Executive summary

Costa Rica has made remarkable economic progress, but faces substantial challenges to safeguard its achievements and further improve living standards. Life expectancy is at par with the OECD average and political stability has been sustained thanks to solid institutions. Unemployment (Figure 1) and informality, affecting nearly half of the labour force, are high. Growth prospects were deteriorating before the pandemic and going forward population ageing will take an additional toll.

A targeted fiscal response, a successful vaccination campaign and strong export performance have supported a rapid recovery from the pandemic (Figure 2). Growth will slow, as consumption is damped by rising inflation (Table 1). Exports will benefit from specialisation in high value-added resilient sectors, but their dynamism will be mitigated by the global economy’s loss of momentum. The gradual resumption of tourism will improve employment. Inflation will remain high, as external inflationary pressures are expected to continue.

Inflation has risen, exacerbated by global supply constraints and Russia’s invasion of Ukraine, with food and energy prices up most. Inflation expectations have increased significantly, reaching more than twice the 3% inflation target. In response, the Central Bank raised its policy rate by 825 basis points, to 9%. Costa Rica has put in place targeted measures to support those most impacted by high energy prices.

After a decade of widening fiscal deficits, fiscal performance improved, thanks to stronger than expected economic activity in 2021 and the fact that all elements of the 2018 fiscal reform, such as the fiscal rule and the VAT, were in place for the first time. With public debt at 70% of GDP and a large interest rate bill (Figure 3), maintaining fiscal prudence, including by ensuring full implementation of the fiscal rule, is critical for debt sustainability. The interest rate bill could increase more than planned in light of on-going increases in global interest rates.

Containing public spending and improving its quality to better support growth and equity is a critical challenge. Continuing spending reallocation efforts, based on spending reviews, can facilitate deploying capital spending to address infrastructure gaps. The implementation of the public employment framework law, key to comply with the fiscal rule and improve public sector efficiency, is expected to bring annual savings of 0.8% of GDP.

The tax system is overly reliant on social security contributions. This favours informality, erodes the tax base and generates inequalities. Broadening tax bases holds the promise of increasing revenues without raising rates and making the tax system more progressive. Moving towards a more centralised and less fragmented tax payment and collection system could yield efficiency gains and facilitate tax compliance. Making social security charges more progressive, by reducing them for low-income workers, can facilitate formal job creation.

Costa Rica’s strong commitment to trade has been key to attract foreign direct investment, move up in global value chains and diversify exports. Nearshoring trends are providing new opportunities. Costa Rica’s clean electricity matrix (Figure 4) and its decarbonisation plan bring the opportunity to become a global leader in low-carbon exports. An ambitious and wide reform agenda would help to seize these new opportunities and to spread the benefits of trade integration throughout Costa Rica.

Boosting competition should be a key element of the government’s reform agenda. The competition authority has received less than one third of the budget granted by law, which hampers its ability to perform its duties. Moreover, the stock of regulations is large and complex and there is no formal requirement to assess the impact of new regulations on competition. There is also a need to boost competition and efficiency in sectors where state companies play a dominant role, such as electricity, banking and e-communications.

Further fighting corruption is also crucial to spread the benefits of Costa Rica’s trade integration more widely. The country has been regularly shaken by corruption scandals and trust in government is relatively low. There is currently no dedicated law providing protection to public or private employees once they have disclosed wrongdoing.

Reducing the carbon footprint of the transport sector is a key challenge. The sector accounts for 42% of carbon emissions. The lack of an efficient public transport network has encouraged widespread and increasing use of private transport to meet mobility needs. Putting in place reliable, efficient and green public transportation is a key pillar of the decarbonisation plan.

Enhancing education outcomes, reducing informality and facilitating female labour market participation are also crucial to fully realize Costa Rica’s growth potential and reduce inequality. Moreover, there is room to improve the targeting of some social programmes and to reduce fragmentation.

Female labour force participation lags other OECD countries. Women taking on family care responsibilities face difficulties to complete education or be in the labour force. More than 90% of women in poor households are out of the labour force. Expanding access to early education would facilitate women’s labour market participation and raise outcomes and equity in education. The coverage of early education for five-year-old children has recently increased, but access should also be expanded for children under the age of four.

Costa Rica’s commitment to education and training is strong, but educational outcomes are weak. The country has achieved almost full enrolment in primary education but lags behind in other key outcomes. Only half of the population aged 25-34 has completed upper secondary education, far from the OECD average (85%). Too many Costa Ricans leave the education system before completing secondary education. These challenges were exacerbated by one of the longest school closures in the OECD during the pandemic.

Firms struggle to fill vacancies, particularly in technical and scientific positions, endangering Costa Rica’s capacity to attract foreign direct investment. Only 16% of graduates follow scientific studies (Figure 5), a similar share as in 2005. Revisiting universities funding mechanisms can improve accountability and the responsiveness to labour market needs. Recent reforms in vocational education aim at increasing the supply and quality of technicians. This would reduce skills mismatches and help to access formal jobs.

Virtually universal health care and primary education and high pension coverage have led to remarkable social outcomes, but inequality keeps trending up. Costa Rica should streamline its social protection system, as 21 institutions currently deliver more than 35 schemes. This would facilitate increasing coverage and reinforcing social protection in some key areas, such as the social protection of children.

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