San José, Costa Rica, since 1956

Economy Experienced Banner Year

It was a banner year for the Costa Rican economy.

All the important macroeconomic indicators went up, except for the bad ones, which went down. Exports broke records, gross domestic product (GDP) growth continued between 6-7% and unemployment numbers remained in the basement.

Not all was blue sky, however.

Even as overall poverty went down, the gap between the rich and the poor in Costa Rica increased. Likewise, tied up as it was with the debate over the Central American Free-Trade Agreement with the United States (CAFTA), the government failed to make important reforms to overhaul the country’s tax system and cut down red tape to increase the country’s competitiveness in the region.

The CAFTA debate did perhaps more than anything else to raise the country’s consciousness of how important international trade has become for the Costa Rican economy, and 2007 was perhaps the best example yet of that trend.

While debate raged in the political arena, the country’s exporters quietly worked to export more than $9 billion worth of goods, about a 15% increase compared to 2006. Foreign direct investment showed signs that it would outstrip the almost $1.5 billion the country pulled down the year before.

Costa Rica’s free zones – which account for 52.6% of the country’s exports – continued to be threatened by World Trade Organization (WTO) rules that prohibit giving special incentives to export manufacturers.

They received yet another reprieve this year, however, when the WTO voted again to extend the grace period for developing countries such as Costa Rica – this time until 2010.

In any case, in the medium term it may not matter. Costa Rica’s free zones are increasingly focusing on services rather than manufacturing. Three new serviceoriented free zones opened their doors just this year.

Manufacturing, however, still remains a focus, and in fact this year the country’s most prestigious free-zone tenant – the Intel factory – celebrated its 10th anniversary in Costa Rica as it accounted for the vast increase in the country’s exports to its new trade partner, China.

During 2007, the relationship with China warmed to the point that China went on to hold its first ever trade expo in Costa Rica (see separate story).

Also in the foreign trade arena, Costa Rica signed a free-trade agreement with Panama in August.

Even with the warming trade ties between Costa Rica and Panama, relations with the rest of the region hit a snag when Costa Rica declined to sign on to the Customs Union framework agreement until after CAFTA was voted on in the October referendum. The framework was another step toward standardizing tariffs schedules and import taxes among Guatemala, Honduras, El Salvador, Nicaragua and Costa Rica, something the European Union had requested to begin negotiating an association agreement.

Costa Rica signed on to the agreement in late October, after the country approved CAFTA (see separate story on page Y3).

Talks between Central America and the European Union began soon after (see separate story on page Y8).

The Central Bank’s goal to reduce inflation to 8% this year hit a snag thanks to high international prices of oil and foodstuffs like wheat, rice and corn. As of October, 12-month period inflation was up above 9%.

Central Bank president Francisco de Paula Gutiérrez noted, however, that while the consumer price index – that is, the inflation index that concerns average people – was above the Central Bank’s target, if the inflation numbers are tweaked to eliminate the uncontrollable factors like international gasoline prices, inflation in Costa Rica would come in at about 8%.

Among the Central Bank’s bag of tricks to get control of inflation was the move last year to change the U.S. dollar-colón exchange rate from one of mini-devaluations of the colón to the so-called “crawling band,” in which the bank sets the upper and lower limits to the value of the colón, and maintains it by buying  and selling currency using its growing stockpile of foreign reserves.

The value of the colón pushed up against the U.S. dollar during much of the year, forcing the Central Bank to intervene  constantly, but by November, the colón wasfloating slightly above the floor, and the  Central Bank was able to widen the bands further, giving Costa Rica’s currency more flexibility.

Late that month, however, the Central Bank made the surprise move of abruptly dropping the bottom of the band, pushing down the value of the U.S. dollar against the colón by about 4% and sparking worries among expatriates, exporters and others with income in dollars.

At year’s end, economists were advising against rushing to change long-term dollar investments into colones, noting it was too early to tell if the strengthening of the colón against the dollar was a trend.

The reduction of Costa Rica’s foreign debt to a historically low $81 million, along with the elimination of the government’s fiscal deficit, also helped lighten the economy’s inflationary pressure.

Even with all the good news, however, there were a few flies in the ointment.

According to the latest numbers released by the National Statistics and Census Institute (INEC), the gap between Costa Rica’s rich and poor continued to grow.

The country’s businesses also saw a labor crunch in a number of different sectors.

The construction boom sucked workforce away from the already desperate agriculture industries, while at the other end of the social ladder, multinational companies said they were desperate for a greater amount of qualified bilingual staffers for outsourced back office work.

Sykes, for one, took matters into its own hands and opened an English academy, where it “polishes” candidates’ English to a level that allows them to work in the company’s call centers.

An initiative to increase Costa Rica’s competitiveness – including teaching more English in public schools – has been batted around for some time, but it wasn’t until the end of 2007 that President Oscar Arias appointed his Vice-Minister of Economy, Jorge Woodbridge, to the new Cabinet position of “Competitiveness Minister” in charge of cutting down red tape.

Other government reforms never saw the light of day, buried, as they were in the mound of CAFTA detritus.

Long talked of tax reforms, for example, did not materialize, save for one technical advancement: The Costa Rican government awarded a $20 million contract to U.S. firm Bearing Point to modernize the country’s tax collection system.


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