Costa Rica: Growth without Poverty Reduction

February 18, 2014

Costa Rica has grown for the last quarter century but the number of Costa Ricans in poverty has remained steady, says Juan Carlos Hidalgo, a policy analyst at the Cato Institute.

Costa Rica suffered an economic crisis at the beginning of the 1980s after its protectionist policies that had encouraged the creation of state-owned enterprises became an overwhelming financial burden on the government.

But over the last 30 years, Costa Rica has instituted a number of liberalization measures that have led to strong economic growth and boosted tourism, the most important business sector in the country.

  • It created tax-free zones to encourage business development (Intel built a plant in Costa Rica in 1997, thanks to this incentive), and it entered into a number of free trade agreements with countries across the globe.
  • All of these reforms increased the value of exports, which rose as a percentage of gross domestic product from 27 percent in 1985 to 49 percent in 2007.
  • Many state-owned businesses were also privatized, though some remained under state control.
  • From 1985 to 2005, Costa Rica went from ranking 62nd out of 109 countries in terms of economic freedom to 23rd, growing at 4.7 percent per year since 1987.

However, this growth has come without a reduction in poverty over the last two decades, and the percent of those living below the poverty line has hovered around 20 percent since the early 1990s. Why? Because the country's economic model is largely mercantilist and its policies have benefited Costa Rica's export sectors but hurt Costa Ricans as a whole.

  • Monetary policy: Costa Rica's policies undervalued its currency, which boosted its export sectors but led to inflation. Basically, its monetary policy functioned as a subsidy to exporters, and as inflation always hurts the poorest segments of an economy, the lower classes suffered.
  • Agricultural protectionism: High tariffs on products such as milk, rice, beans, potatoes and chicken basically function as a reduction in income. A 1998 study found that this type of protectionism reduced the income of the poorest 70,000 Costa Rican families by a full 41 percent.
  • Regulatory and tax policy: The total tax rate in Costa Rica adds up to 55.3 percent of an average business's profit. And its regulatory environment, marked by inefficient bureaucracy, put the country at 94th out of 148 nations in terms of "burden of government regulation."

Costa Rica needs to institute actual free market reforms that keep the government from picking winners and losers. Abolishing agricultural tariffs, peeling back regulations and adopting neutral exchange rate and tax regimes would do much to bring more Costa Ricans out of poverty.

Source: Juan Carlos Hidalgo, "Growth without Poverty Reduction: The Case of Costa Rica," Cato Institute, January 23, 2014.

 

Browse more articles on Economic Issues