Costa Rica Karan

8/3/2019 Costa Rica Karan

1/13

[Type the document title]

Costa Rica Case Study

Karan Khilnani

PGDM-A

27


2/13


3/13

International Business Costa Rica Case Study

3

2. When & why do Governments of countries resort to Import Substitution policies?Specifically for Costa Rica, what was the economic rationale for its Import Substitutionpolicies?Which were the other initiatives taken by the Costa Rican Govt. to support it?

Why?

Import Substitution is a Government strategy that emphasizes replacement of some

agricultural or industrial imports to encourage local production for local consumption, rather

than producing for export markets.

The Government of a country resorts to import substitution policies to reduce its foreign

dependency, to generate employment to protect local companies, to encourage diversifiedproduction and economic self-sufficiency, to extend the sphere of influence, make

the country self-reliant in critical areas such as food, defense, and advanced technology and to

maintain the national identity and become self sufficient by promoting industrialization. The

Import substitution policies were implemented mostly by developing countries which exported

mainly primary products and imported almost all the industrialized or manufactured products

they consumed.

The economic rationale behind Costa Rica going for import substitution policies was to reduce

dependency on other foreign countries, to increase local and foreign investments within the

country to promote industrialization, to generate employment and also to protect domestic

producers from competition of imports.

The Costa Rican government joined with four other countries- El Salvador, Guatemala,

Honduras and Nicaragua- to form the Central American Common Market (CACM), which

allowed goods produced in any member country to enter freely into the market of any other

member i.e. a company located in a member country could serve a five country market. The

government even subsidized domestic producers to hold down prices of various commodities.

This was done mainly because the Costa Rican market alone was too small to support

investments requiring large-scale production.


4/13


4

3. Explain briefly the static effects & dynamic effects of regional economic co-operation among countries. Illustrate your answer for CACM.What was the overallimpact of CACM on its member countries?Why?

Regional economic integration reduces or eliminates the trade barriers for member countries. It

produces both static & dynamic effects. Static effects are the shifting of resources from

inefficient to efficient to efficient companies as trade barriers fall. Dynamic effects are the

overall growth in the market and the impact on a company caused by expanding production & by

the companys ability to achieve economies of scale.

Conditions for Static Effects:1. Trade creation: For gaining comparative advantage and to supply better quality goods at a

lower price production shifts to more efficient producers. This is not possible without

integration. The strategic implication is that companies that might not have been able to export to

another country-even though they might be more efficient than producers in that country-are now

able export when the barriers come down

2. Trade diversion: Trade shifts to countries in the group at the expense of trade with countries

not in the group, even though the non-member companies might be more efficient in the absenceof trade barriers.

Conditions for Dynamic Effects:1. Economies of Scale: The average cost per unit falls as the number of units produced rises;

occurs in regional integration because of the growth in the market size.2. Increased Competition:It results in existing companies becoming more efficient due to

competition in market.The CACM was formed in response to the need of member countries to cooperate with each

other to attract industrial capital and diversify their economies. By the late 1960s the CACM had

made considerable progress in expanding commerce and manufacturing in the region. Many

trade barriers between its member states were eliminated or reduced, and between 1961 and 1968

trade among them increased to a figure seven times its previous level. Some of the advantages

that Costa Rica reaped are:


5/13


5

a. Import substitution led to increased exports and export promotion. New markets, both localand international were established and built, for processed coffee and cotton seeds.b. The local producers were protected due to favourable policies such as price controls, import

prohibitions & subsidies which shifted countrys resources from areas of production (agricultural

sector) in which it had long been most efficient.c. The pharmaceutical industry benefitted tremendously because of the policy of import

substitution because of small-scale packaging & processing strategies, and not because of larger

market.

d. The less efficient rice producers survived in the country as against more efficient producers

outside CACM because of trade barriers.

In 1969, however, Honduras and El Salvador broke off commercial and diplomatic relations

during their so-called Soccer War. After blocking El Salvadors access to the Pan-American

Highway, Honduras virtually withdrew from the CACM in early 1971 and imposed tariffs on

imports from the other common-market countries. Despite growing discontent, the other

members agreed to continue the CACM until Guatemala imposed many restrictions on regionaltrade in 1983. Because of internal political instability and violence in some member countries

and mounting debt and protectionist pressures, the CACM suspended its activities in the mid-

1980s. Thus, the overall impact of CACM was not as successful as it was hoped due to its

inability to last for a long period owing to the political instability and violence among some

member countries.


6/13


6

4. Based on the economic & non-economic rationale for protectionism, comment onthe appropriateness of the trade barriers imposed by the Costa Rican Govt. during itsImport Substitution regime.Which trade barriers would you have recommended to the

Govt. of Costa Rica?Why?

The Costa Rican Authorities resorted to import Substitution to provide both the Costa Rican and

Foreign investors an incentive to produce more products domestically. Their motive was to

increase sales and revenue for the domestic producers and to protect them against foreign

competition. Some of the trade barriers that they could have applied during its Import

Substitution regime are as follows:

1. Tariff: The Costa Rican Government could have imposed tariff in those sectors where itwanted to protect its local players

2. Standards: High levels of standards could have been set for imported products. Thiswould automatically decrease imports, as maintaining high standards would be difficult.

3. Consular fees: Increasing consular fees, would result in a decrease in incentive to import,as it increases the cost and time to import.

4. Buy Local legislation: Costa Rican government instead of restricting imports could

have imposed a buy local legislation on its product stating that a certain percentage of theproduct have to be manufactured locally . This would increase the amount of investment indomestic market.

5. Improving comparative position - Costa Rica was able to increase export of processedcoffee as well as coffee seeds. It also became self sufficient in crops like rice. The negativeimpact was that the resources moved into industries or commodities in which the country did nothave a comparative advantage.

The Non- Economic rationales are as given below:

1. Maintaining essential industry - Before the protectionist policy was adopted CostaRicas economy was not self sufficient and dependent upon export of a few commodities.2. Maintaining or extending spheres of influence - Costa Rica was able to increase itsexport of coffee and cotton seeds to a larger number of countries and also became self sufficientin rice production and thus was able to increase its sphere of influence.


7/13


7

For example, Costa Rica was not able to diversify its economy as much as it hoped. Moreover,

the policies were helping in channeling Costa Rica's resources away from areas of production inwhich it had long been most efficient. For example, resources were used in production of rice

instead of coffee and other products because the policies kept the lower-cost foreign-produced

rice out of the market. Also, the government subsidized such industries through levying heavy

taxes on efficient industries which as a result found it hard to expand. Finally, spending power of

consumers was affected by having to pay higher prices for the inefficiently produced products as

compared to lower cost foreign products.

The trade barriers that I would have suggested to the Costa Rican government along with the

currently implemented are as follows:

1. Provide subsidies to industries or cultivation of agricultural products which have comparative

advantage and are produced most efficiently.

2. Impose quota restrictions instead of import prohibition on certain agricultural products like

rice which are available at lower prices and are not efficiently produced.

3. Provide tax credits or partial exemption on imports of machinery and equipment, raw

materials, etc. needed for industrial purposes.

4 Partial or total exemption of revenue taxes on capital investments in industries under theagreement of re-investment of profits.

These barriers will promote the production of more efficiently produced products, diversify the

economy, make available to the consumer cheaper products, increase local and foreign

investments in the country and also promote industrialization.


8/13


8

5. What were the key elements of Costa Rica's Strategic Trade Policy from 1990 onwards?

Which were the industries identified for Inbound FDI?Why? Explain your rationale basedon the relevant International Trade theory.

Post 1990 Costa Rica adopted a new set of policies regarding international trade and factor

mobility i.e. the Strategic Trade and Investment Policy and this policy calls for the production

of specific type of products along with openness to imports to promote international competition.

The key elements of Costa Ricas Strategic Trade Policy from 1990 onwards were:

1. CINDE officials working with the Costa Rican government to identify and attractinvestors who matched up better with Costa Rican resources.

2. Diversification of export portfolio3. Improvement of the overall infrastructure4. Improvement and simplification of regulations5. Hiring the Foreign Investment Advisory Service (FIAS) of the International FinanceCorporation.

6. Focus on sustained development and growth by increased investment in innovation andresearch and development (R&D) activities

7. Boosting FDI to the extent it leads to increasing economic growth, exports andemployment. The industries that were identified of inbound FDI were:

y Electronicsy Biotechnologyy ITThe ideology for selecting these industries can be explained by the Absolute Advantage

Theory. This international trade theory states that the countries should export only those

goods/services which it can produce more effectively than the others. Costa Rica with its long

history political stability, upper middle income country status and with high literacy rates and the

availability of skilled workforce all act as a natural stimulus to growth for the above mentioned

industries.


9/13


9

6. Why did the U. S. Govt. provide funding for CINDE?What were CINDE's objectives?

How & why did the Costa Rican Govt. support CINDE? As of 2005, to what extent wasCINDE & Costa Rican Govt. successful in achieving CINDE's objectives? Explain the

rationale for your answer.

The Caribbean Basin Initiative was initiated by the US to allow goods produced in Caribbean

nations to allow imports at lower tariffs and import taxes as compared to imports from other

nations. To capitalize on this opportunity Costa Rica formed CINDE (Coalitions and Initiatives

forDevelopment).

In the period around 1980s Costa Rica received more than $1.2 billion from the US which

prevented the Costa Rican economy going into depression. Thus, the US and CI

NDI

E tried tochannelize the funds for foreign trade diversification and agro-export development.

The objectives of CINDE were:

y To enhance and contribute to productive organizations by improving their knowledge,technology, managerial and technical capacities, efficiency, productivity and strengthening and

restructuring in order to allow them to compete with MNEs from other nations, thus supporting

home grown industries and aiming for import substitution and export maximization.

y Formation of a stable and sustainable environment for growth in order to attractinvestments for development of the private sector.

y Liberty, democracy, the respect for institutions and laws, justice and peace has beenCosta Ricas fundamental values. A very important objective of CINDE was to protect the

culture and values.

y Strengthening the economy of the nation, developing and increasing exports andenhancing the private sector and making it competitive along with assisting in the social and

economic welfare of the society on the whole.

To encourage direct foreign investment the Costa Rican government set up CINDE (Costa Rican

Investment and Trade Development Board), to assist and guide investors and companies in the set up

for operations in Costa Rica. The Costa Rican Government supported CINDE to emphasize the

production of goods that could compete in international market by providing ideal conditions and

promoting inflow of FDI which allows development of technology and creates employment.

CINDE achieved its objectives of promoting export growth, attracting foreign investment andcreating a flexible, self-sustaining organization. Nearly 80% of their claimed foreign investmentbetween 1986 and 1990 reflected positive results and positive outcome was also observed with61.3 % of the $566 million of direct foreign investment flowing into Costa Rica. The favourable


10/13


10

trade and political relations with the US assured massive inflows of foreign assistance and the

accompanying policy conditionality to liberalize the economy. It also gave USAID a significantvoice in helping to plan the country's move toward an export oriented economy and in CINDEscreation and subsequent management. CINDE promoted the development of nontraditionalexports and through investment promotion. CINDE's success stems largely from its legal status,organizational structure coupled with institutional flexibility, early and considerable access toresources and its management of GOCR and donor relations.

An Export Processing Zone (EPZ) which allowed companies to export finished goods and to

import necessary raw materials, inputs and equipments required for production on a tax-free

basis was set up by the Costa Rican Government to support CINDE. Companies were givenfurther incentives by exempting then from paying Costa Rican income tax for eight years and

allowed to pay at a 50% discount for the next 4 years.

7.What are your learnings from this case regarding economic development models of small

sized developing countries? Explain your rationale.

We can see from this case how Costa Rica tried different economic models before getting it right

with Strategic Trade and Investment. According to the International Trade Theory of Country

Size any small sized economy like Costa Rica deals with the issue of limited/small market

potential. According to this theory larger the area is of a country, the more self-sufficient it is. On

the other hand, the smaller the size of a country, the more dependent it tends to become on trade

with foreign countries. Due to its size these economies usually have limited resources and are

highly dependent on trade. Also to leverage any possessed natural or acquired resources to the

best, these economies necessarily need to look at markets outside their country as their market

size is small. Costa Rica realized the importance of international trade for its economy and

selected sectors where it had some natural or acquired advantage. It made efforts to harness these

sectors leading to economic and social development.

The lessons to be learnt from this case are


11/13


11

1. Identify and invest/build sectors with comparative advantage:

Costa Rica realized the following strengths and capitalized on them

y Strategic locationy Highly educated skilled labory Infrastructurey Stable political environment and long running democratic form of governmenty Attractive government policies supporting foreign investment.

Similarly the other countries should identify sectors in which they have a comparative advantage

and which promising stable sustainable growth in the future.

2. Maintain a large and diversified portfolio of countries:

To ensure that the economic scenario of a nation is not hampered by any unforeseen

circumstances in the importing nation such as change in political ideology, war, economic

instability the trade relations should not be restricted to few nations only.

3. Develop supporting industries for these sectors:

Costa Rica promoted the sectors that they saw scope for development and favourable factors.

Similarly countries should focus on supplier development, improving logistics and infrastructure

and augment growth of the favourable sector.

4. Encourage exports in identified sectors

To bring about social and economic welfare government should promote export in identified

sectors. The government should also encourage FDI in these sectors as that will lead to infusion

of technology and infrastructure development. This will help the industries produce better and

internationally competitive products. To promote exports the government should set up Special

Economic Zones or Export Processing Zones like Costa Rica did.

5. The initial policy of Costa Rica was to focus only on bananas and coffee, without even

considering the other favourable factors. This proved to be detrimental later. However, they

realized this and started using their acquired variables such as skilled and educated labour.


12/13


12

Similarly other developing nations should consider all aspects instead of simply focusing on one

aspect.

6. Encourage healthy competition in the sector to produce products to meet globalstandards.

8. Using Country attractiveness-Competitive strength matrix, evaluate for SamsungElectronics, Costa Rica today as a country for its international operations. Which

entry strategy you recommend for Samsung Electronics, if you feel Samsung Electronics

should enter/continue to be in Costa Rica in a significant way? Explain the rationale for

your answer.

Using country attractiveness and competitive strength matrix, we can say that for Samsung Electronics

Costa Rica has high attractiveness as well as high competitive strength. We can evaluate this on the

following basis:

y Costa Rica has a large base of educated and skilled population in terms of engineers who can beeasily availed of.

y The country has had a history of high political stability and has a democratic form of governmentat the centre.

y The favourable location factor and the availability of ports make it a perfect location for settingup an export factory.

y Costa Rica capitalized on various favourable factors available within its own boundaries andadapted to the changing economic environment.

y Development of infrastructure by favourable FDI policy and being a nation open to foreign tradeis an added advantage.y The moderately high per capita income and high quality of life coupled with the economicbalance is a major factor that will attract Samsung Electronics.

Thus to enter in the Costa Rican market Samsung Electronics should get into a joint venture with a local

electronics company. The following will be the advantages for Samsung Electronics


13/13


13

y The local partner will act as the cultural bridgey The local partner will give Samsung Electronics all the local knowhow of the country.y Sharing of risksy Established distribution networky Established link with local suppliers

Costa Rica Karan

Documents

Transcript of Costa Rica Karan