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Rethinking Foreign Investment for Sustainable Development: Foreign Investment and Economic Development in Costa Rica: The Unrealized Potential

The Working Group on Development and Environment in the Americas, founded in 2004, brings together researchers from several countries in the Americas who have carried out empirical studies of the social and environmental impacts of economic liberalization. The goal of the Working Group Project is to contribute empirical research and policy analysis to the ongoing policy debates on national economic development strategies and international trade. The project also brings more prominently into U.S. policy debates the rich body of research carried out by Latin American experts, as well as their informed perspectives on trade and development policies. Introduction After a long history of dependence on a few traditional exports, followed by import substitution in the 1960s and 1970s, and a debt crisis in the early 1980s, Costa Rica launched an aggressive attempt at diversifying production and exports in 1985. The new approach to development consisted of two main elements: pursuit of free trade agreements and the attraction of foreign direct investment (FDI). Costa Rica has been remarkably successful in attracting FDI. It is the only country in Latin America where most FDI has gone to manufacturing over the last decade, and it stands out even further for its ability to attract FDI in high-tech sectors. In this article we analyze why Costa Rica was an attractive destination for transnational corporations (TNCs), and the impact FDI has had on economic development in the country. We show that FDI in the Free Zones has had a beneficial impact primarily at the macroeconomic level, through employment and trade balance effects. At the microeconomic level, however, the impact has been rather limited as backward linkages and technological spillovers are small in absolute and relative terms. The limited extent of backward linkages from FDI is due to the limited potential for spillovers for part of the foreign investment as well as to the limited domestic absorptive capacity for linkages. Ultimately, we argue, the lack of a coherent long-term development strategy has hindered the ability of the country to take more advantage of high tech FDI. On the one hand, the government did not adopt pro-active policies to address existing market failures, which make it difficult for national producers to become competitive input suppliers. And on the other hand, an approach that aims at attracting high tech FDI is not compatible with trade liberalization and provision of tax exemptions to TNCs in the industrial and tourism …