Tutt- Master's Thesis- Final

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Over the last 15 years, Costa Rica has experienced strong growth in its overall economy, and particularly in its nontraditional-export sector

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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 PoliticsNew 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, USA2009Abstract: This paper investigates Costa Ricas 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 Ricas 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 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 ContentsHYPERLINK \l "_Toc247707354" Introduction- 1 -HYPERLINK \l "_Toc247707355" The Link Between FDI and Development- 6 -HYPERLINK \l "_Toc247707356" Spillovers, Linkages and Development- 9 -HYPERLINK \l "_Toc247707357" FDI, Stability, and Strategy- 12 -HYPERLINK \l "_Toc247707358" The Costa Rican Case- 17 -HYPERLINK \l "_Toc247707359" Background- 17 -HYPERLINK \l "_Toc247707360" Neoliberal Reforms and Growth- 21 -HYPERLINK \l "_Toc247707361" Costa Ricas Intel Plant- 27 -HYPERLINK \l "_Toc247707362" A Closer Look at Costa Ricas Success- 31 -HYPERLINK \l "_Toc247707363" Stability- 32 -HYPERLINK \l "_Toc247707364" Long-Term Attraction Strategy- 37 -HYPERLINK \l "_Toc247707365" Discussion: How Affordable Is an Investment Promotion Strategy?- 43 -HYPERLINK \l "_Toc247707366" Conclusion- 49 -HYPERLINK \l "_Toc247707367" End Notes- 50 -

List of Tables and Figures

HYPERLINK \l "_Toc247707836" Table 1 - Distribution of Global FDI Inflows, 1970-2000- 5 -HYPERLINK \l "_Toc247707837" Table 2- Employment in Free Zones by Sector- 23 -HYPERLINK \l "_Toc247707838" Table 3- Exports in Millions of U.S. $ in Costa Ricas Free Zones- 24 -Table 4- Foreign Direct Investment by Year in Constant $US Millions ...- 24 - Table 5- Composition of Costa Rican Exports in 1985 and 2003...... - 25 - HYPERLINK \l "_Toc247707839" Table 6- FDI Inflows by Sector in Millions of Constant US Dollars and Percentages- 27 -HYPERLINK \l "_Toc247707840" Table 7- U.S. Aid to Costa Rica, 1980-2001- 33 -

List of AbbreviationsCACM Central American Common MarketCAFTA Central American Free Trade AgreementCBI Caribbean Basin IniativeCENPRO Centro de Promociones de Exportaciones e Inversiones.CINDE - Coalicin Costarricense de Iniciatvas para ed DesarrolloCRP Costa Rican ProveECLA- Economic Commission on Latin AmericaFDI foreign direct investmentFUNDEX - Fundacin 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

IntroductionOver 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. Robert N. Gwynne and Kay Cristbal, Latin America Transformed: Globalization and Neoliberalism. In Latin America Transformed: Globalization and Modernity 2nd ed., eds. Robert N. Gwynne and Kay Cristbal, (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 Cristbal, eds., Latin America Transformed: Globalization and Modernity 2nd ed. (London: Edward Arnold, 2004): pgs 77-84 Costa Ricas 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. Eva Paus, Foreign Investment, Development, and Globalization: Can Costa Rica Become Ireland? (New York: Palgrave Macmillan, 2005), 135-143. 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. 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) 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. 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. 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 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 Ricas growth. 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 531-555Debora Spar, FIAS Occasional Paper 11- Attracting High Technology Investment: Intels Costa Rican Plant. (Washington D.C.: World Bank, 1998): pg 13 While these endogenous factors have certainly played a key role in Costa Ricas 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 countrys 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 received from the US government, Costa Ricas successful investment strategy would have, at the worst, never existed or, at least, not have been nearly as successful. 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. 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. For an overview of Latin Americas experiences with liberalization reforms see Robert N. Gwynne and Kay Cristbal, eds., Latin America Transformed: Globalization and Modernity 2nd ed., (London: Edward Arnold, 2004), Chapters 1-4. Many countries in Latin America started from roughly similar circumstances, followed roughly similar liberalization programs and have seen booms in investment. Gwynne and Kay, pg 12. 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. 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 263Daniela Magalhes 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 Many countries in Latin America were only able to liberalize their economies, Costa Ricas massive inflow of external aid money allowed it to construct a much more elaborate attraction policy. Clark, Transnational Alliances, pgs 71-94. 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 area Klak, pg 69.) seeking to achieve developmental gains through an FDI strategy (which remains the current paradigm for development for a majority of developing countries 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. ). 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. 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. Gilpin, pgs 289-290; Klak, pg 78, Paus, Foreign Investment, pgs 3-5. Table 1 - Distribution of Global FDI Inflows, 1970-2000

1970198019902000Total 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)Developing Countries (China not included)

C...