Costa Rica’s Way Forward After “Intel Bombshell”: Experts Call for Country to Sharpen its Competitive Edge

The Costa Rican services economy had an interesting past few weeks. Just days after the election of a new left-leaning president – who immediately began to take steps …

Robert Wolf, CEO, EX2 Outcoding, and Freddy Fachler, partner, Pacheco Coto.

The Costa Rican services economy had an interesting past few weeks. Just days after the election of a new left-leaning president – who immediately began to take steps to reassure the investor and business communities – the country experienced near-simultaneous announcements from Intel, cutting their Costa Rica workforce by over half, and Bank of America, announcing the complete closure of their Costa Rica shared services center, along with closings in Mexico and the Philippines.

Those analysts bullish on Costa Rica felt somewhat vindicated when less than a week after Bank of America’s announcement shuttering the three shared services centers, the banking giant announced a $276 million (US) quarterly loss, just a year after posting a $1.48 billion quarterly profit a year ago. Nearshore analysts point to this as the real reason Bank of America decided to shutter Costa Rica operations: simple cost cutting related to Bank of America’s severe hemorrhaging of cash, including $6 billion in litigation expenses related to toxic mortgage backed debentures, and a $9.5 billion settlement with US federal housing regulators. “The cost of resolving more of our mortgage issues hurt our earnings this quarter,” admitted CEO Brian Moynihan in announcing the loss Wednesday morning. Still, the case with Intel seems more organic, as manufacturers seek to control long term costs of production taking into account factors such as labor and energy.

To assess the current Costa Rica situation, Nearshore Americas assembled a virtual roundtable of heavy hitters who have agreed to share their opinion on the state of the Costa Rican economy, skilled tech labor market and political landscape. The panelists include Irving Soto, Investment promotion director for CINDE, Costa Rica’s investment promotion agency; Robert Wolf, founder and CEO of EX2 Outcoding Solutions, a Costa Rican software development and outsourcing company; Dr. Roberto Artavia, distinguished researcher, IADB (Inter-American Development Bank) adviser, executive, and board member of several corporations including Diebold, Inc., Fundacion Marviva, and Fundacion Latinoamérica Posible; Mario Merino, Costa Rica country manager for Gorilla Logic, a Boulder, Colorado based technology and outsourcing firm; and Freddy Fachler, partner with Pacheco Coto, the oldest law firm in Costa Rica, with offices throughout Central America, Europe, and New Zealand.

Nearshore Americas: Intel is a manufacturer, and has a chip fabrication facility in Costa Rica. What does this pullout by Intel mean for Costa Rica as a labor market, and as a destination for high tech manufacturing? Is it still competitive? Is this a sign that Costa Rica’s economy has entered a different phase in its sovereign economic lifecycle?

Robert Wolf: Costa Rica is moving towards services. No longer manufacturing, but other areas like services software development, IT, that’s where Costa Rica is going. So I would say that manufacturing in Costa Rica is no longer quite as competitive as in other countries, but in some sectors Costa Rica is just not going to be as competitive because the energy production costs are very high.

Roberto Artavia: The answer has two separate parts. I believe that Costa Rica remains competitive for higher value added services and advanced manufacturing. Our labor productivity growth outpaces that of most international competitors including China. The problem is that China and all of Asia are moving from being a manufacturing center to becoming also the most important market for intermediate goods and therefore the logistics of supply become very important. Short of moving the country, neither Costa Rica nor any other western manufacturer will be able to hold the production of goods for the intermediate market for long. We need to move to a different way of creating value with knowledge, design, and highly specialized niche manufacturing. For a small country like ours, that should be enough. This year we were on path to export more medical devices than chips and for several years we have been increasing the content of design and specialized services in our exports.

Freddy Fachler: I think that we need to put Intel’s decision into perspective. First of all, it is a partial pullout since the company’s shared services and I+D departments will stay in Costa Rica and, without diminishing the impact of the decision, this is part of the answer to your question. Costa Rica, like any other country, is entering—and needs to enter, into a new economic lifecycle.

Just like we went from being a single export country (coffee) to where we are now, the country will have to enter into a new phase. When the “maquiladoras” moved out of Costa Rica, the country had to reinvent itself; now we have to do the same thing. Take advantage of the highly educated professionals and the skills that companies like Intel required and move into higher value-added kind of services.

Also, in a joint effort between the government and the private sector, the country needs to promote entrepreneurship amongst those professionals that would like begin new companies and develop products and services that can be offered to companies located in Costa Rica and anywhere else. For every new company, you not only compensate for a lost job but you also create new ones, strengthening an independent service providing sector.

Most of all, this should be taken as wake-up call for everybody. Probably there are things that we should have been doing earlier, but there is no point in looking back other than to start doing them right now.

Nearshore Americas: Two weeks ago, Costa Rica elected a new President. This President is from the same political group that has opposed free trade agreements, opposed the benefits of the free trade zones, advocated possible higher taxes, and seems aligned with the new Latin American Left. When business leaders look at what has happened when leftist leaders took the reign in places like Argentina and Venezuela, it scares them. Even Roussef in Brasil is dealing with civil strife and unrest. Should multinational executives worry about Costa Rica or are such thoughts hyperbole and overblown. What is your opinion, and why?

Roberto Artavia: Not at all. Not only has president elect Solis been clear about his position about free export zones, but he could not change much, even if he wanted, because most aspects of these are already tied down in free trade agreements and other long term mechanisms. You can’t compare a country with strong institutions, such as Costa Rica, with countries that have demonstrated time and again that they don’t have a trustworthy institutional framework. Costa Rica is closer to Chile and Uruguay, which technically also have more progressive—I would not call them leftist, governments with strong institutions. Multinational corporate investors and managers can rest easy. Costa Rica will not change in its path, strategy, or capacities. If anything, by investing a little more in social programs, it will avoid the conflicts that seem to take place in many countries around the world, including Mexico and Brazil.

Irving Soto: Investors should not worry; the president elect has been very clear on his position about the free trade zone. He has been very specific saying that foreign direct investment has been a booster for economic development of the country, and he will continue supporting more FDI coming into the country,. He took a clear position that he will respect the free trade zone laws, and furthermore, last weekend he appointed a group from the private sector that will be led by CINDE and linked to him directly in order to participate more directly in everything related to FDI, so he is very committed to that.

Robert Wolf: Seven years ago we had a referendum about the free trade agreement with the USA. There was a right wing and a left wing. Solis, the current president was part of the party against the free trade agreement. With business people there is uncertainty. Not only were they against the agreement, but they were aligned with the communists and other people against free trade zones and liberal economics. So is he going to make drastic changes, or is he going to keep his word? There is worry about whether he is going to change rules along the way.  Solis is not as radical as other people in his party, but unfortunately the experience that we have had with this party is that they were against lots of agreements, against having a liberal economy, and that’s what worries lots of the business people. He has been assuring that he is not going to change the rules, that he is going to be pro-business. I hope he keeps his word. On the other hand he has said that in the first 2 years he will reconsider adding more taxes. His party over the years has been saying that they want to tax the free trade zones.

There is another party in Costa Rica that only got 17% of the elections. That party is one to worry about. It has the same ideology as Chavez in Venezuela, Argentina, and those other countries. This party that got elected and is going to take over the government in May is not as radical as that party.  I think they are more moderate, they are more conservative than the countries that you mentioned, such as Chavez in Venezuela, although we have to be very careful that the new party, we are hoping that they will not change the rules along the way but I wouldn’t be as worried as if the other party that was very close to making it to the second round of elections got through. At this point all the business people are waiting to see what happens. It seems like the new President is not going to change the rules.

Freddy Fachler: I do not think they should worry. There will be a change in government and there will be a change in certain policies but the socioeconomic realities of the countries that you mentioned (Venezuela, Argentina and Brazil) are very different from Costa Rica’s reality. I also think that the new President brings a pragmatism and a political background somewhat different from that of the historical leaders of his party.

He is an academic, a diplomat and a firm believer in political institutions. He has always said that he is open to hear the arguments of those that think differently and change his views if  he needs to do it (he just said this in connection with the possibility of opening the energy production market) and last week, in the a meeting of the most important private sector organization UCCAEP (Costa Rican Union of Chambers and Private Sector Business Organizations), the new President clearly stated that he wanted the private sector to be involved in his promotional visits to other countries from day one. I think that, form what we know about him and what we have seen so far, the message is clear.

Mario Merino: I think that the concerns are hyperbole and overblown.  Historically Costa Rica has always been slightly left of center.  During the past 20, or so years we adjusted to right of center to become competitive in line with geopolitical events and market forces that presented opportunities that we certainly capitalized on and the fruits of that alignment can be seen now.  The potential and presumed left of center alignment hasn’t been observed yet and this new government very well may make sustainable growth and fighting corruption its goal.

Nearshore Americas: Costa Rica’s currency has been on the rise, making international operations more expensive. I have been told by executives operating in the country that they planned for a tight labor market, but the currency situation has made their Costa Rica operations no longer profitable. Will the new government have better success than the previous government in defending the colón? If so, or if not, why?

Roberto Artavia: Defending the colón depends on a strong export sector, on strong tourism, and on FDI, mainly, with other minor flows. I believe that we will do well in the midterm, although I don’t doubt that the Intel effect will have some impact, real and through speculation. But this country has done fairly well in controlling inflation, we are now much closer to opening new sustainable energy plants, the cost of labor is low relative to productivity growth and in that area the country is outstanding. We might see a short term dip, but nothing long lasting.

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Irving Soto: For a couple of years we have faced a situation where we have seen our currency, the colón, appreciate against the dollar, and of course that’s good for some; companies established here are paying salaries in colóns, but the situation has changed. We have seen some devaluation, and for the next couple of years we should see a weaker currency situation.

Mario Merino: The currency will have, no doubt, an impact on people and the economy, but to a lesser extent, on those of us in professional services and technology because, our inflows are in US dollars and we’re favored in some aspects, yet punished in others such as fuel and costs tied to the US dollar balance of trade.  On the other hand, the departure of Intel and Bank of America should inject a dose of reality and remind us of the importance of remaining competitive. Labor will always be tight in a country as small as this, but the service economy in Costa Rica is still young and becoming more professional as a function of time as well as growing. It’s clear that what we do best is articulate value.

Nearshore Americas: The previous Chinchilla government sent a draconian bill to the congress last year proposing to raise the current 8% tax on foreign investment, and proposing that foreign investors make a non-interest bearing deposit at the central bank of up to 25% of any investment. It almost looks as if the Chinchilla administration wanted to close the door to any new investment. What is behind this thinking, and how will it change under the new government?

Roberto Artavio: These laws are misunderstood attempts to increase dollar flows using mechanisms that are misinterpreted or that have short term impact on some FDI decisions. However, in our experience, FDI investors and their advisors have become much more sophisticated in analyzing the long term productivity gains of their companies and in this area Costa Rica remains competitive. I believe, as you, that you should not try to charge a company up front because it might make their decision harder to make, but in reality, once all the long term flows are in, the good companies will stay.

Irving Soto: The first thing is that the Chinchilla Administration has attracted over 140 business deals into the country, and did a great job in attracting more high tech jobs to our country, and the new government is committed to doing the same thing. The new president has been very clear that he will continue to do everything in his power to position Costa Rica as the right location for investment.

Nearshore Americas: We continue to hear about the cost of labor in Costa Rica as compared to peer countries. Costa Rica certainly has some advantages, but like everywhere else, it has its unique disadvantages. How can Costa Rica compete in the mid to long term with giants in the neighborhood like Mexico and Colombia, countries that also have highly educated talent and solid urban infrastructure? In the past, Costa Rica boasted stability, education, and experience as its selling points. What will be Costa Rica’s value proposition going forward?

Irving Soto: The one country that provides not only political and social stability, but our highly qualified human capital. What we are doing as a country is we are continuing to work to have more and better prepared people for the companies that are coming in. In just the last year we started offering 12 new career tracks in the universities, and the government is allocating more than $150 million (US) in loans with the IADB and World Bank, towards human capital development, because we are aware of the importance of continuing to leverage and develop the standards of our people. So right now what we are working on as a country is developing the human capital, we need to provide a safe environment for the companies that establish operations here in Costa Rica—not only social, economic and political stability, but a safe country as well, with a very open market. We have a good track record. Every year we have attracted a fairly good number of international companies here, and that has been our track record.

Roberto Artavio: Costa Rica’s labor force will continue to be an advantage. It is not about labor cost, it is about the relationship between cost and real productivity and in that area we remain competitive. Having said that, it is important to continue educating our labor force at ever more demanding technical schools and solve some of the problems with logistical infrastructure. Those are under way, We now have a much better airport and are already talking about a new one, we are investing in new port facilities: not easy, but under way, and we now have better technical schools throughout the country. We have not been passively seeing these changes, we are reacting strongly and consistently. Also, as a small country we can react a lot faster than others, especially than the larger ones, to adapt to new technologies and processes.

Mario Merino: Costa Rica is the country that attracts the most FDI in the region, has the highest ranked educational system in Latin America, has the first place in innovation in Latin America (according to Cornell, INSEAD, and OMPI 2013 Golbal Innovation Index) as well as first in human capital as ranked by the World Economic Forum.  Costa Rica’s concentration of skilled human resources, ability to articulate value, and our history of peace, democracy, sustainability, human rights, and quality of life are aspects that will continue to attract the type of companies that have been attracted to the country thus far, and that is Costa Rica’s value proposition.  It certainly is to Gorilla Logic.

Nearshore Americas: Lastly, what does the incoming administration need to do—what needs to be changed, improved for Costa Rica to maintain its reputation as an IT and Shared Services Destination. No country, company, or government can rest on its laurels and live off of past glory. What structural changes does Costa Rica need to make to remain a premier business destination in the CaLa (Caribbean/Latin America) region?

Mario Merino: A step in the right direction is the appointment of Alexander Mora as foreign trade minister (Ministro de Comercio Exteriór).  He’s a respected and seasoned IT executive and has been a member of the Costa Rican IT Chamber for many years as president and additional roles.  Structurally, Costa Rica needs to implement strategic initiatives to attract and retain talent.  The country as a whole needs to invest in infrastructure and transportation.  This will benefit the work force and the economy in general.  Other initiatives that incentivize and attract business partners have to be economic in nature.  They may be related to how the country realizes income from local rather than international business.

Roberto Artavio:  Four things: 1) show clearly that the strategy remains consistent, show that we are open for business and this means engaging the new President himself in the process of attracting FDI; 2) consolidate the new technical schools and programs to assure that we will maintain our advantage in labor force productivity growth; 3) complete the energy investments under way; we will need more energy and at a better cost; and 4) finalize the investments in our international logistics. And of course, do so maintaining the strong public-private alliance that has existed for 31 years between CINDE, the Foreign Trade Ministry and all of government. It will be key to our efforts.

Freddy Fachler: Costa Rica needs to reassess its advantages and shortcomings. Infrastructure and energy cost are top of the list, but also education and entrepreneurship. It is true that no one can rest on their laurels but it is also true that no country can remain long term doing the same thing and providing the same kinds of services. We need to position ourselves in the ranks of high value added services and compete with other countries not only based on cost but also, but most of all, on quality.

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