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 allowe