Foreign Direct Investment: A Look into Costa Rican Policy and Its Effects on Growth in the Medical Device Industry.

Introduction

Free trade and free trade zones along with tax incentives are thought to be the motivating factor for policies relating to growth in Central America. These newly acquired exporting industries were designed to fuel growth for subsequent expansionary policies into other areas of commerce. In addition, exportation of manufactured goods achieves the opportunity for countries in the region to increase GDP and purchase investments in the form of capital to protect the overall welfare of the country. The key for this region is to understanding what industries Central America could offer as a comparative advantage over other developing countries, for example Asia, India, Ireland, and South America in various industrial goods with specific attention to the medical devise sector; particularly Synthes, a global leader in surgical power tools, trauma products, and biomaterials. This paper analyzes the inflows of FDI and how they have helped transform Costa Rica into one of a regional leader for growth. It also looks at some of the reform with respect to markets and determines their effectiveness in attracting FDI and Multinational Corporate interests. Finally, we'll look into whether Synthes can take advantage of Costa Rican policies to gain competitive advantage in its market.

Costa Rican Policies: Past, Present, Future

Trade reform and the utility of foreign direct investment is a highly contentious debate in globalization. There are competing arguments that promulgate globalization does not engender wealth for the country as a whole; in fact, it increases inequality between and within nations. (Martin Ravallion, 2004) However, economic reforms are intended to be positive for growth; they can remove barriers that allow for multinational corporations (MNCs) to take risks where the potential for higher gains remain attractive. When evaluating tax reforms including tax incentives and trade liberalization one must question the effects on domestic industries (Rui Albuquerque, June 2000) contends these reforms have a surprisingly small impact on the country's industrial configuration. Furthermore, their analysis shows economies with increased specialization in a particular sector actually reduce the effect of trade reforms, like tax incentives. It is disconnects such as these that are not advantageous to growth and development for domestic industries.

Central American and Costa Rica governments have had as much opportunity to foster growth as other developing nations, as a matter of fact; Central America had productivity close to that of the leading economies in the 60's. (Ferreira, 2008) This statistic significantly falls short of what can be seen in other developing nations over time (see Figure 1), the question is did this have to happen? Costa Rica and a good portion of Central America have been engaged in foreign direct investment for a considerable amount of time with regard to traditional agricultural exports. Foreign direct investment by multinational fruit companies deepened their integration into Central American economies to expand international markets, primarily, through promotion of bananas as an agricultural export. (Simpson, 2001) Today Central America has become an epicenter for many of the world's supply of agricultural needs. For example, in 2006 Costa Rica out produced Hawaii and is currently the world leader in pineapple exports - their output almost totals a half a billion USD annually. (USDA, 2006)

Figure 1 FDI Inputs (WDI 2010)

This type of production wouldn't have been possible if Costa Rica had not changed its policies towards FDI and domestic development. From the 1940's leading into the 80's, Costa Rican and other Central American countries developed incentives to increase trade within the region be forming the Central American Common Market, CACM. This free trade mechanism was to allow the incumbent countries to pool resources without trade barriers and export to the world market. High tariff barriers would protect firms producing manufactured products within the regional economy that would otherwise be imported. (Simpson, 2001) This alliance was proven to be successful, however to limited proportions. Central American countries were not exactly competitive to world markets either. It was found by (Monge - Gonzalez, 1994) that 66 percent of tariff protections granted to Costa Rica's manufacturing sector during the import substitution period was transferred as an implicit tax to the country's exporting sector. This is another example where policy management ultimately resulted in counterproductive results to the industry and only hindered long term growth. It doesn't make sense to increase rents for imported goods as those costs will be passed through to the outputs thereby making good less competitive to export markets. (Willnore, 1976)

From the 70's onward into the 80's, Central America had some discontent with ruling parties which caused significant instabilities of markets and CACM alliances became ineffective in maintaining the losses in export demand. To make matters worse, Central American Governments began to increase government spending to offset the negative effects of falling exports. (Simpson, 2001) Oil shortages followed by the implosion of commodity prices in the 80's caused policy makers in Costa Rican governments to look toward diversification in their manufacturing and exportation sectors to promote stabilization in their productivity. With export demand reduced and political unrest in the region foreign direct investment was cut off, which further exacerbated the problems for this region. This can be seen in the Chart 1 which was obtained from the World Bank Database. In the late 70's one can see the reduction in foreign direct investment from 1977-1979, then again from 1980-1983 - it wasn't until the mid 1980's that investment wouldn't return to Costa Rica.

Reform in Central American countries and Costa Rica was prevalent in many forms as well. By far the most successful of these reforms was development of Export Processing Zones (EPZs) as an incentive to promote duty free exports. The incentives where geared mainly toward multinational corporations in the form of tax breaks. One of the most attractive aspects of the law was that corporations could move their operations and realize a 100 percent income tax break for 8 -12 years followed by a subsequent income tax incentive of 50 percent for up to 6 years. (Monge- Gonzalez, 2009)

This reform was highly lauded by many departments in the various Costa Rican Regulatory Ministries