Executive summary

Economic and social progress has been impressive

Costa Rica has achieved strong well-being and robust economic growth. Almost universal access to education, health care and pensions have contributed to high levels of life satisfaction. This has been facilitated by robust economic growth and continued convergence towards OECD living standards. Poverty, income inequality and gender gaps are low by Latin American standards, though high when compared to OECD countries. Shortcomings also exist in some well-being indicators such as work-life balance, safety and income. Costa Rica has established a world-renowned green trademark and eco-tourism industry by protecting its abundant biodiversity and developing renewable energy sources.

Convergence towards higher living standards is in progress
% of upper half OECD
picture

Source: OECD, Productivity Database.

 http://dx.doi.org/10.1787/888933701509

Open trade and foreign direct investment are an integral part of Costa Rica’s successful growth model. This has underpinned Costa Rica’s structural transformation from an agricultural-based economy to one with a more diversified structure that is integrated into global-value chains. Building on these achievements, Costa Rica has the opportunity to increase its specialisation in medium- and high- technological intensive sectors. Robust growth of around 3.7% is projected for 2018 and 2019: a low inflation environment will protect household income and exports will benefit from the global economic recovery. Public investment is also expected to strengthen from its historically-low levels owing to ongoing large infrastructure programmes.

Costa Rica is an open economy, benefiting from strong FDI inflows, 2010-16 average
picture

Source: World Bank Development Indicators.

 http://dx.doi.org/10.1787/888933701528

However, anti-competitive regulations and high labour market segmentation hinder the full realisation of opportunities to make growth more inclusive. Employment growth is also stagnant and unemployment remains above pre-crisis levels, hitting predominantly youth and the low skilled. As a result, and against the general trend in Latin America, informality and inequality are increasing.

The economy will continue to expand at a solid pace
picture

Source: OECD Economic Outlook Database.

Restoring fiscal sustainability is a priority

The fiscal stimulus imparted in 2009 to support the economy as the global crisis unfolded has not been reversed, in spite of a quick recovery and steady growth thereafter. The budget deficit has exceeded 5% of GDP for the past five years. Recent efforts to increase tax collection have not reduced the budget deficit due to the extensive use of earmarking, public sector fragmentation into autonomous agencies and spending mandates. As a result, central government debt has soared, from less than 25% of GDP in 2008 to 49% in 2017.

The fiscal position continues to deteriorate
picture

Source: Ministerio de Hacienda.

 http://dx.doi.org/10.1787/888933701547

A comprehensive fiscal reform package is needed to stabilise the debt-to-GDP ratio. There is ample room to raise additional revenue by broadening the tax base and continuing to fight tax evasion and avoidance. However, raising tax revenue will not help to contain the deficit unless strong earmarking is restricted. The government should also regain control of resource allocation, including by addressing institutional fragmentation. Reforming public-sector compensation, strengthening the budgetary framework with a new, operational fiscal rule and improving debt management would help to balance the budget.

Strengthening monetary policy and financial stability

Monetary policy has successfully achieved low inflation, but challenges remain to further reduce dollarization and strengthen the financial sector. Around 40% of deposits and credits are denominated in foreign currencies, and around 70% of such credits have been extended to unhedged borrowers. The Central Bank has raised the policy interest rate to incentivise savings in local currency and prudential regulation measures have been taken to discourage borrowing in foreign currency. The impact of these measures needs to be carefully assessed and authorities should consider the possibility of also strengthening prudential regulation with a view to continuing to reduce dollarization. Institutional reforms to enhance the independence of the Central Bank should be approved.

While the banking sector appears to be healthy, recent difficulties in two state-owned banks highlight weaknesses in governance. The government should improve the selection of board appointees to state-owned banks and other public enterprises. Opening entry to FinTech start-ups, with appropriate regulation, would boost competition and reduce the high cost of financial intermediation.

Making growth more robust and more inclusive

Productivity growth has gained some momentum over the past decade, but many institutional obstacles are hampering stronger growth and spreading of its gains more widely. Obstacles include labour market marginalisation, restrictions to competition and low outcomes and inequities in education. If Costa Rica does not address these challenges, it risks becoming stuck in a “vicious cycle” whereby individuals with low skills and poor access to opportunities are confined to low-productivity and low-wage jobs. Setting in motion a “virtuous cycle” will require reforms across several policy areas that present win-win opportunities to boost both productivity and inclusion.

Childcare provision is low and differs largely across income levels and geographical areas. These asymmetries impact negatively both on the future educational outcomes of children from disadvantaged backgrounds and on female labour market participation, also hampering equity. Expanding early childhood education and care for low-income groups and improving its quality should become a priority. To facilitate the improvement and expansion of services, all spending on early childcare education and care should be classified under the constitutionally-mandated spending on education and a single agency with clear responsibility for delivering national ECEC policy across the entire sector should be appointed.

Inequality is high
Disposable income distribution (80/20 income ratio), 2016 or latest available data
picture

Source: OECD Income Distribution Database.

 http://dx.doi.org/10.1787/888933701566

About 43% of workers hold informal jobs. High informality is a source of persistent inequalities and is also a drag on productivity. The complex minimum wage structure increases firms’ compliance costs, discouraging job formalisation. The government has reduced the high number of minimum wages from 25 to 23 and plans further reductions to 10 by the end of 2019. Moving to a smaller number of categories, based on geographical and age differentiation, rather than the current complex web of sectoral, occupation, education attainment and skill categories, would significantly reduce compliance costs.

In spite of high education spending, outcomes are poor

Costa Rica has a strong commitment to education as a social and economic development measure. At 7.9% of GDP, education spending is higher than in all OECD countries. However, spending is inefficient both in the learning process and in reducing inequality. PISA results reveal that one third of students lack core competencies and outcomes are strongly influenced by socio-economic background. Grade repetition and drop-out rates are high. Resources need to be channelled and even reallocated to secondary education and early childhood education and care. More focused, targeted support should be given to students at risk early on. Resources should also focus on providing initial and on-the-job training to teachers as well as education materials, which are currently in shortage. Developing good quality dual vocational education and training in secondary education would offer young people strong skills and a close link to the labour market. Overall, the government should move from the current focus on resources and funding to outcomes, and should establish clear and verifiable performance-based targeting against which to measure the success of its education policies.

Overly complex regulations are holding back entrepreneurship

Product market regulations are stringent; there are large barriers to entrepreneurship, extensive anti-trust exemptions and high state control in many sectors. The potential productivity gains from reducing anti-competitive regulations are large. Improving state-owned enterprises’ governance according to OECD standards, establishing one-stop shops for business registration and licensing, streamlining insolvency procedures, removing anti-trust exemptions and enhancing trade facilitation would bring large growth benefits.

Product Market Regulations are stringent
PMR score, 2013
picture

Source: OECD-WBG Product Market Regulation Database for all LAC countries except Brazil, Chile and Mexico; OECD Product Market Regulation Database.

 http://dx.doi.org/10.1787/888933701585

MAIN FINDINGS

KEY RECOMMENDATIONS

Improve macroeconomic stability

Fiscal performance is weak and continues to deteriorate.

Implement immediate measures to reduce the budget deficit by 3 percentage points of GDP during 2018-20 to stabilise the debt-to-GDP ratio, through a comprehensive package of measures to raise revenue, curb spending, and strengthen the fiscal rule. In the medium term take actions to reduce the debt-to-GDP ratio to prudent levels while building fiscal space to address contingencies.

Reduce budget rigidities stemming from legally mandated spending and earmarking of government revenues.

Streamline public sector employment to better control payroll costs.

Assess contingent liabilities.

Create a fiscal council and introduce a multi-year expenditure framework.

Modernise debt management by reducing the number of benchmark securities and improving communication with the markets.

The central bank’s independence in the conduct of monetary policy can be improved. Monetary policy transmission mechanisms are weak, dollarization and currency mismatches are high.

Adopt the draft bill that reforms the rules for appointing the President of the Central Bank; rule out that Ministers or their representatives can vote in Board decisions.

Gradually reduce interventions in the foreign exchange market.

Financial systemic risks remain.

Strengthen prudential regulation on FX loans to unhedged borrowers.

Create a bank resolution mechanism and a deposit insurance scheme for all banks.

Make growth more inclusive

The system of multiple minimum wages exacerbates compliance costs, creating distortions and inequities.

Continue moving to a smaller number of minimum wages.

The share of informal employment is high by OECD standards and has failed to decrease.

Implement a comprehensive plan to reduce informality, including greater enforcement of obligations to pay contributions.

Labour-market gender gaps are high.

Increase the supply of publicly-funded childcare services. Classify all spending on early-childhood education and care under the constitutionally-mandated spending on education.

Spending on education is high, but outcomes are poor. Per student spending on basic education is low, while spending on tertiary education is high. Inequalities in educational outcomes are high; the school drop-out rate is high and teaching quality needs strengthening.

Establish better educational outcomes as the main policy target, instead of a focus on spending, and develop performance indicators.

Rebalance education spending towards early childhood and secondary education. Strengthen targeted support for at-risk students, and teachers’ training.

Boost productivity growth

Competition is weak.

In the banking sector, weak competition drives up intermediation costs.

Adopt and implement the bill reinforcing the powers, independence and funding of the competition commission.

Continue the implementation of the action plan to increase consistency with the OECD Guidelines on Corporate Governance of State-Owned Enterprises.

Continue with the planned 25 sector studies evaluating the exemption from competition and eliminate unjustified exemptions.

Open entry to FinTech start-ups, with appropriate regulation.

Barriers to entrepreneurship are high.

Establish a one-stop-shop for business registration and licensing. Introduce performance targets. Continue to improve the insolvency regime and trade facilitation.

Transport infrastructure is deficient due to a complex institutional setting.

Improve co-ordination among the different public-works bodies by clarifying mandates and granting overall control to a single lead agency. Prioritise projects based on cost-benefit analysis.