Theme: This paper analyses the challenges of governability facing Costa Rica during the second mandate of Oscar Arias (2006-10) in a national and international context that is very different from that of his first mandate (1986).

Summary: The current political and economic situation in Costa Rica is substantially different to what it was during Oscar Arias’s first term as President (1986-90). First, the historical bipartisan political system in Costa Rica (which lasted from 1950 to 1990) has given way to a multi-party model which has proved to be extremely unpredictable in terms of parliamentary negotiations and political agreements. Secondly, the challenges posed by the negotiation of the Free Trade Agreement with the US and the Dominican Republic (CAFTA-DR) and its ratification by Parliament have monopolised political debate in 2006 and are likely to continue to do so in 2007. However, aside from the CAFTA, the real challenge and the top priority for Arias’s second mandate and for the nation as a whole will be the redefinition of a new development agenda for the 21st century, including administrative and institutional reform and a new fiscal strategy and system to close the gap on other OECD countries.

Analysis: The most serious problem facing President Oscar Arias in this second mandate is that –contrary to the words of a famous tango[1]– 20 years is indeed a long time and a country can change considerably over the period, becoming almost unrecognisable. The Costa Rica of 1986, when Arias first came to power to develop his peace project for Central America –for which he won a Nobel Prize and in respect of which he devoted much effort to foreign policy– is different from that of 2006; it is far more complex and demanding on the domestic front. His first months in government have made evident the difficulties of facing political realities and rules that are different and changing. In the first place, it is no longer a bipartisan country predictable in terms of parliamentary negotiation and rules, as in the long and peaceful period from 1950 to the end of 1990, in which the social democrats and the conservative Social-Christian opposition alternated in power. The Costa Rica where the heirs of Figueres and Calderón Guardia –as though leading two lay religions– shared out the world and the voters, is a thing of the past. Today it is a diverse country, fragmented and multi-party where the political spectrums are diffuse and there has been a shift in the economic and productive sectors. This has triggered changes in social classes, socio-economic levels and the political parties themselves. The political and electoral uncertainty which reigns in most of Latin America has also spread to Costa Rica.

The social democratic badge is the object of dispute between Arias’s National Liberation Party (Partido Liberación Nacional – PLN) with 25 deputies and Ottón Solis’s Citizens’ Action Party (Partido Acción Ciudadana – PAC) with 17 deputies, a social democracy spin-off, which is the main opposition party. Arias won the election over Solís by a narrow margin of just 1% (although he had a larger advantage in the parliamentary elections) and the country is experiencing profound ideological divisions, the deepest of which is linked to the ratification of the Free Trade Agreement with the US and the Dominican Republic (CAFTA-DR). This question has polarised Costa Rica between supporters of opening up the economy and supporters of the Welfare State à la Costa Rica. President Arias, backed by domestic and foreign business sectors and the media, is the main advocate of the FTA, making it the central issue of his first year in government. Ottón Solís, representing the middle classes, professionals, public workers and academic sectors, proposes a renegotiation of the Agreement, invoking amendments in the opening of the telecommunications, social security, patents and intellectual property segments, the solving of controversies regarding investments and other matters of social interest.

There are other political sectors, such as the Libertarian Party (Partido Libertario - PL, with seven deputies), formed by a kind of radical ‘libertarian’ followers of Hayek, Friedman and the US’s CATO Institute, who, supported by private sector companies and companies which lobby against taxes, promote a reduction of the State, deregulation and free market dynamics. The old Social Christian Unity Party (Partido de Unidad Socialcristiana – PUSC), a combination of conservative and Christian-democratic sectors inspired by the papal encyclical Rerum Novarum, slumped at the last election and has gone from being one of the two major parties in the last 50 years to a parliamentary minority with only five deputies and an uncertain future. A number of other minority parties, with single deputies in the Legislative Assembly, complete a complex parliamentary map, making negotiations difficult and results uncertain.

This fragmented political scenario has compelled President Arias to conduct his parliamentary negotiations on a case-by-case basis, with one-off alliances focusing on specific issues, which implies the absence of long-term agreements. Today’s parliamentary partner might be tomorrow’s adversary. The PL and the PUSC, the government’s main allies in approving the FTA, will no doubt be adversaries in approving a possible tax reform. They have often made this plain. And so on, case by case. This is a kind of minefield that has to be negotiated daily and in which Costa Rica’s former skill in reaching structural agreements and long term definitions of public policy (which distinguished this country from others in Latin America) seems to be out of reach.

The CAFTA-DR
The central issue in 2006 was the negotiation of the FTA with Central America and the US, and this is likely to be the case in 2007 also. The Agreement’s most controversial areas in the Costa Rican political and social scenario are, among others, the following:

(1) Opening up of telecommunications and changes to the ICE (Instituto Costarricense de Electricidad), one of the flagship institutions of the welfare State in recent decades. Annex 13 of the Telecommunications Section of the CAFTA seeks the opening up of wireless telephony, international telecommunications and fibre optics, including Internet and state-of-the-art technology. The opposition claim that fibre optics are protected by the Constitution, as are mining and other strategic products, and that opening up requires more stringent supervision than that envisaged by the TLC.

(2) Elimination of generic medicines, based on patent protection rules and industrial property regulations, which constitute a significant percentage of the medicines provided by the Costa Rican social security system. This debate has been further compounded by the media impact in Costa Rica of a number of resolutions from the latest Doha round, particularly those relating to the protection of health vs. industrial property and patents.

(3) Resolution of disputes. This area has generated a fierce academic debate, since it forces the country to go to courts of arbitration and panels for resolving disputes in all cases, which apparently generates a constitutional conflict as it leads to an involuntary sidelining of national jurisdiction. It also contradicts the ICSID Agreement (the World Bank’s International Centre for Settlement of Investment Disputes) ratified by Costa Rica with an interpretative clause obliging the country to first exhaust its internal procedures, both administrative and jurisdictional.

It is a fiery and complex debate, since Costa Rica cannot ignore bilateral and multilateral free trade processes, at a time when almost the whole of Latin America is negotiating with Washington. But many citizens are fearful of undergoing a repeat of Mexico’s experience with NAFTA, which has been contradictory and worrying, and which Costa Rican society is carefully observing. After a decade of free trade, GDP might have grown in Mexico but poverty does not seem to have been mitigated; quite the contrary. The wall measuring hundreds of kilometres which the Bush Administration is erecting along the length of the Rio Grande to prevent Mexican migrants from entering the US is the clearest sign that FTAs without compensation funds or structural funds might indeed generate growth and investment, as well as ample profits for some sectors, but they also signify poverty for other population groups. These are the pros and cons of free trade: investment growth at the cost of a parallel increase in internal economic asymmetry.

The issue is thorny, since (unlike the rest of Central American nations where the FTA was approved relatively easily) in Costa Rica there is strong opposition from some union sectors, public universities and civil servants at main State institutions. Although Costa Rica endured neither the civil war or left-wing insurgent groups that countries like El Salvador and Nicaragua did in the sixties and seventies, civil resistance to the FTA has been stronger, to the extent that it is the only country in the region whose Parliament has not ratified the text. Costa Rican society is currently split by the debate. President Arias has made it practically the leitmotiv of its government; this is a risky strategy since, even supposing he manages to get it approved in early 2007, the result will be a divided country, with a complex scenario, since other key issues such as tax reform and State restructuring are pending and will be tough to negotiate.

The Economic Context and the Legal Framework of CAFTA-DR
The CAFTA DR comes in a context of deep-rooted structural asymmetry between the US and the Central American countries (asymmetry which exploded like a time-bomb at the WTO meeting in Cancún in 2005). The negotiation process served to bring to the fore a serious deficiency in Central America: the absence of national organic and long-term development plans. The countries in the region, including Costa Rica, lack real any development strategies. The reform and underpinning of the productive sectors –in agriculture, industry and the upcoming services economy– make sense within the framework of a general development plan for the next 20 or 30 years and their insertion in the international economy. No Central American country, including Costa Rica, is looking beyond the immediate horizon of closure of the forthcoming tax year, and, at best, towards the next presidential elections. The absence of strategic planning and the structural weaknesses in respect of international competitiveness are a common characteristic in Central America and this is a heavy historical burden to adequately meet the challenges of the CAFTA-DR. 

Costa Rica has no framework law for planning, budgeting, monitoring and accounting to enable it to afford systematic unity to a series of disperse legal bodies. On the one hand there is National Planning Law (Ley de Planificación Nacional) 5.525, dated 2 May 1974, with no regulatory or strategic connection with Financial Administration and Public Budget Law (Ley de Administración Financiera y Prespuestos Públicos) 8.131. This is a major step forward, although it lacks a strategic reference, since it is not related to the 1974 Planning Law. The concept of the National Development Plan is ineffective in Costa Rica and throughout Central America, since it is an executive decree issued, abolished and transformed every four years as a new government enters power. This has an impact on the logic of the Budget Law, annually enacted by Parliament, which is more or less circumstantial, and not bound to any long-term planning. Unlike Europe, where, to a great extent, there is sector-by-sector strategic planning, in Costa Rica the absence of a systemic relationship between programme development and the development of the State budget yields disastrous results for the implementation of public policy. Precisely for this reason, the most significant law enacted annually by any Parliament, the Budget Law, which establishes global strategic plans by institution and annual operating plans for all offices of the State, has no strategic direction. Ultimately, insertion in the international economy does not seem possible if Costa Rica (like its Central American neighbours) does not set its own long-term development targets. It must have its own agenda to compete with the rest of the world.

The CAFTA-DR hampers the main ambition of not only the political classes but also of most of Costa Rican society: how to meet the challenges of the 21st century with the standards of the second half of the twentieth century in a different and changing domestic and foreign reality. As already indicated, the Welfare State à la Costa Rica –resulting from social reforms implemented in the forties by Calderón Guardia, and, especially, the successful social-democratic project from 1950 onwards devised by José Figueres and Rodrigo Facio, among others– is today in a state of slow crisis, trapped by an entropy that is the result of the fiscal crisis and various internal and external factors. The political parties have not been able to reinvent themselves and much less to reinvent the general blueprint of the State. This is the main challenge facing President Arias during this mandate: to create a new State agenda. Nevertheless, six months into his mandate, the scene is one of uncertainty and Costa Rica is in the midst of a one-track and damaging debate (the CAFTA-DR) which is preventing it from resolving other important issues. The almost exclusive attention to the FTA is risky. To discuss opening up the economy without fine-tuning the global development agenda hardly seems fitting. The debate regarding opening up the economy to foreign investment must be conducted in conjunction with talks on a new National Development Plan. Otherwise, the foreign investment agenda will cancel out and marginalise the need to recompose the country’s public policy strategy.

More Resources for Social Investment and the Fight Against Poverty
Despite its acceptable performance in human development (it has generally been among the top performers in intermediate human development according to the UNDP index, alongside Chile, Uruguay and Argentina in Latin America), Costa Rica has endemic social problems that remain unsolved. Poverty fluctuates between 20% and 25% of the population, an unjustified percentage for a country with such a high turnover from tourism, agricultural and industrial exports and some major technology and services transnationals. The weak tax system is exposed here.

Programmes to fight poverty –which are generally specific and funded by a kind of budgetary mishmash called the FODESAF (Development Fund of Family Assignations)– have served only as palliative efforts in some serious crises, such as that of 1980 and 1981, to prevent social indicators from slumping, as they did in other Central American countries. However, they have not solved the problem of endemic and structural poverty, which seems to be trapped in the range of 20% to 25%. The strategic solution in social investment which Costa Rica so successfully brought to the fore on other occasions (universal investment in education, health and housing between 1950 and 1980) cannot be furthered because of the fiscal imbalances and the Ministry of Finance’s low liquidity capacity. There are significant entropies in this regard. For example, the constitutional imperative of 6% of GDP for State investment in public education has been breached for several years, with the actual amount not exceeding 5.2%. Tax reform is one of the most urgent matters pending in the transformation of the State.

As indicated in the State programme for 2004 (the trend was confirmed in 2005 and 2006), the incidence of total poverty, measured by income, rose from 18.5% to 21.7%, the highest level in the last decade. This signified the emergence of more than ‘38,000 new poor households and an accumulation of some one million poor people’. There was also an increase in the intensity of poverty and the percentage of people vulnerable to poverty. At the same time, there was a 6% decline in average real per capita income in households where income was known. As shown in Table 1 there is a backward trend in poverty indicators.

Table 1. Social Statistics, 2001-04 (%)

Source: Informe Estado de La Nación), 2005, Programa Estado de la Nación, Costa Rica.

The figures indicate that poverty has become concentrated in rural areas, mainly in the Pacific and Atlantic coasts and in the provinces of Guanacaste, Puntarenas and Limón. These figures show that poverty in the Central Region is half of that existing in other regions. There has been a sizeable increase in poverty in Brunca, rising from 33.6% to 40.4% between 2003 and 2004. A survey of social inequality in the cantons of this region indicate that the Gini coefficient varies between 0.477 (Osa) and 0.492 (Golfito), more than five points higher than the national average and, from the international standpoint, similar to the average in Latin American nations.

Table 2. Social Inequality

Source: Informe Estado de La Nación), 2005, Programa Estado de la Nación, Costa Rica. 

Costa Rica has no choice but to carefully examine its social investment strategy in order to implement a real and effective policy to cut poverty. To this end, it must push forward global tax reform, changing the typologies of income tax and VAT and the mechanisms for tax and tariff control. It must first replace the territorial income model with a world-wide income model, an indispensable step to avoid tax evasion in this area, which accounts for no less than 50% of the country’s tax income. From the standpoint of the fiscal system applicable to free economic zones, there must be a reasonable renegotiation for all companies participating in the ‘tax haven’ until 2008. The aim is to impose on so-called footloose companies a standard rate of 15% income tax –in line with the system in Ireland and other investment-capturing countries– and, at all events, a substantially lower percentage than the 25% or 30% which they would pay the IRS (Internal Revenue Service) in the US, or even higher sums in the European countries where their parent companies are located. Furthermore, it is necessary to implement urgent reforms in other aspects of the tax model, global income and VAT to include not only goods but also services, like most OECD countries. The idea is to promote an integral reform to increase the scant tax income, currently 13% of GDP, to 18%-20%. This matter must be dealt with urgently to sustain and reconstruct the middle class and to fight against poverty.

The Option of New Competitiveness
In the last decade and a half, Costa Rica managed a relatively successful transition from its traditional productive model (agricultural economy based on coffee and bananas) towards a more open and competitive system. Today, tourism is the most important income factor. The traditional agrarian economy has been partially replaced by a flourishing seed industry, flower exports, etc. Half of the country’s jobs are currently linked to exports and 80% of cultivated land is used for products associated with exports. Despite its very small territory, Costa Rica produces 97% of the Cassava consumed in the US, as well as 90% of the pineapple, 80% of the Chayote squash, 80% of the yucca, 60% of the bananas, 40% of melons and 25% of orange juice; it also produces 41% of the pineapple consumed by Europeans, 30% of the melons, 28% of the lichen they purchase and 23% of water melons.

The attraction of large foreign corporations such as INTEL, Abbot and Procter and Gamble, among others, imply a major economic synergy for Costa Rica, despite the system of free zones (with tax exemptions) whereby they were introduced into the country. The economic dynamisation generated for Costa Rica by these transnational companies is only relative. As the figures show, the difference between GNP and GDP with or without INTEL is close to 25%, a disproportionate amount for a company with total exoneration in relation to income tax. Once again, fiscal correction is indispensable in this sphere.

Conclusions: For several decades, Costa Rica was one of the Latin American countries which proved that the ideas of Keynes could be a key to the development and construction of the middle classes: investment in human capital (education and health); participation of the State as a promoter of private investment and market expansion; and the creation of social infrastructure not only as the provision of a labour force but also as a means to growth. Unlike other countries on the continent, particularly in the Southern Cone, which experienced the dismantling of the State’s installed capacity (with privatisation and opening-up processes that were dissimilar and unregulated, which in some cases proved successful and in most cases were a resounding failure), Costa Rican society has been profoundly cautious and unhurried. Electricity, communications, insurance and liquors are still run under a State monopoly and their liberalisation is likely to be slow, calculated and negotiated. A phlegmatic approach seems to be one of the historical keys to the political nature and sociology of Costa Ricans. 

Within this process, one of the linchpins of the new political agenda in Costa Rica in this first decade of the 21st century should be an intelligent and reasonable chemistry between State participation and market forces to re-launch the country’s strategic agenda. Costa Rica has historically shown that the State can be a major and indeed indispensable partner in development, not only as a facilitator of investment and a social promoter, but as a regulator and organiser of private economic forces and the various market agents. At a time when dismantling the State in developing countries seems to be one of the causes of the failure of the Washington Consensus, Costa Rica’s track record shows that neither State fundamentalism nor market fundamentalism are realistic or practical options in the real world. Development will always come hand in hand with a balance between private and public. The crucial point for Costa Rica (which for most of the 20th century already demonstrated that this chemistry and balance are possible) is to re-write and reinvent this old and successful formula.

Jaime Ordóñez
Director of the Observatory Programme for Democracy in Central America –under the auspices of the AECI, the DFID and the ACDI–, Professor of State Theory and Tenured Professor of Costa Rica University