillovers and

backwards linkages along with competitive pressures to transform the domestic economy

into an industrially based economy that is versed in modern technologies and business

procedures, knowledgeable of the international economy, and capable of manufacturing

Available Online. http://www.petersoninstitute.org/publications/papers/paper.cfm?ResearchID=48621 John Williamson, “Did the Washington Consensus Fail?” (Speech at the Center for Strategic &

International Studies, Washington, DC, 6 November, 2002). Accessed Online. http://www.iie.com/publications/papers/paper.cfm?researchid=488

22 Eva A. Paus, “Productivity Growth in Latin America: The Limits of Neoliberal Reforms,” World Development 32 No.3 (March 2004): pg 40; Paus, Foreign Investment, pgs 11-43.

23 Moran, pgs 6- 44.

internationally competitive products through utilizing a country’s competitive

advantage.24 The neoliberal model was not supposed to produce immediate results; it was

expected that it would take countries time to adjust to market demands and to remove the

inefficient institutions and practices that the ISI model had produced.

Even though the term ‘neoliberal’ has acquired negative connotations and has

been much maligned, studies on domestic protection policies have shown that the more

liberalized a country becomes and the fewer restrictions a country places on foreign

investment entering the country, the greater the spillovers and backwards linkages are.25

Initially, the best way to achieve spillovers and linkages was thought to be to require

foreign firms to source a certain percentage of products from local firms. However, these

requirements only raised the costs of production, disqualified many countries from being

able to cater to the needs of foreign firms, and encouraged firms to recycle outdated and

obsolete technology and techniques in the host country for profit.26 Only when firms were

allowed to operate without restrictions were they able to fully integrate host countries

into their supply chain and then actually introduce the cutting edge technologies and

techniques that led to spillovers and subsequent development.27 In Moran’s overview of

findings on FDI, he finds that, inline with the neoliberal model, by opening up markets

and lowering barriers, not only does investment increase, but also efficiency and

innovation increase.28 Furthermore, foreign firms that invest in LDCs, even without

guaranteed wages and labor conditions, regularly provide higher wages and better

working conditions than the domestic firms do.29 Thus, despite many of the critiques of

24 Moran, pgs 1-3, 6-74 ; Paus and Gallagher, pgs 56-61; Mytelka and Barclay pg 535; Paus, Foreign Investment, pgs11-49.

25 Moran, pgs 6-2726 Moran, pgs 7-927 Moran, pgs 10-15. 28 See Moran, pgs 6-43.29 Moran, pgs 45- 74

neoliberal reforms and the painful experience that many countries had engaging in

structural reform, the neoliberal model’s main strength is pointing out that development

can not occur if basic economic principles are ignored.

The other major source of FDI-led development theories are theories about

globalization. For the purposes of this paper, the most important aspect of theories about

globalization is the argument that firms are becoming continually less national. Originally

theorized by Michael Porter, who argued that due to increased advances in

communication and transportation, it is becoming increasingly viable and necessary for

transnational firms to fragment their production chains across national lines and to take

advantage of cheaper labor, strategic location, unique skill sets, and any other advantages

a foreign location may offer. In order for a firm to remain competitive, it must maximize

its efficiency on a global scale.30 Thus, as firms becoming increasingly multinational,

more FDI is available to spur the kinds of economic development described above.

Another aspect of globalization that has major implications on theories of FDI-led

development are theories that deal with the changing source of value in the global

economy. Robert Reich argues that the global economy has shifted from one where value

was primarily based in the volume of production to an economy where value is primarily

determined by innovation and knowledge. Reich argues that most of the growth in the last

quarter of the century has not been in firms that produce more products, but more niche,

specialized products that can produce higher profits.31 Now, just increasing industrial

production isn’t enough to spur development, since the increases in technology,

communication, and transportation that have come with globalization have also eroded

the profits that can be made from assembly productions through greatly increasing

30 Gilpin, pgs 285-286. Also discussed in Paus, Foreign Investment, pgs 1-6, 13-4331 Robert Reich. The Work of Nations: Preparing Ourselves for 21st Century Capitalism. (New

York: A.A. Knoff, 1991)

efficiency. According to this line of reasoning, all types of FDI are not equal. Different

industries produce different amounts of value-added, the fastest way for FDI to spur

economic growth is for it to occur in higher value production.32 Therefore, a country that

attracts FDI from a high value-added computer company is going to be far more

benefited than a country that can only attract textile assembly operations.

FDI, Stability, and Strategy

This brings us to actual theories of FDI-led development. According to neoliberal

and globalization theories, the combination of globalizing, transnational firms and under-

developed countries with location specific assets who follow sound macroeconomic

policy should provide the perfect circumstances for increased development. Theories of

FDI-led development are predominantly domestic, comparative theories, seeking to find

which domestic policies attract the most investments, the highest value investments, and

produce the greatest spillover and linkage effects. However, it should be noted that most

FDI-led theories are not purely neoliberal. In a purely neoliberal model, the state’s only

role is to provide macroeconomic stability. FDI-led theories acknowledge that

information asymmetries exist between under-developed countries and potential

investors.33 Some authors contend that the state plays a central role in overcoming those

asymmetries while others view private actors as the most suited. For example, on end of

the spectrum, Mary Clark argues that the state’s primary role is to provide

macroeconomic stability and appropriately oriented tax incentives. She argues that a

‘transnational alliance’ of private actors is best suited to overcome the informational

asymmetries between firms since they are best able to avoid costly political

entanglements and divisions. Others, such as Mytelka and Barclay and Paus argue that a

32 Paus, Foreign Investment, pgs 12-2333 Moran, pgs 29-30 Clark, Transnational Alliances, pgs 71-94.

state itself should go as far choosing investment opportunities and lobbying potential

investors.34 However, in essence FDI-led development theories remain neoliberal because

the main actors responsible for producing economic development and nation-wide

structural change are still private, while the state plays, at most, a coordinating and

planning role.

Different authors emphasize different aspects of FDI attraction strategies as key.

For example, Timothy Moran argues that a successful attraction strategy requires four key

aspects-- a stable investment climate, the overcoming of information imperfections,

calming investor anxiety, and providing investment incentives.35 Roy Nelson argues that

the autonomy of a country’s leaders from special interests and the possession of an

ideological consensus among political elites are the key aspects of a beneficial investment

climate. Second, he argues that a government must possess transnational learning

capabilities, which requires governments to learn about prospective investors and the

potential benefits the country offers to the transnational firm and the firm to the country.

A country with transnational learning capacity must then be able to be responsive to the

needs of potential investors and engage in a sustained effort of attraction.36 Similarly, Eva

Paus and Kevin Gallagher argue that an FDI policy must seek to maximize linkages and

spillovers, which is achieved by matching a country’s specific spillover potentials with

the global strategy of transnational corporations.37 Finally, Lynn Mytelka and Lou

Barclay argue that a country must develop a ‘system of innovation’ to be able to

continually compete for FDI. They define a ‘system of innovation’ as a “network of

economic agents, together with the institutions and policies that influence their innovative

34 See Mytelka and Barclay, pgs 534-536; Paus and Gallagher, pgs 55-60. 35 Moran, pgs 27-3136 Nelson, pgs 3-28.37 Paus and Gallagher, pgs 53-65.

behavior and performance.” They argue that domestic policies play a central role in

determining the behavior of economic actors. Therefore, simply acquiring FDI is not

enough to spur development if domestic policies encourage the wrong kinds of behavior.

FDI will only lead to development if policies encourage the right domestic and

international actors to interact. Mytelka and Barclay argue further that the state must

monitor those interactions and make sure that they are guided in beneficial direction with

the right information reaching the right actors. Thus, Mytelka and Barclay argue a

government must have a long-term, big picture, dynamic view of how FDI will be used to

stimulate growth.38

For the purposes of this paper, all of these different terms can be simplified into

two key components. First, a country must have political and macroeconomic stability.

This can be derived from Moran’s need for a stable investment climate and Nelson’s need

for the political leaders’ autonomy from special interests and ideological consensus. The

key characteristics that the literature has focused on that bring stability are low inflation,

favorable exchange rates, low crime, low corruption, reliable and transparent regulatory

framework, stable property rights, and reliable transportation and communication

infrastructure.39 Transnational firms are much less likely to invest in an LDC, as opposed

to an OECD country, unless they can expect the same rule of law and basic stability that

those countries offer. Furthermore, with regard to autonomy, Nelson argues that

governments can make much better decisions about which investments to target if a

country’s leaders are not involved in rent-seeking behavior.40 Then, with regard to

ideological consensus, businesses are much less likely to invest in countries if an election

38 Mytelka and Barclay, 531-539.39 Moran, pgs 21-22; Paus, Foreign Investment, pgs 17-18; 40 Nelson, pg 5, 8-11

holds the possibility of markedly altering their relationship with the government of the

country.41

The second core component is that a country must engage in a long-term strategy

of attracting and utilizing investment. This can be derived from Moran’s need for a

country to overcome information imperfections, calm investors’ concerns, and provide

incentives; Nelson’s need for transnational learning capacity; Mytelka’s system of

innovation; and, finally, Paus and Gallagher’s concept of spillover maximization. It is not

enough for a country to just remove trade barriers, it must judiciously pursue investment

that will generate long-term and beneficial growth and provide necessary incentives to

attract investors. The reasoning is as follows: FDI strategies are based on developing non-

traditional exports in under-developed countries. However, these countries will have few

competitive advantages outside of tax benefits, cheap labor, and location. Therefore, most

countries will begin with low-tech, low-skill, low return assembly operations. In order for

a state to avoid being relegated to cheap labor, low-return operations, the state (or an

investment promotion organization) needs a long-term plan that will attract the highest

value, most appropriate investment (i.e., most conducive to long-term, stable growth),

maximize spillover and linkage potentials (which are the crux of the FDI model), and

continually invest in upgrading skills and infrastructures to keep upgrading the

investment potential of a country.42 Therefore, it is not enough to just have a stable

macroeconomic environment, or just possess location or skill specific assets that would

be beneficial to a transnational firm’s productivity.

41Nelson, pgs 6, 8-1142 See Jose Cordero and Eva Paus, Discussion Paper Number 13- Foreign Investment and

Economic Development in Costa Rica: Unrealized Potential. (Medford, MA: Working Group on Development and Environment in the Americas, 2008):, pgs 15-23;

Paus and Gallagher, pgs 54-56; Paus, Foreign Investment, pgs 11-43; Mytelka and Barclay, pgs

535-539.

The common proposed solution for this long-term strategy is the creation of an

investment promotion agency (IPA). FDI-led growth theories acknowledge that

information asymmetry and information costs pose real obstacles to ideal market

operation and FDI development. Investment promotion agencies are theorized to be able

to not only help coordinate a long-term strategy, but also help both LDCs and

transnational firms overcome information asymmetries. Investment promotion agencies

are tasked with researching investment opportunities, marketing the country abroad,

directly lobbying potential investors, assisting domestic producers connect with

international investors, training domestic actors, and lobbying the government on future

policy recommendations.43 An IPA’s job is highly specialized and requires highly skilled

technocrats and bureaucrats who not only design an appropriate strategy, but also

successfully lobby and persuade investors.44

To summarize, the initial neoliberal models argued that LDCs only way to

develop was to pursue sound economic policies and remove gross market distortions.

Theories of globalization then argued that transnational firms offered an ideal source of

needed capital and technology to spur development in LDCs. Finally, FDI-led

development theories argued that countries needed to follow two core, stability and long-

term strategy, goals in order to attract the necessary FDI and to utilize it for development.

As we will see in the next section, Costa Rica experienced first hand the failures of the

ISI model and thrived from FDI after structural adjustment, thus providing an ideal case

to analyze the validity of these theories.

The Costa Rican Case

Background

43 Morrissett and Andrews, pgs 32-4444 Moran, pg 29; Morrissett and Andrews, pgs 51-52.

Costa Rica shares many of the historical traits and pitfalls as many other Latin

American countries, yet it also possesses unique characteristics that have allowed it to

enjoy greater levels of political and economic stability. Like the rest of Latin America, it

was part of the Spanish Empire and its initial economy was designed around mono-crop

exports.45 Initially, Costa Rica served as a producer of cocoa for the other Spanish

colonies. Later, it switched to producing tobacco. Finally, in 1830, coffee and bananas

became its primary exports. This economic legacy remained largely unchanged through

the twentieth century, with the only United States replacing Spain as the primary

destination of its exports.46

However, unlike many other Latin American nations, Costa Rica avoided some of

the other, more vicious aspects of colonization. First of all, Costa Rica did not contain a

large indigenous population. It was situated on the outskirts of the Mayan and Olmec

civilizations, and was largely just a trading zone with no dominant group to enslave.47

Secondly, it lacked abundant extractable resources. These two factors allowed Costa

Rica to avoid many of the most destructive dynamics of racial subjugation and

environmental exploitation that many other Spanish colonies suffered.48 Most notably,

Costa Rica did not develop a plantation-based economy, but instead developed a more

egalitarian farming tradition, avoiding widespread inequalities in land and income

distribution.49 This has allowed Costa Rica to have one of the smaller disparities between

45 Klak, pg 73. 46 Cordero and Paus, pg 2. 47 Frederick Wherry, “Trading Impressions: Evidence from Costa Rica.” The ANNALS of the

American Academy of Political and Social Science 610 (March 2007): pgs221-22348 See Jorge Larraín, “Modernity and Identity: Cultural Change in Latin America,” in Latin

America Transformed: Globalization and Modernity 2nd ed., eds. Robert N. Gwynne and Kay Cristóbal, (London: Edward Arnold, 2004): pgs 24-25

49 Gary S. Fields, “Employment and Economic Growth in Costa Rica,” World Development 16 No.12 (1988): pg 1494

the rich and poor in Latin America.50 Only Uruguay and Bolivia have lower GINI

coefficients.51

Another unique aspect of Costa Rica is its relatively high levels of investment in

public goods. After the 1948 civil war, Costa Rica abolished its army, which allowed it to

spend considerably more on social goals, such as education, health care, and

infrastructure.52 For example, from 1958 to 2001, compared to the Dominican Republic,

Costa Rica regularly spent two to four times as much, as a percentage of GDP, on public

social spending, health care, and education.53 Also, Costa Rica ranks 43 on the Human

Development Index, which is quite high for a country of its size.rd Comparatively, the

worst HDI scores the region are in Haiti and Guatemala, at 146 and 120thth respectively

and the highest in score in the region is 31st in Barbados.54 Costa Rica has enjoyed

undisturbed democratic rule since 1948, has a strong tradition of the rule of law and

transparent legal structures, and a well-trained professional bureaucracy.55 This unique

Latin American experience contributed to Costa Rica having a much more peaceful

history than many of its neighbors, more stable political institutions, fewer ethnic

tensions, fewer class tensions, a better educated populace, better infrastructure, and a

much more positive image for foreign investors and politicians.iii

Finally, Costa Rica also sits in a strategically advantageous position. It lies close

to the US, has access to both the Pacific and Atlantic oceans. Thus, products can get to

50 Wherry, pgs 221-22251 Kelly Hoffman and Miguel Angel Centeno. “The Lopsided Continent: Inequality in Latin

America.” The Annual Review of Sociology 29 (2003): pg 366. 52 Paus and Cordero, pg 2; Lynn K. Mytelka and Lou Anne Barclay, “Using Foreign Investment

Strategically for Innovation.” European Journal of Development Research 16 No.3 (Autumn 2004): pg 548.

53 Diego Sanchez-Ancochea, “Development Trajectories and New Comparative Advantages: Costa Rica and the Dominican Republic Under Globalization.” World Development 34 No. 6 (2006): pg 997-999.

rd Klak, pgs 70-71.54 Klak, pgs 70-7155 Spar, pg 137.

the US from Costa Rica within hours by the air, and Costa Rica can easily ship products

to both Europe and Asia with ease.56

However, even given Costa Rica’s unique heritage, it has not been immune to

many of the macroeconomic dynamics that have plagued Latin America. Despite the fact

Costa Rica has a notably peaceful history for the region, Costa Rica remained

economically undeveloped and largely agricultural until the mid-1980s. For example, in

1960 63% of its labor force lived in rural areas while 50% of the labor force was engaged

in agriculture, as opposed to 11% in manufacturing, 10% in commerce and 17% in

services. Agriculture accounted for the largest sector of Costa Rica’s GDP at 26%, and

Costa Rica had a GNP of only $336 per capita. 57 Thus, Costa Rica was by no means

wealthier than the rest of the region.

Following World War II, Costa Rica embarked on an extensive Import

Substitution Industrialization (ISI) program similar to the rest of Latin America.58 Costa

Rica witnessed relatively strong economic growth, 6.5% annually, in the 1960s and early

1970s.59 Its ISI program, while still inwardly oriented, was regionally based. Costa Rica,

along with the other Central American countries created the Central American Common

Market (CACM). In the CACM, all the states created national industries though heavy

subsidies and protections. However, they then traded their industrial products freely with

each other. The only major exports, and consequently the only source of funding for their

ISI program, outside of the CACM remained primarily coffee and bananas. So even

though manufacturing had risen from 4% of Costa Rica’s exports to 29% by the late

1970s, 80% of those products were going to other CACM countries.60 This provided a

56 Paus, Foreign Investment, pg 160.57 Fields, pg. 149458 For a more in depth look at Costa Rica’s ISI strategy, see Fields, for a broad over view of the

general ISI model adopted in Latin America, see Klak. 59 Paus, Foreign Investment, 13760 Fields, pg 1494.

slightly larger market for Costa Rican industrial exports, but still a considerably small

one. This situation essentially amounted to a few small economies trading their

overpriced goods between each other without collecting the tariffs which were necessary

to finance the industry protections necessary for the industry to even operate. All the

while, the increased trade did nothing to change Costa Rica’s primary source of capital:

bananas and coffee.61

The combination of growing government spending, a ballooning foreign debt, and

a collapse in the prices of coffee and bananas led Costa Rica into a dire balance of

payments crisis in 1980.62 Coffee prices had seen a 45% drop. At the same time, their

foreign debt had increased 14-fold in the past decade. These two factors were

compounded by sky-rocketing interest rates on that debt and little currency reserves,

which left Costa Rica in a crisis of quickly decreasing income and quickly increasing

obligations. Costa Rica’s currency was also highly over valued, which exaggerated these

problems. Once the value of Colon was adjusted, its value compared to the US dollar

quickly dropped from 9:1 to 65:1. Furthermore, major political upheaval sent many of

Costa Rica’s CACM trading partners into disarray.63 By 1981, Costa Rica was forced to

put a moratorium on its international debt, inflation reached 90%, industrial production

dropped 44%, Gross Domestic Product (GDP) dropped by 9%, and unemployment more

than doubled from 4.6% to 9.5%.64

Neoliberal Reforms and Growth

By 1982, Costa Rica had hit rock bottom and needed to engage in a major

structural reform program. Costa Rica was facing a nearly identical situation as the rest of

61 Fields, pg 1494. 62 Paus, Foreign Investment, pg 138; Fields, pgs 1497-1498; Gwynne and Kay, pg 16-18.63 Fields, pgs 1497-1498. 64 Fields pgs 1498-1501

Latin America – skyrocketing debts, collapsed commodity prices, and uncompetitive

industries.65 Costa Rica and the rest of Latin America implemented a similar set of

reforms – the Washington Consensus. According to Morley, Machado, and Pettinato,

Costa Rica scored a .848 on the Washington Consensus reform index. The average Latin

American country scored a .821. In Costa Rica, the reform process began in 1982 with

the start of the Monge administration. Costa Rica’s reforms included three main

components—reduce trade barriers, reduce the size of the state, and encourage FDI.

In order to achieve the first two goals, Costa Rica lowered its tariffs from an

average of 60% in 1982 to an average of 5.8% by 2004. The next step was to reduce of

the size of the state. By the early 1990s, most state firms had been privatized, and in the

1990s, Costa Rica also downsized its civil service ranks and reduced its public

employment.66 The primary goal for drastically reducing the size and the commitments of

the state are to aid in macroeconomic stability. As the ISI experiment showed, persistent

debt and inflation caused by an over-extended state is disastrous. Since downsizing the

Costa Rican state, Costa Rica has been able to keep inflation under 10% and keep debts

under 3% of the GDP.67

Finally, since the early 1980s, Costa Rica has seen a strong and steady increase in

the amount of FDI entering the country. The main tools used to pursue this goal have

been the use of free zonesiv and the creation of an investment promotion agency to attract

investors. Free zones are designated areas where foreign corporations are initially exempt

from income taxes and are allowed to freely move products and capital in and out of the

country. In Costa Rica, free zones were responsible for the creation of 39,000 jobs. In

65 See Robert N. Gwynne and Kay Cristóbal, eds., Latin America Transformed: Globalization and Modernity 2nd ed., (London: Edward Arnold, 2004), Chapters 1-4.

Quoted in Paus, Foreign Investment, pg 140. 66 Paus, Foreign Investment, pgs 136-14267 Mirchandani and Condo, pg 338.

fact, employment in free zones doubled between 1997 and 2003, and free zones, on

average, provide wages 20% higher than non free zone jobs in similar sectors.

Furthermore, free zones have seen employment grow fastest in the highest skilled jobs

(see Table 2).

Table - Employment in Free Zones by Sector

1997 1998 1999 2000 2001 2002 2003 2004 2005

Machinery, electronic materials, and components

2,625 6,837 7,319 9,729 9,637 9,096 8,034 10,643 9,081

Services 3,654 4,186 1,320 1,372 2,631 3,922 5,463 6,985 8,577Textile, design, leather & shoe

8,296 9,887 11,331 9,086 12,211 11,963 9,718 7,689 7,517

Precision instruments & medical equipment

135 212 1,576 2,101 2,678 3,512 4,063 2,371 5,113

Agroindustry 454 683 1,072 1,841 2,459 2,512 2,632 2,982 3,171Plastic, rubber & their manufacture

65 223 967 1,009 887 977 1,003 1,568 1,593

Metal manufactures 22 397 416 363 755 384 650 740 893Chemical & pharmaceutical products

102 113 137 129 148 94 87 114 136

Agriculture & cattle 0 3 20 45 467 509 698 749 776Others 1,324 1,745 2,203 2,515 2,211 2,085 1,956 1,772 2,152Source: Cordero and Paus, pg 15. Data originally provided by PROCOMER. Emphasis added.

Free zone production was responsible for an annual average of $3.27 billion in

US$ between 2001 and 2006. Exports from free zone exports grew 81.2% between 2001

and 2006, from a gross total of $2.31 billion to $4.31 billion. Within the free zones during

2001 to 2006, from 66% to 72% of exports were in the high value sectors electronics,

precision instruments, and pharmaceutical industries, while the rest of exports (listed

from greatest to least by percentage) were textiles, services, agroindustries,

plastics, metals, and livestock (See Table 3).68 As expected by FDI-led-growth theories,

free zones were instrumental introducing industries that led to higher wages, higher value

exports, and increased economic growth. In fact, Costa Rica has the amount high-tech

production when measured by percentage of GDP in Latin America.69

68 Paus and Cordero, pgs 9-18. 69 Derek Hill, “Latin America: High-Tech Manufacturing on the Rise, but Outpaced by East

Asia.” InfoBrief (August 2002): pg 3.

Table - Exports in Millions of U.S. $ in Costa Rica’s Free Zones

2001 2002 2003 2004 2005 2006Machinery, electrical

materials & components

1218 1256 1789 1560 1878 2305

Precision instruments &

medical equipment

330 412 529 541 585 676

Agroindustry 97 204 246 307 336 337

Textiles, clothing, leather, and

shoes404 425 347 334 328 306

Services 106 128 143 147 172 222

Plastic, rubber & their manufactures

67 81 93 139 163 189

Chemical and pharmaceutical

products40 39 51 68 68 67

Metal products 33 30 34 48 57 76

Agriculture and livestock

18 21 27 25 23 20

TOTAL 2381 2665 3327 3242 3699 4314

Source: Cordero and Paus, pgs 10-11. Data originally provided by PROCOMER. Emphasis added.

One of the most important aspects of FDI attraction in Costa Rica is the

Coalición Costarricense de Iniciativas para el Desarrollo (CINDE), which is an extra-

governmental agency comprised by Costa Rican business men and external advisors who

make policy suggestions to the Costa Rican government, lobby foreign companies to

invest in Costa Rica, and provide find investment opportunities.70 CINDE’s role in the

planning of Costa Rica’s long-term strategy cannot be understated. CINDE was not only

primarily responsible from overcoming informational asymmetries between Costa Rica

and investors,71 it was also primarily responsible for designing Costa Rica’s electronics-

focused development plan.72 Due to lobbying performed by CINDE, Costa Rica has been

able to attract investment from such major firms as Intel, Baxter Healthcare, Abbott

Laboratories, Sensor Scientific, Motorola, Maersk Sealand, and others.73

Source: The World Bank Group/ Multilateral Investment Agency, pg 13.

70 Clark, Transnational Alliances, pg 8071 Nelson, pgs 11-12; Paus, Foreign Investment, pgs 165-172; Spar, pgs 15-16; 72 Cordero and Paus, pg 7 73 Nelson, pgs 13-14; Paus, Foreign Investment, pgs 165-168; Spar, pg 16;

Source: The World Bank Group/ Multilateral Investment Guarantee Agency

Table - Foreign Direct Investment by Year in Constant $US Millions

Table - Composition of Costa Rican Exports in 1985 and 2003

The most significant effects

of Costa Rica’s reform program

has been sharp increase in FDI

that began flowing to Costa

Rica in the 1980s and has

continued since then (See Table 4). Whereas in

the 1970s the country saw on average $ 44

million in FDI per year, the 1980s saw that

average rise to $70 million, the 1990s saw that average jump to $352 million per year,

and by the year 2002, Costa Rica saw $662 million in FDI enter the country. More

importantly, however, is that the majority of these FDI inflows were neither speculative

hot money, nor largely due to the privatization of industries. Much of the FDI flowing

into Costa Rica was concentrated in the industrial export sector (See Table 6). Under this

huge boom in investment, Costa Rica has been able to transition from a primarily

agricultural exporter to an exporter primarily in non-traditional exports and high-tech

exports (see Table 5). For example, between 1982 and 1992 coffee fell from 30% of

exports to 10%, bananas remained around 20-24% of exports, but non-traditional exports

rose from around 5% of GDP to 40%. This trend continued throughout the 1990s and

between 1997 and 2003, from 49% to 73% of FDI each year occurred in the industrial

sector. During this period, Costa Rica saw non-traditional exports came to further

The World Bank Group/ Multilateral Investment Guarantee Agency. The Impact of Intel in Costa Rica:

Nine Years After the Decision to Invest. (Washington D.C.: The World Bank, 2006): pgs 8-12.

dominate its export portfolio. The two primary exports, coffee and bananas, fell to a

combined 12.3% of exports by 2003. At the same time, although domestic industrial

exports fell from 27.3% to 17.3%, industrial and manufacturing exports from FDI

industries rose from 21.6% of exports to a staggering 60.5% of exports.74 Whereas in

1985 only 3.5% of exports were in high technology intensive sectors and 75% were in

primary commodities, by the year 2000, 34.3% of Costa Rica’s exports were in high

technology intensive sectors, while low technology industrial products were an additional

17.1% of exports and primary products and resource exports had fallen to 37.6%.75

Additionally, as of 2002, Costa Rica has the highest rate of research and development

spending in Latin America, which suggests that it will be able to continue attracting high

technology investment.76

Table - FDI Inflows by Sector in Millions of Constant US Dollars and Percentages

Sectors: Agricultural Industry Commerce Other Total

Total % Share Total % Share Total % Share Total % Share Total

1990 89.9 55.05 % 48.8 29.88 % -0.5 0.31 % 25.1 15.37 % 163.31991 108.4 61.76 % 32 17.94 % 9.6 5.38 % 28.4 15.92 % 178.4

1992 113.8 50.35 % 51.9 22.96 % 5.8 2.57 % 54.5 24.12 % 226

1993 81.9 33.20 % 98.3 39.85 % 12.4 5.03 % 54.1 21.93 % 246.71994 42.7 14.35 % 167.7 56.42 % 48.5 16.30 % 38.5 12.94 % 297.61995 48.4 14.37 % 186.3 55.30 % 21.2 6.29 % 81 24.04 % 336.91996 34.6 8.10 % 257.4 60.30 % 35.5 8.32 % 99.4 23.28 % 426.91997 38.1 9.36 % 270.6 66.50 % 17.6 4.33 % 80.6 19.81 % 406.91998 41.9 6.85 % 423.5 69.24 % 39.3 6.43 % 106.9 17.48 % 611.61999 49.9 8.05 % 355.9 57.54 % 9.2 1.49 % 204.5 33.01 % 619.52000 -11.2 -2.74 % 296.2 72.49 % 17.4 4.26 % 106.2 25.99 % 408.62001 1 0.22 % 231.4 51.01 % 8.3 1.83 % 212.9 46.94 % 453.6

74 All of these figures are originally from the World Bank, UNCTAD, and the Central Bank of Costa Rica, I obtained them from Paus, Foreign Investment, Paus and Cordero, and Mary A. Clark, “Nontraditional Export Promotion in Costa Rica: Sustaining Export-Led Growth.” Journal

of Interamerican Studies and World Affairs 37 No.2 (Summer, 1995): 181-223.

75 Paus, Foreign Investment, pg 15276 Hill, pg 3

2002 -8.6 -1.30 % 482.7 72.93 % 15.2 2.30 % 172.6 26.08 % 661.9

2003 -29.8 -5.08 % 356.5 60.74 % 0.5 0.09 % 259.7 44.25 % 586.9

Source: Mirchandani and Condo, pg 355.

Costa Rica’s Intel Plant

The most recognizable mark of achievement by Costa Rica was the choice in

1996 by the Intel Corporation to build a $300 million semiconductor assembly plant in

Costa Rica. The Costa Rican Intel plant has been an exhaustively studied phenomenon,

and it serves as an excellent anecdotal case for examining the success of Costa Rica’s

reform program and the FDI model itself.77 The main reason that the Intel plant attracted

so much attention was that Costa Rica was never viewed as a serious candidate until the

decision to invest there was announced.78 Intel built a 52 hectare-plant, which employs

around 2900 employees directly, with thousands of other indirectly created jobs. Intel has

continued to expand and invest further in the plant. The Costa Rican plant, by 2003,

assembled 22-25% of Intel’s total sales. Intel is estimated to have generated between $90-

200 million per year for Costa Rica’s economy.79

One of the most important aspects of Costa Rica’s attraction of Intel was the

signaling affect afterwards.80 After the signaling effect,’ Proctor and Gamble and Abbott

laboratories, who had also been considering investing in Costa Rica, were swayed to

invest.81 Just within the first two years of Intel’s presence, they attracted an additional ten

electronics companies to invest in Costa Rica.82 Furthermore, since the establishment of

the Intel plant, Costa Rica has seen concrete backwards linkages and spillovers occur. For

example, Intel’s list of local suppliers quickly grew to over 200 in the first two years.

77 See Spar, and The World Bank Group. 78 Spar, pg 8. 79The World Bank Group/ Multilateral Investment Agency, pgs 7-17. 80 World Bank Group/Multilateral Investment Agency, pg 9.81 The World Bank Group/Multilateral Investment Agency, pg s 9-10. 82 Mytelka and Baclay, pg 551

Furthermore, 63 different domestic firms provide essential electronics inputs. Even more

encouraging is the fact that Costa Rican companies that have arisen to provide sourcing

needs for Intel have expanded their clients and capabilities to be able to serve the other

electronics companies in Costa Rica, which will facilitate further electronics

investment.83

Technology and management technique spillovers have also occurred. Studies

have found that up to 35% of the domestic supplier firms received their training at Intel,

with 80% of that training occurring at Intel’s facilities, giving those employees access to

and experience in a world-class facility. Furthermore, around 18% of Intel’s suppliers

reported that they had altered business and production practices solely due to their

interaction with Intel.84

However, what is more instructive for the purposes of this paper is understanding

how Intel came to their decision to invest in Costa Rica. According to Intel executives,

Costa Rica’s stability and their long term investment strategy were the deciding factors in

their investment decision. The stability factors that convinced them to invest were their

confidence in Costa Rica’s future stability, their commitment to economic openness, and

the pro-foreign investment climate. Specifically, they noted Costa Rica’s long-standing

democratic governance, the ideological coherence and popular support for FDI-led

development and attraction that both the political elites and Costa Rican electorate

possessed, the transparent and reliable legal structure, and educated, competent civil

service were the explicit factors that Intel executives listed as their basis for trusting in

Costa Rica’s future stability.85 Furthermore, Costa Rican officials restrained from offering

bribes or other backdoor deals, which further spoke to Costa Rica’s stable and reliable

83 Mytelka and Barclay, pgs 551-552.84 Mytelka and Barclay, pgs 551-552. 85 Spar, pgs 12-18.

business climate.86 Costa Rica’s long-term investment strategy was also decisive in Intel’s

decision to invest. According to executives, they were particularly impressed by Costa

Rica’s singular focus on attracting investment in and fostering of the electronics sector.

Not only did Costa Rica possess a highly educated and bilingual population, it also

implemented technology classes in high schools and colleges to raise the technology skill

levels of its population. The programs were even geared to cater to industries as specific

as microprocessors.87

Another key aspect of Costa Rica’s strategy was the active role played by high-

level bureaucrats and politicians. Even President Jose Figueres would sit in on meetings

and offer his assurances of the concessions and agreements. Indeed the Costa Rican

negotiating team ensured Intel that they were all on the same page. This allowed the

Costa Ricans to respond to Intel’s concerns in a rapid and reassuring manner.88

The third key aspect of the attraction strategy that convinced Intel was that Costa

Rica was willing to make the necessary policy concessions to cater to Intel’s needs. Even

beyond Costa Rica’s free zone policy, Intel was worried over uncertainty in certain

provisions in the tax code. Costa Rica’s Attorney General offered a thorough policy

review and ruling, assuring Intel that they would not be affected by additional taxes.

Then, Costa Rica’s transportation department guaranteed that they would improve road

and airport infrastructure to meet Intel’s needs. Costa Rica also committed to building the

Intel factory’s own dedicated power plant and offered Intel a discounted rate on

electricity.89 Thus, as we can see Costa Rica’s attraction of Intel involved much more than

just lowering trade barriers. Even beyond free zone benefits, considerable investments in

86 Spar, pgs 12-18.87 Spar, pg 1488 Spar, pgs 15-19, Nelson, pgs 11-13. .89 Spar, pgs 15-19.

education, training programs, and construction of Intel specific infrastructure were all

required to persuade Intel to invest in Costa Rica.

However, the most important factor in attracting Intel’s investment was the

aggressive lobbying and coordination performed by CINDE.90 Once CINDE decided to

focus on attracting electronics investment, it began researching opportunities. CINDE

both made the initial contact with Intel and facilitated the interactions and negotiations

between Intel and Costa Ricans. Indeed, CINDE provided the “one-stop shop” for Intel’s

Costa Rican concerns and needs. More importantly, CINDE designed and promoted an

aggressive campaign to counter Intel’s concerns over Costa Rica’s size. For example,

Intel had concerns over labor laws. CINDE contacted Costa Rica’s Minister of Labor,

researched all the relevant labor laws, and then provided an extensive explanation which

assuaged Intel’s concerns. CINDE’s direct control over this process prevented lengthy

and costly attempts by Intel officials to try and navigate Costa Rica’s bureaucracy or

research the answer themselves. Furthermore, by CINDE’s control of this process, they

prevented miscommunication and confusion between Intel and Costa Rica.91 CINDE was

also highly active in domestic lobbying efforts. They organized an aggressive domestic

campaign by distributing strategic memos to key political players and even engaging in a

media campaign to prevent fears of potential exploitation.92 As we can see, there was

considerable information asymmetry between Costa Rica and Intel. Not only was Intel

initially not aware of Costa Rica’s potential benefits, there were also countless hurdles in

communication and information along the way. CINDE’s competent and expedient

90 Spar, pgs 15-18. 91 Spar, pg 16.92 Spar, pgs 15-16.

handling of these informational issues proved to be decisive attracting Intel to Costa

Rica93

Thus, in the interaction between Costa Rica and Intel we can see that Costa Rica’s

stability and long-term strategy were certainly key components in attracting FDI that lead

to beneficial spillovers and feedbacks. However, we also see that considerable

investments were required and considerable information asymmetries existed, which

CINDE was central in overcoming.

A Closer Look at Costa Rica’s Success

A cursory glance of both Costa Rica’s macroeconomic growth and its

microeconomic interaction with Intel strongly conforms to the expectations of the FDI-

led growth models. The combination of Costa Rica’s historical stability, once combined

with sound macroeconomic management allowed Costa Rica to attract high quantities of

FDI, which have seen Costa Rica move rather rapidly from a largely agricultural country

to a country with a dynamic electronics sector. However, a major part of the story has not

been told. External actors, namely the United States Agency for International

Development (USAID), played a key role in ensuring Costa Rica’s stability, and in

planning and funding its long-term strategy. USAID played a major role in providing the

monetary resources necessary to maintain stability and the informational resources

needed to plan and implement a long-term strategy. The combination of a long-term plan

and resources then allowed Costa Rica, through CINDE, to overcome informational

asymmetries and attract FDI.

Stability

Costa Rica’s long-term investments and notable stability have greatly improved

its investment potential and many aspects of its political stability are largely due to

93 Spar, pg 16.

endogenous factors. However, as noted earlier, the early 1980s was also a rather dire

time in Costa Rica’s history as well as for the rest of Central America. During the 1980’s

liberalization reforms and structural adjustment program, the United States played a

decisive role in ensuring Costa Rica’s continued macroeconomic stability. The United

States accomplished this through two main tools: direct aid money, which protected

Costa Rica from the most jarring aspects of structural adjustment, and ensuring Costa

Rica had a stable export market and continued steady investment.

As Nicaragua, El Salvador and Guatemala became engulfed in civil wars,

Costa Rica became central to the Reagan Administration’s anti-communist policies in the

hemisphere. In the words of the USAID director Daniel Chaij (1982-1987), Costa Rica

was to be the “beacon of democracy” in Central America. Between 1982 and 1990, Costa

Rica received $1.34 billion in US aid, which averaged out annually to 3.15% of Costa

Rica’s GDP during that time (See Table 7). At its peak in 1985, Costa Rica received $220

million, which was equivalent to 5% of Costa Rica’s GDP. Costa Rica used this huge

inflow of funds to pursue economic stabilization and to alleviate its balance of payments

crisis. This aid money allowed Costa Rica to exit the crisis of the

Table - U.S. Aid to Costa Rica, 1980-2001

Year Millions of current US$

Percentage of Costa Rica’s

GDP1980 15.9 0.6

1981 15.2 0.6

1982 51.8 1.6

1983 214.1 5.8

1984 169.8 4.31985 220.1 5.0

1986 162.7 3.6

1987 181.2 3.9

1988 120.3 2.3

1989 121.9 2.11990 95.3 1.3

Paus,Foreign Investment, pgs140-143; Clark, Transnational Alliances, pg 79

1991 44.9 0.5

1992 26.7 0.3

1993 27.6 0.3

1994 12.1 0.11995 6.2 0.1

1996 2.1 0.0

1997 0.1 0.0

1998 0.7 0.0

1999 1.1 0.02000 0.5 0.0

2001 0.5 0.0

Source: Paus, Foreign Investment, pg 141. Originally from USAID.

early 1980s much sooner than most other Latin American countries, and to avoid the high

social costs that other Latin American countries experienced during their periods of crisis

and structural readjustment.94

Furthermore, Costa Rica received enough aid from the US that it was able to

avoid the extensive involvement from the World Bank and International Monetary Fund,

whose policies have been largely

associated with some of the more jarring and negative aspects of structural adjustment

programs that many other Latin American countries engaged in.95 Since the bulk of Costa

Rica’s money was not coming from those institutions, it was able to avoid the

implementation of more severe shock therapy programs that they advocated.v For

example, instead of having to immediately open its financial sector, USAID allowed

Costa Rica to gradually liberalize, and not fully open up its domestic financial market

until 1992. Also during this time a considerable amount of US aid went into building up

Costa Rica’s domestic banking sector. Specifically, USAID gave the Costa Rican bank

BANEX a $10 million loan so that it could keep Costa Rican industries afloat, keep

coffee farmers exporting, and serve as a base for international exchange. With a better-

94 Paus, Foreign Investment, pg 14295 Klak, pg 77

supported financial sector, Costa Rica was equipped to handle liberalization, and avoided

hot money flows.

USAID also allowed Costa Rica to privatize its state run-industries gradually and

remove its industrial protections slowly throughout the late 1980s and early 1990s.

Another important aspect of US aid was that it was used for the “voluntary labor mobility

program,” which was a program that helped retrain and downsize Costa Rica’s public

sector employment in the early 1990s, as opposed to having to drastically and

immediately reduce the public sector in order to meet austerity requirements.96 Also, due

to US aid, Costa Rica was able to largely keep its social safety net and welfare spending

in tact.97 A final major expenditure of US aid money was to stabilize Costa Rica’s

northern border and limit turmoil spillover from Nicaragua.98 Thus, even though the

1980s were a turbulent time, US aid funded Costa Rica’s debt, allowed it to gradually

introduce structural reforms, and to slowly downsize its public sector. This was certainly

a far cry from the experience of many other Latin American countries in the 1980s, many

of which had to strictly meet austerity requirements and rapidly liquidate state holdings.

These sharp measures were often accompanied by a simultaneous raise in taxes in order

to meet fiscal austerity measures. Unsurprisingly, the combination of eliminated

industries, reduced social safety nets, and increased taxes proved to be incredibly jarring

to many Latin America societies. While the Washington Consensus reforms were often

harshly implemented, most states had little choice, since the ISI program had rendered

many states in Latin America nearly insolvent.99

Clark,Transnational Alliances, pg 80-8196 Paus, Foreign Investment, pg 142.97 Stephen Haggard and Robert F. Kaughman. Development, Democracy, and Welfare States:

Latin America, East Asia, and Eastern Europe. (Princeton, NJ: Princeton University Press, 2008): 291-292.98 Paus, Foreign Investment, pgs 137-143; Clark, Transnational Alliances, pgs 80-83. 99 Klak, pg 77

While it would be unrealistic to posit a counterfactual of Costa Rica having

collapsed without US aid, it is still fair to note that without US aid, Costa Rica would

have been in a much poorer position to capitalize on FDI in the 1990s without having

received so much assistance throughout the 1980s. Indeed, when heavy US aid decreased

and eventually stopped in the early 1990s after the US shifted its priorities away from

Cold War ventures, Costa Rica has had trouble running balanced budgets. While Costa

Rica has not been racking up egregious levels of debt, its continued budget deficits do

pose a risk to Costa Rica’s continued macroeconomic stability through creating

inflationary pressure with no easy remedies. Costa Rica’s social safety net and services

are salient issues, and attempts to reduce commitments have been met with strong

popular opposition.100 According to Eva Paus, there doesn’t appear to be a viable electoral

coalition that could negotiate the necessary fiscal adjustments.101

Furthermore, Costa Rica’s continued deficits have greatly reduced its ability to

continue investing in infrastructure, which, as evidenced in the necessary infrastructure

concessions made to Intel, is desperately needed to keep attracting high-tech

investment.102 In fact, Intel president Craig Barrett even criticized Costa Rica for its

failure to make continued necessary investments in infrastructure and education.103 Since

2000, according to Mirchandani and Condo, Costa Rica has seen its growth rate decline

and its regional advantages in high-tech electronics begin to erode.104

The second major tool that the US used to support Costa Rican stability in the

1980s was the Caribbean Basin Initiative (CBI). Under the CBI, the US eliminated tariffs

for most non-traditional exports for member states, and allowed for the re-importation of

Paus,Foreign Investment, pg 162. 100 Haggard and Kaufman, pg 292.101 Paus, Foreign Investment, pg 162.102 Mirchandani and Condo, pg 339103 Paus and Gallagher, pg 70. 104 Mirchandani and Condo, pgs 336-338

assembled US materials to only be taxed for the value added.105 The creation of the CBI

had major effects on Costa Rica. Not only did it make it easier for Costa Rica to sell its

products in the US, which is where 70% of Costa Rica’s exports went at the time,106 but it

also created strong incentives for US firms to invest in the Caribbean region. Under the

CBI, US firms could set up assembly plants, freely send materials and bring back finished

products, and only have to pay a duty on the comparatively cheaper labor involved in

assembling the products. Considering Costa Rica’s great dependence on the US market,

the CBI played a considerable role in making Costa Rica’s FDI strategy even feasible.

Without preferential trade treatment on non-traditional exports from the US, there

would have been much less incentive for many firms to invest in Costa Rica, regardless

of how beneficial the tax benefits were or persuasive the investment agency was, since

the savings would have been eaten away by tariffs. Thankfully for Costa Rica, the

benefits of the CBI have been continued under the current Central American Free Trade

Agreement (CAFTA), and there doesn’t seem to be any feasible reasons in the near future

for Costa Rica’s trade relationship with the US to change.107

Finally, even though Costa Rica’s dependence on the US has been decreasing, it

remains highly dependent on the US for its source of FDI, creating a risky situation. For

example, in 2003, 60.5% of FDI in Costa Rica came from the US. Mexico and Canada

were second and there, with a mere 7% and 5.75%, respectively.108 If the US, for some

reason decided to alter Costa Rica’s favorable trade status, that would almost certainly

have disastrous effects for Costa Rica, regardless of any endogenous Costa Rican factors.

Long-Term Attraction Strategy

105 Paus, Foreign Investment, pgs 142-143. 106 Clark, Nontraditional Export Promotion, pg 205107 Daniel P. Erikson, “Central America’s Free Trade Gamble.” World Policy Journal 21 No. 4

(Winter 2004/2005): pgs 19-21108 Mirchandani and Condo, pg 354.

The most important aspect of an FDI-led development strategy is to implement an

appropriate long-term strategy to boost the utility of FDI investments and increase

spillovers and backwards linkages. However, before these linkages can occur,

information asymmetries between investors and the host country must be overcome. In

Costa Rica, the IPA CINDE was the primary designer of Costa Rica’s strategy and

primary lobbyer of investors. Indeed, it was the central player in overcoming

informational asymmetries. CINDE, however, was not truly a Costa Rican agency. In

reality, it was a foreign creation, was predominantly foreign ran, and was primarily

foreign funded.109 While Costa Rican business and political elites were not non-existent

or purely passive actors, the high degree of involvement by USAID is a remarkable fact.

Furthermore, with the decline of USAID involvement, CINDE’s attraction capabilities

also declined.

The story of the success of CINDE cannot be told without acknowledging the

primary role that USAID played in its creation and operation. As was noted above,

CINDE is a private, not government run, agency. For the first nine years of its existence,

CINDE was entirely funded by USAID, not the Costa Rican business community or

government.110 Even after the eventual withdrawal of USAID from Costa Rica, a

considerable amount of its funding remains based in an endowment set up by USAID,

Fundación de Exportaciones (FUNDEX).111 To be clear, the private nature of CINDE has

actually been an asset in many ways for CINDE and Costa Rica. Its autonomy and

diverse make up of consultants and Costa Ricans have kept it from being entangled in

special interests, and CINDE has been able to maintain a strong image of independence

109 Clark, Transnational Alliances, pg 79-91.110 Clark, Transnational Alliances, pg 89111 Clark, Nontraditional Export Promotion, pg 202.

and competence to foreign investors.112 As Morrissett-Andrews argue, the independence

of an IPA is directly correlated with greater attraction capabilities.113 Furthermore, Intel

executives also noted CINDE’s independence as a positive in their negotiations.114

However, the reality remains that the operational capability of CINDE was

directly linked to its amount of funding. Its amount of funding was solely determined by

USAID expenditures. The reduction of USAID funding resulted in immediate contraction

of CINDE’s capabilities. CINDE was established in 1983 with a grant of $21 million and

had annual operating budgets from $4 million to $8 million during most of the 1980s. At

its peak, CINDE had a staff of 400 and could afford to hire many of Costa Rica’s most

talented officials. After the loss of direct US funding in 1991, its annual budget decreased

to $1.5 million, which was primarily from FUNDEX grants. It reduced many of its

training programs, decreased its staff all the way to 29, and closed all of its foreign

offices except for its New York office.115

The loss of foreign offices is particularly detrimental. Without them, Costa Rica

has greatly reduced its abilities to make contact with new potential investors, its ability to

compete with other sites of FDI, and the ability to find new markets for Costa Rican

exports. Foreign offices play a key role in overcoming information hurdles. Even though

these are considerable losses neither the government nor any private entity in Costa Rica

has been thus far willing or able to replace the loss of external funding and maintain the

level of access and benefits the foreign offices provided.116 Thus, CINDE has many fewer

resources to continue attracting high value FDI. With the loss of USAID funding, CINDE

112 Nelson, pgs 11-12; Paus, Foreign Investment, pgs 164-166.113 Jacques Morisset and Kelly Andrews-Johson, FIAS Occasional Paper 16: The Effectiveness

of Promotion Agencies at Attracting Foreign Direct Investment. (Washington D.C.: The World Bank, 2004): pgs 1-6, 47-51

114 Spar, pg 16. 115 Paus and Cordero, pg 3.116 Clark, Nontraditional Export Promotion, pg 203.

has not only lost its foreign offices, but it has also lost strategy planning capabilities. With

its smaller budget and staff, CINDE has had markedly fewer resources to develop a full-

fledged FDI strategy and invest in ensuring that strategy’s fulfillment.117

Interestingly, the scarcity of monetary resources has been problematic for Costa

Rica’s development in the past as well. Costa Rica had started its own investment

promotion agency back in 1968, Centro de Promociones de Exportaciones e Inversiones

(CENPRO), which was a resounding failure. Beyond CENPRO’s crippling internal

political divisions and incoherent strategy, one of CENPRO’s major limitations was its

low budget and inability to attract high skilled employees or consultants. Since CENPRO

could only offer meager public salaries, it couldn’t afford to hire top quality business

people out of the private sector. Even more impossible was the prospect of CENPRO

hiring foreign consultants.

Even after the lead and generous external funding of CINDE, the Costa Rican

government has had trouble further funding other necessary initiatives to their

investment-attraction strategy. A specific example of this is the Costa Rican Proveé

(CRP), which was founded in 2001 with the goal of helping increase backwards linkages

and spillovers by researching how to create additional local sourcing opportunities. Even

though CRP was officially part of the Costa Rican government, it also required external

funding from the Inter American Development Bank and CINDE to be created and run.

Although CRP has been responsible for the creation of 140 new linkages, it only has a

staff of seven and an annual budget of $275,000. Since it only has the funds to act in an

advisory capacity, it has been unable to make a larger impact. Many small Costa Rican

117 Paus, Foreign Investment, pgs 165-167. Clark, Transnational Alliances, pgs 88-89. Paus and Gallagher, pgs 68-69.

businesses that have been targeted as possible linkages have been unable to receive the

loans necessary to transform their businesses and create linkages.118

Thus, with the loss of US aid, Costa Rica has seen a strategy wide reduction in

capabilities. This is not surprising considering two realities of Costa Rica’s strategy. First,

as noted above, it was created with external resources. Second, Costa Rica’s main

destination of FDI, free zones, creates no new tax revenues to fund these new programs

and skill and infrastructure investments. The Costa Rican government’s tax base has

remained around 11-13% of its GDP119. Thus, even though Costa Rica has seen increased

investment and exports, it has not been able to change its tax base or find new sources of

revenues. However, even though foreign exchange has increased, Costa Rica’s attraction

policies have actually caused their tax revenues from foreign exchange to decrease. As a

share of total tax revenues, international exchange has decreased from 35% in 1987 all

the way to 8% in 2004.120 Obviously, trade liberalization was a key component of Costa

Rica’s ability to attract more investment which would necessitate a decrease in some

revenues. However, if the Costa Rican government can not find ways to obtain revenue

from the increased economic activity, the country will be unable to continue invest in the

necessary human capital and infrastructure that attracted investors to the country in the

first place. Eva Paus, who has offered the most extensive critiques of Costa Rica’s

attraction strategy, argues that between Costa Rica’s 13% of GDP tax revenue and

CINDE’s $1.5 million budget, there are not enough resources to implement an effective

and long-term investment attraction policy and adequately invest in infrastructure and

educational resources.121

118 Paus and Gallagher, pgs 68-69.119 Cordero and Paus, pg 13; Paus and Gallagher pg 70.120 Cordero and Paus, pg 11, Paus, Foreign Investment, pgs 170-171, 121 Cordero and Paus, pg 13; Paus and Gallagher pg 70

Even beyond funding, informational resources are also a major issue in designing

a long-term investment attraction strategy. Information refers to gathering all the

information and input required to develop the initial investment strategy as well as the

ability to effectively adjust it. This requires both a full assessment of the capabilities and

strengths of the host country for investment opportunities, as well as researching potential

investors and finding the right combinations, then planning the appropriate policies to

pursue their findings. This was bore out in CINDE’s courting of Intel and its ability to

overcome the informational asymmetries between the two.

Even beyond the cost of the interactive process, a fundamental assumption of the

FDI model is that inefficient business practice and ignorance of the practices of

international markets inherited from the ISI model was a primary obstacle to economic

development in LDCs. One of the main reasons that FDI is believed to be the solution is

because of its supposed introduction of efficient business practices and models along with

its ability to force a country to learn to compete at the international level. This raises the

logical question of how solely domestic actors in the LDC would be able to properly

conceive of an appropriate FDI attraction strategy.

In the case of Costa Rica, not only was CINDE funded by USAID, it was also

entirely conceived and, for the first three years of CINDE’s existence, run by the Costa

Rican office of USAID.122 In fact, CINDE was an entirely new project. CINDE was the

largest, private-sector business promotion project that USAID had ever attempted up until

that point. Of course, CINDE quickly incorporated many significant Costa Rican actors.

In fact, CINDE’s recruitment of many prominent Costa Ricans is a main reason that

CINDE was able to achieve legitimacy within Costa Rica and to foreign investors.123

122 Clark, Transnational Alliances, pgs 89-90123 Clark, Transnational Alliances, pg 81-82.

However, the entire initial structure and strategy was developed through USAID officials

hiring outside consultants who advised USAID and Costa Rican businesspersons on how

to design the program. According to internal memos, neither Costa Ricans nor the US

officials knew exactly how they were going to develop a diversified, export-led economy

in Costa Rica. Thus, the major strategy that USAID followed was to hire top-quality

business consultants to come in and evaluate Costa Rica and provide input on the

investment strategy.

Even more interesting is that CINDE underwent a major redesign in 1985 because

of pressure from Washington for quicker results.124 CINDE again went on a spree of

hiring foreign consultants. Actually, for the next seven years, foreign consultants were

paid by USAID to manage CINDE. The main assets the Costa Ricans provided were their

opinions on domestic matters, local lobbying, and added prestige to the program. All

important planning and training programs were under the direction of foreign consultants,

who were on the dime of USAID.125

In the case of Costa Rica, external resources were central to the success of the

FDI-led growth that has occurred. Not only did external aid help maintain a stable

investment climate, it also was primarily responsible for allowing Costa Rica to

overcome information asymmetries with investors.

Discussion: How Affordable Is an Investment Promotion Strategy?

The experiences of Costa Rica indicates that FDI-led development theories have

problematically omitted the key issue of resources, both monetary and informational,

necessary to overcome informational asymmetries between potential host countries and

investors. Even though the FDI-led model keeps private actors and market forces central

124 Clark, Transnational Alliances, pg 88.125 Clark, Transnational Alliances, pgs 84-86

to development, and the state’s new role in designing a long-term strategy is far less than

the ISI model’s entire fabrication of industries, investment attraction measures require

access to considerable monetary and informational resources. In theory, a government

should be able afford to create and staff an investment agency, make some concessions to

influence investors, and increase investment in human capital and infrastructure.

However, the reality remains that states that are small, trade dependent, under developed,

and who were in many cases rendered insolvent in the 1980s, are not likely to be able to

afford such an extensive and dynamic program. This is especially true since the task of an

investment agency is enormous, education and infrastructure are not cheap, and

concessions can cause the forfeiting of new revenue sources.

There are three key characteristics of the world economy and LDCs that should

either be incorporated into the literature of FDI-led growth or that suggest the limited

applicability FDI-led growth. The first is the structural constraints of LDCs. The second

is the lack of and the high cost of credit for LDCs. The third is the limited nature of

investment opportunities. These three realities work together to place major constraints

on LDCs and their ability to afford to attract FDI investment.

First, most LDCs are small, on the periphery of the world economy, and are

largely trade dependent. Furthermore, many of them have both problematic colonial

heritages and suffer from the effects and distortions of ISI programs. In other words, most

of them do not have a booming industrial tax base or very much domestic capital

resources. It is not likely for a country with a relatively small and unproductive tax base

to be able to embark on an extensive investment promotion strategy, infrastructure

investment, and skill investments. As the ISI-induced balance of payments crises showed,

smaller LDC states do not operate in a world where the state can just create money. The

limited economic activity in many LDCs puts real limits on state capacity. The

experience of Costa Rica suggests that many countries will not have the state capacity to

embark on an extensive FDI attraction policy since Costa Rica itself is a most-likely case

to be able to succeed.

Second, even if states do not have a large pool of domestic resources, it should

theoretically be able to attain credit. However, as has been shown by authors like Robert

Wade and Erik Wibbels, LDCs have far fewer international credit options and limited

internal currency manipulation ability. Robert Wade argues the international credit market

is not structured in the interests of LDCs.126 He argues that when the US left the Gold

Standard in the 1970s the world economy was flooded the with US currency. This excess

currency chases too few actual goods, resulting in destructive speculation bubbles and a

marked increase in the world’s financial volatility. Since all currencies float against each

other, Wade argues, this has created a currency competition. The only way smaller

countries can get investors to buy their currency is through offering high interest rates.

This has the de facto effect of making the price of debt for LDCs much higher than for

the US or other developed nations.

Not only is government debt more expensive for smaller countries (which on top

of that have smaller economies and tax bases to be able to generate the revenues needed

to pay back debt) Erik Wibbels demonstrates that structural factors (the limited economic

development and limited exports of LDCs, the lack of credit available for LDCs, and the

use of interest rates to attract capital) has much greater affects on a peripheral countries

ability to make political choices and choose between long-term and short-term goals in

economic crises, as opposed to core countries. By looking at records of state spending,

126 Robert Wade. “Choking the South.” New Left Review 38 (March/April 2006): 115-127. Erik Wibbels, “Dependency Revisited: International Markets, Business Cycles, and Social

Spending in the Developing World,”International Organization 60 (Spring 2006): pgs 433–468.

Wibbels makes four key findings: First, he demonstrates that exogenous shocks create a

much larger loss of revenues for peripheral countries as opposed to core countries.

Second, he finds that external circumstances are the cause of the majority of peripheral

countries economic shocks. Third, he finds that the costs of economic crises are much

higher for peripheral countries. Fourth, he finds that social spending in peripheral

countries is pro-cyclical and that only core countries can afford to spend counter-

cyclically during crises. For this paper’s purposes, the last finding is the most important.

Since peripheral countries cannot afford to spend counter-cyclically, which means that

they are least able to engage in a long-term FDI strategy in the times when they would

need to the most. If countries have to spend pro-cyclically, then they are likely to only be

able to afford the luxuries of investing in FDI attraction during economic booms. The

flip-side to this, Wibbels argues, is that economic crises force countries to choose short-

term over long term goals. Also, Wibbels demonstrates that in periphery countries, social

security spending was more stable, while human capital investments were much more

procyclical. Again, this means the constant investment in skill and infrastructure

upgrading that transnational firms require of investment sites can only be done during

economic booms. When crises occur, social safety nets are a much more significant

political liability than long-term infrastructure investments. These realities are even

further magnified when considering that peripheral countries are much more affected by

the economic crises that they have much less to do with creating.

The third major limitation of the FDI-led strategy is the limited nature of

international commerce. Even though international commerce has greatly increased in

recent decades, two key facts should be pointed out. First, even though more companies

are expanding abroad, the vast majority remain nationally based and focused. As Robert

Gilpin and Robert Boyer have argued,127 international trade is actually at much lower

levels today than it has been in the past, particularly the end of the nineteenth century.

The only international commodity that really has seen a huge boom is finance. Second,

most transnational firms are actually products of unique market imperfections and state

created incentives. Thus, the current confluence of incentives and policies that have made

global expansion profitable for some firms isn’t a guaranteed facet of the future economy,

nor is it necessarily a natural progression or even a rapidly growing trend currently. Thus,

while not to discount the potential benefits of FDI investment, the amount of FDI

investment that is available for attraction is not an infinite resource.

These three characteristics, along with the case study of Costa Rica, in my

opinion, have two possible implications for other countries seeking to attract FDI in order

to pursue economic development. First, many under-developed, periphery countries are

not only dependent on core states as trading partners, but are also more dependent than

previously recognized in the FDI literature on them for the resources and information

required that could lead to necessary economic development. If this dependence is the

case, then a successful development model would need to explicitly incorporate

international relations theories into their model in order to better understand actual

development trajectories. Only when core states were compelled to provide resources

would they be available for under-developed countries to use.

The second possible implication is a new source of resources for funding and FDI

attraction strategy should be found. Outside of external aid and assistance, the most likely

alternate source for these resources would be the discovery of significant extractable

127 Robert Boyer, “Globalization Myths and Realities: One Century of External Trade and Foreign Investment,” in Robert Boyer and Daniel Drache. States Against Markets. (New York: Routlege, 1996);Gilpin, pgs 278-304.

natural resources. However, even then, the country would have to avoid the large pitfalls

involved in the ‘resource curse,’ and then use the monetary assets to appropriately acquire

the necessary informational resources that would allow them to overcame information

asymmetries with investors. Furthermore, the viability of endogenous funding has not

been conclusively disproved. It is yet to be seen if generous tax breaks are vital to

investment attraction. For example, Biglaiser and DeRouen, Jr., find that tax reforms

were not a significant predictor in a large-N study on FDI investments.128 Furthermore,

Moran disputes the necessity of tax breaks to attract investors.129 Thus, it is feasible that a

self-sufficient FDI attraction policy can be designed.

However, if resources and information are largely exogenous to under-developed

countries, the more likely implication is that the political and strategic actions of the

external actors who possess the necessary resources (namely core countries) are an

important determinant of which countries have the possibility of achieving development.

The most likely option in this scenario would be to factor in a country’s ability to attract

foreign aide, as well as FDI, would need to become a central part of a country’s

development strategy. The most likely solution, especially in light of the Costa Rican

case, appears to be incorporating international relations understandings into

developmental theories. Specifically, hegemonic stability theories seem to hold particular

promise. As was shown earlier in the paper, aid money and, consequently, CINDE ability,

rose and fell roughly along with the US’s interest in anti-communist policies in the

region. With the loss of US interest and aid, Costa Rica has lost ground in utilizing FDI.

Furthermore, another pertinent example is the 1960s Dominican Republic. At the time,

For a discussion of the ‘resource curse’ and an investigation of how natural resources affect economic development, see Edward Barbier, Natural Resources and Economic Development, New York: Cambridge University Press, 2005

128 Biglaiser and DeRouen, Jr., pgs 59-69. 129 Moran, pg 30.

the Dominican Republic received more aid than Southeast Asia. Indeed it was the

destination of the most US aid of any country because of the US’s strong concerns over

Cuba at the time.130 However, as the US’s anti-communist policies shifted more focus on

Vietnam from Cuba, aid priorities shifted. However, the Dominican Republic lacked

political and macro-economic stability during the time and was unable to utilize the large

inflows of aid as affectively as some of the Southeast Asian Tigers. Obviously, much

more investigation would be required to adequately assess this model.

Conclusion

In the case of Costa Rica, it went from being a relatively peaceful, but under-

developed, Latin American state trapped in a balance of payments crisis in 1980, to being

a high-tech exporter and prime example of how development through FDI is supposed to

occur.131 While domestic factors such as Costa Rica’s legacy of democracy, stability, rule

of law, investments in education, which were certainly vital factors in determining a

transnational corporation’s choice of which country to invest in, the case of Costa Rica

suggests that those factors are not the only ones that explain the process of FDI led

growth. A vital component to Costa Rica’s success was heavy assistance and involvement

by external actors, namely USAID, which provided the bulk of the monetary and

informational assistance required to maintain macroeconomic and political stability,

design a long-term plan to attract high-value FDI, and overcome informational

asymmetries with investors.

To be clear, the policies of USAID were not exploitative, surreptitious, or coerced

on Costa Rica. CINDE was a private, extra-governmental organization, and it only held

the power of influence. By all accounts, the Costa Rican government determined its own

130 Andrew Shrank, “Foreign Investors, Flying Geese, and the Limits to Export-Led Industrialization in the Dominican Republic,” Theory and Society 32 No.4 (August, 2003): pg 423.

131Moran, pg 30

policies, even though it held CINDE’s opinion in high regard. For example, in the

negotiations with Intel, Costa Rican President Figueres was present at most meetings and

heavily lobbied Intel to invest, as well as personally ensured that necessary concessions

could and would be made.132 The Costa Rican government certainly preferred the FDI

model and sought to utilize it to its advantage. What must be noted, though, is that the

majority of the resources, monetary and informational, that Costa Rica utilized to

promote investment and spur growth were external to Costa Rica. Even though Costa

Rica ultimately set its own policies (and judging by their economic performance over the

past twenty years, they choose well), it had access to resources and information that

would not have been available unless the United States had not taken such an active

interest in Costa Rica.

The experience of Costa Rica’s development stands in contrast to the theoretical

models of FDI-led development. These models and theories only investigated which

policies would lead to the most beneficial growth. They did not investigate the costs or

feasibility of these policies. While Costa Rica did experience the growth and benefits

stipulated by the theories, by incorporating the true costs of these policies into these

models, they appear to have a much more limited applicability.

End Notes:

132 Spar, pgs 15-18.

i For example, according to UNCTAD, between 1991 and 2001, out of 1,395 changes made to investment regimes, only 80 were adverse to FDI strategies. ii There is still a considerable debate over whether the key failures in Latin America under the ISI model were due to the role that the state played or just the inward orientation of the development policies were key. Scholars on East Asian development have argued that the key to the successful development of East Asian countries was the combination of an active state and an outward or export orientation. Others have argued that the role of the developmental state in East Asia is exaggerated and that sound fundamental policies were the sole reason for economic development. For a more extensive discussion on this topic, see Gilpin, pgs 305-340 and Gwynne, pgs 39-54. iii One interesting note about foreign perception of Costa Rica is that it was perceived as a white and ‘civilized’ country, as opposed to other Central American and Costa Rican countries, which were viewed a corrupted by the indigenous and African ancestries. For example, while General Leonard Wood of the United States Army was arguing that the black nature of Cuba negated the possibility of democratic rule in the country. Around this same time, US President William Taft upheld Costa Rica as the “Switzerland of Central America.” Costa Rican elites actively promoted and exploited the perception of a white Costa Rica through an extensive racial campaign that could be seen as the countries first promotion investment program. For more on this, see Wherry, pgs 217-231. While the goal of this paper is not to investigate racial issues, the perception of Costa Rica as a Europeanized nation, as opposed to its ‘barbaric’ neighbors has certainly been an asset. The highly racialized lens that both American and Spanish legislatures viewed the Latin America with has had immeasurable effects on the development of the region. For more on this, see author’s like Alejandro de la Fuente, Peggy Lovell, and Edward Telles. iv Costa Rica implemented multiple different programs of investment attraction set ups. Free-zones were the most successful. The other two were drawbacks and export contracts. The drawbacks and contracts were more costly than the free zones and saw much more limited spillover effects. By 1996, only the free zone program remained. See Clark, Nontraditional Export Promotion, pgs 193-201. v The rapid implementation of Washing Consensus reforms and the dismantling of the ISI institutions were often called ‘shock treatment.’ The reforms necessitated eliminating state budgets, which resulted in a huge reduction in many states’ social safety nets, the removal of industry protections, and a drastic reduction in the public workforce. The removal of protections and slashing of the public sector quickly led to large jumps in unemployment. These sharp measures were often accompanied by a simultaneous raise in taxes in order to meet fiscal austerity measures. While the Washington Consensus reforms were often harshly implemented, most states had little choice, since the ISI program had rendered many states in Latin America totally insolvent, and Latin American firms uncompetitive Shock treatment is especially associated with the IMF, who often required countries to engage in shock treatment reforms in order to receive desperately needed loans. For a discussion of IMF and World Bank policies, see Stiglitz, v Naomi Klein provides an extensive look into a broad range of cases where, under the IMF and World Bank’s tutelage, crises were used to leverage immediate reduction in protective trade barriers and fire sales on state assets, and the high costs of those policies.

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