Costa Rica: FDI at its finest

Foreign Direct Investment
| The European | 22 April 2020

When forming a strategy for FDI it is crucial to understand the long-term return on every dollar that has arrived into a host country. The stock of FDI in Latin America was estimated at $2.3tn as of 2018 and the average return on FDI in 2018 edged up to 5.5%. Nonetheless, the average profitability levels recorded during the commodity price boom cycle (8.1% on average in 2005–2012) were not attained. The nature of FDI inflows to Costa Rica differs significantly from inflows to the rest of Latin America. While several countries (particularly in South America) attract the most FDI in natural resource sectors, Costa Rica concentrates its inflows to the technology- and knowledge-intensive sectors. This difference would account for the higher profitability and lower volatility, favouring Costa Rica, between 2013 and 2018.

The stock of FDI in Costa Rica was estimated at $40bn as of 2018 with a profitability of 6.3%. As shown in the graph opposite, the average return on FDI between 2013 and 2018 in Costa Rica reached 6.1% annually, 110 basis points higher than in the rest of Latin America during the same period. As a point of comparison, the rate of return for European companies investing abroad rose from 5.7 % in 2008 to a peak of 7.0 % in 2011 before falling back to 3.9 % in 2016. In 2018 it rose to 4.5 %.

Costa Rica’s FDI strategy has proven highly successful, with inflows leading to profound changes in the kind of trade the country specialises in. Costa Rica evolved from an export structure, which was highly concentrated on agricultural products and textiles and garments to a more diversified export structure with new, more knowledge and technology-intensive products and services.

FDI has driven a demand for improved education and training standards, fostering learning among workers, management and production, therefore improving the business environment in Costa Rica.

FDI also has a positive impact on workforce quality. Modern companies which use modern technologies need highly skilled staff; they pay a lot of attention and promote high levels of education, and by disseminating the patterns worked out within their organisations, they impact the mentality of employees. Then, the latter see the need to improve and upgrade their skills. Foreign companies often offer more courses, and better access to means of improving workforce productivity than domestic businesses.

Increasing labour productivity with the right talent allows firms to produce greater output for the same level of input, earn higher revenues and ultimately achieve a higher return on their investments.

A more productive local human capital – with innovative skills, currently working for foreign companies – is particularly appealing to foreign companies without operations in Costa Rica. The availability of this highly skilled human capital sends a signal to other efficiency-seeking companies about Costa Rica’s appeal as the ideal location for the true return of FDI. The demonstration effect has worked. Foreign companies may have strong incentives to follow previous foreign investors because of the signal they send regarding the reliability of the host country.

Two notable effects of knowledge intensive FDI attraction are related to value-added services exports. First, non-tourism services exports have grown more than six-fold since 2000. Costa Rican IT and IT-enabled services exports reached more than $4bn in 2018 (+6% growth) and the US market accounted for 65% of total Costa Rican knowledge-intensive services exports. Costa Rica leads this kind of export of services in Latin America as a percentage of GDP (6.7%).

Second, Costa Rica is a net exporter of services. Its trade balance surplus reached nearly 10% of GDP in 2018, and for the rest of Latin America it resulted in an average deficit of 1% of GDP. Apparently, Costa Rica’s human capital, which is trained and upskilled by foreign companies, makes all the difference.

Further information

www.cinde.org

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