84607 Costa Rica Five years after CAFTA-DR assessing early results for the Costa Rican economy June 2014 Report No. 84607-CR Costa Rica Five years after CAFTA-DR assessing early results for the Costa Rican economy June 13, 2014 Co st a R ic a a n d Panama C ountry M ana g em ent U ni t · Poverty Red ucti on a nd E co no m i c M a n a g e m e n t · Latin A me rica and the Ca ri b bea n Reg i o n · Do cum ent of th e Worl d Bank © 2014 International Bank for Reconstruction and Development /The World Bank 1818 H Street NW Washington DC 20433 Telephone: 202-473-1000 Internet: www.worldbank.org This work is a product of the staff of The World Bank with external contributions. The findings, interpretations, and conclusions expressed in this work do not necessarily reflect the views of The World Bank, its Board of Executive Directors, or the governments they represent. The World Bank does not guarantee the accuracy of the data included in this work. 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US$1.00 = ¢ 499 Fiscal Year January 1 - December 31 Abbreviations and Acronyms ACAR Costa Rican Association of Insurance and Reinsurance (Asociación Costarricense de Aseguradores y Reaseguradores) ADSL Asymmetric Digital Subscriber Line ARESEP Regulatory Authority of Public Services (Autoridad Reguladora de los Servicios Públicos) ASSAL Association of Insurance Supervisors of Latin America (Asociación de Supervisores de Seguros de Latinoamérica) AXCO Insurance Information Services BCCR Central Bank of Costa Rica (Banco Central de Costa Rica) BSE Uruguay’s State Insurance Bank (Banco de Seguros del Estado de Uruguay) CAATEC High-Tech Advisory Committee (Comisión Asesora de Alta Tecnología) CAFTA-DR Dominican Republic-Central America-United States Free Trade Agreement CBERA Caribbean Basin Economic Recovery Act CBI Caribbean Basin Initiative CBTPA Caribbean Basin Trade Partnership Act CCSS Costa Rican Social Security Administration (Caja Costarricense de Seguro Social) CINDE Costa Rica Investment Promotion Agency (Coalición Costarricense de Iniciativas de Desarrollo) COMEX Ministry of Foreign Trade (Ministerio de Comercio Exterior) CONASSIF National Council for the Supervision of the Financial System (Consejo Nacional de Supervisión del Sistema Financiero) CPI Consumer Price Index CRC Costa Rican Colón FDA Food and Drug Administration of the United States FDI Foreign Direct Investment FONATEL National Telecomunications Fund (Fondo Nacional de Telecomunicaciones) FTA Free Trade Agreement FTZ Free Trade Zone GAM Greater Metropolitan Area of the Central Valley of Costa Rica GDP Gross Domestic Product GVC Global Value Chain HSPA High Speed Packet Access ICE Costa Rican Electricity Institute (Instituto Costarricense de Electricidad) ICT Information and Communication Technology IMF International Monetary Fund INEC National Institute of Statistics and Census (Instituto Nacional de Estadísticas y Censos) INS National Insurance Institute (Instituto Nacional de Seguros) IP Intellectual Property ITU International Telecommunication Union LRIC Long-term Incremental Costs MAG Ministry of Agriculture MEIC Ministry of Economy, Industry and Commerce (Ministerio de Economía, Industria y Comercio) MICITT Ministry of Science, Technology and Telecommunications (Ministerio de Ciencia, Tecnología y Telecomunicaciones) MINAET Ministry of Environment, Energy and Telecommunications (Ministerio de Ambiente, Energía y Telecomunicaciones) MNC Multinational Company MNVO Mobile Network Virtual Operator NAFTA North American Free Trade Agreement OECD Organization for Economic Co-operation and Development PAHO Pan American Health Organization PROCOMER Center for Promotion of Foreign Trade (Promotora del Comercio Exterior) PRUGAM Regional and Urban Plan for the Greater Metropolitan Area of the Central Valley of Costa Rica (Planificación Regional y Urbana de la Gran Área Metropolitana del Valle Central de Costa Rica) RACSA Radiográfica de Costa Rica RETEL Rectoría de Telecomunicaciones SUGESE Superintendency of Insurance (Superintendencia General de Seguros) SUTEL Superintendency of Telecommunications (Superintendencia de Telecomunicaciones) TRIPS Trade Related Aspects of Intellectual Property Rights WDI World Development Indicators WTO World Trade Organization Vice President: Jorge Familiar Country Director: Maryanne Sharp (Acting) Sector Director: J. Humberto Lopez Sector Manager: Auguste Tano Kouame Sector Leader: Oscar Calvo-Gonzalez Task Team Leaders: Friederike (Fritzi) Koehler-Geib and Susana Sanchez Table of Contents Foreword ix Acknowledgements xi Overview xiii Trade and FDI Patterns xiv The High-tech Sector: FDI and Export Performance xiv Insurance: The end of a monopoly, and a new beginning for a market xv Telecommunications and the end of another monopoly xvi Intellectual Property Rights in CAFTA-DR and its linkage to Pharmaceuticals in Costa Rica xvii Chapter 1. The Context of CAFTA-DR in Costa Rica 1 Introduction 1 CAFTA-DR in historical context 1 Economic arguments for and against CAFTA-DR at the time of ratification 3 Legal and regulatory changes with CAFTA-DR 4 Trade and FDI patterns with CAFTA-DR 5 Annex 1.A Legal changes under CAFTA-DR 10 Annex 1.B Costa Rica Trade Patterns 13 Annex 1.C Gravity Model 15 Chapter 2. CAFTA-DR and the High-tech Sector: FDI and Export Performance 20 Introduction 20 The impacts of FTAs on FDI and exports in Costa Rica’s high-tech sector 22 CAFTA-DR and FDI in the high-tech sector: evidence from secondary data 23 CAFTA-DR and exports in the high-tech sector: evidence from secondary data 24 CAFTA-DR, FDI, and MNC performance in the high-tech sector: findings from online surveys 26 CAFTA-DR, FDI, and exports in the high-tech sector: findings from structured interviews 28 Chapter 3. Insurance: The End of a Monopoly, and a New Beginning for a Market 30 Introduction and summary 30 Legislative change 31 Market dynamics 32 Comparison with CAFTA-DR and Latin-American countries 37 Interpreting recent developments 37 Outlook 42 Chapter 4. Telecommunications and the End of Another Monopoly 44 Introduction and summary 44 Legal and regulatory developments 45 The entry of private mobile service providers 47 Liberalization drives improvements in access to telecom services 48 Fixed-line telephone services 48 Fixed Internet 49 Mobile broadband services 49 Household access to telecom services, prices, and quality of services 51 Fixed Internet services 51 Mobile services 52 Mobile broadband 53 Penetration in rural areas vs. urban areas: FONATEL 53 The contribution of the telecommunications sector to the Costa Rican economy 54 Conclusions and remaining challenges 55 Rates, investments, and sustainability 56 Private operators do not have enough spectrum 56 Infrastructure sharing and municipal permits 57 Universal service and FONATEL 57 Chapter 5. Intellectual Property Rights in CAFTA-DR and Pharmaceuticals in Costa Rica 58 Introduction 58 Intellectual property regulations for pharmaceuticals in international trade treaties 58 Data protection, new chemical entities, and patent linkages after CAFTA-DR 61 How have CAFTA-DR’s IP rules affected the CCSS? 62 references 67 List of Tables Table 1.1 Top Export Products 2003 - 2012 (percent of total exports) 8 Table 2.1 Responses: How CAFTA-DR Impacted Firm Performance (percent of surveyed firms) 27 Table 3.1 Trends in Market Size and Development 33 Table 3.2 Insurers Operating in Costa Rica since Liberalization 35 Table 3.3 Competition, Development and Performance Indicators 36 Table 3.4 Total Assets (CRC Millions) 36 Table 3.5 Expense Ratios (percent of premiums) 37 Table 3.6 Comparative Insurance Market Data in CAFTA-DR and Latin America 38 Table B3.1.1 Comparative Statistics for Costa Rica, Czech Republic, Poland, and Uruguay 40 Table 4.1 Concessions for Mobile Telecommunication Service (in US$) 47 Table 4.2 Phases and Criteria for Cellular Concessions in Costa Rica 48 Table 4.3 Fixed Internet Prices in Costa Rica, US$ per Month, August 2013 51 Table 4.4 Cellular Pre-paid Rates (US$) 53 Table 4.5 Tariffs, Prices, and Equivalent Tariffs for Selected Services 53 Table 4.6 Estimation of Consumer Surplus for Internet Access Services 55 Table 5.1 Pharmaceutical Products with Patent Linkage Protection 62 List of Figures Figure 1.1 Costa Rican Exports (FOB) to the U.S. (2002-2012) in US$ Billions 6 Figure 1.2 U.S. Imports (CIF) from CAFTA-DR Countries (1980-2012) in US$ Billions 6 Figure 1.3 Costa Rica Exports to U.S. (US$ Millions) 7 Figure 1.4 Costa Rica Imports from U.S. (US$ Millions) 7 Figure 1.5 Composition of Total Export of Goods, FOB (in percent) 8 Figure 1.6 Costa Rica Export Concentration Index of Agricultural Goods Relative to World Average 8 Figure 1.7 FDI Inflows to Costa Rica by Country of Origin (percent of Total FDI Inflows) 9 Figure 1.8 FDI Inflows to Costa Rica by Sector (percent of total FDI inflows) 9 Figure 2.1 Net FDI Inflows (percent of GDP) 23 Figure 2.2 FDI inflows by Country of Origin (percent for FDI inflows) 23 Figure 2.3 Number of MNCs in High-tech Sectors 24 Figure 2.4 Average FDI Inflows in High-tech Sector (percent of total FDI flows) 24 Figure 2.5 Costa Rica’s Exports and Imports of Goods and Services (percent of GDP) 25 Figure 2.6 Exports of Costa Rica’s FTZs 25 Figure 2.7 Exports of High-tech and Low-tech Sectors of Costa Rica (percent of total exports) 26 Figure 2.8 Exports of Costa Rica to the U.S. by Sector (percent of total exports to the U.S.) 26 Figure 2.9 High-tech Sector Exports in Costa Rica (percent) 27 Figure 2.10 Number of Surveyed Firms by Year and Product Line of First Investment 27 Figure 2.11 Top 3 Reasons for Last Investment in Costa Rica by Product Line of Last Investment 28 Figure 3.1 Explaining Non-life Insurance Penetration Trends 33 Figure 3.2 Insurance Penetration Following Liberalization (scaled penetration – percent of GDP) 39 Figure 3.3 Pace and Direction of Liberalization on Market Shares: Costa Rica Follows a Well-worn Path 41 Figure 4.1 Sector Structure Before and After CAFTA-DR 46 Figure 4.2 Mobile Cellular Lines in Costa Rica, 2003-2012, in thousands 49 Figure 4.3 Mobile Cellular Lines per 100 Inhabitants, Costa Rica and Selected Countries, 2003-2012 49 Figure 4.4 Fixed Telephone Lines per 100 Inhabitants, Costa Rica and Selected Countries, 2003-20012 49 Figure 4.5 Fixed Internet Connections in Costa Rica, 2006-2012, in thousands 50 Figure 4.6 Fixed Internet Connections per 100 Inhabitants, Costa Rica and Selected Countries, 2003-2012 50 Figure 4.7 Mobile Broadband Connections in Costa Rica, 2009-2012, in thousands 50 Figure 4.8 Mobile Broadband Connections per 100 Inhabitants, Costa Rica and Selected Countries, 2005-2012 50 Figure 4.9 Usage of Telecom Services in Costa Rica (percent of Households) 50 Figure 4.10 Fixed Internet Download Speeds in Costa Rica, 2007-2012, percent distribution 50 Figure 4.11 Fixed Internet Prices of One Mb/s, Selected Countries, 2012, percent of GDP per capita 52 Figure 4.12 Cellular Prepaid Prices in U.S. Cents per Minute, Peak for Latin American Countries, 2010 52 Figure 4.13 Mobile Broadband Rates for Selected Countries, percent of GDP per capita 54 Figure 4.14 Telecommunications Sector (percent of GDP) 54 Figure 5.1 Registration of Active Ingredients with the Ministry of Health in Costa Rica, number 61 Figure 5.2 Costa Rica Patent Requests, 2000-2012 63 Figure 5.3 Costa Rica Patent Issues, 2000-2012, number 63 Figure 5.4 CCSS Expenditures for Health Care and Medicines 64 Figure 5.5 Percentage Distribution of CCSS Medicine Expenditures by Therapeutic Group, 2007-2012 65 Figure 5.6 CCSS Medicine Investments by Type, millions of US$ 66 List of Boxes Box 2.1 Survey of MNCs in High-tech Sectors 27 Box 3.1 Comparing Czech Republic, Uruguay and Poland 40 Foreword This volume was motivated by a request from the Ministry -- such as building critical infrastructure, removing excessive of Trade (COMEX) of Costa Rica to evaluate the impact of regulations and improving education quality. Otherwise, the CAFTA-DR treaty, five years after ratification. They were there was a risk that the impact of the treaty could be keen to hear from an independent, credible source about muted. We also thought that the energetic debates around the early effects of this important treaty on the Costa Rican CAFTA-DR could provide an unparalleled opportunity for economy. Central Americans to advance the development agenda in a way that would be beneficial for growth and equity, For us at the World Bank, this was a welcome request, regardless of whether the agreement materialized. The considering that one of our technical teams was deeply Bank’s work was crystallized in 2004 in the publication involved in the CAFTA-DR debates since 2002. In that year, “Challenges of CAFTA-DR: Maximizing Benefits for Central the five Central American countries and the United States America”, a book I had the pleasure to co-author with first engaged in pre-negotiation talks. I was fortunate Daniel Lederman. to coordinate that team, supporting Central American governments and other stakeholders in evaluating key The topic was contentious, and produced passionate aspects of the treaty. We met with a large group of people exchanges in most of the countries involved. Many of the engaged in discussions on agricultural and industrial good debates were serious, well informed, and allowed for the tariffs, sanitary restrictions, intellectual property rights, airing of important concerns. Would this really facilitate foreign investment, trade in services and more, trying to more exports from Central America? Or would it unleash assess what an agreement could mean for the economies a tsunami of imports that would quash local companies? of Central America. For those of us involved in these Would local farmers be badly affected, particularly semi- discussions, it proved to be very rewarding due to the subsistence producers of basic staples? Would there be a breadth and richness of the exchange. strong impact on foreign direct investment, as was found in Mexico during the early years of NAFTA? How could On balance, the World Bank team concluded that a free Central Americans ensure that the treaty would attract trade agreement with the United States, the largest trading investment, particularly in higher value-added items that partner for the five nations, would be a useful tool to could provide good quality formal jobs? For Costa Rica, promote investment, growth and employment. However, many of the questions focused on the impact of the the team highlighted that in order to obtain the strongest opening of the insurance and telecommunications sectors positive developmental impact, Central Americans would to competition. Bank teams focused some of their work on need to resolve key bottlenecks of the development agenda trying to answer some of these important questions. Five Years After CAFTA-DR: Assessing Early Results for the Costa Rican Economy ix The chapters in this volume include the response of the came at a good time, nearly a decade and a half after the World Bank to the request from Costa Rica to provide an country opted for a strategy of “smart” integration in the early look at impacts of CAFTA-DR, focusing on trade and global economy. The “smart” part comes from its heavy FDI flows between Costa Rica and the US, and events in emphasis in shaping the type of investment it wanted to the telecoms, insurance and pharmaceutical sectors. Of attract--looking for investors who can bring high value- course, these cannot provide a comprehensive, definitive added manufacturing or service. assessment. Too little time has gone by and the evidence is still only partial. In addition, at this early stage, it is not It is indeed impressive to look at the revolutionary trans- easy to disentangle the precise impact of the treaty from formation of the Costa Rican economy after 25 years. In those arising from other significant developments—such the mid-1980s, exports were still dominated by agricultural as the strong impact on growth, exports, investment and goods such as coffee, bananas, and pineapples. In more employment during the global recession of 2009-10. recent years, exports have become increasingly diversified, with significant shares in areas such as microprocessors, Despite these caveats and the short time since ratification, medical devices and services for back office functions. This the evidence reviewed suggests that Costa Rica has derived is perhaps the most dramatic transformation of the export significant positive benefits from CAFTA-DR. Export flows structure of any Latin American economy since the 1980s. to the US have risen, and preliminary econometric tests CAFTA-DR seems to be contributing to deepening this suggest that the treaty has provided an extra boost. While important trend. it is harder to measure the precise impact on FDI, it is clear that investors have continued to prefer Costa Rica Going forward, an important research agenda remains over other destinations, particularly in the sophisticated on the impacts of CAFTA-DR. The work presented manufacturing and service areas that the country has here does not include a detailed analysis of impacts on developed in recent years. A survey of investors performed employment, poverty or inequality. Another important specifically for this assessment indicates that many aspect that may deserve further analysis is the impact of had CAFTA-DR on their mind when they planned their free trade agreements on fiscal receipts and the changing investment. structure of Costa Rican taxation associated with its strong pro-trade and pro-FDI strategy. Another angle that should The telecommunications market has shown extraordinary be explored is the impact on trade and investment flows growth in access and price reductions after the opening within Central America, as CAFTA-DR was instrumental in created by CAFTA-DR. Service supply is now abundant, deepening integration rules in the region. Finally, future prices for Internet access have reduced dramatically, and work will also need to compare and contrast the impact Costa Ricans can now buy a cell line with no waiting time. across the other Central American member countries as In the insurance sector, the opening fostered by CAFTA-DR well as the Dominican Republic. has prompted a market in which 12 insurers compete, benefiting consumers through improved efficiency, solid growth and product innovation. And on pharmaceuticals, preliminary evidence indicates that CAFTA-DR regulations have not noticeably restricted generic competition, drug prices or the finances of the Costa Rican Social Security Administration (Caja Costarricense de Seguro Social—CCSS). Given the positive results obtained, a key question is: Why has this success materialized quickly for Costa Rica? Clearly, the country was in a privileged position among member countries. Decades of investment in human capital, political stability, policies supporting trade and open investment, Carlos Felipe Jaramillo along with citizen security were responsible for a significant Former Country Director transformation of the economy since the 1980s. CAFTA-DR Central America Department x Five Years After CAFTA-DR: Assessing Early Results for the Costa Rican Economy Acknowledgements This report was prepared by a team led by Friederike (Fritzi) Koehler-Geib and Susana Sanchez under the overall supervision and guidance of Oscar Calvo-Gonzalez (Lead Economist and Sector Leader, LCSPR), Auguste T. Kouame (Sector Manager, LCSPE), J. Humberto Lopez (Sector Director, LCSPR) and C. Felipe Jaramillo (Country Director, LCC2C). The core team included Cinar Baymul, Mateo Clavijo, Jorge Cornick, Alejandra Castro, Diana Mercedes Lachy, Eric Scharf, Hulya Ulku, Craig W. Thorburn, and Eloy Vidal. The team also thankfully acknowledges helpful comments and support from Jose Daniel Reyes, Daniela Marrotta, David Gould, Desiree Gonzalez, Cynthia Flores Mora, Patricia Chacon Holt, Patricia Mendez, Aleksandra Iwulska, and Sergio Vargas Tellez. Special thanks to the Ministry of Foreign Trade (COMEX) for facilitating the preparatory mission for the report and for the support from its staff, especially Francisco Monge, Karen Chan, Reyner Brenes, Natalia Porras, Carolina Vargas, and Alejandra Aguilar. Furthermore, special thanks to the Costa Rican Investment Board (CINDE), which supported the survey of high-tech firms in the FTZ. Additional thanks to the various organizations that provide the data used in this report, including the Central Bank of Costa Rica, Caja Costarricense de Seguro Social (CCSS), Costa Rican Electricity Institute (ICE), National Institute of Statistics and Census (INEC), National Insurance Institute (INS), Center for Promotion of Foreign Trade (PROCOMER), Radiográfica de Costa Rica (RACSA), Rectoría de Telecomunicaciones (RETEL), Superintendency of Telecommunications (SUTEL), and Superintendency of Insurance (SUGESE). Five Years After CAFTA-DR: Assessing Early Results for the Costa Rican Economy xi Overview The Dominican Republic - Central America - United sectors. Legal changes increased the attractiveness of States Free Trade Agreement (CAFTA-DR) has been member countries to foreign investors. The agreement fundamental in creating a stable framework for provides protection for all forms of investment, including Costa Rica’s trade with the United States. On August enterprises, debt, concessions, contracts and intellectual 5, 2004, the U.S. entered into a free-trade agreement property. CAFTA-DR also meets the labor objectives set with the Dominican Republic and five Central American out by the U.S. Congress and grants workers improved countries (Costa Rica, El Salvador, Guatemala, Honduras, access to procedures that protect their rights. Moreover, and Nicaragua). Following a national referendum in 2007, CAFTA-DR led to the modernization of key norms and with 51.6 percent of voters approving, Costa Rica ratified procedures in areas such as government procurement the treaty, which came into force on January 1, 2009. The and intellectual property rights. agreement consolidated benefits that had previously been unilaterally extended under the Caribbean Basin Initiative This report analyses how CAFTA-DR has impacted (CBI) into a multilateral FTA, providing a much more stable the Costa Rican economy in the five years after environment for trade relationships, although with limited ratification, both on a macro level and in key specific changes to overall market access relative to the CBI. sectors. The trade agreement was highly controversial in Costa Rica when it was under negotiations, with some For Costa Rica, CAFTA-DR is more than a trade arguing that it would give the economy a major boost agreement. Besides eliminating tariffs and reducing and others suggesting that it would negatively impact non-tariff barriers between member countries, CAFTA-DR specific sectors and social groups. While recognizing also introduced major changes to the legal framework the limitations of data and analysis on such a complex of member countries, reducing barriers to services, issue in such a short time after coming into effect, this promoting transparency, and ensuring a secure and report seeks to better understand what CAFTA-DR, and predictable environment for investors. The most substan- the legal changes that came along with it, has meant for tial transformation was breaking down government Costa Rica. It presents stylized facts and some indication monopolies in the telecommunications and insurance of the impact of CAFTA-DR, without claiming to establish Five Years After CAFTA-DR: Assessing Early Results for the Costa Rican Economy xiii a stringent causal link or being able to disentangle Over the past two decades, the country has it fully from other effects. At the request of the Costa successfully moved up the global value chains. Rican government, the report considers impacts at both The share of traditional exports has declined in favor of the macro level as well as in the specific sectors of the non-traditional and higher value goods. Moreover, the high-tech industry, telecommunications, insurance and share of electronic products and medical instruments and pharmaceuticals. appliances in total exports has been constantly rising. The report shows that CAFTA-DR is yielding benefits In terms of FDI, the country has been very successful, to the Costa Rican economy, but it is too early to and the composition of the flows has changed provide a complete account just after five years. The considerably since CAFTA-DR, with an increasing agreement has succeeded to further trade integration share of investment in services. Since 2000, FDI to Costa between Costa Rica, the U.S., and other CAFTA-DR Rica has ranged between 2 and 7 percent of GDP, and countries. Exports to the U.S. began increasing several stood at 5.1 percent in 2012. The share of FDI originating years before the agreement, but CAFTA-DR accelerated from the U.S. has remained high. A major shift since the the trend. Costa Rica continues attracting FDI above levels signing and ratification of CAFTA-DR has been the increase observed in other CAFTA-DR countries, with an increasing in inflows into the services sector. share from U.S. investors and a focus on medical devices and business services. Online survey and interviews of The High-tech Sector: high-tech firms in FTZs found that CAFTA-DR was an FDI and Export Performance important factor in the investment decisions. CAFTA-DR ignited an explosion of changes in the telecom and Although both FDI and exports of Costa Rica’s high- insurance sectors, bringing new regulatory frameworks, tech industry have been trending steadily upward competition, product innovations, and price reductions. since the 1990s, CAFTA-DR is expected to contribute Consumers are reaping the benefits of improved telecom to further developments. The majority of multinational and insurance services. But some issues remain for those companies (MNCs) in the high-tech sector are from the markets to mature. Finally, the concern regarding the U.S., and the agreement was expected to strengthen the potential negative impact on the CCSS’ finances due to attractiveness of Costa Rica as destination for foreign the intellectual property rights measures have not been investors. Thus, a review of the FDI and export performance observed. of high-tech sectors (electronics, medical instruments, and business service) can provide insights into the short-term Trade and FDI Patterns impact of CAFTA-DR. The analysis is conducted in light of key historical developments shaping the high-tech sector This section provides stylized facts on trade and FDI (the launch of the FTZs in 1981; arrival of Intel in 1997; patterns over time. Multiple reasons make it difficult to signing of CAFTA-DR in August 2004, followed by a establish a direct causal link between trade and FDI trends referendum for its approval in 2007; and full commitment and CAFTA-DR, including the development trajectory of to CAFTA-DR in January 2009) and the fact that CAFTA-DR the country, domestic economic policies, multiple other came into effect in the midst of the 2008/09 global trade agreements joined by Costa Rica before and after financial crisis. CAFTA-DR, and the intervening impact of the global economic crisis. Nevertheless, some trends are likely In spite of the adverse effects of the global financial attributable to the trade agreement. crisis, the number of MNCs and the total amount of FDI inflows to Costa Rica increased significantly Costa Rica has experienced significant shifts in its following the signing of CAFTA-DR in 2004 and its trade flows over the past 20 years, with an overall entry into force in 2009. The GDP share of total FDI increase in trade integration with the U.S. and Central inflows to Costa Rica increased substantially after 2004 America. A gravity model estimate of trade indicates that until the onset of the global financial crisis, during which it some of the increase in exports to the U.S. can be linked dropped significantly, though the decline was still smaller to CAFTA-DR, while the result is insignificant in the case of than the regional average. This performance was most imports from the U.S. to Costa Rica. likely due to CAFTA-DR. xiv Five Years After CAFTA-DR: Assessing Early Results for the Costa Rican Economy The FDI share of the electronics sector has been local suppliers in order to increase the absorptive capacity stagnant since 2004, while the share of medical and innovation capability of the country. devices and business services has been on an impressive upward path, especially after CAFTA-DR In order for Costa Rica not to fall into the middle- came into force in 2009. The rise in the FDI shares of the income country trap, it must transform its economy medical devices appears to be a result of increased interest from being a recipient of innovation to producing it. in the sector by U.S. companies following CAFTA-DR, One way of achieving this, as the experiences of the Asian while the rise in the FDI share of the business services Tigers have shown, is to maintain FDI and export-oriented sector appears to stem largely from the liberalization of policies—as Costa Rica has been successfully doing during the telecommunication sector due to CAFTA-DR. the last three decades—and to strengthen the ability of the country to innovate through increased investment in Total export share of GDP increased steadily education and infrastructure and through greater exposure throughout the 1990s and most of the 2000s, with to advanced technologies. the largest increases taking place after the arrival of Intel in 1997 and the signing of CAFTA-DR in 2004, Insurance: The end of a monopoly, before declining since 2007. However, these aggregate and a new beginning for a market figures mask some interesting changes in the composition of exports of high-tech industries. Although the export CAFTA-DR imposed significant change on the share of the electronics sector has remained largely flat insurance sector. A new insurance law was required for throughout the 2000s, the export share of medical devices the liberalized market, a supervisory authority needed to has increased steadily since 2007, and has not been be established and developed to full functionality, and significantly affected by the financial crisis, most likely the Instituto Nacional de Seguros (INS)—the existing due to the arrival of new U.S. companies in the industry monopoly insurer—needed to adjust to the new after CAFTA-DR. In addition, the IT-enabled sector had the environment. Until liberalization, the life insurance sector largest boom in its export share during the second half had been merely nascent. While the non-life business of 2000s, with the biggest increase taking place after showed a penetration above regional comparisons, it CAFTA-DR came into force. tended to follow international pricing cycles with some amplification. Online surveys and in-person structured interviews indicate that CAFTA-DR was an important factor in Insurance premiums have grown in a healthy fashion the investment decisions of a significant number of since liberalization, particularly in the life sector. By firms. One of the most important benefits of CAFTA-DR 2012 written premiums for all classes of business totaled was to reinforce government commitment to liberal CRC 466.16 billion (US$924 million), which is already trade and FDI-friendly policies and to strengthen the substantial compared to other CAFTA-DR countries. legal framework on the rights of foreign investors. Non-life premiums represented 80 percent, which in local Other important outcomes included an increase in the currency terms was an increase of just over 16 percent over competitiveness of the Costa Rican economy through 2011 figures. As would be expected, life insurance offered several provisions of CAFTA-DR, including the liberalization considerable potential for growth, as it was substantially of the telecommunication, and insurance sectors, which underdeveloped at the time of liberalization. increased the FDI and exports of the high-tech sector. The market composition in terms of insurers, market Given that CAFTA-DR is still new, and that it came share, and product offerings is still developing. Twelve into force in the middle of the global financial crisis, insurers are competing in the market. The market share many of its anticipated effects will take longer to of the INS has fallen to around 90 percent of the total be realized. Having already achieved most of its early- to market (including compulsory classes) and the Herfindahl mid-developmental goals, Costa Rica’s next challenge is index has fallen to 8,799 and 8,290 for life and non-life to attract FDI at the high-end of the production chain in segments respectively. The increased proportion of business order to increase the value-added content of production, represented by life insurance and the falling measure of and to establish linkages between foreign investors and auto insurance as a proportion of total non-life business Five Years After CAFTA-DR: Assessing Early Results for the Costa Rican Economy xv are both indicators of a maturing market. Furthermore, There are some areas that would be useful for the product mix for non-life is becoming more diverse, policymakers to consider for the future. First, the reducing the level of risk to insurers as they have a more liberalization of compulsory automobile and occupational diverse portfolio of risks. risk business will likely require specific attention from the Superintendency of Insurance (SUGESE), particularly The new entrants have overcome the initial costs regarding adequate statistics for pricing and provisioning, of establishing operations, and innovations in and arrangements for the treatment of cases involving distributions are likely to increase access to insurance uninsured or unidentified motorists or employers. Second, products. Legally, intermediation can be conducted the INS should expand cautiously into new business lines through either agents or brokers, both of which can be and new jurisdictions, and can benefit from the lessons individuals or companies. To date, SUGESE has registered of other entities that have tried and failed in similar large number of intermediaries: agency companies endeavors. Finally, continued development of supervisory (63), individual agents (1,692), brokerage firms (17), capacity will need to be an ongoing priority as the SUGESE and individual agents (177). In addition there were staff continues to grow into their supervisory roles. 49 distributors of mass-marketed insurances and two registered cross-border providers. Microinsurance policies Telecommunications (Seguros autoexpedibles) have promoted innovations in and the end of another monopoly distributions through kiosks, and through relationships with banks, retailers, and the post office. CAFTA-DR opened the door for private investments in the telecommunication sector. A new telecommunication The insurance sector is showing benefits through law was required for the liberalized market; a new improved operating performance, solid growth, regulator, Superintendencia de Telecomunicaciones product innovation, and improved efficiency. Expense (SUTEL), needed to be established and to develop its ratios have reduced by 10 percent between 2010 and functionality; and the Instituto Costarricense de Electricidad 2012, which can be attributed to the impact of competitive (ICE), the existing monopoly provider, needed to adjust to initiatives on expense control, innovation from new the new environment. Until liberalization, ICE dominated entrants, as well as economies naturally generated from the telecommunication sector. In this environment, there increased market size. Moreover, a 20 percent increase was a large unmet demand for mobile telephone services, in claims ratios (payouts as a proportion of premiums) prices for Internet access were very high, and the sector demonstrates increased value for money. was supply-constrained. The liberalization dynamics are very similar in The market has shown extraordinary price reductions terms of pace and progress compared to the and growth in access following CAFTA-DR. The forces other countries, but the complete benefits of the of competition have led to an abundant supply of services, initiative are not yet fully captured. New market prices for Internet access fell dramatically, and Costa entrants are seeking to compete and innovate, while Ricans have responded by subscribing massively to the the incumbent is seeking to defend share and meet new services. New entrants have become established and new market challenges. These dynamics include are actively competing with the ICE, which is responding gradual, rather than dramatic, reduction in INS market to the competitive landscape with its own strategies. All share, overall sector growth, and faster growth in life indicators demonstrate that after sector liberalization insurance. There is still plenty of distance to travel, but Costa Rica is well positioned in comparison with Latin early progress has yielded results and indicates what can American countries of similar GDP per capita. Today be expected in the future. Improved value, innovation, consumers can buy a cell line instantly, without the long and dynamism in the sector has already made a positive wait times prevalent prior to liberalization. Finally, the economic contribution; the natural process toward a telecommunication sector’s contribution to GDP increased final balance in competition in the market usually takes substantially. The sector attracted large FDI flows, produced many more years, so these early benefits are the tip of a large consumer surplus advantage stemming from the iceberg. The INS has shown a keen interest in being reduced prices and increased Internet access and cellular part of the innovations in the sector. lines, and made a large contribution to economic growth. xvi Five Years After CAFTA-DR: Assessing Early Results for the Costa Rican Economy However, as in any liberalization of the telecom- and government use that were already part of Costa munication sector, some issues remain. In Costa Rica, Rica´s regulation prior to CAFTA-DR approval. CAFTA-DR these issues are partly due to the fact that the Government expressly states that nothing in the agreement will affect still owns the largest telecommunications operator, which a country’s ability to take measures necessary to protect is not typical of the majority of Latin American countries. public health. Four important challenges remain: liberalizing rates to allow for sufficient investment, broadening spectrum access to Despite discussions of the impact that IP provisions enable improved service, facilitating infrastructure sharing would have on the CCSS’s financial results and access and municipal permits, and ensuring universal access by to generics, CAFTA-DR did not diminish the state´s reforming the activities of the National Telecommunications ability to fulfill its obligations to secure the right to Fund (Fondo Nacional de Telecomunicaciones—FONATEL). health services of the Costa Rican population, as the following evidence indicates: Intellectual Property Rights in CAFTA-DR and its linkage to Pharmaceuticals in Costa Rica • About eight percent of the CCSS’s budget is used for medicine purchases. The protection of intellectual property (IP) was • Most drugs developed and registered worldwide perhaps the most controversial aspect of CAFTA-DR. every year by pharmaceutical companies are new The CAFTA-DR’s IP chapter is also the only one including presentations or formulations of preexisting medicines, regulations that could impact access to pharmaceuticals in and only a small portion of these products are actually Costa Rica. During discussions about the treaty, national new chemical entities that could receive data protection opinion was divided between those who argued that according to Costa Rica’s definition of new chemical intellectual property regulations would lead to an increase entities. in the price of medicines and those who believed that the • From 2009 to 2012, 2,541 new active ingredients were provisions would incentivize innovative medicines to enter registered with the Ministry of Health, of which only 30 the market. received data protection. Only one product with data protection is in the CCSS’s Official Medicine List. The local generic industry argued that IP provisions • Costa Rica has only granted patent linkage to four would prevent the approval of generic medicines and pharmaceutical products (or two active ingredients) grant additional exclusive marketing rights to brand- registered at the Ministry of Health. This means that name manufacturers. This led to concern that CAFTA-DR the marketing approval of generic drugs must await was going to severely restrict or block generic competition, the expiration of the innovative drug’s patent before leading to rising medicine prices and the disappearance producing those products. of the generic market. The strongest position against IP • None of CAFTA-DR’s provisions are actually affecting the rules held that these effects would make it economically CCSS’s financial balance, and several studies confirm unsustainable and legally impossible for the Costa Rican that the CCSS’s financial crisis is not related to the cost Social Security Administration (Caja Costarricense de of medicines. Analysis by the Pan-American Health Seguro Social - CCSS), to ensure universal coverage and Organization (PAHO) of the current financial crisis at access to medicines for the population. the CCSS showed that expenditures on medicines have not affected this situation. CAFTA-DR included provisions on intellectual • The CCSS has added seven active ingredients or 12 property rights. CAFTA-DR’s ratification process actually pharmaceutical presentations to its Official Medicine led to the implementation of legislation sensitive to public List. Only one product with data protection is included health, adopted to avoid restrictions in the market for in the official list of medicines of CCSS (Tenofovir generic companies and to give flexibility to CCSS. The disoproxil fumarate). The IP rules have not restricted or terms were as follows: a) limiting patent term restoration blocked the purchase of generic products by the CCSS. to a maximum of 18 months; b) a restrictive definition of innovative products limiting the scope of products subject to protection of test data; and c) the preservation of provisions for parallel importation, compulsory licensing, Five Years After CAFTA-DR: Assessing Early Results for the Costa Rican Economy xvii Chapter 1 The Context of CAFTA-DR in Costa Rica Introduction scope of this analysis. Moreover, the coincidence of the ratification of CAFTA-DR with the global economic and CAFTA-DR has been more than a trade agreement for financial crisis makes it difficult to identify the agreement’s Costa Rica, and for this reason it catalyzed intense impact. Finally, disentangling the impact of CAFTA-DR from debate about potential impacts on the economy. In other free trade agreements, such as the Caribbean Basin particular, CAFTA-DR brought about the opening of state Initiative (CBI), is a challenge. The study presents stylized monopolies in telecommunications and insurance, which facts and some indication of the impact of CAFTA-DR, polarized the country. As a consequence, the agreement without claiming to establish a stringent causal link or could only be ratified after narrowly passing a referendum being able to disentangle it fully from other effects. in October 2007. Topics of debate included the impact on overall export and growth performance, on foreign direct This chapter provides the background of the investment flows, and on sectors such as agriculture, agreement, setting the stage for the sector-specific industry, telecommunications, insurance, and health. assessments in subsequent chapters. The chapter first provides the historical context of the agreement, then Given the high level of interest and controversy prior gives an overview of the main arguments in favor and to CAFTA-DR’s ratification, it is worth examining its against the agreement prior to its ratification, summarizes actual impacts on the economy. The purpose of the the main legal changes, and sketches an account of trade current study is to take stock of these impacts, and to and foreign direct investment (FDI) patterns. identify areas where complementary reform is needed to reap the full benefit of the agreement. Given that only five CAFTA-DR in historical context years have elapsed since ratification and some provisions are not in force yet (e.g., those related to the agricultural Costa Rica has used trade liberalization and promo- sector), the establishment of causal links is beyond the tion of international trade as a core development Five Years After CAFTA-DR: Assessing Early Results for the Costa Rican Economy 1 strategy for decades. As early as 1963, Costa Rica CAFTA-DR has been fundamental in creating a stable joined the General Treaty on Central American Economic and reliable framework for Costa Rica’s trade with Integration that had been initially signed by El Salvador, the U.S. On August 5, 2004, the U.S. entered into an FTA Guatemala, Honduras, and Nicaragua in 1960. This with the Dominican Republic and five Central American agreement spearheaded trade integration in Central countries (Costa Rica, El Salvador, Guatemala, Honduras, America that has led to a customs union so far. Liberalizing and Nicaragua). The agreement consolidated benefits the movement of workers across the member states is the that had previously been extended on an unilaterally basis component of a common market that is outstanding.1 CBI under CBI into a multilateral free trade agreement for the was an important step for Costa Rica’s trade relationships CAFTA-DR member states, providing a much more stable with the U.S. On August 5, 1983, the U.S. Congress passed trade environment (Hornbeck, 2012). the Caribbean Basin Economic Recovery Act (CBERA), a preferential trade and tax benefits program to support CAFTA-DR has led to the liberalization of the political and economic stability in 27 Caribbean countries Costa Rican insurance and telecom sectors and the and territories including Costa Rica (Dypsky, 2002).2 This introduction of regulatory reforms. Regarding market act was amended twice in 1990 and 2000 granting further access, CAFTA-DR generated limited changes relative to benefits to the member countries. Due to the nature of the arrangements under CBI. Some improvements over this initiative, U.S. Congress had to regularly ratify it and the CBI were made in the area of manufacturing, where could cancel it or exclude countries at any point.3 Through additional tariffs were eliminated for a few products the CBI, Central America was subject to the same terms that had been explicitly excluded under CBI preferences, as Mexico for apparel, and duty-free access was given to such as canned tuna, shoes, and jewelry. In agriculture, approximately 75 percent of Central America’s exports to a reciprocal elimination of tariffs consolidated access the U.S. by 2000 (Lopez and Shankar, 2011). Besides the previously allowed under CBI, and provided for some CBI, Costa Rica signed a free trade agreement (FTA) with expansion of zero-duty access for a few new products that Canada primarily on the trade of goods, and became the had been excluded from the preferences. However, those first Central American country with a FTA with a developed changes in agriculture were agreed with transition periods economy when the agreement entered into force in 2002. ranging from five to 20 years, depending on the goods, In the same year, Costa Rica signed two more treaties with to allow for gradual adjustment.4 In terms of textiles and Chile and the Dominican Republic. Another instrument for apparel, CAFTA-DR implied increased flexibility in the rules trade policy have been the free trade zones (FTZs), which of origin, which should allow zero-duty entry to the U.S.5 are an important vehicle for Costa Rica to attract FDI. The main changes occurred through domestic reforms, most importantly the liberalizations of the insurance 1  O’Keefe (2009). and telecom markets, which will be discussed in further 2  The initial beneficiary countries included Anguilla, Antigua and detail in subsequent chapters. In addition, key norms and Barbuda, The Bahamas, Barbados, Belize, British Virgin Islands, Cayman Islands, Costa Rica, Dominica, Dominican Republic, El Salvador, procedures in areas such as government procurement, Grenada, Guatemala, Guyana, Haiti, Honduras, Jamaica, Montserrat, intellectual property rights, and the treatment of foreign Netherlands Antilles, Nicaragua, Panama, Saint Kitts and Nevis), Saint Lucia, Saint Vincent and the Grenadines, Suriname, Trinidad and investors were modernized under CAFTA-DR, and have the Tobago, and the Turks and Caicos Islands. potential to improve the country’s investment climate.6 3  The Caribbean Basin Economic Recovery Expansion Act of 1990 (CBI II) was enacted under the Customs and Trade Act of 1990. CBI II amended CBERA by making its trade benefits permanent through Costa Rica was the last member country to ratify the the repeal of its 12-year termination date (initially set for September agreement, following a referendum in October 2007. 30, 1995) and implementing certain improvements to its trade and tax benefits. The Caribbean Basin Trade Partnership Act (CBTPA), enacted The U.S. Congress signed the bill to implement CAFTA-DR on May 17, 2000 under the Trade and Development Act of 2000, on July 28, 2005; CAFTA-DR entered into force in El reduces or eliminates tariffs and abolishes most quantitative restrictions on certain products that were previously not eligible for preferential Salvador on March 1, 2006, in Honduras and Nicaragua treatment under either CBERA or CBI II. CBTPA is also intended to foster on April 1, 2006, in Guatemala on July 1, 2006, in the increased opportunities for U.S. companies in the textile and apparel sector to expand co-production arrangements with countries in the CBI Dominican Republic on March 1, 2007, and in Costa Rica region. CBTPA benefits are in effect during a “transition period” that continues through September 30, 2010 or the date, if sooner, on which 4  Jaramillo and Lederman (2006). the Free Trade Area of the Americas or another free trade agreement as described in legislation enters into force between the United States and 5  Ibid. provides a concise summary of the changes of these sectors a CBTPA beneficiary country. There are currently 19 CBERA beneficiary under CAFTA-DR. countries as reported by the International Trade Administration (2013). 6  Ibid. 2 Five Years After CAFTA-DR: Assessing Early Results for the Costa Rican Economy on January 1, 2009. The liberalization of the telecom sectors. Opponents argued that the agreement would and insurance sectors in Costa Rica required substantial be asymmetrical and unfavorable for Costa Rica, due to legislative changes. This led to strong opposition against U.S. agricultural subsidies, technological advantages, CAFTA-DR, both in the Costa Rican Legislative Assembly and market power. Opponents were concerned that and by social and labor organizations, delaying ratification. the agreement would only generate benefits for large- In October 2007, the Costa Rican electorate narrowly scale agricultural corporations and already competitive approved the treaty in a referendum (51 percent of votes industries, while harming small farmers and other small cast in favor and 48 percent against), enabling its entry and medium-sized enterprises. With CAFTA-DR, it was into force at the beginning of 2009. feared that small farmers would not be able to compete with highly subsidized U.S. agricultural exports, and that Encouraged by CAFTA-DR, Costa Rica entered into small companies would be driven out of business, causing further FTAs. In 2011, Costa Rica signed and ratified an job losses.7 FTA with China that included raw materials, intermediate goods, and other merchandise, mainly on electronics. Another concern resulted from the opening of Costa Rica entered into a regional FTA with Mexico, El government-run telecommunication and insurance Salvador, Guatemala, and Nicaragua, which was signed in monopolies. While CAFTA-DR did not require privatizing 2011 and entered into force in Costa Rica in July 2013. In the state-run telecommunications and insurance addition, Costa Rica signed separate FTAs with Peru and companies, it led to the opening of both sectors. Strong Singapore in 2011, entering into force in July and June public sector unions were concerned about job losses and 2013, respectively. Together with other Central American argued that services could become more expensive for countries, Costa Rica also negotiated to an association consumers.8 In the case of telecommunications, opponents agreement with the European Union. As with most of of CAFTA-DR argued that private companies would enter the other trade agreements, the association agreement into the most lucrative segments of the market, such as contains rules for raw materials, intermediate goods, and Internet services; this in turn was presented as a threat other merchandise, but also covers provisions for openness to the ability of the state-owned telecommunications to European FDI in services such as telecommunications, provider (Instituto Costarricense de Electricidad—ICE) to clean technology, biotechnology, medical industry, subsidize losses in less profitable segments of the market, and public infrastructure. The trade component of the particularly rural and poor areas.9 agreement entered into force in October 1, 2013. A third cluster of arguments against the agreement Economic arguments for and against grouped around intellectual property rights and CAFTA-DR at the time of ratification fears that strengthening regulations on these would negatively impact the public health care system. In Given its comprehensive nature, CAFTA-DR sparked particular, opponents argued that stricter rules regarding intense debate about its risks and benefits in patent protection would slow down the entry of generic Costa Rica. Because Costa Rica was the last country medicines into the Costa Rican market and consequently in Central America to eventually open up monopolies drive up prices for medicines. This would in turn harm the in telecommunications and insurance, the debate was provision of services by Costa Rica’s social security system particularly heated. Topics of discussion included the (Caja Costarricense de Seguridad Social-CCSS), which impact on overall export and growth performance, on serves 90 percent of the population.10 FDI flows, and on sectors such as agriculture, industry, telecommunications, insurance, and health. While labor The main arguments in favor of CAFTA-DR were and environmental standards were also taken up both by the stable environment for trade with the U.S. and supporters and opponents of the agreement, these topics Central American neighbors and the potentially are not addressed in this study. positive impacts on FDI and export flows. Supporters 7  See Reuters (2007) and Public Broadcasting Service (2005). Prior to the referendum, the debate about CAFTA-DR 8  Latin Business Chronicle (2007). polarized Costa Rica, with a major concern that the 9  Bindman (2008). agreement could harm the agricultural and industrial 10  Latin Business Chronicle (2007). Five Years After CAFTA-DR: Assessing Early Results for the Costa Rican Economy 3 of CAFTA-DR brought forward general arguments in A third set of arguments in favor of CAFTA-DR related favor of FTAs, such as the positive effects on FDI flows to efficiency gains and benefits to consumers due to of lowering tariffs, expanding market size, reallocating potentially lower prices and better service provision. resources efficiently, increasing economies of scale, The argument of lower prices and better service was promoting technology diffusion, and protecting intellectual particularly prominent in telecommunications and property rights. In addition, they argued that the new insurance, where supporters of CAFTA-DR argued that the multilateral agreement would generate legal certainty, in liberalization and competition would force state-owned contrast to the CBI, which could be removed by the U.S. companies to operate more efficiently.16 Congress at any point.11 Moreover, proponents pointed out that the other Central American countries had already Overall, research suggests that complementary ratified the agreement and that Costa Rica would lose reforms are needed to reap the full benefits of part of its competitive edge vis-à-vis those countries.12 CAFTA-DR. In the case of Central America, Lopez and A further argument in favor was that the potentially Shankar (2011) identify infrastructure reforms (differenti- improved provision of telecom and insurance services in a ating between energy, and logistics and transportation), competitive environment, along with improved regulatory human capital, access to finance, competition policy, and processes and the legal certainty of a multinational trade enforcement of intellectual property rights as important agreement with the U.S., would attract more FDI to Costa complements. With specific attention to Costa Rica, Rica and would ultimately help the country move towards Jaramillo and Lederman (2006) mention improving road the production of higher value goods and bolster its export quality, enhancing port and customs efficiency, boosting and growth performance.13 financial depth, and improving the quality and coverage of secondary education. Proponents argued that impacts on the industrial and agricultural sectors would be mainly positive due to The jury is still out on most of the arguments for or adjustments in the sectors already having occurred against the agreement, and the current study intends prior to CAFTA-DR and the emergence of new to provide stylized facts and an initial analysis to serve opportunities. In particular, supporters of the agreement as a starting point for discussion about the impact of referred to anecdotal evidence from other CAFTA-DR CAFTA-DR so far. While the study can offer an overview of countries that had already ratified the agreement, trends and a stylized narrative, rigorous disentanglement presenting positive impacts on industry and small of causal effects and attribution of effects exclusively to businesses; these benefited more from FTAs than large CAFTA-DR is not possible, due to the relatively short time corporations, which did not need FTAs to be competitive period that has elapsed since its entry into force and the in international markets.14 Moreover, backers argued that difficulty of measuring the impact of CAFTA-DR relative to small business owners would not suffer under CAFTA-DR the impact of the international financial crisis and the role due to wider lines of products to import, export, and of previous and subsequent trade agreements. distribute. Another argument pertaining to agriculture was that Costa Rica’s transformation had already started over Legal and regulatory changes the 25-30 years prior to the negotiations of CAFTA-DR on with CAFTA-DR the back of the country’s structural adjustment plans. In that time, agricultural production had shifted from rice, CAFTA-DR led to a major adjustment of the legal beans, and yellow corn for domestic consumption to system in a short time, both through substantial highly successful production for export of pineapples, transformations and less fundamental amendments. melons, strawberries, winter vegetables, and similar crops. The most sweeping legal transformations were the Therefore, only a modest further adjustment in the sector opening of the telecommunication and insurance markets. was expected.15 Other amendments updated and modernized Costa Rica’s legislation without representing a radical overhaul, mainly 11  See Hornbeck (2012) and Latin Business Chronicle (2007). in the areas of (i) intellectual property; (ii) government 12  Lydersen (2007). 13  Latin Business Chronicle (2007). procurement; (iii) protection to distributors and agents 14  Murphy (2007). 15  Latin Business Chronicle (2007). 16  Roberts and Markheim (2007). 4 Five Years After CAFTA-DR: Assessing Early Results for the Costa Rican Economy of foreign companies; and (iv) financial services. In these Superintendence (SUGESE), the local authority in charge cases, the amendments would likely have taken place of regulating the market, supervising its participants, and without the agreement, as they had been started before protecting consumers. Through the approval of the new the negotiations, but CAFTA-DR accelerated their approval law, Costa Rica covered the requirements under CAFTA-DR and implementation. Implementing CAFTA-DR in Costa Rica and also set up the regulatory apparatus needed to required approving 13 laws and adopting approximately 30 implement the new legislation. executive decrees or resolutions (Annex 1.A). While Costa Rica has generally complied with the legal requirements Less fundamental legal amendments related to of CAFTA-DR within the agreed timeframe, in a few cases intellectual property and procurement. Intellectual delays have occurred, mainly in telecommunications and property legislation was amended through, among others, insurance partly attributed to the time that elapsed before the ratification of international agreements. Not all of the the referendum. international agreements mentioned in CAFTA-DR have been ratified to date. The overall purpose of the changes In a series of changes to the legal framework for the is to render intellectual property protection more stringent. telecommunications sector, the government opened Procurement legislation in Costa Rica was amended to three market segments, mandated the modernization comply with obligation under CAFTA-DR regarding the of ICE, established and clarified supervision, and integrity of procurement practices. The changes included enacted corresponding regulations. In June 2008, the the punishment of fraudulent procurement practices, Legislative Assembly approved the Telecommunication including corruption, and an update of regulations to Law (Ley General de Telecomunicaciones), which opened reflect specific procurement procedures, practices, and private network services, Internet services, and mobile guidelines. wireless services for competition. In addition, the so-called “ICE Law” (Ley de Fortalecimiento y Modernización de Trade and FDI patterns with CAFTA-DR las Entidades Públicas del Sector Telecomunicaciones) approved in August of the same year modernized ICE and The purpose of this section is to provide an overview its subsidiaries with legislation to enable it to adapt to any of trade patterns over time, although establishing changes in the legal regime of generation and delivery of clear causality behind these trends is not possible. electricity, telecommunications, info-communications, and Several reasons make it difficult to establish a causal link. other information services. The same law established the First of all, CAFTA-DR has only been ratified in 2009, and Telecommunications Superintendence (SUTEL), which is some of its provisions have not been applied yet (e.g., tariffs responsible for regulating, implementing, monitoring, and on agricultural goods). Second, as the changes in market controlling the telecommunications regulatory framework. access under CAFTA-DR were of secondary importance, it Finally, several regulations were issued by the Regulatory is difficult to disentangle the impact of the other elements. Authority for Public Services of Costa Rica and through Third, CAFTA-DR was negotiated with the CBI and FTZs executive decrees. By the end of 2008, the relevant already in place, further complicating attempts to assign legislation and regulation was in place, albeit after the responsibility for impacts. Finally, identification of a causal deadlines established under CAFTA-DR. link is handicapped by the fact that the global financial and economic crisis coincided with the ratification of Main legal changes in the insurance sector included CAFTA-DR. Despite all these caveats, some changes in the establishment of a regulatory body and the trends are worth presenting. Although a causal link cannot opening of all insurance products. A major step in be clearly established, these patterns are consistent with the opening of the insurance sector was the approval the theory that CAFTA-DR has already had a significant of the Insurance Law (Ley Reguladora del Mercado de positive impact on trade. Seguros), which was approved in August 2008. This new law established the general framework for carrying out Costa Rica has experienced significant shifts in its insurance activities in Costa Rica, as well as the obligation trade flows over the past 20 years, with an overall for insurers, producers, local service providers, and increase in trade integration with the U.S. and cross-border providers to register with or be licensed by Central America. After growing continuously since the the local regulator. It also created the General Insurance 1980s, Costa Rica’s trade flows to the U.S. have increased Five Years After CAFTA-DR: Assessing Early Results for the Costa Rican Economy 5 Figure 1.1: Costa Rican Exports (FOB) to the U.S. Figure 1.2: U.S. Imports (CIF) from CAFTA-DR Countries (2002-2012) in US$ Billions (1980-2012) in US$ Billions17 5.0 14 4.5 12 10 4.0 8 3.5 6 3.0 4 2.5 2 2.0 0 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 Costa Rica Dominican Republic El Salvador Guatemala Honduras Nicaragua Source: Based on data from COMEX. Source: Based on data from Direction of Trade Statistics, IMF. significantly since the ratification of CAFTA-DR in the to CAFTA-DR, while the agreement had a statistically beginning of 2009, growing by around 50 percent by 2012 insignificant causal link with imports.18 Following the (Figure 1.1). Import growth from the U.S. to Costa Rica methodology applied in Gould (1998), the current study has been more moderate, amounting to almost 30 percent applies the gravity model to a case of bilateral trade flows between 2008 and 2012, while the share of U.S. exports between Costa Rica and the U.S. using a time series sample in Costa Rican GDP has actually declined by 3 percentage in order to determine the effects of CAFTA-DR on exports points of GDP over the same period, according to the and imports between Costa Rica and the U.S. As the IMF. Costa Rica has increased its share of trade exports physical distance between Costa Rica and the U.S. does not to Central America in total exports since the 1980s, while vary over time, the measure of “distance” is not included shares of exports to the U.S. and to the rest of the world in the underlying model for this study. Exports to the U.S. have decreased (Annex 1.B). Costa Rica has also diversified are estimated to have grown faster than they would have imports away from the U.S., with the share of U.S. imports had there not been a free trade agreement (Figure 1.3). in total imports dropping from 51 percent in 1980 to 34 This result is highly significant and not negligible in size. percent in 2012, and the shares of the rest of Central Similarly, imports from the U.S. are estimated to have America and of the rest of the world increasing. grown faster than they would have had there not been a free trade agreement (Figure 1.4). However, the estimation Costa Rica seems to have benefited more than its output shows this effect to be statistically insignificant. Central American neighbors since 2009 in terms While these results indicate a link between CAFTA-DR and of commerce with the U.S. Comparing U.S. imports the increase in export flows towards the U.S., the difficulties from different Central American countries, Costa Rica in identifying and disentangling the economic effects of displays by far the largest increase since 2009 (Figure 1.2). the agreement have to be taken into account. Annex 1.C According to data from the Direction of Trade Statistics, provides a detailed description of the gravity model. the value of U.S. imports from Costa Rica tripled by 2012 compared to 2008, while the increases were more different treatment of the value of intellectual property rights and moderate for other Central American countries, varying exports from free trade zones. The Direction of Trade Statistics data is between 10 and 60 percent. used for Figure 1.2 as it is comparable across countries. 18  The gravity model was based on export and import data from the Central Bank of Costa Rica, which excludes exports from free trade A gravity model of trade suggests that some of the zones. Thereby the dataset is not comparable to the other data sources increase17in exports of goods to the U.S. can be linked used in this first chapter of the report. The reason for using Central Bank data is that free trade zones house companies with foreign and US ownership. Finding an effect in a dataset excluding these zones is 17  Data of Figures 1.1 and 1.2 are not comparable because of the therefore a stricter test on the impact of CAFTA-DR. 6 Five Years After CAFTA-DR: Assessing Early Results for the Costa Rican Economy Figure 1.3: Costa Rica Exports to U.S. (US$ Millions) Figure 1.4: Costa Rica Imports from U.S. (US$ Millions) 400 CAFTA-DR signing 1400 CAFTA-DR signing 350 1200 1000 300 800 250 600 200 400 150 200 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 CAFTA-DR Without CAFTA-DR CAFTA-DR Without CAFTA-DR Source: Based on data from BCCR, Bureau of Economic Analysis, and INEC. See Annex 1.C for Source: Based on data from BCCR, Bureau of Economic Analysis, and INEC. See Annex 1.C for details. Note: The data excludes exports from the FTZs. details. Note: The data excludes exports from the FTZs. Costa Rican export goods have successfully moved 2009 (Figure 1.6).19 Moreover, the overall variety of up the global value chain over the past two decades. products exported to the U.S. rose since 2003. An important shift occurred at the end of the 1990s, when the existing law on FTZs was amended. While Costa Rica has been very successful in attracting prior to this change traditional exports (coffee, banana, FDI, and the composition of the flows has changed meat and sugar) had represented around 30 percent of considerably since CAFTA-DR. Since 2000, FDI to total exports in 1997 and non-traditional exports (the Costa Rica has ranged between 2 and 7 percent of GDP. manufacturing industry and products exported from In 2003, the year prior to the signing of CAFTA-DR, FDI FTZs) represented 24 percent and 20 percent of total stood at US$575 million (3.3 percent of GDP). There were exports, the share of products from FTZs increased to 54 slight increases in this percentage prior to the ratification percent after the amendment (Figure 1.5). This suggests of the FTA in 2009, and FDI reached 5.1 percent of a move towards higher value exports. A similar trend GDP in 2012. Costa Rica’s FDI inflows have historically can be seen between 2003 and 2012, with the share come to a large extent from the U.S. In 2000, these FDI of electronic products and medical instruments and inflows represented 75 percent of total FDI inflows. The appliances consistently rising (Table 1.1). U.S. share of FDI inflows has remained high with the ratification of CAFTA-DR, but has varied (Figure 1.7). At the same time the share of Costa Rica’s top 20 An interesting pattern is the shift in composition of FDI export products has slightly decreased as the variety since the ratification of CAFTA-DR. Before 2004, FDI in of products to the U.S. grew since 2003. The share of the service sector only represented 2 percent of total FDI the top five, top ten, and top 20 export products have inflows. In 2009 this increased to 18 percent of total FDI, remained fairly stable since 2003, with the percentage and then further to 39 percent in 2012 after ratification trending slightly downward (Table 1.1). An index of and the liberalization of telecom and insurance sectors export concentration as measured by the share of (Figure 1.8). Chapter 2 will provide an in-depth analysis agricultural products in total Costa Rican exports relative of FDI flows in the high-tech sector. to the world average of the share of agricultural products in total exports indicates a drop in the concentration of Costa Rican exports over the longer term, with the most important decrease in concentration at the end of the 1990s. However, the data shows a slight increase since 19  This is defined as DXi = (sum |hji – hj|) / 2, where hij is the share of commodity j in the total exports of country i and hj is the share of the commodity j in world exports. The lower this index, the more diversified a country’s exports. Five Years After CAFTA-DR: Assessing Early Results for the Costa Rican Economy 7 Figure 1.5: Composition of Total Export of Goods, Figure 1.6: Costa Rica Export Concentration Index FOB (in percent) of Agricultural Goods Relative to World Average 70 0.8 Prior to signing Signing Rati cation Prior to signing Signing Rati cation 60 of CAFTA-DR of CAFTA-DR of CAFTA-DR of CAFTA-DR 0.7 50 40 0.6 30 0.5 20 0.4 10 0 0.3 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Manufacturing Industry Traditional Exports FTZ Source: Based on data from BCCR. Source: Based on data from World Integrated Trade Solution. Table 1.1: Top Export Products 2003 - 2012 (percent of total exports) 2003 2005 2009 2012 Product % of Product % of Product % of Product % of total total total total Parts and accessories (other 24 Electronic integrated circuits 11 Parts and accessories (other 13 Electronic integrated circuits 19 than covers, carrying cases and micro-assemblies than covers, carrying cases and and micro-assemblies and the like)* the like)* Bananas, including 10 Parts and accessories (other 9 Electronic integrated circuits 10 Instruments and appliances 9 plantains, fresh or dried than covers, carrying cases and used in medical, surgical, and the like)* dental or veterinary sciences Instruments and appliances 8 Instruments and appliances 7 Instruments and appliances 8 Dates, figs, pineapples, 7 used in medical, surgical, used in medical, surgical, used in medical, surgical, avocados dental or veterinary sciences dental or veterinary sciences dental or veterinary sciences Dates, figs, pineapples, 3 Bananas, including plantains, 7 Dates, figs, pineapples, 7 Bananas, including plantains, 6 avocados fresh or dried avocados fresh or dried Medicaments 3 Dates, figs, pineapples, 5 Bananas, including plantains, 7 Coffee, whether or not roasted 4 avocados fresh or dried Top 5 in total exports 48 39 45 45 Top 10 in total exports 59 52 60 56 Top 20 in total exports 69 64 71 66 Source: Based on data from World Integrated Trade Solution. Note:* Refers to parts and accessories suitable for use solely or principally with specific machines (headings 84.69 to 84.72). ** Electrical apparatus for switching or protecting electrical circuits, or for making connections to or in electrical circuits in addition to boards, panels, consoles, desks, cabinets, and other bases. 8 Five Years After CAFTA-DR: Assessing Early Results for the Costa Rican Economy Figure 1.7: FDI Inflows to Costa Rica by Country of Origin (percent of total FDI inflows) 90 80 70 60 50 40 30 20 10 0 -10 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Central America USA Europe (relevant countries) Asia (relevant countries) Source: Based on data from BCCR. Figure 1.8: FDI Inflows to Costa Rica by Sector (percent of total FDI inflows) 2004 2012 Agriculture, 6 Other, 28 Agriculture, -1 Other, 31 Commerce, 3 Commerce, 6 Services, 2 Manufacturing, 27 Manufacturing, 57 Services, 39 Source: Based on data from BCCR. Five Years After CAFTA-DR: Assessing Early Results for the Costa Rican Economy 9 Annex 1.A: Legal Changes Under CAFTA-DR The table below includes a list of all the legislation that Costa Rica produced to implement its obligation under CAFTA-DR and achieved its entry into force on January 1, 2009. This legislative implementation consisted of the promulgation of more than 10 laws including the ratification of three international treaties, and about 30 executive decrees and resolutions.20 Table 1.A.1: Summary of executive decrees and laws resulting from CAFTA-DR Subject Implementation of Legislation National Treatment and Market Access for Executive Decree No. 34912-COMEX of November 25, 2008, “Reglamento para la distribución y Goods asignación de contingentes arancelarios de importación otorgados al amparo del Tratado de libre comercio República Dominicana, Centroamérica y Estados Unidos”. Executive Decree No. 34926-COMEX of November 27, 2008, “Contingentes arancelarios de importación de arroz en granza otorgados al amparo del Tratado de libre comercio República Dominicana, Centroamérica y Estados Unidos y 34926-COMEX”. Executive Decree No. 36598-COMEX of February 23, 2011 that established a Committee on Agricultural Trade. Rules of Origin and Origin Procedures Executive Decree No. 34753-H-COMEX of September 16, 2008, "Reglamento para la aplicación y administración de las disposiciones aduaneras y de las reglas de origen del CAFTA-DR". Commercial Defense Executive Decree No. 34755-COMEX-MEIC of August 22, 2008, “Implementación de la Sección A: Salvaguardias del Capítulo Ocho Defensa Comercial, del Tratado de Libre Comercio República Dominicana-Centroamérica-Estados Unidos”. Government Procurement Law No. 8630 of January 17, 2008, that modified the Criminal Code (Law No. 4573) and the Law Against Corruption and Illicit Proceeds (Law No. 8422). Cross-Border Trade in Services Law No. 8629 of November 30, 2007, “Modificación de la Ley de Protección al Representante de Casas Extranjeras No. 6209, and Repeal of subsection b) of article 361 of the Commercial Code, Law No. 3284”. Financial Services Approved resolution by article 28 of the meeting No. 569-2006 that took place on April 6, 2006 of CONASSIF “Reglamentación general para las empresas responsables de la administración de los fondos de inversión en Costa Rica”. SUPEN Resolution of November 6, 2006 “Regulación SP-A-036 relativa a fondos de pensiones y fondos de pensiones complementarias”. 20  The objectives of this legislative implementation are to ensure the correct application of the treaty and to maximize its potential for Costa Rica. 10 Five Years After CAFTA-DR: Assessing Early Results for the Costa Rican Economy Table 1.A.1: Summary of executive decrees and laws resulting from CAFTA-DR (cont.) Subject Implementation of Legislation Insurance Law No. 8653 of July 22, 2008, “Ley Reguladora del Mercado de Seguros,” which includes reforms to Law N° 12 od October 30, 1924” and establishes rules to regulate the opening of the insurance market. Executive Decree No. 34924-MP-H-COMEX of November 26, 2008, “Garantía Estatal a favor del Instituto Nacional de Seguros”. Approved resolution by article 7 of the meeting number No. 744-1-008 of CONASSIF “Reglamento sobre la Solvencia de Entidades de Seguros y Reaseguros”. Approved resolution by article 6 of the meeting number No. 744-2008 of CONASSIF “Reglamento sobre Autorizaciones, Registros y Requisitos de Funcionamiento de Entidades Supervisadas por la Superintendencia General de Seguros”. Law No. 8642 of June 4, 2008, “Ley General de Telecomunicaciones”, establishes rules to regulate the opening of the telecommunications market following the CAFTA-DR guidelines. Telecommunications Law No. 8660 of August, 2008, “Ley de Fortalecimiento y Modernización de las Entidades Públicas del Sector de Telecomunicaciones”, that establishes a legal framework for the strengthening of ICE. Executive Decree No. 34765-MINAET, “Reglamento a la Ley General de Telecomunicaciones” of September 22, 2008, and it’s modifications: Executive Decree No. 34916- MINAET “Modificación al Reglamento a la Ley General de Telecomunicaciones of December 1, 2008.” Resolution of the Board of Directors of the ARESEP of October 6, 2008 “Reglamento de Acceso e Interconexión de Redes de Telecomunicaciones”. Resolution of the Board of Directors of the ARESEP of October 6, 2008 “Reglamento de Acceso Universal, Servicio Universal y Solidaridad”. Resolution of the Board of Directors of the ARESEP of October 6, 2008 “Reglamento del Régimen de Competencia en Telecomunicaciones”. Law No. 8631 of March 6, 2008, “Ley de protección de las obtenciones vegetales”. Intellectual Property Rights Law No. 8632 of March 28, 2008, “Modificación de varios artículos de la ley de marcas y otros signos distintivos, ley N° 7978, de la ley de patentes de invención, dibujos y modelos industriales y modelos de utilidad N° 6867 y de la ley de la biodiversidad N° 7788”. Law No. 8633 of April 4, 2008, “Adhesión de Costa Rica al Tratado de Budapest sobre el reconocimiento internacional del depósito de micro organismos a los fines del procedimiento en materia de patentes”. Law No. 8834 of May 3, 2008, “Reforma del artículo 2 de la ley N° 6683, de 14 de octubre de 1982, y el artículo 52 de la ley N° 8039, de 12 de octubre de 2000”. Law No. 8635 of April 21, 2008, “Aprobación del Convenio Internacional para la Protección de las Obtenciones Vegetales”. Law No. 8636 of April 29, 2008, “Ley de Aprobación de la Adhesión de Costa Rica al Tratado sobre el derecho de marcas y su Reglamento”. Five Years After CAFTA-DR: Assessing Early Results for the Costa Rican Economy 11 Table 1.A.1: Summary of executive decrees and laws resulting from CAFTA-DR (cont.) Subject Implementation of Legislation Intellectual Property Rights Law No. 8656 of July 18, 2008, “Modificación de varios artículos de la Ley de Procedimientos de Observancia de los Derechos de Propiedad Intelectual N° 8039”. Law No. 8686 of November 21, 2008, “Reforma, Adición y Derogación de varias normas que regulan materias relacionadas con Propiedad Intelectual”. Executive Decree No. 34756-J-COMEX, of September 17, 2008, “Reforma al artículo 21 del Reglamento de las Disposiciones Relativas a las Indicaciones Geográficas y Denominaciones de Origen, contenidas en la Ley de Marcas y Otros Signos Distintivos, Ley N° 7978”. Executive Decree No. 34760-J-COMEX, of September 18, 2008, “Reforma al artículo 22 del Reglamento de la Ley de Marcas y otros signos Distintivos, Decreto Ejecutivo N° 32033-J del 20 de febrero de 2002”. Executive Decree No. 34904-J of November 21, 2008, “Modificaciones al Reglamento a la Ley de Derechos de Autor y Derechos Conexos”. Executive Decree No. 34758-J-COMEX of September 18, 2008, “Modificaciones al Reglamento de la Ley de Patentes de Invención, Dibujos y Modelos Industriales y Modelos de Utilidad, Decreto Ejecutivo N° 15222-MIEM-J del 12 de diciembre de 1983”. Executive Decree No. 34925-S-COMEX of November 27, 2008, “Modificación al Reglamento de Inscripción, Control, Importación y Publicidad de Medicamentos”. Executive Decree No. 34903-MAG-S-MINAET-MEIC-COMEX of November 21, 2008. By the Executive Decree No. 35828-MAG-S-MINAET-MEIC-COMEX of February 25, 2010, “La Derogación, adición y modificaciones de determinadas disposiciones relativas al "Reglamento sobre el Registro, Uso y Control de Plaguicidas Sintéticos Formulados, Ingrediente Activo Grado Técnico, Coadyuvantes y Sustancias Afines de Uso Agrícola”. Executive Decree No. 34927-J-COMEX-S-MAG, of November 28, 2008, “Reglamento a la Ley de Información No Divulgada”. Executive Decree No. 36880-COMEX-JP of October 18, 2011, “Reglamento sobre la limitación a la responsabilidad de los proveedores de servicios por infracciones a Derechos de Autor y Conexos de Acuerdo con el Artículo 15.11.27 del Tratado de Libre Comercio República Dominicana-Centroamérica- Estados Unidos”. Executive Decree No. 34757-MTSS-COMEX of September 19, 2008, “Implementación del Capítulo 16 Laboral del Tratado de Libre Comercio República Dominicana-Centroamérica-Estados Unidos, Ley de aprobación N° 8622 del 21 de noviembre de 2007”. Labor Executive Decree No. 34754–MINAET-COMEX of September 17, 2008, “Implementación del Capítulo 17 Ambiental del Tratado de Libre Comercio República Dominicana-Centroamérica-Estados Unidos”. Environment Executive Decree No. 34958-MINAET-COMEX of December 11, 2008, “Reglamento al Artículo 80 de la Ley de Biodiversidad, Ley Nº 7788 del 30 de abril de 1998”. Executive Decree No. 34959-MINAET-COMEX of December 11, 2008, “Reglamento al Artículo 78, Inciso 6) de la Ley de Biodiversidad, Ley Nº 7788 del 30 de abril de 1998” Transparency Law No. 8630 of January 17, 2008, modified the Criminal Code (Law No. 4573) and the Law Against Corruption and Illicit Proceeds (Law No. 8422). Source: Information provided by COMEX with inputs from Eric Scharf. 12 Five Years After CAFTA-DR: Assessing Early Results for the Costa Rican Economy Annex 1.B: Costa Rica Trade Partners Table 1.B.1: Stylized facts on regional trade patterns Export as percent of total (FOB) 1980 1990 2000 2010 2012 Costa Rica to CA 21 21 14 14 32 to US 39 38 55 46 34 to rest of the World 40 41 31 40 34 Dominican Republic to CA 4 2 1 0.1 0.2 to US 53 57 87 67 46 to rest of the World 43 41 12 33 53 El Salvador to CA 42 40 27 32 29 to US 47 49 66 34 42 to rest of the World 12 12 7 34 29 Guatemala to CA 32 33 33 28 31 to US 40 39 36 41 29 to rest of the World 28 28 30 31 40 Honduras to CA 21 24 24 4 12 to US 35 37 57 63 53 to rest of the World 45 39 19 33 35 Nicaragua to CA 11 12 28 15 20 to US 56 53 42 11 39 to rest of the World 33 35 30 74 42 Panama to CA 13 15 17 13 16 to US 21 30 49 46 58 to rest of the World 66 55 34 41 26 Source: Based on data from Direction of Trade Statistics, IMF. Five Years After CAFTA-DR: Assessing Early Results for the Costa Rican Economy 13 Table 1.B.2: Stylized facts on regional trade patterns Imports as percent of total (CIF) 1980 1990 2000 2010 2012 Costa Rica from CA 8 7 9 9 17 from US 51 47 36 41 34 from rest of the World 42 46 55 50 49 Dominican Republic from CA 3 4 3 1.9 1.5 from US 40 41 61 41 45 from rest of the World 57 55 37 57 54 El Salvador from CA 22 23 20 18 35 from US 38 37 52 44 20 from rest of the World 40 41 29 38 45 Guatemala from CA 14 14 15 9 14 from US 38 37 41 40 35 from rest of the World 47 48 44 52 51 Honduras from CA 24 19 24 9 11 from US 44 41 48 44 42 from rest of the World 32 41 28 47 46 Nicaragua from CA 26 27 29 19 36 from US 19 24 28 15 28 from rest of the World 55 49 43 66 37 Panama from CA 11 11 8 6 5 from US 34 38 38 43 37 from rest of the World 54 50 55 51 58 Source: Based on data from Direction of Trade Statistics, IMF. 14 Five Years After CAFTA-DR: Assessing Early Results for the Costa Rican Economy Annex 1.C: Gravity model Introduction and Literature Four years after the ratification of the CAFTA-DR in Costa Rica in 2009, the present study provides some empirical Models called gravity models are extensively used in trade evidence of the effects of the FTA on Costa Rican trade literature to explain econometrically the ex-post effects flows. This evidence corroborates, to a certain extent, the of economic integration agreements on trade flows. The assessment of the potential trade benefits found in Jaramillo “gravity model” name is derived from its resemblance to and Lederman (2006). Furthermore, the study provides Newton’s law of gravity and in it, trade flows between a simple but comprehensive framework to evaluate the countries are described as an economic function of increases in trade flows that occurred due to the CAFTA-DR their incomes or “sizes”, physical distances between and evaluate their magnitude and importance. them and trade barriers, among others. The studies of Anderson (1979) and Bergstand (1985) provided early The findings of this study have to be read with caution formal theoretical foundations for the gravity equation and can only be seen as an indication of a link between based on utility and profit maximization. Given the solid CAFTA-DR and trade flows. The reasons difficulties in microeconomic foundations underlining the general identifying and disentangling the effects from CAFTA-DR model, the gravity model is among the most comprehensive and earlier trade agreements as well as simultaneous models used in the trade literature. events such as the global financial and economic crisis. An empirical application of Bergstand’s theoretical Data foundation of the gravity model was used by Gould (1988) to determine the effects on trade flows of the North The data to be used in the gravity model is quarterly data for American Free Trade Agreement (NAFTA) between the the 1997-2013 period. For trade flows the value (in millions US, Canada and Mexico. Gould used a bilateral approach of USD) of exports and imports of goods between Costa Rica to the gravity model and estimated the effects of NAFTA and the US is used as provided by the Central Bank of Costa on exports and imports between US and Canada, US and Rica. As discussed, the gravity model includes the size of the Mexico and Canada and Mexico, separately. economy, the most comprehensive measure to account for this is real gross domestic product (GDP) of Costa Rica (in Following Gould (1988), the current study applies the millions of 1991 colones) and the real GDP of the US (billions gravity model to a case of bilateral trade flows between of 2009 USD). In order to control for prices the GDP price Costa Rica and US using a time series sample in order to deflator for Costa Rica and the US is used. In order to control determine the effects of CAFTA-DR on exports from Costa for Costa Rica’s external conditions with the US and the Rica to the US and imports from the US to Costa Rica. rest of the world the real effective exchange rates between As the physical distance between Costa Rica and the US Costa Rica and the US and between Costa Rica and the does not vary over time, the measure of “distance” is not rest of the world (excluding the US), respectively is used. 21 included in the underlining model for this study. Model Within the Costa Rica context the study of Jaramillo and Lederman (2006) provided a preliminary assessment of To assess the effects of CAFTA-DR since its signing the the expected trade and nontrade benefits of CAFTA-DR following benchmark gravity model of Costa Rican and US in the moment it was signed in 2004 and while it was bilateral trade flows is estimated using quarterly data from being negotiated. Their study, drawing from different 1997 through 2013 (first quarter). The empirical equations approaches and methodologies, concluded that CAFTA-DR are based on the application of the gravity model found in was likely to generate greater trade levels arising from Gould (1988), which is derived from standard microeconomic the removal of most tariff and quota barriers among all foundations of Bergstand (1985). All variables are seasonally the parties involved in the agreement. This in turn would adjusted quarterly data and are expressed in log first- improve growth levels. differences (growth rates): 21  The real effective exchange rate between the US and the rest of the world was calculated using Costa Rica’s 13 main trading partners and using their respective consumer price indices. Five Years After CAFTA-DR: Assessing Early Results for the Costa Rican Economy 15 The variables are defined as follows: Xij is country i’s (Costa for seasonality, consists of using plots for autocorrelation Rica) exports to country j (US); t refers to the quarterly date; and partial autocorrelation to decide which autoregressive qn (where n=1,2,…,7) refers to the number of periods each components and lags of the independent variable should individual independent variable in equation (1) is lagged22; be used in the model. pn (where n=1,2,…,7)refers to the number of periods each individual independent variable in equation (2) is lagged23; The results of the model selection for equations (1) and (2) Mij is country i’s (Costa Rica) imports from country j (US); using the Box-Jenkins methodology are presented below: GDPi is real gross domestic product of country i and GDPj is real gross domestic product of country j; Pi is the GDP Equation (1): q1=1, q2=4, q3=1, q4=1, q5=1, q6=1, q7=1 price deflator of country i and Pj is the GDP price deflator Equation (2): p1=4, p2=2, p3=3, p4=2, p5=1, p6=4, p7=4 of country j; Eij is the real effective exchange rate between country i and country j and Eiw is the real effective exchange Once the lag structure is determined for models (1) and rate between country i and the rest of the world (excluding (2) they are estimated by ordinary least squares (OLS). The country j). Dt represents other free trade agreements signed results are presented in tables 1.C.1 and 1.C.2. by Costa Rica during the period 1997-2013. CAFTA is a binary variable representing the period in which CAFTA-DR Having estimated the sign and magnitude of the effects was signed24 in Costa Rica (August 5, 2004). CAFTA equals of CAFTA-DR on exports we are able to show how trade 1 beginning the third quarter of 2004 and 0 before that. trends would have changed without the existence of the agreement. Figures 1.C.1 and 1.C.2 show CAFTA’s Three different regressions were estimated for both the estimated effect on bilateral trade flows (exports and equation on exports (1) and imports (2). These three imports, respectively) between Costa Rica and the US. As different regressions include different dummies for the dotted line in Figure 1.C.1 indicates, exports to the CAFTA-DR: (i) CAFTA starting in 2004 (CAFTA04); (ii) two US are estimated to have been greater than they would different CAFTA-DR dummies for when it was signed 2004 have had there not been a free trade agreement. This and for its ratification in 2009 (CAFTA04 and CAFTA09, result is highly significant although in terms of magnitude respectively) and; (iii) only CAFTA-DR when it was ratified it is relatively small as each quarter the effect of CAFTA-DR (CAFTA09).The size and statistical significance of the CAFTA is estimated to have increased export growth by 5.6 coefficients tell us the degree to which CAFTA-DR affects percent.25 Similarly for imports, as the dotted line in Figure bilateral trade flows in Costa Rica. Figure 1.C.2 indicates, imports from the US are estimated to have been greater than they would have had there not Methodology & Results been a free trade agreement. However, this effect was not significant. The Box-Jenkins methodology was used in order to determine the lag structure and select the model’s underlining equations (1) and (2). This methodology, after identifying the variables’ stationarity and correcting 22  The methodology used to determine these lags and select the model is discussed in the Methodology section. 25   For the semi-logarithmic functional form presented in model (1) the coefficient associated to the CAFTA dummy cannot be interpreted 23  Ibid. as the percentage impact on the log first difference of X of a change in 24  Although CAFTA-DR was not ratified until five years later in January the dummy variable CAFTA from 0 to 1 status. The correct expression for 1st, 2009, the effects on trade were evidenced since its signing in 2004. this percentage change impact is . 16 Five Years After CAFTA-DR: Assessing Early Results for the Costa Rican Economy Figure 1.C.1: Costa Rica Exports to U.S. (US$ Millions) Figure 1.C.2: Costa Rica Imports From U.S. (US$ Millions) 400 CAFTA-DR signing 1400 CAFTA-DR signing 350 1200 1000 300 800 250 600 200 400 150 200 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 CAFTA-DR Without CAFTA-DR CAFTA-DR Without CAFTA-DR Source: Based on data from BCCR, Bureau of Economic Analysis, and INEC. See Annex 2 for Source: Based on data from BCCR, Bureau of Economic Analysis, and INEC. See Annex 2 for details. Note: The data excludes exports from the FTZs. details. Note: The data excludes exports from the FTZs. Table 1.C.1: OLS estimation of equation (1) Exports (i) (ii) (iii) VARIABLES Xijt Xijt Xijt Xijt-1 -0.491*** -0.491*** -0.446*** (0.113) (0.114) (0.119) GDPit-1 -0.677 -0.676 -0.240 (0.760) (0.775) (0.800) GDPit-2 1.320* 1.321* 1.516* (0.720) (0.737) (0.775) GDPit-3 0.978 0.979 1.248 (0.724) (0.748) (0.783) GDPit-4 -1.816*** -1.815*** -1.840*** (0.630) (0.641) (0.678) GDPjt-4 2.371* 2.370* 1.152 (1.363) (1.388) (1.379) Pit-1 -1.122*** -1.122*** -1.100** (0.405) (0.415) (0.439) Pjt-1 1.810 1.820 5.966 (3.218) (3.832) (3.675) Eijt-1 -0.335 -0.336 -0.0884 (0.514) (0.536) (0.558) Ejwt-1 0.261** 0.261** 0.265** (0.103) (0.106) (0.112) CAFTA04 0.0543*** (0.0177) CAFTA04-09 0.0542** (0.0211) CAFTA09 0.0544** 0.0351 (0.0228) (0.0228) Constant -0.0193 -0.0193 -0.0225 (0.0218) (0.0270) (0.0286) Observations 59 59 59 R-squared 0.489 0.489 0.416 Standard errors in parentheses, *** p<0.01, ** p<0.05, * p<0.1. Five Years After CAFTA-DR: Assessing Early Results for the Costa Rican Economy 17 Table 1.C.2: OLS estimation of equation (2) Imports (i) (ii) (iii) VARIABLES Mt ij Mt ij Mijt Mijt-1 -0.154 -0.162 -0.162 (0.122) (0.122) (0.120) Mijt-2 -0.100 -0.111 -0.111 (0.120) (0.120) (0.118) Mijt-3 -0.0341 -0.0524 -0.0524 (0.117) (0.118) (0.116) Mijt-4 -0.600*** -0.595*** -0.595*** (0.117) (0.117) (0.115) GDPit-1 2.863** 3.021** 3.021** (1.217) (1.229) (1.191) GDPit-2 2.702** 2.396* 2.397** (1.176) (1.219) (1.158) GDPjt-1 3.288* 3.264* 3.264* (1.813) (1.815) (1.789) GDPjt-2 0.352 0.407 0.406 (1.768) (1.771) (1.620) GDPjt-3 -5.520*** -5.604*** -5.605*** (1.689) (1.693) (1.604) Pit-1 1.835*** 1.697** 1.698*** (0.609) (0.626) (0.599) Pit-2 1.359** 1.163* 1.164* (0.651) (0.683) (0.654) Pjt-1 -6.641 -8.962 -8.958* (5.024) (5.576) (5.040) Eijt-1 -0.393 -0.211 -0.211 (0.829) (0.851) (0.825) Eijt-2 1.559** 1.679** 1.679** (0.754) (0.765) (0.755) Eijt-3 1.165 1.016 1.017 (0.729) (0.746) (0.730) Eijt-4 1.089 1.187 1.187* (0.707) (0.715) (0.690) Standard errors in parentheses *** p<0.01, ** p<0.05, * p<0.1. 18 Five Years After CAFTA-DR: Assessing Early Results for the Costa Rican Economy Table 1.C.2: OLS estimation of equation (2) Imports (cont.) (i) (ii) (iii) VARIABLES Mtij Mt ij Mijt Eiwt-1 0.176 0.155 0.155 (0.112) (0.114) (0.112) Eiwt-2 -0.303** -0.318*** -0.318*** (0.116) (0.117) (0.113) Eiwt-3 -0.275** -0.284** -0.284** (0.122) (0.123) (0.117) Eiwt-4 -0.548*** -0.532*** -0.532*** (0.164) (0.165) (0.159) CAFTA04 -0.0109 (0.0263) CAFTA04-09 5.84e-05 (0.0287) CAFTA09 -0.0300 -0.0300 (0.0330) (0.0282) Constant -0.0424 -0.0202 -0.0202 (0.0297) (0.0376) (0.0368) Observations 59 59 59 R-squared 0.679 0.687 0.687 Standard errors in parentheses *** p<0.01, ** p<0.05, * p<0.1. Five Years After CAFTA-DR: Assessing Early Results for the Costa Rican Economy 19 Chapter 2 CAFTA-DR and the High-tech Sector FDI and Export Performance Introduction export-based development. While the country has progressed significantly in diversifying output and exports Free trade agreements (FTAs) are generally consi- away from traditional goods to manufacturing products, dered to promote foreign direct investment (FDI) Costa Rica must further increase the high technology and increase exports of member countries. They do content of its manufacturing production and exports by so by lowering tariffs, expanding market size, reallocating attracting FDI in the high-end manufacturing sector and resources efficiently, increasing economies of scale, and by increasing the linkages of MNCs to the local producers. promoting technology diffusion. Most FTAs have provisions Given that the majority of the MNCs in the high-tech governing investment to reduce risk of expropriation and to sector are from the U.S., and coupled with Costa Rica’s ensure against the discrimination of foreign firms, further attractive location and small size, CAFTA-DR can help the stimulating FDI inflows. FTAs also help governments lock country achieve its goals. in reforms, promoting stability and reassuring foreign investors about the security of their long-term investments. This chapter analyzes the potential impact of Moreover, given that most multinational companies CAFTA-DR on FDI and export performance of high- (MNCs) operate in global value chains (GVCs), they are tech sectors in Costa Rica. The high-tech sectors included expected to increase the exports of the host countries and are electronics, medical instruments, and business service. incorporate local suppliers, promoting their know-how The analysis uses secondary sources as well as primary and technological progress. data collected through two surveys from firms in the high- tech sector: an online survey of 61 firms, and in-depth CAFTA-DR is of great significance for Costa Rica’s long- interviews focusing on 11 firms. Furthermore, the analysis term strategy of attracting more FDI and promoting is conducted with attention to key historical developments 20 Five Years After CAFTA-DR: Assessing Early Results for the Costa Rican Economy shaping the high tech sector (e.g., the launch of the FTZs the exports of the high-tech industries. Although the in 1981; the arrival of Intel in 1997; signing of CAFTA-DR export share of the electronics sector remained largely in August 2004, followed by a referendum for its approval the same throughout the 2000s, the export share of in 2007; and its ratification in January of 2009) and the medical devices has grown steadily since 2007 and fact that CAFTA-DR came into effect in the midst of the has not been significantly affected by the financial 2008/09 global financial crisis. During that period most crisis, most likely due to the arrival of new American economies in the world suffered significant losses, which companies in the industry after CAFTA-DR. In addition, impacted the way in which CAFTA-DR had an effect on the IT-enabled sector had the largest boom in its export the Costa Rican economy. Given that CAFTA-DR came share during the second half of 2000s, with the biggest into force just five years ago, the analysis can only provide increase taking place after CAFTA-DR came into force. insights into the short-term impact of CAFTA-DR on Costa • Survey and interview evidence suggests that CAFTA- Rica’s high-tech sector. DR was an important factor in the investment decisions of a significant number of firms. One of the most The findings provide interesting insights into the important benefits of CAFTA-DR for foreign investors links between CAFTA-DR and the high-tech sector, was to reinforce the government’s commitment which are summarized as follows: to liberal trade and FDI-friendly policies, and to strengthen the legal framework protecting the rights • In spite of the adverse effects of the global financial of foreign investors. Other important outcomes were crisis, the number of MNCs and total FDI inflows to an increase in the competitiveness of the Costa Rican Costa Rica increased significantly following the signing economy through several provisions of CAFTA-DR, of CAFTA-DR in 2004 and its ratification in 2009. GDP including the liberalization of the telecommunication share of total FDI inflows to Costa Rica also increased and insurance sectors. substantially after 2004 until the onset of the global • Given that CAFTA-DR is still new and that it came into financial crisis, during which it dropped significantly, force in the middle of the global financial crisis, many though the decline was still smaller than the regional of its anticipated effects will take some time to be average, most likely due to CAFTA-DR. realized. Costa Rica’s next challenge is to attract FDI • The FDI share of the electronics sector has been at the high end of the production chain in order to stagnating since 2004, while the share of medical increase the value-added content of production taking devices and business services has been on an impressive place in Costa Rica, and to establish linkages between upward path, especially after CAFTA-DR came into force foreign investors and local suppliers to increase the in 2009. The rise in the FDI shares of medical device absorptive capacity and innovation capability. industry appears to be a result of increased interest • In order for Costa Rica not to fall into the middle-income in the sector by U.S. companies following CAFTA-DR, country trap, it must transform its economy from being while the rise in the FDI share of the business services a recipient of innovation to producing it. One way of sector appears to largely stem from the liberalization achieving this, as the experiences of the Asian Tigers of the telecommunication sector, which is also due to have shown, is to maintain FDI and export-oriented CAFTA-DR. policies—as Costa Rica successfully done over the last • Although FDI inflows to Costa Rica from almost all three decades—while at the same time strengthening source countries increased after CAFTA-DR in absolute the ability of the country to innovate through increased terms, with the largest increase from the U.S., only investment in education and infrastructure and through the U.S., the Latin American region, and Mexico greater exposure to advance technologies. have increased their shares of total FDI following the agreement. This chapter is organized as follows. The next section • Total exports as a share of GDP increased steadily provides a summary of Costa Rica’s experience with FTAs throughout the 1990s and most of the 2000s, with and the potential impact of CAFTA-DR on FDI and exports the largest increases taking place after the arrival of in the high-tech sector. The next two sections present an Intel in 1997 and the signing of CAFTA-DR in 2004, analysis of the trends in FDI and exports in high tech sector before declining since 2007. However, these aggregate of Costa Rica before and after CAFTA-DR, using secondary figures mask interesting changes in the composition of sources, is presented. Drawing on an online survey of Five Years After CAFTA-DR: Assessing Early Results for the Costa Rican Economy 21 high-tech firms in the FTZs, the perspective of MNCs on countries to foreign investors. The agreement provides CAFTA-DR’s effects on their performance is presented next. protection for all forms of investment, including enterprises, The last section analyzes the effect of CAFTA-DR at the debt, concessions, contracts, and intellectual property firm level based on interviews conducted with a selected (Francois et al., 2007). The chapter 14 of e-commerce sample of firms. in CAFTA-DR introduces the digital product concept and blocks possible future tariffs on these products (Villalobos The impacts of FTAs on FDI and exports in and Monge-Gonzalez, 2010). CAFTA-DR also meets the Costa Rica’s high-tech sector labor objectives set out by the U.S. Congress and grants workers improved access to procedures that protect their Costa Rica launched a trade liberalization-based rights (Francois et al., 2007). development strategy in the mid-1980s. The country unilaterally reduced the average import tariff from Several studies have looked into the potential impact 46.3 percent in 1982 to 16.8 percent in 1989 (Monge- of CAFTA-DR on FDI inflows. Frutos et al., (2011) find Ariño, 2011). The establishment of FTZs in 1981 and tax that CAFTA-DR will positively affect FDI inflows in Costa incentives to attract FDI rapidly transformed Costa Rica Rica by lowering export tariffs and providing protections into a high-tech manufacturing exporter (Trejos, 2008). for investors. They conclude that as a result of continuing Intel’s decision to open an assembly and test plant in FDI inflows the manufacturing sector will develop further. Costa Rica in 1997 paved the way for many other high- In another study, Francois et al. (2007) demonstrate that tech companies to invest in the country, with FDI in the increase in FDI and capital stock would be the biggest targeted knowledge-based sectors reaching 65 percent welfare improving mechanism of CAFTA-DR. However, in the following 15 years (Rodríguez-Clare, 2001; OECD, they also point out that an increase in FDI inflows does not 2012). Around the same time, the country signed trade necessarily foster economic development without positive agreements with Mexico in 1995, Chile, Canada, and knowledge spillovers. the Dominican Republic in 2002, states of the Caribbean Community (Trinidad and Tobago, Guyana and Barbados) CAFTA-DR is also expected to diversify Costa Rican between 2005 and 2006, and Panama in 2008 (Monge- exports’ incorporation in GVCs through FDI. Costa Ariño, 2011). These agreements helped Costa Rica Rica contributes to at least five major high-tech GVCs: diversify exports and increase the share of manufactured electronics, medical devices, automotive, aeronautic/ products in total exports, reducing dependence on primary aerospace, and film/broadcasting devices (Monge- products (Ferreira and Harrison, 2012). Ariño, 2011). These GVCs benefit from economies of agglomeration, attracting more investment from other With CAFTA-DR, Costa Rica carried out changes to its firms and thus further strengthening Costa Rica’s place legal framework, consolidating further gains from in GVCs. Twenty four firms are primarily engaged in trade. Costa Rica signed the CAFTA-DR trade agreement electronics industry, of which only six are producing final in 2004, and it ratified the agreement in January of 2009, products (Gereffi et al., 2013).26 The medical devices at which point it came into effect. The U.S. has traditionally industry consists mostly of U.S. firms, with most significant been Costa Rica’s largest trade partner, with 45 percent growth occurring after the implementation of CAFTA-DR, of Costa Rican exports going to the U.S. and 45 percent and growth in the sector has been driven by export- of imports coming from the U.S. Only 16 percent of its oriented strategies.27 The nascent aerospace industry in exports went to Central America and only 5 percent of its Costa Rica—with no lead firms, a relatively small labor imports came from other CAFTA-DR members before the force, and limited access to finance and technological agreement was implemented (Hicks et al., 2013). Besides expertise—struggles to expand (Gereffi et al., 2013). eliminating tariffs and reducing non-tariff barriers between 26  In 2011, electronics exports worth US$2.14 billion represented member countries, CAFTA-DR also introduced changes 20.4 percent of the country’s total exports. These exports are highly to the legal framework of member countries, ensuring concentrated on one product group, electronic integrated circuits, processors, and controllers, which represents 86.9 percent of electronics a secure and predictable environment for investors, exports. The top export destinations are the U.S. (31.9 percent), Hong with a commitment to develop an appellate mechanism Kong (23.5 percent) and the Netherlands (19.2 percent). for investor-state disputes (Frutos et al., 2011). These 27  While firms first entered Costa Rica for low-cost manufacturing, they rapidly expanded their operations and upgraded their products, modifications increased the attractiveness of member with total exports amounting up to US$1.3 billion in 2011. 22 Five Years After CAFTA-DR: Assessing Early Results for the Costa Rican Economy Figure 2.1: Net FDI Inflows (percent of GDP) Figure 2.2: FDI inflows by Country of Origin (percent of FDI Inflows) 8 80 7 70 63.1 6 60 50 5 40 4 30 3 20 14.2 2 8.7 8.4 10 3.7 1.8 1 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Central Canada and USA Latin Europe Other America Mexico America Costa Rica Latin America CAFTA-DR 1997-99 2000-03 2004-08 2009-12 Source: Based on data from World Development Indicators. Source: Based on data from CINDE. Even if CAFTA-DR has a significant positive effect in the development the sector through three channels: a) on both the FDI inflows and high-tech exports—as it had a direct impact on employment, investment, trade, one might assume—this does not automatically output and the development of technology cluster; b) it translate into long-term growth. Ferreira and Harrison served as a catalyst for repositioning Costa Rica as an (2012) challenge the view that government-backed attractive investment location, through its impact on export diversification based on FDI is the main driver the country’s technical education, incentives laws and of long-term economic growth. They show that neither regulations, and infrastructure (MIGA, 2006); and c) it vertical nor horizontal diversification is associated with increased the confidence of foreign investors through the economic growth in Costa Rica. The main challenge demonstration effect. Third, the recent global financial to development is not only to increase FDI and trade crisis coinciding with the passage of CAFTA-DR also volume, but also to ensure backward linkages from impacted the sector. knowledge-based industries to the local economy to generate positive spillovers and enter a virtuous circle FDI inflows increased remarkably to member (i.e., Giuliani, 2008). countries after signing in 2004, apart from a tempo- rary downturn coinciding with the global financial CAFTA-DR and FDI in the high-tech sector: crisis (Figure 2.1). FDI flows from the U.S., Latin America, evidence from secondary data and Europe surged throughout the two periods of CAFTA-DR—2004-2008 and 2009 onward—while in the An analysis of the linkages between CAFTA-DR and case of Mexico there was a marked increase after CAFTA-DR FDI inflows should consider the key developments came into effect in 2009 (Figure 2.2). The increase in related to the high-tech sector. First, Costa Rica’s Mexico’s FDI after CAFTA-DR was a result of the investment promotion of its high-tech sector started in 1981 with of América Móvil (Claro) that started operating in Costa the passage of a law creating FTZs. This law was passed Rica in 2011 after the liberalization of telecommunication to promote the export of non-traditional products and industry with CAFTA-DR, according to Costa Rica’s attract foreign direct investment (Monge-Gonzales Investment Promotion Agency (Coalición Costarricense de et al., 2005). The second key turning point for Costa Iniciativas de Desarrollo—CINDE). Increased FDI inflows Rica’s high-tech sector was when Intel moved part of its from Latin America after 2009 was entirely a result of the production to Costa Rica in 1997.28 Intel played a vital role investments of Colombian companies—Nutresa, Grupo 28  Numerous studies examined why Intel decided to invest in Costa of the government of Costa Rica, led by COMEX, in collaboration with Rica and not in other countries, including Brazil, Mexico, and Chile, and CINDE to persuade Intel of the advantages of investing in Costa Rica find that the location of the country, its educated labor force, and its has been widely cited as the critical factor for Intel’s decision (Larrain political stability played a key role in Intel’s decision. Committed efforts et al. 2000). Five Years After CAFTA-DR: Assessing Early Results for the Costa Rican Economy 23 Figure 2.3: Number of MNCs in High-tech Sectors Figure 2.4: Average FDI Inflows in High-tech Sector (percent of total FDI flows) 60 59 18 17.1 15.9 16 50 45 13.5 14 12.6 12.3 40 12 10 8.3 9.1 30 28 8 7.6 20 6 4.9 14 10 4 10 7 8677 6 4 33 3 2 21 113 1 0 0 Business Medical Electrical Metalwork Electronics Medical devices Business services Services Devices and Electronics and Automative 1980-89 1980-89 1994-98 1999-03 2004-08 2009-13 2000-03 2004-08 2009-12 Source: CINDE (O cial presentation's clusters). Data until August 2013. Source: Based on data from BCCR. Aval and Banco Davivienda—in Costa Rica. The increases in U.S. companies that dominate the industry.29 The increase FDI flows from Europe during 2004-08 was due to a large in FDI inflows to the business services industry, including Belgian investment, and the increases after 2009 were a the IT-enabled sector, after 2009 can partly be explained by result of the investment by the Spanish telecommunication the liberalization of the telecommunication sector due to company Telefónica in 2011 and Italian power company En CAFTA-DR. Most of the foreign investment in the business el S p.A in 2012. services sector after 2009 was made by U.S. companies in shared services, including P&G, HP, IBM, Sykes, and The distribution of MNCs across high-tech industries Wal-Mart. In sum, these trends suggest that CAFTA-DR also changed during the last decades (Figure 2.3). had a direct impact on FDI inflows to the medical device Throughout the 1980s only six MNCs operated in the and business service industries. high-tech sector, but following the arrival of Intel in 1997 the number of MNCs increased to 18 by 1998. CAFTA-DR and exports in the high-tech Starting from 1999, the numbers of MNCs stagnated sector: evidence from secondary data in electronics, while the number in medical devices and business services doubled between 2004 and 2008, and The main goal of the FDI- and export-led development continued to increase after 2009 when CAFTA-DR came model of the government of Costa Rica has been to into effect. As of August 2013, 34 MNCs are present in diversify exports away from traditional products to the electronics sector, 54 in the medical device sector, and high value-added manufacturing products. Successful 121 in business services. implementation of these policies, together with the educated labor force, political stability, and pro-investment Trends in FDI flows also show a shift towards public policies, enabled the country to become an medical devices and business service and a decrease important manufacturing and business service location for in electronics after the signing of CAFTA-DR. The MNCs and transformed the country’s export composition. average share of FDI allocated to the medical devices The share of manufacturing goods exports as a share of sector increased to 17.1 percent of net FDI flows during total exports increased substantially during 1992-2000, 2009-12, from 12.3 percent in 2000-02 (Figure 2.4). due mainly to the exports of the MNCs in the FTZs. During the same period the share of electronics as a percentage of FDI flows decreased from 15.9 percent to 8.3 percent (Figure 2.4). The largest growth in FDI flows 29  According to CINDE, the largest increase in FDI inflows to the medical devices industry in 2010 was due to the investment of U.S. to the medical device industry took place right after the companies in Costa Rica, including St. Jude Medical, Sterigenics, Tegra implementation of CAFTA-DR, due to protections for the Medical, NDC, and others. 24 Five Years After CAFTA-DR: Assessing Early Results for the Costa Rican Economy Figure 2.5: Costa Rica’s Exports and Imports of Goods Figure 2.6: Exports of Costa Rica’s FTZs and Services (percent of GDP) 60 6,500 55 55 6,000 54 5,500 50 53 5,000 45 4,500 52 40 4,000 51 3,500 35 50 3,000 30 2,500 49 25 2,000 48 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 Exports of goods and services Imports of goods and services Exports of FTZs (in million USD) Exports of FTZs (percent of total exports) Log (Exports of goods and services) Log (Imports of goods and services) Source: Based on data from World Development Indicators. Source: Based on data from CINDE using data from PROCOMER. This section analyzes these anticipated impacts of Total export shares of the high-tech and low-tech CAFTA-DR using secondary data from WDI, CINDE, sectors show diverging trends. As expected, the export and the Central Bank of Costa Rica. Given the close share held by the low-tech sector has declined gradually linkages of the high-tech sector of Costa Rica to MNCs, since 2004, while the export share of the high-tech sector the majority of which are from the U.S., CAFTA-DR is increased from 37 percent in 2004 to 47 percent in 2007 expected to contribute significantly to the exports by and stayed stable until the global financial crisis (Figure 2.7). attracting new MNCs and expanding the investment of the existing MNCs. In addition, by strengthening intellectual According to industry-level data from CINDE, textile property rights and the legal framework protecting foreign exports of Costa Rica to the U.S. declined steadily investors, CAFTA-DR is expected to increase FDI at the over the course of 2000s. The sharpest decline occurred higher end of the manufacturing sector, which is more during 2005-08, from 7.7 percent to 2.8 percent (Figure technology-intensive. 2.8). Agricultural exports have remained stable at around 25 percent, owing to the country’s internationally Import and export shares of national GDP increased renowned agricultural products, innovative diversification significantly up until the onset of the global financial of the sector, and the exception of some products from crisis in 2008. The first peak in both series is observed liberalization. in 1999 after the arrival of Intel, and the second one in 2006, two year after CAFTA-DR was signed (Figure 2.5). Medical instrument exports to the U.S. surged during The losses due to the financial crisis were so severe that in 2007-12, increasing from 15 percent to nearly 25 2010 both export and import shares of GDP dropped to percent (Figure 2.8). In contrast, the electronics sector their lowest levels since 1990, before starting to improve export share to the U.S. declined sharply from 2003 to slowly in 2011. 2005, falling from 30 percent to nearly 20 percent, after which it remained stable at around 22 percent. These Although FTZ exports steadily rose in absolute terms, figures exhibit similar patterns to FDI inflows to the their share of total exports fluctuated annually around medical instruments and electronics industries, indicating, 53 percent. The export levels of FTZs increased following as expected, close linkages between FDI and exports of both the signing and entry into force of CAFTA-DR in 2004 high-tech industry. and 2009, respectively (Figure 2.6). Although the export share of FTZs also increased after the signing of CAFTA-DR, As indicated above, information and communication there was no increase following its entry into force, most technology (ICT) services have become one of the likely due to the interference of the global financial crisis. dominant high-tech sectors in Costa Rica during the Five Years After CAFTA-DR: Assessing Early Results for the Costa Rican Economy 25 Figure 2.7: Exports of High-tech and Low-tech Sectors Figure 2.8: Exports of Costa Rica to the U.S. by Sector of Costa Rica (percent of total exports) (percent of total exports to the U.S.) 49 14 35 47 12 30 45 25 10 43 20 8 41 15 6 39 10 37 4 5 35 2 0 2004 2005 2006 2007 2008 2009 2010 2011 2012 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Low tech (scaled on the right axis) High tech (scaled on the left axis) Electrical and electronic Precision and medical equipment Textiles Agriculture Source: Based on data from BCCR. Source: Based on data from CINDE. last decade. Export shares increased impressively from reasons for investing in Costa Rica, second only to about 12 percent in 2005 to about 32 percent in 2011, the presence of FTZs. It is not surprising that skilled labor with a large percentage of this increase taking place after and FTZs were among the most cited reasons to invest in CAFTA-DR’s entry into force in 2009 (Figure 2.9). Most Costa Rica, as these factors have been widely covered in the of these changes were due to the liberalization of the literature as being one of the strengths of the Costa Rican telecommunications sector, which decreased the price of economy (Figure 2.11). The third most cited reason was cost telecommunications, including broadband, and increased among high-tech manufacturing firms; on the other hand, its quality substantially. firms in the business services and software industries cited location as the third most important factor. Interestingly, CAFTA-DR, FDI, and MNC performance surveyed firms in high-tech manufacturing cited CAFTA-DR in the high-tech sector: findings from before location and institutional environment as a reason online surveys for investing in Costa Rica, while firms in business services ranked CAFTA-DR above institutions. This section provides some insights on the impact of CAFTA-DR on FDI inflows to high-tech firms located Although a quarter of surveyed firms indicated that in the FTZs. Using a survey of 61 firms in the software, CAFTA-DR did not have an effect in their operations, business services, and high-tech manufacturing sectors the rest reported positive changes in their output, (Box 2.1), we found that 28 percent of surveyed firms investment, exports, or other economic performance made their first investment after the entry into force of indicators. About 30 percent of surveyed firms stated CAFTA-DR in 2009 and that all but two firms had made that CAFTA-DR increased their exports, while 28 percent further investments after 2009 (Figure 2.10). The fact indicated that it decreased their cost (Table 2.1). Only 8 that almost a third of the total firms in the sample made percent of firms surveyed claimed that it led to increased their first investment after CAFTA-DR’s implementation, output. and that almost all firms in the sample expanded their investment after CAFTA-DR, suggests that CAFTA-DR The reported effect of CAFTA-DR varied across might have already had significant impact on FDI flows to sectors. While 43 percent of high-tech firms indicated the high-tech sector in Costa Rica, despite the short time that CAFTA-DR increased their exports (which was the since its entry into force and the global recession. most frequently chosen answer in this sector, followed by decreased cost), this was true for only 16 percent of firms The majority of the surveyed firms listed the in business services and 17 percent of the firms in software availability of skilled labor among their top three industry. The majority of firms in business services and 26 Five Years After CAFTA-DR: Assessing Early Results for the Costa Rican Economy Figure 2.9: High-tech Sector Exports in Costa Rica Figure 2.10: Number of Surveyed Firms by Year and (percent) Product Line of First Investment 60 20 18 50 16 6 7 40 14 12 30 10 1 8 20 6 11 12 4 10 10 1 1 6 2 3 3 0 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Automotive, Software Call Electronics Medical Business metal, Centers and devices Services High-technology exports (percent of manufactured exports) aerospace micro-chips ICT goods exports (percent of total goods exports) ICT service exports (percent of service exports, BoP) First Investment before 2009 First Investment after 2009 Source: Based on data from World Development Indicators. Source: Based on data from CINDE. Box 2.1: Survey of MNCs in High-tech Sectors To gain insight on the effects of CAFTA-DR on investments, production, exports, imports, and costs, we carried out a survey of firms in the high-tech sector. The questionnaire was distributed to 200 firms operating in the FTZs in the high-tech sector and was administrated online by CINDE during June-August 2013. Out of 200 firms contacted, only 62 (or 31 percent) responded to the questionnaire, but one firm was dropped as it was not in the high-tech sector. The response rate is similar to that of other enterprise surveys in Costa Rica. Although it is difficult to assess the representativeness of the sample, its distribution across sectors is similar to the distribution of firms and FDI across the high-tech sector, suggesting that the firms in the sample can be, to a large extent, considered as representative of the high-tech industry. Table 2.1: Responses: How CAFTA-DR Impacted Firm Performance (percent of surveyed firms in each row category) Product Line of Last Investment # of firms No effect Decreased cost Increased output Increased exports Other reasons Software 6 33.3 50.0 - 16.7 Business services and call centers 25 32.0 36.0 8.0 16.0 16.0 High-tech 30 20.0 16.7 10.0 43.3 16.7 Total 61 26.2 27.9 8.2 29.5 14.8 Source: Based on data from firm survey facilitated by CINDE in July-August 2013. Note: Multiple responses were allowed. The product line of last and first investment is different for two firms, which explains why there are 6 software firms instead of 4 as in Figure 2.10. software industry responded that it decreased their cost. answers: CAFTA-DR created legal certainty; provided About 20 percent of the high-tech manufacturing firms, stability and clarity to trade relations with the U.S.; made 32 percent of the business services firms, and 33 percent Costa Rica more attractive for new customers from the of the software firms said that CAFTA-DR has not had an U.S.; created the possibility of importing raw materials impact on their economic performance. from other CAFTA-DR signing countries; improved Costa Rica’s business environment to stimulate tier two suppliers Other effects of CAFTA-DR reported by the surveyed to follow Original Equipment Manufacturer (OEM); and firms illustrated how CAFTA-DR improved the improved Costa Rica’s international reputation as having country’s investment climate. The nine firms that a good business climate, justifying the decision to invest highlighted other effects of the treaty listed the following in Costa Rica rather than in another country. Five Years After CAFTA-DR: Assessing Early Results for the Costa Rican Economy 27 Figure 2.11: Top 3 Reasons for Last Investment in also indicated “no impact,” the other three indicated that Costa Rica by Product Line of Last Investment without CAFTA-DR they would either not have an operation (Number of Surveyed Firms) in Costa Rica or that they would not have expanded 30 their pre-CAFTA-DR levels of operation. For business service firms, the benefits are more indirect in that they 25 24 23 are associated with the liberalization of the telecom and 20 20 insurance markets, and enhanced legal security due to the 17 treaty. In software, we found an interesting effect that may 15 14 14 12 13 11 also apply to other sectors, which is that the cost of bank 11 financing reduced as a result of CAFTA-DR, albeit through 10 6 indirect channels: local banks are funded by U.S. banks, 5 5 5 3 3 and those banks estimate that Costa Rica’s country risk is 1 1 0 lower than before due to CAFTA-DR. In consequence, their 0 Software Business services High-tech loan rates for local banks have been reduced, and some of and call centers manufacturing this rate reduction has been passed on to local borrowers. Skilled Labor FTZ Cost Location Institutions CAFTA-DR Source: Based on data from rm survey facilitated by CINDE in July-August 2013. Note: The product line of last and rst investment is di erent for two rms, which explains why there Interviewed firms see CAFTA-DR as commitment are 6 software rms instead of 4. to stable trade and investment policies. All except one firm considered that CAFTA-DR provided additional legal security, clear and stable “rules of the game” and CAFTA-DR, FDI, and exports that it signaled Costa Rica’s commitment to its current in the high-tech sector: trade and FDI policies. This is particularly important as findings from structured interviews the confidence of foreign firms was badly shaken when the country discussed a change in the taxation regime for To get further insights about the impact of CAFTA-DR companies operating in FTZs not long after the current in the high-tech sector, 11 firms were interviewed in regime had been approved by a unanimous vote in the depth. Through open-ended questions, these structured Legislative Assembly in 2009. One firm even mentioned interviews gathered information on whether and how that CAFTA-DR provided protection against a possible CAFTA-DR impacted high-tech firms on their economic return to protectionism in U.S. trade policy. CAFTA-DR was decisions, such as investment, output, exports and imports. credited with bringing more legal security by providing Interviews were conducted during August-September treaty-based preferential access to the U.S. market— 2013 with 11 firms: three in electronics, four in medical instead of the unilateral and hence revocable concessions devices, one in software, two in the IT-enabled services under the Caribbean Basin Initiative (CBI)—and also a industry, and one in other advanced manufacturing. The conflict resolution mechanism in case of disputes between firms were selected with the help of CINDE and technical foreign investors and the government of Costa Rica. For experts. The Ministry of Foreign Trade (COMEX) helped in the one software firm in our sample, it provided increased securing appointments with the firms in the sample. legal security through a surprising channel: enforcement of intellectual property rights in Central American countries Most of the interviewed firms indicated that where these rights were feebly enforced, or not enforced CAFTA-DR had a positive impact on their investment at all, prior to CAFTA-DR. decisions. However, the intensity of the impact and the channels through which it took place varied considerably Among some of the interviewed firms, CAFTA-DR among sectors. In the case of electronics, while one firm appears to have increased product lines and local indicated “no impact,” for the other two the impact was linkages. For example, one company, each in the considerable: one is moving several product lines from electronics, medical devices, and “other manufacturing” Europe to Costa Rica as a result of reduced U.S. tariffs sectors indicated that they were bringing new product lines for their products under CAFTA-DR, and the other shifted to Costa Rica. Only in the case of electronics, however, was from a “trial” to a “permanent” operation as a result of this due to reduced import tariffs as a result of CAFTA-DR; the treaty. In the case of medical devices, while one firm in the other two cases, increased investor confidence 28 Five Years After CAFTA-DR: Assessing Early Results for the Costa Rican Economy seems to have been the key factor in the decision. One firm Rica—CAFTA-DR has made a big difference by substituting in the electronics sector and one in the medical devices treaty-based preferential access conditions to the U.S. sector indicated that as a result of CAFTA-DR, some of market for the unilateral concessions that had been their clients were either expanding or setting up operations granted as part of the CBI. One interviewee indicated that in Costa Rica, so that their local sales were increasing. Two as Costa Rica “graduated” from poor to middle income firms in the electronic sector indicated that they were trying status, the likelihood of keeping CBI benefits would have to source their imports from CAFTA-DR countries, and one declined over time. of them is specifically trying to strengthen its Costa Rica- based supply chain. Just as importantly, CAFTA-DR reassured investors of the Costa Rican government’s commitment to its Seven out of 11 interviewed firms reported that current trade and FDI attraction policies. By providing rejection of CAFTA-DR could have had a negative policy continuity, clear and stable “rules of the game,” impact on them. One firm in the electronics sector and mechanisms for conflict resolution between investors indicated it would not have set up a permanent operation and the government of Costa Rica, CAFTA-DR increased in Costa Rica without CAFTA-DR. Three out of four firms investor confidence and played a key role in the decision to in the medical devices sector and one in the services sector set up or expand the operations of most of the firms that indicated that while they would not have shut down the we interviewed. operations they had at the time of rejection, they would have been unlikely to make further investments in Costa Rica. A stable, rather than growing, market was the estimated impact of the software firm, and a possible relocation outside Costa Rica of their main raw materials supplier could have been the consequence for the firm in the “other manufacture” sector. Other impacts of CAFTA-DR include effects on competitiveness and origin of imports. Seven out of 11 firms estimated they were more competitive (or Costa Rica was more competitive as an investment destination) as a result of CAFTA-DR: one in the electronics sector, two in the medical devices sector, and all firms in the services, software, and “other manufacture” sectors. CAFTA-DR had no impact in the destination of exports, but it has had a small impact on the origin of imports. As some firms try to develop Costa Rica or CAFTA-DR-based supply chains, this impact could increase over time. All firms in the electronics, medical devices, and services sectors indicated that their sectors were growing very quickly, and agreed that CAFTA-DR was helpful in increasing such growth. Some of them even identified CAFTA-DR as the decisive growth factor. The results of our interviews suggest that CAFTA-DR was relevant for foreign investors. For most investors CAFTA-DR has been clearly an important factor in deciding to set up or to expand operations in Costa Rica. While CAFTA-DR has not fundamentally altered the economic conditions under which these firms operate—import tariffs in Costa Rica and the U.S. or income taxes in Costa Five Years After CAFTA-DR: Assessing Early Results for the Costa Rican Economy 29 Chapter 3 Insurance: The End of a Monopoly, and a New Beginning for a Market Introduction and summary are actively competing with the INS, which is responding to the competitive landscape with its own innovations The CAFTA-DR agreement imposed significant change and strategies. Although CAFTA-DR was the trigger on the insurance sector. A new insurance law was for the liberalization, it is notable that all new insurers required for the liberalized market, a supervisory authority have entered from outside the territories of the Central needed to be established and developed to full functionality, American signatories to the agreement. and the National Insurance Institute (Instituto Nacional de Seguros - INS)—the existing monopoly insurer—needed Since liberalization, the market has shown healthy to adjust to the new environment. Until liberalization, the growth and improved efficiency, and provided a life insurance sector had been mostly nascent, while the broader range of services to clients at better value. non-life business showed a penetration30 above regional At the same time, analysis suggests that early progress comparators but had tended to follow international pricing toward the new market structure is slower than the cycles with some amplification.31 average of other comparable countries, though progress is not significantly out of line with expectations. It is widely accepted that without CAFTA-DR, there would have been no liberalization in the insurance This chapter makes a number of recommendations: sector. The market is now functioning in a competitive and open manner. New entrants have been established and • The liberalization of compulsory automobile and occupational risk insurance will likely require specific 30  “Insurance penetration” is defined as premium divided by GDP. attention from the Superintendency of Insurance 31  The World Bank provided advice on these three issues in June 2004. (Superintendencia General de Seguros - SUGESE), 30 Five Years After CAFTA-DR: Assessing Early Results for the Costa Rican Economy particularly regarding adequate statistics for pricing may operate as locally incorporated entities or branches. and provisioning, and arrangements for the treatment The main regulations were issued shortly after the law of cases involving uninsured or unidentified motorists was gazetted.33 The authorities also issued a range of or employers. “acuerdos” and other circulars to clarify the requirements • The expansion by the INS into new business lines and on insurers, intermediaries and other relevant actors in the new jurisdictions should be implemented carefully and insurance sector.34 cautiously, and can benefit from learning the lessons of other entities that have tried and failed in similar The same law established the supervisory authority endeavors. (SUGESE). At first, SUGESE operated within the pension • Continuing to develop supervisory capacity should be superintendence. Operational separation was established an ongoing priority as SUGESE staff continues to grow in 2010, and SUGESE now has a maximum permitted into their supervisory roles. staff of 41, organized in three divisions (regulation and authorization, supervision, and legal). From the The chapter offers a summary of the most relevant legislative commencement of the law, it has conducted a program changes, covers market dynamics since liberalization, and of active on-site inspections to supplement off-site then discusses what might be concluded from comparisons operations, and established a complaint handling service. with other CAFTA-DR countries and markets that have SUGESE has indicated that it would like to move to a more liberalized. Some conclusions and policy recommendations risk-based supervisory approach. SUGESE is financed by are included in the final section. an allocation from the Central Bank of Costa Rica (BCCR), although is substantively independent of it. Legislative change Investment and solvency regulations have been When CAFTA-DR was signed in 2004, steps to overhaul designed in line with an open but prudent approach. the insurance market were set in motion. With a history Minimum entry requirements for capital are set at levels dating back to the Insurance Monopoly Act of 1922, the that do not act as a barrier to entry for serious insurers.35 insurance market in Costa Rica had been operated through Investment requirements require an overall prudent the INS. CAFTA-DR included an important policy decision approach. Limitations include the need for investments to to open the market. It is widely recognized that, absent be channeled into publicly offered securities in Costa Rica the motivation from CAFTA-DR, the insurance market was or similar instruments in other jurisdictions. unlikely to have liberalized. Most products operate under a “file and write” In 2008, a new insurance law provided the key system, but active approval is required for mechanism for liberalization. The Insurance Law compulsory business lines. Initially, the review was (Ley Reguladora del Mercado de Seguros) No. 8653 motivated to give greater weight to consumer protection, was published on August 7, 2008. The law abolished so it focused more on the products issued in volumes (by the INS’s monopoly for most classes of insurance; albeit the INS). This slowed approval for some newer insurers, with a later deadline for compulsory automobile and leading some to comment that the process was not very occupational risk insurances. With limited exceptions, all fast at first. All insurers could leverage existing approvals, insurance activity in Costa Rica has to be conducted by as SUGESE intended that they provided a solid benchmark. authorized organizations.32 Insurers can be life, non-life 33  Reglamento sobre Autorizaciones, Registros y Requisitos de or composite. Local entities may be cooperatives or public Funcionamiento de Entidades Supervisadas por la Superintendencia limited companies, although state owned banks may only General de Seguros and the Reglamento sobre la Solvencia de Entidades de Seguros y Reaseguros were both gazetted on 24 September 2008. act as minority shareholders with the INS. Foreign insurers 34  “Other relevant actors” includes actuaries, auditors, claims 32  Article 2 of the Insurance Law. There are limited exceptions such adjusters, etc. that non-admitted insurances are permitted on a cross-border basis 35  Minimum capital requirements in development units are 3 million with insurers in countries where there is a current trade agreement for either a life or non-life insurer and 7 million for a composite. that makes provision for such cross-border transactions of insurance Reinsurers are required to have 10 million in development units. These (Article 16 of the Insurance Law) and providers have to register with amounts currently translate to around US$4.75 million, US$10.5 million the SUGESE. To date, Costa Rica has undertaken commitments in cross- and US$15.5 million respectively. Although these levels are the highest border trade of insurances services in the CAFTA-DR and the Association of all CAFTA-DR countries, they far from high when compared to, for Agreement with the European Union example, countries that are members of the ASSAL. Five Years After CAFTA-DR: Assessing Early Results for the Costa Rican Economy 31 In mid-2013, legal issues were fully determined such that business totaled CRC 466.16 billion (US$924 million) of private insurers could participate in occupational risk and which non-life premiums represented 80 percent. In local compulsory third-party automobile insurance markets. currency terms, this was an increase of slightly more than These products have a standard benefit and coverage 16 percent over 2011 figures. As expected, when the structure, and pricing is approved by SUGESE.36 Although market was liberalized life insurance was substantially less it is not clear how many of the current insurers or potential developed, and offered considerable potential for growth new entrants will be attracted to this business, it is likely (Table 3.1). that SUGESE will have to review the arrangements for oversight of pricing, adequate data available to the market, Growth in the sector has been heavily influenced by and the treatment of special cases, such as those involving global pricing cycles in the non-life sector. Levels of unidentified or uninsured drivers. insurance penetration follow the global trend, consistent with a view that global market prices were the main driver The legal framework was further enhanced with the of total premium figures and suggesting there has been no issue of an insurance contract law, the Ley Reguladora material change in insurance utilization (Figure 3.1). Before del Contrato de Seguros, in September 2011. SUGESE liberalization took effect, penetration levels rose, and after followed up the publication with regulations that support liberalization, trends have returned to match global prices. the law.37 This law allows more flexible interventions in This would also be consistent with the relatively high consumer protection and policy wording issues, so SUGESE need for reinsurance protection in Costa Rica (discussed can feel more comfortable with a more traditional file-and- below). However, these trends are also heavily influenced write approach.38 by the response of the INS to competitive pressures both in preparation for and after the arrival of competitors. The liberalization under CAFTA-DR is not a one-way Innovations in distribution and reach by insurers have street. The law also made provision for the possibility that increased insurance utilization, but an offsetting effect is the INS may consider operating in other markets. After some evident in price reductions. clarification of the form that such engagement should take, this path is now clear and unrestricted. The INS has applied The market is now operating on an open, competitive to operate in Nicaragua and registered its trademark in a basis. During 2009, a number of foreign insurers applied number of other countries. In the past, the INS has also for authorization. By February 2010, four new insurers had written some inward reinsurance and has several portfolios been authorized and an insurance association (ACAR), in run-off. The leading market position that the INS has had been established. An association of private insurers in Costa Rica suggests that both geographic and product was set up in 2011. By early 2013, further market entry, diversity expansion should be beneficial and positive. and the acquisition of the Alico business by Panamerican However, the experience of other insurers in similar Life, meant that 12 insurers were competing in the market situations is not always positive; the INS should learn from (Table 3.2). None of the new entrants come from other these experiences and proceed with caution. Central American CAFTA-DR countries, emphasizing that liberalization opened the market to all potential applicants, Market dynamics regardless of country of origin. Market premium has been growing in a healthy Compulsory automobile and occupational risk fashion since liberalization, particularly in the nascent insurances have been liberalized after legal disputes life sector. By 2012, written premiums for all classes of were resolved. The opening up of the compulsory markets was supposed to occur at the start of 2011, but 36  Article 29 (e) of the Insurance Law requires SUGESE authorization there was a legal dispute over whether these classes could of tariffs for occupational risk and compulsory third party automobile be provided by the private insurers in the market. This insurance. was resolved in mid-2013 by the Constitutional Court, 37  Transitorio I de la Ley Reguladora del Contrato de Seguros was issued in the same month as the law was gazetted. although the INS will have an ongoing advantage in these 38  Previously, for most lines of insurance, SUGESE received a technical products, not least because it has extensive data on past report and could comment or require modification within a statutory claims. Ideally, SUGESE should review arrangements for 30 day period only, so had limited opportunity to act after this period (Article 29 (d) of the Insurance Law). oversight of pricing, ensuring adequate data is available to 32 Five Years After CAFTA-DR: Assessing Early Results for the Costa Rican Economy Table 3.1: Trends in Market Size and Development Rates of Growth (percent per year) 2002 2007 2010 2011 2012 1 year 5 years 10 years Insurance Premium (in millions of local currency) Life insurance 13,726 28,646 51,152 69,192 93,050 34.5 26.6 21.1 Non life insurance 109,407 225,028 326,599 331,999 373,105 12.4 10.6 13.1 Total 123,133 253,674 377,750 401,191 466,156 16.2 12.9 14.2 Insurance Premium (in millions of USD) Life insurance 38 55 97 137 184 34.8 27.2 17.1 Non life insurance 305 436 621 657 740 12.6 11.1 9.3 Total 343 491 718 793 924 16.5 13.5 10.4 Insurance Penetration (premium to GDP) Life insurance 0.23 0.21 0.27 0.33 0.41 22.9 14.3 6.1 Non life insurance 1.81 1.65 1.73 1.60 1.64 2.7 -0.1 -0.9 Total 2.03 1.87 2.00 1.93 2.05 6.2 2.0 0.1 Insurance Density (premium per capita) in local currency Life insurance 3,364 6,437 10,977 14,628 19,386 32.5 24.7 19.1 Non life insurance 26,815 50,568 70,086 70,190 77,730 10.7 9.0 11.2 Total 30,180 57,005 81,062 84,818 97,116 14.5 11.2 12.4 Insurance Density (premium per capita) in USD Life insurance 9.3 12.5 20.9 28.9 38.4 32.8 25.3 15.2 Non life insurance 74.5 97.9 133.3 138.8 154.1 11.0 9.5 7.5 Total 83.9 110.3 154.2 167.7 192.5 14.8 11.8 8.7 Source: Based on data from AXCO. Note: In Costa Rica, the category of personal accident and health is considered to be life insurance. Figure 3.1: Explaining Non-life Insurance Penetration Trends Comparing large aggregates in mature markets removes the 1.4 impact of large volume-driven distortions, such as privatization or liberalization of particular classes, or other 1.2 country-specific influences that can impact individual country 1.0 statistics. With these distortions removed, the trend reflects 0.8 changes in price levels rather than changes in insurance utilization (shown as solid lines on the chart). These figures, 0.6 and those for Costa Rica, are then superimposed by 0.4 standardizing all to 1 in 2007. As a result, the Costa Rican 0.2 experience suggests higher utilization offset by price reductions beyond the effects of the global pricing cycle. 0.0 1990 1995 2000 2005 2010 Source: Based on data from AXCO. Costa Rica G-7 OECD World Total Five Years After CAFTA-DR: Assessing Early Results for the Costa Rican Economy 33 the market, and regarding the treatment of cases such as informal leakage is suspected. There are no exchange those involving unidentified or uninsured drivers. control restrictions and remittances are efficiently processed by the banking sector. Visiting brokers from other markets Market composition in terms of insurers, market are thought to secure some business not in compliance share, and product offerings is still developing. The with the insurance law, and the taxation treatment of this market share of the INS has fallen to around 90 percent informal insurance is not clear although it would appear of the total market (including compulsory classes) and to also avoid premium duties and fire levies.41 A significant the Herfindahl index has reduced to 8,799 and 8,290 number of U.S. and Canadian citizens have retired to for life and non-life segments respectively. The increased Costa Rica, and foreign non-admitted insurers are reported proportion of business represented by life insurance and to target expatriates through advertising campaigns. The the falling measure of motor insurance as a proportion of National Council for the Supervision of the Financial System total non-life business are both indicators of a maturing (CONASSIF) issued a regulation in late 2012 that facilitates market. Further, the product mix for non-life is becoming a legal form of fronting for some commercial classes,42 and more diverse, reducing the level of risk to insurers as they there is no minimum retention requirement in Costa Rica. hold a more diverse portfolio of risks (Table 3.3). Claims ratios reflect a profitable but not entirely Legally, intermediation can be conducted through stable insurance market. With the exception of the either agents or brokers, both of which can be small surety portfolio, claims ratios are well below levels individuals or companies. The INS had been operating needed for profitable underwriting by world standards. through retail agents (agencias comercializadoras), which The market claims ratio stood at just below 50 percent generated around 80 percent of business. Banks are of premiums. The INS announced increases in compulsory permitted to set up insurance intermediaries and have third-party automobile insurance premiums in 2012 by an done so particularly to deliver products packaged with average of 43.25 percent after an average reduction in lending activities.39 SUGESE had registered 63 agency 2011 of 13.89 percent. Volatility measures are higher than companies, 1,692 individual agents, 17 brokerage firms, world averages, although this may be the result of a small and 177 individual brokers as of mid-2013. In addition market, and can be expected to improve as experience there were 49 distributors of mass-marketed insurance develops over time. products and two registered cross-border providers.40 The number of registered individuals has grown steadily since Exposure to natural catastrophes requires careful liberalization, as has the diversity of distribution activities. management of risk accumulations by insurers and effective access to and use of reinsurance protection. Innovations in distribution that are likely to increase Costa Rica is exposed to significant earthquake and active access to insurance have been facilitated by micro volcanic risks. Although is not in the most active part of insurance policies (seguros autoexpedibles). Products the hurricane region, it has been impacted by hurricanes, are approved for mass marketing purposes with lower and and tropical storms have led to significant flood events. more standardized terms in some cases and include life, funeral, personal accident, and motor coverage. The INS 41  All non-life insurances are subject to a 13 percent sales tax. The fire brigade charge is 4 percent of premiums and is charged to all insurance has indicated it is distributing such products through kiosks classes as part of the quoted premium. It came about because the and relationships with other distribution options such as INS used to include this rate in all products and was administered by the fire brigade before liberalization. A 33 percent charge is placed banks, retailers, and the post office. on compulsory automobile insurance, although there is little practical impact on the informality issue related to offshore insurances in that case, given that it cannot be written outside Costa Rica even under Despite the prohibition on placing insurance with the legal clauses for countries with trade agreements. Similarly, there carriers not licensed in Costa Rica, unreported is a 5.5 percent withholding tax on reinsurance premiums ceded to reinsurers not domiciled in Costa Rica. 42  Reglamento sobre Autorizaciones, Registros y Requisitos de 39  Banks have been permitted to act as intermediaries since 2001 in Funcionamiento de Entidades Supervisadas por la Superintendencia Costa Rica. General de Seguros issued by CONASSIF in September 2012 permitted 40  Two entities have registered to do specific business on a cross border “paired” or “free discussion” insurance in marine hull, aviation, railway basis: 1) Factory Mutual Insurance Company (Rhode Island), to do vehicles, cargo, fire and allied perils, and third-party liability provided certain international group insurance for international conglomerates; that the insurers are registered for the relevant class of business and and 2) Caledonian Insurance Group (Washington), acting as a broker the premium exceeds 200,000 UD (unidad de desarrollo, around for aviation risks. US$315,000). These insurances are reported to SUGESE. 34 Five Years After CAFTA-DR: Assessing Early Results for the Costa Rican Economy Table 3.2: Insurers Operating in Costa Rica since Liberalization Insurer Date of Business Ownership / Capital Premium in CRC millions Comments entry Lines (and Market Share, percent) Life Non-Life INS 1924 Composite Costa Rica: state owned 194,947 234,521 (93.75) (90.82) Seguros del Magisterio Feb. 2010 Life Costa Rica: cooperative 2,558 based on offering life (1.23) insurance for education workers. Alico Costa Rica Feb. 2010 Life USA Originally part of AIG, sold to (American Life) MetLife through AIG restructure. Regional business transferred to PALIC (announced November 2011, transferred November 2012) ASSA Compañía de Feb. 2010 Composite Panama 887 14,561 Although registered as a composite, Seguros (0.43) (5.64) ASSA has only written non-life and personal accident business prior to 2012, but indicates it will enter life insurance starting in May of 2013 Mapfre Feb. 2010 Composite Panama / Spain 1,326 8,004 Initially registered for non-life but (0.64) (3.10) became composite in 2011. Re- branded from “Mundial.” Pan American Life Mar.2010 Life USA (Louisiana) 5,006 Insurance de Costa (2.41) Rica (PALIC) Aseguradora del Istmo Dec. 2010 Composite Ultimately Australian 2,815 106 A life insurer, but writes some personal (ADISA) (QBE) via QBE Del Istmo (1.35) (0.04) accident business. Compañía de Reaseguros, Inc. of Panama and the Cooperativa Nacional de Educadores, (Coopenae) of Costa Rica Quálitas Compañía de Jun. 2011 Mexico 1,028 A specialist motor insurer in Mexico. Seguros (Costa Rica) (0.40) Seguros Bolivar 2011 Composite Colombia 153 Aseguradora Mixta (0.07) Best Meridian Life U.S. (Florida) 197 Insurance Company (0.09) Atlantic Southern Jul. 2012 U.S. (Puerto Rico) 47 Company also operates in the U.S. and (0.02) British Virgin Islands as well as Puerto Rico. Oceánica de Seguros Jul. 2012 Composite Venezuela Sagicor Feb. 2013 Composite Barbados Source: Based on data from AXCO. Note: Premiums and market shares are shown for the most recent year (2012 or earlier) that each company participated in the market. Five Years After CAFTA-DR: Assessing Early Results for the Costa Rican Economy 35 Table 3.3: Competition, Development and Performance Indicators Competition Measures 2002 2006 2007 2008 2009 2010 2011 2012 Herfindahl Index Life insurance 10,000 10,000 10,000 10,000 10,000 9,895 8,868 8,799 Non-life insurance 10,000 10,000 10,000 10,000 10,000 9,766 8,877 8,290 Market share of largest 5 insures (percent) Life insurance 100 100 100 100 100 100 99.91 99.38 Non-life insurance 100 100 100 100 100 100 100 100 Product Portfolio - Product Mix and Diversity (percent) 2002 2006 2007 2008 2009 2010 2011 2012 Developmental indicators of products Life insurance to total premium 11.1 14.7 11.3 13.0 14.1 13.5 17.2 20.0 Motor insurance to total non-life insurance 45.6 43.8 44.2 42.1 40.5 38.4 37.5 39.0 Non-life product mix Property 23.7 17.9 20.0 18.6 22.3 20.8 19.4 18.7 Construction and engineering 2.6 3.0 3.2 n.a. n.a. n.a. n.a. n.a. Motor 45.6 43.8 44.2 42.1 40.5 38.4 37.5 39.0 Workers Compensation 21.0 28.2 26.3 30.2 27.4 30.1 31.1 30.6 Liability 1.4 2.2 2.1 n.a. n.a. 2.5 2.0 2.0 Surety, Bonds & Credit 1.3 1.0 70.0 n.a. n.a. 30.0 50.0 40.0 Miscellaneous n.a. n.a. n.a. n.a. n.a. 5.6 7.4 6.9 Marine, Aviation, and Transit 4.5 4.0 3.6 9.1 9.8 2.3 2.0 1.9 Personal Accident & Healthcare (non-life) n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. Profit and volatility (percent) 2007 2008 2009 2010 2011 2012 Average Coeff. of variation Claims ratios Property 10.60 n.a. n.a. 14.34 24.81 46.14 20.24 1.113 Construction and engineering 10.22 n.a. n.a. n.a. n.a. n.a. 22.23 1.066 Motor 39.90 n.a. n.a. 47.19 53.53 52.99 57.20 0.174 Workers Compensation 56.41 n.a. n.a. 49.54 53.94 51.30 67.36 0.207 Liability 13.83 n.a. n.a. 19.59 39.62 30.41 33.93 1.496 Surety, Bonds & Credit 25.44 n.a. n.a. 383.93 191.59 203.35 94.20 1.172 Miscellaneous n.a. n.a. n.a. 34.71 17.83 25.43 25.99 0.325 Marine, Aviation, and Transit 24.51 n.a. n.a. 34.43 50.48 48.24 34.80 0.297 Personal Accident & Healthcare (non-life) n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. All non-life insurance 36.24 43.09 56.57 40.25 45.73 49.24 49.60 0.161 Source: Based on data from AXCO. Table 3.4: Total Assets (CRC Millions) 2010 2011 2012 Assets 1,155,893 1,341,088 1,484,494 As a percentage of GDP 6.13 6.47 6.54 Source: Based on data from AXCO. Note: Assets are not reported separately between life and non-life sectors. 36 Five Years After CAFTA-DR: Assessing Early Results for the Costa Rican Economy Table 3.5: Expense Ratios (percent of premiums) 2010 2011 2012 Administrative expenses 22.35 23.09 20.02 Acquisition costs 7.84 7.49 7.11 Total 30.19 30.59 27.13 Source: Based on data from AXCO. Note: Assets are not reported separately between life and non-life sectors. Retention rates for the sector are heavily determined by Comparison with CAFTA-DR the approach that the INS takes in the current market given and Latin-American countries its size, and there is no public information on cessions by insurer. Overall, it is reported that the market ceded The Costa Rican market is already substantial around 33.8 percent of gross premium in 2011 and 32.6 compared to other CAFTA-DR jurisdictions. The market percent in 2011. is larger (in USD premium terms) than any of the other countries and has been growing more rapidly in both life Total assets have increased in real terms, enabling and—with the exception of measures in local currency— the sector to play an increased role as an institutional non-life insurances. As a result of the faster growth, the investor. Total assets have risen as the sector grows and sector might be compared more appropriately to the business becomes more mature, and that value now stands Association of Insurance Supervisors of Latin America at CRC 1,484 billion. In the last two years alone, sector (ASSAL) averages and ratios, suggesting a growth potential investments increased by 6.7 percent over and above GDP in premium of at least 50 percent in the medium term and increases (Table 3.4). a life sector that is three times the current size. The industry has become more efficient. Expense rates The potential for continued growth and development have reduced by 10 percent over the most recent reporting is considerable. Costa Rica has the lowest proportion of periods. This can be attributed to the impact of competitive premium generated from life insurance of all the countries initiatives on expense control, and to innovation from new in Table 3.6, highlighting that the sector has a considerable entrants, as well as economies naturally generated from way to go to reach the point of comparison with its increased market size. However, to the credit of sector neighbors, let alone broader averages. Motor insurance management, cost savings have been passed to customers as a proportion of total non-life premium is higher than (Table 3.5). other countries in the CAFTA group with the exception of Nicaragua, indicating scope for further maturing The market has overcome the initial costs of and diversification in the non-life sector. Diversification establishing operations and is now profitable. In measures also suggest that there is room for further 2010, only the INS was profitable, but the total market has innovation in products to meet market opportunities. reported a pre-tax profit of 76,591 CRC million, or 16.4 Other markets tend to have higher and more volatile claims percent of gross premium, compared to 13.6 percent of experience with the exception of Nicaragua. The lower gross premium in 2011. volatility and greater fundamental profitability inherent in the Costa Rican non-life market also suggests that the At the same time, the value provided by insurance market is attractive. products has increased, providing a material benefit to clients as a result of competition. A 20 percent Interpreting recent developments increase in claims ratios (payouts as a proportion of premiums) demonstrates increased value for money to the The experience of other liberalizing countries market and real economy. With this improved efficiency can provide some clues to where the Costa Rican and value, a conservative estimate of the direct benefit to insurance sector may be headed. Several comparisons the real economy of the market developments since the have been developed based on measures of market reform is around CRC 100 billion per year so far. development and market shares, comparing them to Five Years After CAFTA-DR: Assessing Early Results for the Costa Rican Economy 37 Table 3.6: Comparative Insurance Market Data in CAFTA-DR and Latin America Costa Rica Dominican El Guatemala Honduras Nicaragua CAFTA-DR Latin Republic Salvador (average) America (average) Growth in premium in local currency (percent) Life 26.57 15.55 9.51 12.65 11.65 13.16 Non-life 10.64 6.97 5.10 7.46 5.41 11.84 Total 12.94 8.65 6.52 8.41 8.11 12.17 Market premium in USD (millions) Life 184.44 174.16 187.43 121.60 173.50 36.62 877.75 117,289.77 Non-life 739.55 568.11 315.44 471.80 191.74 108.58 2,395.23 115,260.72 Total 924.00 742.27 502.87 593.40 365.24 145.20 3,272.98 232,549.49 Growth in premium in USD (percent) Life 27.17 11.77 9.51 12.18 11.65 8.83 13.59 13.16 Non-life 11.17 3.47 5.10 7.01 5.41 7.57 6.57 10.61 Total 13.48 5.10 6.52 7.96 8.11 7.88 8.20 11.06 Insurance penetration (premium as percent of GDP) Life 0.41 0.30 0.75 0.23 0.92 0.45 0.43 1.20 Non-life 1.64 0.96 1.39 0.90 1.02 1.33 1.16 1.90 Total 2.05 1.26 2.14 1.13 1.93 1.78 1.59 3.11 Growth in insurance penetration (percent) Life 14.26 3.94 4.88 2.99 2.58 1.19 4.98 4.20 Non-life -0.12 -3.78 0.66 -1.75 -3.16 0.01 -1.51 1.89 Total 1.95 -2.27 2.02 -0.88 -0.68 0.30 0.00 2.29 Insurance density (premium per capita in USD) Life 38.43 17.95 25.66 8.04 21.16 5.28 17.25 175.52 Non-life 154.07 58.57 47.60 31.18 23.38 15.67 47.11 247.45 Total 192.50 76.52 73.26 39.22 44.54 20.95 64.36 422.97 Growth in insurance density (percent) Life 25.26 11.37 9.05 9.43 8.67 4.14 11.33 11.73 Non-life 9.50 3.10 4.66 4.38 2.59 2.93 4.45 9.22 Total 11.77 4.73 6.07 5.31 5.22 3.23 6.05 9.66 Herfindahl Index Life 8,799 1,674 960 1,103 1,471 2,563 2,762 2,182 Non-life 8,290 1,507 961 1,581 1,703 2,215 2,710 1,826 Development indicators Life premium to total premium 20.0 23.5 35.0 20.5 47.5 25.2 26.8 50.4 Motor premium to total non-life premium 39.0 38.8 19.3 28.7 33.0 46.7 34.3 35.0 Product mix Product mix (percent of non-life premium) 18.7 43.8 30.2 25.6 46.1 36.9 33.6 24.6 Construction and engineering 0.0 0.0 n.a. 3.7 6.9 4.5 3.0 5.1 Motor 39.0 38.8 19.3 28.7 33.0 46.7 34.3 35.0 Occupational risk 30.6 n.a. n.a. n.a. n.a. n.a. 30.6 19.6 Liability 2.6 0.0 0.0 2.1 3.0 2.4 1.7 3.7 Surety, Bonds, & Credit 0.4 3.7 3.5 4.9 3.3 4.6 3.4 5.0 Miscellaneous 6.9 8.7 25.4 1.6 1.7 1.2 7.6 7.8 Marine, Aviation, and Transit 1.9 5.0 0.0 6.8 6.0 3.7 3.9 5.3 Personal Accident & Health Care (Non-life) n.a. n.a. 21.5 26.6 n.a. n.a. 24.1 19.4 Claims ratio experience Non-life (dataset average) 49.60 55.83 33.63 63.29 63.13 33.75 50.03 54.70 Coefficient of Variation 0.161 0.949 1.206 0.249 1.339 0.163 0.665 0.404 Source: Based on data from AXCO. Note: All growth rates cover the latest five years available to 2012 and are expressed in percentages per annum. CAFTA-DR averages are the average proportion of the product line; as this applies only to countries that have such a line reported in the data set, this does not add up to 100 percent. Latin American average corresponds to ASSAL. 38 Five Years After CAFTA-DR: Assessing Early Results for the Costa Rican Economy Figure 3.2: Insurance Penetration Following Liberalization (Premium as percent of GDP, scaled to Costa Rica levels) Life Insurance Life Insurance 1.0 1.8 0.9 1.6 0.8 1.4 0.7 1.2 0.6 1.0 0.5 0.8 0.4 0.3 0.6 0.2 0.4 0.1 0.2 0.0 0.0 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 Years post liberalization Years post liberalization Costa Rica Uruguay Poland Czech Republic India Costa Rica Average - full sample Non-life Insurance Non-life Insurance 3.0 3.0 2.5 2.5 2.0 2.0 1.5 1.5 1.0 1.0 0.5 0.5 0.0 0.0 0 1 2 3 45 6 7 8 9 10 11 12 13 14 15 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 Years post liberalization Years post liberalization Costa Rica Uruguay Poland Czech Republic India Benin Costa Rica Average - full sample Source: Based on data from AXCO. Note: Penetration ratios were scaled to Costa Rica’s gures. The full sample includes the following countries: Costa Rica, Uruguay, Poland, Czech Republic, Albania, India, Benin, and Ethiopia. markets that have similarly opened up their market from continues on a similar path then the life sector can be a mandated monopoly. Opening values are standardized expected to continue growth above the rate of GDP for where needed, to ensure a meaningful comparison with an extended period and become very materially larger in the Costa Rican starting position. Charts show a range of real terms; the trends suggest that the sector could grow countries to highlight the range of potential outcomes and from 0.3 percent of GDP to four times that size in 15 years. consistency of tendencies across the data set. Separately, Non-life products tend to follow GDP more closely, given the position of Costa Rica against the average of all the need to insure fundamental economic activities in the countries in the comparative group is shown for clarity. jurisdiction. Like many countries, Costa Rica has seen progressive As would be expected, the INS has attempted to liberalization of product lines, and has historically defend its market position, while new entrants had a relatively weak life sector. Costa Rica’s market focus on innovation in products and services to has seen life insurance penetration increase already, but attract customers and explore new market segments. the experience of other countries suggests there could be Sensible strategic directions at liberalization would indicate a considerable path of real growth ahead. If Costa Rica that the INS should seek to maintain market momentum Five Years After CAFTA-DR: Assessing Early Results for the Costa Rican Economy 39 Box 3.1: Comparing Czech Republic, Uruguay and Poland Prior to the introduction of legislative reforms in 1994, the market in Uruguay operated as a monopoly through the state-owned Banco de Seguros del Estado (BSE). An exception was in cases where insurers and insurance had been grandfathered in from before the introduction of the monopoly, which largely applied to marine and cargo insurance. Once liberalized, worker’s compensation, bonds, and health insurance for public sector employees remained in the portfolio of the BSE. Compulsory third-party automobile insurance was introduced in 2009. Between 1948 and 1989, the Polish insurance sector operated as a monopoly controlled by the state owned PZU (domestic business) and WARTA (reinsurance and hard currency insurances). After 1989, these two companies remained active in the liberalized market and were partially privatized in 1999. In the Czech Republic, the Ceska Pojistovna lost its monopoly in 1989. However it did not see a competitor formed until 1993; moreover, it did not lose its monopoly statues in aviation until 1997, and retained its monopoly on motor insurance until 2000. Since liberalization in these countries, both life and non-life sectors have grown and developed, and the fledgling life insurance sector has been more dynamic. Life insurance as a proportion of total premium has practically doubled in the last 15 years, from 12 percent to over 26 percent in Uruguay, and from 34 percent to just under 60 percent in Poland. The non- life sector has become less dependent on motor insurance over the same period, from nearly 45 percent of non-life premium to 40 percent in Uruguay and from 71 percent to 57 percent in Poland, reflecting increased product innovation and diversification which better meets the needs of the real economy. Although the former monopoly insurers’ shares of the market have fallen steadily, these insurers have seen steady growth in premiums every year since liberalization. The exception has been during economic crisis events, and even during those crises, premiums fell only marginally. Initially, the BSE wrote around 10 percent of total premium as life insurance and 90 percent as non-life insurance, similar to the INS. Life insurance has now grown to over 25 percent of the BSE’s gross written premium. Over the last 15 years, life insurance premiums for the BSE grew at 17.6 percent per annum and non-life insurance premiums grew by 9.7 percent per annum. Life insurance premiums at the two former monopoly insurers in Poland have grown by 10.1 percent per annum over the last 15 years, and total premiums grew by 6.5 percent per annum. Table B3.1.1: Comparative Statistics for Costa Rica, Czech Republic, Poland, and Uruguay Costa Rica Czech Republic Poland Uruguay Land Size (Square Kilometers) 51,100 78,864 312,683 176,215 Population in 2012 (millions) 4.80 10.50 38.10 3.38 GDP 2012 (millions USD) 45,108 195,657 489,235 47,777 Insurance to GDP 2012 - Life insurance 0.41 1.88 2.30 0.57 - Non-life insurance 1.64 2.13 1.60 1.59 Claims Ratios - Non-life Data Set Average 49.60 57.53 47.14 - Most recent 49.24 63.74 49.39 Expense Ratios – Non-life - Non -life Data Set Average 29.30 33.60 43.20 - Most recent 27.13 31.97 36.94 Market share held by life insurance 20.0% 58.9% 26.4% Non-life market share of motor insurance 39.0% 56.8% 40.1% Source: Based on data from AXCO. 40 Five Years After CAFTA-DR: Assessing Early Results for the Costa Rican Economy Figure 3.3: Pace and Direction of Liberalization on Market Shares: Costa Rica Follows a Well-worn Path Former Monopoly Market Share – Life Insurance (percent) Former Monopoly Market Share – Life Insurance (percent) 120 120 100 100 80 80 60 60 40 40 20 20 0 0 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 Years post liberalization Years post liberalization Costa Rica Uruguay Poland Czech Republic India Costa Rica Average - full sample The former monopoly insurer, naturally, sees a reduction in market share. Premium levels for the former monopoly insurer grew strongly despite the fall in share because of the overall market growth rates. The INS share is consistent with the comparative experience in other markets so far. Former Monopoly Market Share – Non-Life Insurance (percent) Former Monopoly Market Share – Non-Life Insurance (percent) 120 120 100 100 80 80 60 60 40 40 20 20 0 0 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 Years post liberalization Years post liberalization Costa Rica Uruguay Poland Czech Republic India Costa Rica Average - full sample The Costa Rican experience is similar to that of other countries, particularly in the larger non-life The INS has exceeded expectations in retaining market share in the non-life segment. sector. The INS market share can be expected to reduce over time in a steady manner. Life Insurance - Her ndahl Index Non-life Insurance - Her ndahl Index 12000 12000 10000 10000 8000 8000 6000 6000 4000 4000 2000 2000 0 0 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 Years post liberalization Years post liberalization Costa Rica Average - full sample Costa Rica Average - full sample Consistent with the realignment of market shares, the Her ndahl measures are expected to fall over a period of ten to 15 years before stabilizing and reaching a more mature stage. Source: Based on data from AXCO. Note: The full sample includes the following countries: Costa Rica, Uruguay, Poland, Czech Republic, Albania, India, Benin, and Ethiopia. Five Years After CAFTA-DR: Assessing Early Results for the Costa Rican Economy 41 in key products rather than develop new initiatives where indicating the potential for a somewhat quicker pace of it had limited experience. At the same time, it needed change. Either way, the country’s indicators and trends to enhance operating and administrative processes and thus far point to continued reductions in INS market share, realign business priorities.43 New players would have been and sector growth and development. attracted to the nascent life sector where the INS had demonstrated weaker capacity and foreign players would Outlook seek to leverage their technical experience in innovative products and distribution. Even though the market share The insurance sector is already showing benefits of the INS would be expected to decrease, the increased through improved operating performance, growth, size of the total market would in turn help the INS so long product innovation, and efficiency, and is contributing as it was able to grow its absolute premium levels and more to the real economy. The more diverse product cover its fixed cost structure. range, which is more accessible and offers better value to clients, is likely helping those in the real economy to All of these trends appeared as expected after better manage risks. Products are offering a better value liberalization. The INS market share has fallen to around for money. Insurance assets are growing in size, allowing 90 percent. Premium growth in the market has meant that insurers to become more relevant as institutional investors. the INS premium has increased at 6.3 percent per annum over the last four years, and stands at CRC 429 billion in The insurance sector should continue its path to a 2012. New players have been more aggressive in the life fully market-driven profile over time. Consistent with sector. observed experience in other jurisdictions, the liberalization process has a long way to go. Developments so far are in Comparisons with other countries suggest that many line with expectations, but could be encouraged through indicators in Costa Rica are evolving at a similar rate continued efforts to ensure an appropriate environment (Figure 3.3). The falling market share of the INS is largely that supports ongoing innovation and development. in line with the experiences of other countries, and can be expected to continue for a good number of years. As with all markets, the sector’s development will be influenced by the operating environment, including The INS share of the life insurance market has held the economic conditions in Costa Rica and globally, as up slightly better than would be expected. One well as the trends in global reinsurance prices. Diligent explanation for this could be the invigoration of the supervision, sound preconditions for market development, general concept of life insurance. Another could be the and targeted interventions to support these preconditions aggressive efforts of the INS to engage with distribution are expected to remain relevant. networks (both traditional and innovative). Also, new entrants into Costa Rica may be less innovative, as they are Recommendations that can be drawn from this not, by global measures, large insurers. As a result, new assessment are limited, as much of the future entrants may not be competing as effectively as their peers advantage can be expected to arise without in other markets. government or policy interference. That said, it would be useful for policymakers to consider: Costa Rica’s liberalization and trends are very much in line with what would be expected given the • The liberalization of compulsory automobile and experience of other countries. New entrants are seeking occupational risk insurances will likely require specific to compete and innovate, and the incumbent is seeking attention from SUGESE, particularly regarding to defend market share and meet new challenges. Costa adequate statistics for pricing and provisioning, and Rica’s experience, and its rate of change, is in line with other arrangements for the treatment of cases involving countries. However, on each measure Costa Rica’s values uninsured or unidentified motorists or employers. suggest that its experience has been slightly conservative, • The expansion by the INS into new business lines and new jurisdictions should proceed carefully, and can 43  For example, the INS separated the previously operated fire service. benefit from learning the lessons of other entities that It also announced it was to sell its pension fund operator in June 2012 to merge it with BCR Pensiones, an operation of Banco de Costa Rica. have tried and failed in similar endeavors. 42 Five Years After CAFTA-DR: Assessing Early Results for the Costa Rican Economy • Continuing to develop supervisory capacity should be an ongoing priority as SUGESE staff continues to grow into their supervisory roles. The initial phase of liberalization in the insurance sector has been positive, but the complete benefits of the initiative are not yet fully captured. As the process continues, the benefits of a more effective industry, able to provide for the needs of the real economy and enhance the well-being of all Costa Ricans, will be realized. Five Years After CAFTA-DR: Assessing Early Results for the Costa Rican Economy 43 Chapter 4 Telecommunications and the End of Another Monopoly Introduction and summary services. New entrants have become established and are actively competing with the ICE, which is responding to the The CAFTA-DR agreement opened the door for competitive landscape with its own strategies. All indicators private investments in the telecommunication sector. demonstrate that after liberalization, Costa Rica is well A new telecommunication law was required for the positioned in comparison with Latin American countries of liberalized market; a new regulator, the Superintendencia similar GDP per capita. Today consumers can buy a cell de Telecomunicaciones (SUTEL), needed to be established line instantly, without the long waits that were prevalent and to develop its procedures and functions; and the prior to liberalization. As well, the telecommunication Instituto Costarricense de Electricidad (ICE)—which was sector’s contribution to the GDP increased substantially. the existing monopoly provider at that time—needed to The sector attracted large FDI flows, produced a significant adjust to the new environment. Prior to liberalization, the consumer surplus advantage from the reduction in prices, telecommunication sector experienced supply constraints, and increase in Internet and cellular line access, and made with a large unmet demand for mobile telephone services an important contribution to economic growth. and very high prices for Internet access. However, as the experience of telecommunications Market penetration was rising before liberalization, liberalization in other countries would lead one to but the market has shown extraordinary growth expect, some issues remain. In Costa Rica, these issues in access and price reduction after liberalization. are partly due to the fact that the government still owns Competition led to an abundant supply of services and a the largest telecommunications operator, which is not dramatic reduction in prices for Internet access, and Costa typical of the majority of Latin American countries. Four Ricans have responded by subscribing massively to the new important challenges remain: liberalizing rates to allow 44 Five Years After CAFTA-DR: Assessing Early Results for the Costa Rican Economy for sufficient investment, broadening spectrum access to for awarding new frequency bands. Operators could enable improved service, facilitating infrastructure sharing gain access to the market through: (a) Concessions, for and municipal permits, and ensuring universal access by services that have commercial use and require the use of reforming the activities of the National Telecommunications radio-electric spectrum, granted through public auction; (b) Fund (Fondo Nacional de Telecomunicaciones—FONATEL). Authorizations, for commercial or private network services that do not require spectrum, granted through direct This chapter presents a summary of the main request to SUTEL; and (c) Permits, for non-commercial, legislative changes, trends in access with international official, navigation or emergency services, granted by the comparisons, and a discussion of prices and service executive through SUTEL. To continue the goal of universal quality. Conclusions and policy recommendations are access and reduce the digital divide, the law created included in the final section. FONATEL to provide funds for priority projects. FONATEL is financed by fees from operators as determined by SUTEL,46 Legal and regulatory developments as well as fines, grants, and interest generated by its resources. CAFTA-DR committed Costa Rica to liberalizing its telecommunications market.44 Costa Rica committed Spectrum, privacy, and numbering regulations were to allow telecommunications providers to compete, enacted.47 The Public Service Regulatory Authority through the technology of their choice, in private network, (Autoridad Reguladora de los Servicios Públicos—ARESEP) Internet, and mobile wireless services. CAFTA-DR also issued regulations that defined the methodology for required the prevention of any anti-competitive practice setting rates. SUTEL would initially set rates until conditions and the provision of reasonable and non-discriminatory allowed for effective competition in a specific market, access to submarine cable facilities. In terms of regulatory at which point operators would be free to set their own principles, CAFTA-DR mandated the establishment of a new rates.48 For the initial determination, SUTEL should use a independent regulator and transparency in interconnection price cap methodology based on long-term incremental agreements, procedures for licensing, and authorizations. costs (LRIC).49 Since this regulation was approved, SUTEL Furthermore, the procedures for the allocation and use of has maintained all initial rates at the same level that was limited resources, such as frequencies, should be objective, approved in 2006 by ARESEP.50 SUTEL has not declared timely, transparent, and non-discriminatory. And, the effective competition in any market yet. This decision will interconnection among public telecommunication have an important impact on operators, as discussed in the suppliers should be non-discriminatory and cost-oriented. next section. In 2008, the new telecommunications law provided The law also affected radio and television broad- the key mechanism for liberalization. The Ley General castings as well as the radio spectrum. It modified the de Telecomunicaciones was gazzetted as Law No. 8642 on June 30, 2008. The law ended the monopoly of ICE in 46  The contribution should be within 1.5 percent and 3.0 percent of the telecommunications sector and allowed the entry of the operator gross revenues. private companies. The same law created a new regulator, 47  Reglamento a la Ley General de Telecomunicaciones, No. 34765, the Superintendencia de Telecomunicaciones (SUTEL). Plan Nacional de Atribución de Frecuencias, No. 35257, and its reforms in 2010 (No. 35866) and 2011 ( 36754), Reglamento sobre Medidas de SUTEL started operations on January 2009, with a mandate Protección de la Privacidad de las Comunicaciones, No. 35205, and Plan to resolve monopolistic practices,45 set tariffs in the form Nacional de Numeración, No. 35187. 48  The regulation confirms Article 50 of the Telecommunications of price caps to stimulate competition and efficiency, and Law that stipulates these rate-setting principles, and elaborates the regulate interconnection of operators’ networks, based on methodology for setting rates. cost-oriented rates. 49  For the calculation of LRIC, this regulation indicated the formula that must be used and defined its main elements. In particular, the rate of return on investment should not be lower than the national or The law assigned to the executive responsibility for international average on comparable markets. Comparable markets are defined using criteria such as: geographic extension, number of users, planning and administering the radio spectrum, and quantity of operators providing services, and average income of users. 50  ARESEP rate-setting of 2006 is RRG-5957-2206 of Sept. 25, 2006. 44  See Annex 13 “Specific Commitments of Costa Rica on SUTEL’s simplification of rates eliminated some of the levels of the Telecommunications Services” of CAFTA-DR. previous structure, but left most of the core rates intact: RCS-121-2012 45  See Articles 49 to 61 of the Telecommunication Law. of March 30, 2012. Five Years After CAFTA-DR: Assessing Early Results for the Costa Rican Economy 45 Figure 4.1: Sector Structure Before and After CAFTA-DR Public Policy Planning Concessions MINISTRY MGPSP MICITT Spectrum Planning Competition Tari s ARESEP ARESEP Quality Control REGULATOR (Tari s) Spectrum Control SUTEL FONATEL OPERATORS ICE ICE Mobile (2) MNVO (2) Fixed (9) Cable TV Companies (12) Internet, Data, Cable TV, Other (119) Source: SUTEL (2013). MGPSP is the Ministry of Interior, Justice and Public Security (Ministerio de Gobernación, Justicia y Seguridad Pública); MNVO is mobile network virtual operator. Ley de Radio,51 and a transitory provision52 required public above, SUTEL is in charge of supervising the use of the radio and private concessionaires of frequency bands to report spectrum, as well as the obligations and rights of users and to the executive the use of each one of them. Then, the telecommunication operators. SUTEL’s governance structure executive could request them to return the frequency bands consists of three council members, who are appointed by that needed to be reassigned. However, the government ARESEP’s Board of Directors and approved by the Legislative has not completed this reassignment yet. ICE still holds the Assembly for five year-terms.56 largest share of the mobile frequency bands, giving it a competitive advantage. The ICE Law also eliminated some restrictions to allow ICE to compete against private companies In 2008, the Legislative Assembly approved another law in the telecommunications sector. It included the changing important elements of the sector structure following provisions, among others: (a) allowed ICE to (Figure 4.1). The so-called “ICE law”53 initially defined the form subsidiaries, national or international, and to form Ministry of Environment, Energy and Telecommunications strategic alliances with private or public companies; (b) (Ministerio del Ambiente, Energía y Telecomunicaciones— restricted concessions of fixed telephone service;57 (c) MINAET) as the sector’s head, by the addition of a new Vice- removed the government’s financial restrictions on ICE; (d) Ministry of Telecommunications. This put MINAET in charge allowed ICE to increase its debt level up to 45 percent of of formulating public policies, planning, and awarding total assets; (e) specified new procurement procedures;58 concessions for the sector, among other functions. The and (f) gave ICE’s board the authority to manage its own Chinchilla Administration later moved this Vice-Ministry human resource administration, including setting staff to the newly-created Ministry of Science, Technology and salaries and benefits. The authorization for ICE to form Telecommunications (Ministerio de Ciencia, Tecnología, strategic alliances with private companies is especially y Telecomunicaciones—MICITT) in January 2013. It also important, because these alliances could bring capital, modified the law governing ARESEP54 to make SUTEL a entrepreneurship, and management experience to improve part of that agency.55 In addition to the functions described ICE’s capacity and competiveness. 51  Law No. 1758 of June 19, 1954. This law regulates radio and TV broadcasting, and the radio spectrum. The Telecom Law re-assigned 56  The initial members were appointed for three, four, and five years, oversight of the sector to MINAET. with the intention of preserving the institutional memory of the entity while also delinking it with the electoral cycle (four years). 52  Transitorio IV of the Telecommunications law. 57  The law specifies this service as “circuit-switched,” or “basic” 53  Ley de Fortalecimiento y Modernización de las Entidades Públicas service and limits this restriction to the executive, as it authorizes del Sector Telecomunicaciones (Law No. 8660, of August 13, 2008) Congress to give basic service concessions. 54  Created by Law 7593 of August 9, 1996. 58  The new procedures were intended to streamline the procurement 55  Article 45 of ICE’s Law. process. 46 Five Years After CAFTA-DR: Assessing Early Results for the Costa Rican Economy Table 4.1: Concessions for Mobile Telecommunication Service (in US$) Concessionaire Price Paid Band Segment Bandwidth, MHz Claro $75 million 1800 MHz C 2X5 D 2 X 15 2100 MHz C 2X5 D 2 X 10 Movistar $95 million 850 MHz E 2 X 5.3 1800 MHz E 2 X 10 2100 MHz E 2 X 10 MHz Source: Based on data from SUTEL. The entry of private mobile service granting the permits, arguing that they had to issue tower providers construction regulations first. For example, at the time of writing this report, Claro had not obtained permits from Private mobile services providers entered the market eight municipalities.62 in November 2011. After a public auction managed by SUTEL, the government granted two concessions Due to difficulties in obtaining construction permits, of frequency bands for mobile services in January to private mobile providers had to request an extension Empresa Claro Costa Rica Telecomunicaciones59 (Claro) to complete Phase One of their roll-out plans (Table and Telefónica60 (Movistar) (Table 4.1). These concessions 4.2). SUTEL granted the extension through early February included obligations to deploy infrastructure (Map 4.1). The 2014. In spite of these difficulties, Claro and Movistar criteria for selecting districts to be covered in Phases One, were able to expand their coverage to near 90 percent Two, and Three were based on coverage, population, and of the coverage of Phase Three.63 The companies have Human Development Index (HDI) (Table 4.2). Companies installed masts in buildings, signs, and other existing had to roll out their networks in 12 months for the San structures. They have even used portable installations José Metropolitan Area (Phase One), 36 months for Phase instead of towers to provide coverage. These practices Two, and 60 months for Phase Three. As can be seen in have resulted in extending coverage almost nationwide in the map, the majority of the country was included in Phase a shorter period of time than originally agreed under their Three. The districts not included have very low population contracts. While this solved the immediate need to provide density, are mountainous, or are located in national service, the companies are concerned about meeting their reserves. coverage obligations in terms of signal strength, because these solutions, while innovative, do not seem to provide Claro and Movistar had delays in installing their the same signal strength as towers of the height and systems due to the slow approval of tower building location specified in the original engineering designs. permits by the municipalities. Although this problem was partially resolved on November 16, 2011 by a ruling 6465 of the Supreme Court,61 some municipalities delayed 62  As reported during interview with Victor Garcia, Director of Regulation for Claro, August 14, 2013. 59  A subsidiary of Mexico’s América Móvil operates with the 63  In the case of Movistar, the information was reported during an commercial name Claro. interview with Juan Pablo Rivera, Director of Regulation, Telefónica de 60  A subsidiary of Spain’s Telefónica operates with the commercial Costa Rica on August 13, 2013 as well as in the coverage map retrieved name Movistar. from www.telefonica.cr. In the case of Claro, the information was reported during an interview with Victor Garcia, Director of Regulation, 61  Sala Constitucional de la Corte Suprema de Justicia (“Sala IV”), Claro, on August 14, 2013 as well as in the coverage map retrieved Resolution No. 015763 – 2011 of November 16, 2011. The Court from www.claro.cr. rejected an appeal from a citizen against a decision of the Municipality of Goicoechea to grant a permit for tower construction in that 64  GAM means Greater Metropolitan Area, as defined by PRUGAM municipality, based, inter alia, on the prevalence of public interest in and includes districts in the San Jose, Cartago, Heredia and Alajuela the installation of telecommunications infrastructure over the entity’s Provinces. interest. 65  Signal strength must be higher than -75 dBm in those areas. Five Years After CAFTA-DR: Assessing Early Results for the Costa Rican Economy 47 Table 4.2: Phases and Criteria for Cellular Concessions in Costa Rica Phase Months Color in Criteria for Selecting Districts Number of Roads Map Districts (P-Primary Coverage by the Population Human Development S-Secondary) Incumbent Index 1 - GAM58 12 = Incumbent >= GAM average >= GAM average 132 (28%) GAM: P,S 2 – Rest of country 36 = Incumbent >= Country Average >= Rest of the country 185 (40%) Rest of the country: P Average 3 – Rest of country 60 = Incumbent >= Country Average All 128 (27%) Rest of the country: S 4- Not covered 21 (5%) High Signal59 466 (100%) Source: SUTEL (2010, Annex A Obligaciones de Cobertura Mínima). Map 4-1. Cellular Coverage Development Plan though ICE significantly increased lines compared with 2008, it lost market share of about one million lines to Claro and Movistar in 2012. Mobile cellular penetration levels have quickly caught up with other countries in the region. As operators expanded their coverage to meet unsatisfied demand for services, mobile cellular penetration levels increased from 42 percent in 2008 to 116 percent in 2012. Costa Rica ranks favorably in the region; it has better penetration than Peru and Colombia, and is close to Uruguay and Guatemala.67 Today consumers can buy a cell line instantly, whereas before liberalization it took months to get a cellular line. This is a major achievement of sector liberalization due to CAFTA-DR, and has benefited consumers and businesses Source: SUTEL (2010, Figure 4 in Annex 1.A Obligaciones de Cobertura Mínima). in Costa Rica. Liberalization drives improvements Fixed-line telephone services in access to telecom services Costa Rica continues to have a high penetration of Since 2009, the number of mobile-cellular lines fixed lines. This is the result of ICE’s investment in its increased markedly, as operators expanded their universal service program during the 1970s and 1980s. infrastructure to meet demand (Figure 4.2). ICE However, starting in 2010, some users disconnected their launched its 3G network in anticipation of competition fixed lines, reversing the growing trend of the past, due purchased with a system from Huawei.66 This was the first to: (i) substitution of mobile for fixed-line service; and nation-wide mobile system of modern technology that (ii) as more people have broadband Internet access, they allowed users to connect to the Internet, and replaced prefer use of VoIP (Voice over Internet Protocol) 68 to call several obsolete systems that ICE had in operation. Even 67  The high value for Panama reveals that operators may have not 66  Costa Rica entered late into the provision of 3G services, while removed inactive accounts from the database. This happens frequently as most other countries in Latin America had started offering 3G services pre-paid customers switch from one operator to another, but leave the old in the early 2000s. 3G refers to third-generation systems, capable of line registered in the database. A value of more than 100 percent indicates providing voice and data communications at broadband speeds. 2G that most inhabitants have a line, since some users have more than one. are digital systems for voice and low data rates, while 1G were analog 68  It allows the user with an Internet connection to make telephone systems. calls using services like Skype, Viber, and others. 48 Five Years After CAFTA-DR: Assessing Early Results for the Costa Rican Economy Figure 4.2: Mobile Cellular Lines in Costa Rica, Figure 4.3: Mobile Cellular Lines per 100 Inhabitants, 2003-2012, in thousands Costa Rica and Selected Countries, 2003-2012 5000 200 4500 180 4000 160 3500 140 3000 120 2500 100 2000 80 1500 60 1000 40 500 20 0 0 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Mobile lines ICE lines Claro lines Movistar lines Costa Rica Guatemala Panama Colombia Peru Uruguay Source: Based on data from Wireless Intelligence. Source: Based on data from World Development Indicators. their friends and family for free. These trends are common Figure 4.4: Fixed Telephone Lines per 100 Inhabitants, in all countries (Figure 4.4). The reduction in the number Costa Rica and Selected Countries, 2003-20012 of lines in operation impacts ICE’s finances, as ICE is the sole provider of fixed telephone services; revenues have 35 decreased while operating expenses have continued to 30 grow due to the labor-intensive nature of maintaining the 25 old copper network. 20 Fixed Internet 15 Fixed Internet connections have increased expo- 10 nentially (Figure 4.5). During the monopoly period, cable 5 companies were forced to rent wholesale Internet access 0 from RACSA,69 an ICE subsidiary that, in turn, leased its 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Costa Rica Guatemala Panama Colombia Peru Uruguay bandwidth capacity from the international submarine Source: Data for Costa Rica from Programa Estado de la Nación for 2003-2009 and SUTEL cable providers. After liberalization, the ability to lease (2013) for years 2010-2012, and from World Development Indicators for other countries. or purchase bandwidth directly from the international providers allowed the cable companies to reduce costs and penetration for fixed Internet in Costa Rica increased to 9.5 increase capacity, freeing resources to invest in connecting percent, the second highest (Uruguay had 16.6 percent) more subscribers and offering higher connection speeds. surpassing Colombia, Panama, and Peru. ICE responded by increasing ADSL70 services on its extensive copper infrastructure. Even though ADSL is still the Mobile broadband services preferred access service, cable modem provided by private cable companies has increased significantly. After 2010, Mobile broadband connections have quickly the market started to show saturation, as the majority of expanded, and private operations have captured a households in urban areas were connected to the Internet large part of the market. In anticipation of competition, Penetration rates to fixed Internet services improved ICE introduced mobile broadband services in 2009.71 markedly. Measured by penetration (lines per 100 Claro and Movistar introduced mobile broadband with inhabitants), Costa Rica had 2 percent penetration in 2006, the opening of their commercial operations and have third in its group (after Panama and Uruguay). By 2012, more subscribers than ICE. The three operators use 3G technology (HSPA+), allowing them to provide medium 69  Radiográfica Costarricense, S.A. 70  Asymmetric Digital Subscriber Line uses the copper wires bandwidth above the voice to provide Internet access. 71  Cordero Perez (2009). Five Years After CAFTA-DR: Assessing Early Results for the Costa Rican Economy 49 Figure 4.5: Fixed Internet Connections in Costa Rica, Figure 4.6: Fixed Internet Connections per 100 2006-2012, in thousands Inhabitants, Costa Rica and Selected Countries, 2003-2012 500 18 450 16 400 14 350 12 300 10 250 8 200 6 150 100 4 50 2 0 0 2006 2007 2008 2009 2010 2011 2012 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Total ADSL/ICE Cable Modem/Cable TV Cos. Other Costa Rica Uruguay Panama Colombia Peru Source: Data from CISCO Barómetro (2009) for 2006-2009 and SUTEL (2013) for 2010-2012. Source: Based on data from World Development Indicators. Figure 4.7: Mobile Broadband Connections Figure 4.8: Mobile Broadband Connections per 100 in Costa Rica, 2009-2012, in thousands Inhabitants, Costa Rica and Selected Countries, 2005-2012 2000 30 1800 25 1600 1400 20 1200 1000 15 800 10 600 400 5 200 0 0 2009 2010 2011 2012 2005 2006 2007 2008 2009 2010 2011 2012 Total ICE Claro Telefonica Movistar Costa Rica Guatemala Panama Colombia Peru Uruguay Source: Based on data from Wireless Intelligence. Source: Based on data from World Development Indicators. Figure 4.9: Usage of Telecom Services in Costa Rica, Figure 4.10: Fixed Internet Download Speeds in percent of households Costa Rica, 2007-2012, percentual distribution 24 100 9 2933 11 38 +33p 18 With Cable TV 3944 80 49 40 56 47 60 69 60 69 With Mobile 69 +22p Services 74 86 76 97 40 76 10 51 12 52 With Internet 15 20 19 24 +16p Services 34 20 47 6 4 2 0 20 40 60 80 100 120 0 2007 2008 2009 2010 2011 2012 2006 2007 2008 2009 2010 2011 2012 <= 512 KB/s 512Kbps-2Mbpss >= 2 Mb/s Source: Data from MICITT (2013) using data from INEC. Source: Based on data from CISCO - Barómetro (2009) and SUTEL (2013). 50 Five Years After CAFTA-DR: Assessing Early Results for the Costa Rican Economy Table 4.3: Fixed Internet Prices in Costa Rica, US$ per Month, August 2013 Download speed TIGO Cable Tica ICE-Kolbi RACSA 1 MB/s 16.95 16.50 18.90 30.00 2MB/s 20.95 19.90 27.90 40.00 3 Mb/s 29.95 28.90 4 Mb/s 38.95 48.90 5 Mb/s 49.95 48.60 10 Mb/s 90.95 87.50 98.90 Source: Information retrieved from: www.tigo.cr (Plan Hogar, Estandar, Plus, Deluxe, Pro, Extreme, Ultra), www.cabletica.com (Basico, Estandar, Plus, Silver, Gold), www.grupoice.com (Kolbi Hogar), and www.racsa.co.cr (WiMax Plus,Premium). speed broadband access. A recent survey indicates that An increasing number of households are using 61 percent of subscribers use Internet on their mobiles, telecom services in Costa Rica. The proportion of tablets, or PCs. In the face of competition, ICE has become households with Internet access has increased from 10 more customer-oriented and introduced a variety of new percent in 2006 to 47 percent in 2013, which corresponds plans and smartphones to the market, like the iPhone and to a 30 percent annual average growth rate (Figure 4.9). In Galaxy,72 among others. the same period, 22 percent of households gained access to mobile phone services, and 16 percent to cable TV. This rapid growth in connections moved Costa Rica Although cable TV has always been provided by private ahead of selected countries in Latin America in terms companies, liberalization of Internet access increased of penetration. Costa Rica’s penetration of mobile competition among public and private companies, who broadband was at 0.17 percent in 2009, the lowest of this began to offer bundled services like double play (TV and group (Figure 4.8). By 2012, however, it was the second Internet) and triple play (voice, TV and Internet). highest, at 20 percent (Uruguay was 28 percent), as a result of the market growth in the years after CAFTA-DR Fixed Internet services was approved. After liberalization, operators introduced higher Household access to telecom services, speed Internet access offers and bundled packages. prices, and quality of services Download speeds for fixed Internet access increased significantly in the period from 2009 to 2012 (Figure Costa Rica climbed five positions in the Global 4.10). In 2008, 52 percent of connections were less than Information Technology Report 2013 of the World 512 KB/s, and in 2012 this service level dropped to only Economic Forum, to 53rd of 144 countries. This 2 percent. During the same period, faster connections compares favorably with position 60 in 2007 (of 127 of more than two Mb/s increased from 9 percent to 53 countries). In Latin America it was only surpassed by Chile percent. A higher access speed is essential for a better (34), Barbados (39), Panama (46), and Uruguay (52). user experience and to enable the use of services like The report states: “Costa Rica, together with Panama, video streaming, videoconferencing, and large file sharing. remains the leader in ICT uptake in Central America Although download speeds in Costa Rica are still below and climbs five positions in the rankings to 53rd place. those of in OECD countries, the trend towards higher Overall, the country has continued its efforts to develop speeds is irreversible. Businesses, especially IT-intensive its very affordable (6th) ICT infrastructure, especially in business like IT help desks, software development centers, terms of improving its international Internet bandwidth outsourcing, banking, and insurance companies, consulting capacity (40th) that, coupled with a well-performing and many IT-enabled businesses that rely on e-commerce educational system (21st), allows for an overall strong or e-services need faster Internet connections. ICT readiness (33rd).” Internet prices in Costa Rica are relatively low 72  ICE introduced the iPhone on May 4, 2011 (Cordero Sancho, 2012). compared to other countries (Figure 4.11). Before 2006, Five Years After CAFTA-DR: Assessing Early Results for the Costa Rican Economy 51 Figure 4.11: Fixed Internet Prices of One Mb/s, Figure 4.12: Cellular Prepaid Prices in U.S. Cents per Selected Countries, 2012, percent of GDP per capita Minute, Peak for Latin American Countries, 2010 United Kingdom 0.03 Costa Rica Japan 0.06 Mexico France 0.06 Guatemala Spain 0.13 Panama Italy 0.15 Portugal 0.19 Chile Uruguay 1.0 Jamaica Panama 1.0 Paraguay Chile 1.3 El Salvador Argentina 1.5 Barbados Mexico 1.5 Honduras On Net Brazil 1.7 Colombia Costa Rica 1.9 Ecuador O Net Colombia 3.2 Dom. Rep. Venezuela 3.6 Bolivia Ecuador 3.9 Nicaragua El Salvador 4.4 Peru 6.5 Uruguay Paraguay 6.6 Belize Honduras 9.1 Argentina Guatemala 11.6 Peru Nicaragua 16.7 Venezuela Bolivia 31.4 Brazil 0 5 10 15 20 25 30 35 0 10 20 30 40 50 60 70 80 90 Source: Based on data from World Telecommunication/ICT Indicators (2012). Source: Observatorio Regional de Banda Ancha (ORBA) (2012). Note: These prices do not include promotions. Prepaid services are more expensive per minute (without promotions) when compared with post-paid (contract) services. ICE offered low speed Internet access at high prices that compares peak rates only, without figuring in any discounts were too expensive for poor households.73 In anticipation or promotions.75 Even though promotions are not reflected of liberalization, ICE reduced prices for high-speed service in the graph, it is fair to say that Costa Rica, in general, has (Acelera ) in 2009. Even though price caps for Internet some of the lowest rates in Latin America; this, in addition access were set relatively high, competition between ICE to control and convenience, induced more users to select and cable TV companies has reduced prices and increased prepaid plans. While there were no prepaid users in 2007, speeds. Data from August 2013 indicates prices well below 49 percent of users selected prepaid plans in 2010, and 79 the price caps fixed by ARESEP and SUTEL (Table 4.3). percent in 2012. Mobile services Mobile rates continue to be fixed at the rates set by ARESEP in 2006, and as a result they have lost value Increased penetration in mobile services is explained in real terms. These tariffs remain valid as price caps,76 by the introduction of prepaid mobile cellular service with the exception of the tariff for off-peak service. If and low tariffs. Compared to other countries and other the tariffs were adjusted by inflation, the “equivalent operators, ICE was late to introduce prepaid services in tariffs” in 2012 colones would have been substantially April of 2008.74 Claro and Movistar offered them from higher (Table 4.5). All operators introduced several plans the start of their operations in November of 2011. Prepaid that are in line with the rates. Cellular rates in most services are very popular in Latin America, especially for countries are de-regulated, as operators compete with the lower-income quintiles of the population, because they different plans and packages that offer phones and a set allow users to control expenditures and purchase service number of minutes, SMS, MMS, and Internet access. The in small incremental amounts. The other key driver for consumer thus has a wide range of options from which growth was the low prepaid tariffs set by ARESEP (Table to select the best plan and the preferred phone. In this, 4.4 and Table 4.5). The prices are low when compared to other countries in Latin America (Figure 4.12). This figure 75  Telecommunication operators use many promotions, such as: double minutes; buy a package and get 50 percent more minutes; reduced rates at non-peak traffic hours; call friends at lower rates; triple 73  Cordero Perez (2008) citing results from CAATEC Barómetro CISCO minutes on net; and others. Therefore Figure 4.12 may be misleading, results and quoting R. Monge. because it does not include these promotions. 74  ARESEP set the rates for prepaid service on March 31, 2008, by 76  SUTEL Resolution 615-2009 of December 18, 2009 established that Resolution 8147-2008. the ARESEP rates “temporarily” applied to all operators. 52 Five Years After CAFTA-DR: Assessing Early Results for the Costa Rican Economy Table 4.4: Cellular Pre-paid Rates (US$) Pre-Paid Plan (US$) 5 10 20 Valid for (days) 30 45 60 Price, cents/min, Peak 8.00 7.40 6.80 Price, cents/min, Reduced (night and weekend rates) 6.40 6.00 5.60 Price, SMS, cents 0.34 0.34 0.34 Source: ARESEP, Resolution 8147-2008. US$1.00 = ¢500. Table 4.5: Tariffs, Prices, and Equivalent Tariffs for Selected Services Tariffs Prices Equivalent 2006 2012 2006 2012 Tariff Cellular (2006 CRC) (2006 CRC) (2012 CRC) Prepaid plan CRC 2500 (US$5), per minute 26.08 26.08 49.41 Postpaid, per month 2,900 1,890.81 2,900 1,890.81 4,447.84 Postpaid, peak, per minute 30 19.56 30 19.56 46.01 Internet access, per month (unlimited) 3,500 2,282.01 3,500 2,282.01 5,368.08 Fixed telephone (2006 CRC) (2006 CRC) (2012 CRC) Rent, residential, per month (includes 160 minutes) 1,850 1,206.20 1,850 1,206.20 2,837.41 Rent, commercial, per month (includes 160 minutes) 2,150 1,401.81 2,150 1,401.81 3,297.53 Calls, peak, per minute (from 7 AM to 7 PM) 4.10 2.67 4.10 2.67 6.29 Fixed Internet access, US$/month (2006 US$) (2006 US$ ) (2012 US$) 1 Mb/s 38 33.40 38 14.50 43.23 2 Mb/s 91 79.98 91 17.58 103.54 Source: ARESEP Resolution RRG—5957-2006 published in La Gaceta of Sep. 25, 2006 and for operators website for fixed Internet access. Note: Equivalent tariff is the tariff in 2012 currency that has the same real value as the tariff of 2006. Conversion to constant 2006 CRC was made using the Central Bank CPI July to July change for each year. Conversion to 2006 US$ was done using the U.S. Department of Labor Avg. to Avg. CPI change from year to year. Costa Rica is an exception. While SUTEL has the authority August of 2013. Costa Rican mobile broadband rates are to de-regulate cellular rates, it has not indicated that it in the middle to low end of Latin American countries in will do so in the near future. terms of mobile broadband fees (Figure 4.13).78 Mobile broadband Penetration in rural areas vs. urban areas: FONATEL An important factor in the high use of mobile broadband has been the flat rate that ARESEP has As a result of liberalization, telecom services became imposed since the introduction of mobile broadband. available in most urban areas of Costa Rica. However, This is a fixed rate, irrespective of the usage. Unfortunately, some rural areas and small towns still do not have access to as in many countries, a small percentage of heavy users the Internet. To provide services in those areas, the Telecom- have congested the networks. Most operators worldwide munications Law created the National Telecommunications charge rates per kilobyte (or megabyte) to deal with this Fund (Fondo Nacional de Telecomunicaciones—FONATEL). issue. SUTEL modified the rate, charging a fee per kilobyte FONATEL has raised US$213 million from auction proceeds of use in October of 2012.77 Operators started charging 78  Again, comparisons depend on the plan chosen by the subscriber. CRC 0.0076 (US$0.00152 cents) per kilobyte of use in Because of the variety of plans offered by each operator, the number of megabytes included in the rate, and the number of operators, it is 77  SUTEL, Resolution 295-2012 of October 3, 2012. difficult to compare rates across countries. Five Years After CAFTA-DR: Assessing Early Results for the Costa Rican Economy 53 Figure 4.13: Mobile Broadband Rates for Selected Figure 4.14: Telecommunications sector, Countries, percent of GDP per capita percent of GDP United Kingdom 0.6 10 Italy 0.9 Japan 1.0 9.1 9.1 Portugal 1.0 8.8 Spain 1.3 9 8.6 Uruguay 1.5 France 1.5 Panama 2.1 7.8 Venezuela 2.7 8 Chile 2.9 7.3 7.4 Mexico 3.0 Argentina 3.2 Colombia 3.4 7 Costa Rica 3.8 Brazil 4.2 El Salvador 5.2 6 Peru 6.1 Paraguay 6.5 Ecuador 7.6 Guatemala 8.0 5 Honduras 9.8 Bolivia 11.3 Nicaragua 21.7 4 0 5 10 15 20 25 2006 2007 2008 2009 2010 2011 2012 Source: Observatorio Regional de Banda Ancha (ORBA) (2012). Source: MICITT (2013). and operator’s fees.79 FONATEL prepared a master plan The FONATEL program has been criticized because that includes four programs: (1) Comunidades no Conec- of the long time it has taken SUTEL to create a trust, tadas, to connect 2,731 communities that do not have and to select and contract a management consulting access to the Internet at a cost of US$155 million; (2) firm to implement the program. It is also criticized Poblaciones Vulnerables, to provide subsidies to 620,000 for the lack of coordinated investments (e.g., computers disabled or vulnerable people, at a cost of US$50 million; in schools, health systems and applications, training (3) “Equipment for Schools,” a program projected to reach of teachers and other civil servants) for the Ministries 40,000 children at a cost of US$30 million; and (4) a yet of Education, Health, and others that FONATEL would to-be-determined program to impose services obligations not finance. SUTEL argues that the law only allowed a on telecommunication operators. maximum of 1 percent of the resources to administer the program, limiting the number of FONATEL staff;80 that Only the first program has been started. FONATEL public procurement procedures in Costa Rica are slow and recently awarded the first bid for Comunidades cumbersome; and that cooperation from other ministries Conectadas in Siquirres. This is a very small pilot project, has been lacking. one of three designed for the Atlantic Region, which is the poorest. The Northern Region was to follow later in The contribution of the telecommunications 2013. It also awarded the La Roxana Project in Pococi sector to the Costa Rican economy in September of 2013. Introduction of the program to the Southern Region was to be completed in early The telecommunications sector has become an engine 2014. The less poor Chorotega and Central Regions are of growth in Costa Rica. As a result of CAFTA-DR and scheduled for late 2014. Comunidades Conectadas will sector liberalization, the telecommunication share of GDP provide Internet access to: (a) all the population in these increased from 7.3 percent in 2006 to 9.1 percent in 2012 towns and villages with up to two MB/s connections; (b) (Figure 4.14). New private companies and ICE contributed schools, health centers, pre-school day care centers, and more to the value-added in telecommunications, as they Community Access Centers with up to four MB/s each. provided more services and added new clients, generating 80  At the time of this writing, FONATEL only had four staff, including 79  Pineda (2013). the director. 54 Five Years After CAFTA-DR: Assessing Early Results for the Costa Rican Economy Table 4.6: Estimation of Consumer Surplus for Internet Access Services Service Lines Prices per month (2012 US$) Consumer Surplus (2012 US$) 2008 2012 2008 2012 per month per year 512Kbps-1Mbps 42,290 136,918 $40.52 $16.50 $1,136,362 $13,636,338 1Mbps-2Mbps 44,593 200,812 $95.96 $24.40 $5,589,701 $67,076,417 > 2Mbps 18,788 50,203 $180.20 $43.90 $2,140,870 $25,690,436 Total 105,671 387,933 $8,866,933 $106,403,192 Source: Based on data from SUTEL (2013) for lines and prices. Conversion to 2012 US$ using CPI index for CRC and US$. new revenues. FDI in the telecommunication sector was politicians makes governments more accountable and US$339 million in 2011 and US$465 million in 2012.81 improves public services. Finally, broadband networks are increasingly used to deliver public services, such Competition has generated a consumer surplus. Fixed as distance education, financial services, health care, Internet access prices tumbled from 2008 to 2012. As prices electronic voting, and land registration. decreased, many Costa Ricans who did not have service began to subscribe and the number of users skyrocketed. Conclusions and remaining challenges The consumer surplus for those consumers was calculated at US$106.4 million in 2012 (Table 4.6). The main conclusion of this review is that the telecommunications sector liberalization brought Improved ICT service has had an economic impact. A by CAFTA-DR was an outstanding success. Before positive correlation exists between a country’s ICT readiness CAFTA-DR, the sector was a monopoly controlled by and its economic competitiveness, and broadband plays an ICE. There was considerable unmet demand for mobile important role in this equation. Numerous studies show telephone services, prices for Internet access were very the effects on the economies of developed and emerging high—making the service inaccessible for the majority of markets alike. While studies vary in their estimates of broad Costa Ricans—and the sector was supply-constrained. band’s impact on growth, the consensus seems to be that After the reforms, increased competition led to an a 10 percent increase in broadband household penetration abundant supply of services, prices for Internet access delivers a boost to a country’s GDP that can range reduced dramatically, and Costa Ricans responded between 0.1 to 1.4 percent.82 Using these parameters, by subscribing massively to the new services. All the estimated economic impact on development for Costa indicators demonstrate that after sector liberalization Rica is 9.5 percent of GDP, applying the average of the Costa Rica is well positioned in comparison with Latin McKinsey study range (from 1.3 percent to 17.7 percent of American countries of similar GDP per capita. Finally, GDP), during the period from 2008 to 2012 (a penetration the telecommunications sector’s contribution to GDP increase of 126 percent). increased substantially. The sector attracted large FDI flows, produced a large consumer surplus advantage ICT also generates important social benefits.83 from the reduction in prices and increases in quantities Broadband connects consumers, businesses, and govern- of Internet access and cellular lines, and made a large ments, and facilitates social interaction.84 It delivers contribution to economic growth. information to individuals and businesses, supports good governance and strengthens social capital. However, as in any liberalization of the telecom- Information about the performance of governments and munication sector in any country, some issues remain. In Costa Rica, these issues are partly due to the fact that 81  As reported by COMEX. 82  Buttkereit et al. (2009). A World Bank study found that every the government still owns the largest telecommunications 10 percentage-point increase in broadband penetration accelerates operator, which is not typical of the majority of Latin economic growth by 1.38 percentage points for middle-income countries (Quiang et al, 2009). American countries. Four important challenges remain: 83  Kim et al. (2010). liberalizing rates to allow for sufficient investment, 84  OECD (2008). broadening spectrum access to enable improved service, Five Years After CAFTA-DR: Assessing Early Results for the Costa Rican Economy 55 facilitating infrastructure sharing and municipal permits, the current challenge, SUTEL should consider exercising its and ensuring universal access by reforming the activities right to declare this market competitive and end regulation of FONATEL. of cellular rates. Rates, investments, and sustainability Private operators do not have enough spectrum SUTEL established the initial price caps for cellular services equal to existing rates at the time of Spectrum bands are critical for deploying mobile liberalization. This means that ICE rates were used telecommunication services. As operators deploy new as the basis of the price cap levels. This initial rate- and modern systems to provide faster access to the users, setting may have had a negative impact on the financial more spectrum is needed. Therefore, the timely award of performance of the new cellular private companies, frequency bands in the quantity and quality85 required because: (a) unlike its competitors, ICE did not pay for is essential for development of modern mobile services. its use of spectrum, and its rates did not reflect this cost; Today, the majority of countries in Asia, North America (b) ICE had depreciated assets, like towers, transmission and Europe have awarded frequency bands for 4G LTE, facilities, and buildings, as opposed to the new entrants which provides higher speed Internet access. As a result, that had to build every element of their networks from operators have deployed their networks and are actively scratch; and (c) interconnection rates may have given ICE providing this important service to customers. In Latin a competitive advantage due to the fact that, initially, the America, several countries have already awarded bands for majority of the traffic of new entrants’ lines was to and 4G, and operators are rolling out the service. from ICE’s subscribers, forcing the new entrants to pay for interconnection to ICE, while the majority of ICE’s traffic Mobile services in Costa Rica are 3G, which is the was confined to its own network. previous generation of mobile service. In order to roll out 4G, especially LTE advanced, operators will Low price caps on cellular rates restricted investment, need additional spectrum. However, when Costa Rica because private companies need profits to invest liberalized the telecommunication sector, ICE was the in new technologies, such as 4G LTE, to update only telecommunication operator. Because of that, the the network and provide faster service to users. government had assigned 78 percent of mobile spectrum Therefore, these lower rates are detrimental to promoting available to ICE.86 Therefore, on SUTEL’s recommendation, investment in the sector. In the majority of Latin American MINAET decided to auction three new concessions. Only countries and in the world in general, governments do not two were granted, to Claro and Movistar. There were no regulate cellular rates, due to the competitive nature of bidders for the other concession. In addition, Claro does these markets, where three or more players are actively not have lower frequencies, which is a technological providing services in a level playing field. In Costa Rica, and cost disadvantage in comparison with the other two there are three mobile telecommunication operators operators, particularly in the provision of services in rural and two mobile network virtual operators (MNVOs), for areas.87 SUTEL also recommended awarding frequencies a total of five operators. In many countries, as well as in in the 900 MHz band. This band is occupied by narrow Costa Rica, operators compete by offering different plans band point-to point-UHF links that can easily migrate to of minutes of voice, SMS, and megabytes of Internet other frequencies. In addition, ICE holds the majority of downloads per month. They offer discounts for on-net, the 2.5 GHz band that International Telecommunication weekends and non-peak hour calls and many other Union recommends for 4G use.88 ICE plans to roll out LTE alternatives. Consumers benefit from a wide choice of 85  Quality refers to the fact that these frequencies are not in use by plans and services. other operators. 86  SUTEL (2009). SUTEL should consider declaring the market compet- 87  Lower frequencies in the 700, 800, and 900 MHz bands offer four times the area of coverage for the same emitter power than high frequencies itive to end rate regulation. Article 50 of the Telecom- (1800, 1900, 2100, and 2500 MHz bands) and are useful for rural munication Law gave SUTEL the power to declare whether deployments, as fewer cell sites (towers) are needed to roll out the network. a specific market is competitive. In a competitive market, 88  ITU approved the use of the 2,500 to 2,690 MHz band for mobile broadband; the band is called “IMT Extension” and was recommended SUTEL would no longer regulate rates. As a solution to in WRC 2000. 56 Five Years After CAFTA-DR: Assessing Early Results for the Costa Rican Economy in this band in 2014. Another option is using the 700 MHz training of students, teachers, vulnerable populations, and “digital dividend” band, derived from the transition from government officials. This may result either in ineffective analog to digital TV.89 However, MICITT has announced use of the facilities or delays in their use. that this transition will not occur until December 2017. The sooner operators roll out 4G services, the higher the benefits will be for consumers and businesses. Infrastructure sharing and municipal permits When Claro and Telefónica started building their networks, they were delayed due to the slow process of obtaining construction permits from municipalities. The Sala IV decision and the recent loss of a court case by several municipalities90 provide reason to hope that this problem will be solved soon. However, as operators roll out 4G in the future, they will probably need to build more towers, and they may encounter delays again. Also, fixed-line operators and cable TV companies need to use ducts and poles to lay fiber. Therefore, this issue has to be resolved. One option is to enforce infrastructure sharing as stated in the law.91 The recent case of TIGO against JASEC was resolved favorably, as SUTEL forced JASEC to rent its poles to the company. This precedent may help solve future disputes between new entrants and existing operators over towers, buildings, poles, or ducts sharing, as these elements of the network become critical to deploy new networks. Universal service and FONATEL FONATEL effectiveness needs to be improved to expand access for disadvantaged communities and individuals. FONATEL is finally initiating the program to invest the universal service fund resources to extend service to un-connected communities, schools, health centers, day care centers and other public community centers in rural areas of Costa Rica. However, it has taken a long time, partly due to the lengthy government procedures established by law. The coordination between FONATEL and the Ministries of Education, Health, and others has not been very effective, and as a result FONATEL has only funded Internet access, leaving to the ministries the financing of computers, local area networks, and the 89  A digital TV standard definition channel uses about one fourth of the spectrum of an analog TV channel. 90  Agüero (2013) relates the case of Alta Vista Towers S.A. Costa Pacífico Torres Ltda. and Claro against the municipalities of Montes de Oca and Curridabat. 91  Articles 52 and 59 of the Telecommunication Law. Five Years After CAFTA-DR: Assessing Early Results for the Costa Rican Economy 57 Chapter 5 Intellectual Property Rights in CAFTA-DR and Pharmaceuticals in Costa Rica Introduction and whether those provisions have any effect on purchases of medicine by the CCSS. Even though it CAFTA-DR’s chapter on the protection of intellectual does not analyze the effect on prices resulting from the property (IP) was controversial due to its potential IP provisions, the analysis shows that CAFTA-DR includes implications for the pharmaceutical industry. The local provisions that allow access to low-cost pharmaceuticals. generic industry argued that IP provisions would prevent The number of medicines with some sort of IP protection the marketing approval of generic medicines and grant is very small, including four pharmaceutical products additional exclusive marketing rights by prohibiting drug (or two active ingredients) with patent linkages and 39 regulatory agencies from using original pharmaceutical products (or 30 active ingredients) with protection of test data for the registration of generic medicines. This test data during 2009-2012. Only one product with data would have the effect of severely restricting or blocking protection has been added to the CCSS’ Official Medicines generic competition. The strongest position against IP rules List. Furthermore, the share of CCSS expenditures devoted was that it would become economically unsustainable to medicines has hovered around 8 percent during 2000- and legally impossible for the country’s social security 2012, suggesting that IP provisions have not impacted program, Caja Costarricense de Seguro Social (CCSS), to medicine costs. provide universal coverage and access to medicines for the population, given that the prices of medicines were going Intellectual property regulations to increase as a result of the agreement. Another group, for pharmaceuticals in international however, believed that the IP provisions in CAFTA-DR would trade treaties encourage innovative medicines to enter the market. Costa Rica’s regulatory framework on IP for This chapter assesses the IP provisions within pharmaceuticals has been shaped by TRIPS and CAFTA-DR related to the pharmaceutical sector CAFTA-DR. Since 1996, Costa Rica is a signatory to 58 Five Years After CAFTA-DR: Assessing Early Results for the Costa Rican Economy the World Trade Organization Agreement on Trade Related importation.93 Moreover, CAFTA-DR does not force Aspects of Intellectual Property Rights (TRIPS), which countries to regulate second-use patents.94 provided the baseline for intellectual property protection for all WTO member countries. Costa Rica also adopted, • New chemical entity or new product.95 CAFTA-DR along with all other WTO members, the 2001 Doha defines a new chemical entity or new product by its Declaration on TRIPS and Public Health, which clarified novelty in the market in question. The implementation several TRIPS provisions on exemptions and exceptions rules in Costa Rica limited the definition of new contained in the agreement. For instance, it states that pharmaceutical products and new agricultural each member has the right to grant compulsory licenses chemical entities, which resulted in excluding from and the freedom to determine the grounds upon which this protection uses or indications, changes in the such licenses are granted. It also clarifies that each member route of administration, dosage, dosage form or in the country is free to establish its own regime of exhaustion formulation of a chemical entity, as well as products that of intellectual property rights without challenge. When constitute combinations of chemical entities previously CAFTA-DR came into force in January 2009, it introduced registered in the country. This definition includes a additional regulations that affected IP provisions applicable significant limitation on the amount of drugs that could to the pharmaceuticals market. receive test data exclusivity protection in the country. Several provisions in TRIPS and CAFTA-DR are • Test data exclusivity.96 One of the most controversial related to pharmaceuticals, which guarantee that aspects of the present IP regulatory regime is the there is no real danger to Costa Rica’s ability to regulation of originator undisclosed information, access low-cost medicines. Based on these provisions, including test data (i.e., information that should Costa Rica approved several regulations to ensure the be kept secret). CAFTA-DR confers non-disclosure implementation of agreements on IP and access to rights of use for clinical information for a period pharmaceuticals. For example, compulsory licensing of five years for pharmaceuticals and ten years for exceptions, parallel importations, and the Bolar agricultural chemicals after the product is approved provision, which are not restricted by CAFTA-DR, are in the country.97 As a result, unless generic drug a significant guarantee of access to pharmaceuticals manufacturers generate this test data through their in line with international standards. The most relevant own means, they are forced to delay the marketing provisions in CAFTA-DR relate to patent protection of the product, since without this information they systems, new chemical entities, the Bolar provision cannot prove that the products are safe and effective. exception, patent term restoration, patent linkages, compulsory licensing, parallel importations, and data 93  Parallel importation allows for the importation of a patented exclusivity. In particular: product that has been approved in a country’s national market, as well as other markets abroad, but is sold for a lower price in another country. This is an important provision to ensure access to affordably • Patent protection systems.92 Both TRIPS and priced medicines. Article 6 of TRIPS allows countries to determine their own rules on parallel importation. CAFTA-DR required countries to create national 94  Second-use patents—whether a result of a new registration or of patent protection regimes to issue patent licenses for new associated claims (the discovery of new uses)—are not recognized inventions. The patent protection will last for 20 years in Costa Rica. 95  Article 8 of the Costa Rican Undisclosed Information Law states from the date the patent application was filed. TRIPS that: “A new product” means one that does not contain a chemical defines what is considered an invention and details entity that has been previously approved in Costa Rica. Executive Decree Nº 34927-J-COMEX-S-MAG, Undisclosed Information Law the kind of enforcement regime that countries must Regulations in article 4 defines it as “a pharmaceutical product that have, including civil and administrative procedures does not contain a chemical entity in the product formula that already has a regulatory approval in Costa Rica. It will not be considered a new and remedies, provisional measures, border measures, chemical entity if those entities include new uses or indications, changes and criminal procedures. CAFTA-DR does not prohibit in the administration route, dosage, dosage form or formulation of a chemical entity or those products constituting combinations of the importation of pharmaceuticals via parallel chemical entities previously registered in the country.” 96  Test data is defined as the clinical information generated by companies that have investment in research and development of new 92  Patents provide the patent owner with the legal means to prevent chemical and agro-chemical entities, with the purpose of demonstrating others from making, using, or selling the new invention for a limited its efficacy and safety. period of time (20 years), subject to a number of exceptions. 97  See Article 15.10 of CAFTA-DR. Five Years After CAFTA-DR: Assessing Early Results for the Costa Rican Economy 59 • Bolar provision exception. By preserving the Bolar actions in court rather than in an administrative/ provision allowed under TRIPS,98 CAFTA-DR gave regulatory level. generic medicine producers a victory. The Bolar provision in CAFTA-DR99 is a limited exception to patent rights • Compulsory licensing.102 One of the most important that enables companies to develop a generic product achievements of the CAFTA-DR negotiation in terms in order to obtain marketing approval and then enter of patent protection and access to pharmaceuticals the market as soon as the patent has expired. It sends was in preserving the compulsory licensing provisions a clear signal that third persons using IP material will be and exceptions under TRIPS as well as in those in able to generate data for the creation of information regulations of the Costa Rican Patent Law. In order to that will be used to support market approval for a obtain a compulsory license exception, the following product (whether a pharmaceutical or agricultural must be analyzed: chemical product). · If there have been unsuccessful attempts to obtain • Patent term restoration. Under CAFTA-DR, the a voluntary license from the patent holder under period of protection can be extended beyond 20 reasonable terms and conditions and within a years if there have been delays in granting the patent reasonable timeframe. This condition may be license or analyzing the regulatory approval.100 With waived in the case of a national emergency. the implementation rules, Costa Rica limited to a · If there are adequate payments made according to maximum of 18 months any extension of the duration the circumstances appropriate for each case. of the patent protection to compensate for procedural · The decisions to apply this exception are subject to delays (either in granting patents or in securing judicial review or another independent review by a marketing approval for pharmaceuticals). The patent superior and independent authority. term restoration will apply in the following cases: • Parallel imports. As under TRIPS, CAFTA-DR allows · Delays of five years or more by the Industrial countries to determine their own rules on parallel Property Registry from the date of filing of the imports, including from which market and at what price patent, they will purchase pharmaceuticals. Parallel importation · Delays of three years or more by the Industrial allows for the importation of a patented product that Property Registry from the application of the has been approved in a country’s national market, as substantive examination, or well as other markets abroad, but is sold for a lower · Delays three years or more by the Health price in other markets. Thus, parallel importations Ministry in authorizing the commercialization of provide access to affordably-priced medicines. pharmaceutical products from the date of filing marketing approval of the drug product in the The provisions in TRIPS and CAFTA-DR could have country. affected producers of generic drugs in a narrow set of situations. One situation could have occurred if • Patent linkages.101 CAFTA-DR obliges regulatory generic manufacturers were producing pharmaceuticals authorities to prevent the registration and marketing in violation of patents that have not expired. In this case, of a generic product when the product has a patent. they would have contravened the IP or the purchase However, its implementation rules in Costa Rica do regimes in place. Another situation could emerge as not allow the regulatory authority to reject a generic the generic manufacturers need to wait until the patent approval procedure based on patent linkage, and term has elapsed to sell their products. But this condition therefore the patent titleholder is forced to take further existed under TRIPS, before CAFTA-DR entered into effect. A third case is if the data protection for five years had 98  See TRIPS Article 30. required manufacturers to make reasonable efforts to 99  See Article 15.9.5 of CAFTA-DR. 100  See Article 15.9.6 of CAFTA-DR. 102  Through compulsory licensing, a government temporarily 101  Patent linkage refers to a system where drugs covered by a patent overrides a patent in the public interest and negotiates a better price are linked before the regulatory authority with the patent for patent for the medication or seeks the approval for licensing for production of enforcement purposes to prevent generic approval to sell the drug. generic versions of a patent product, which are generally at a lower cost. 60 Five Years After CAFTA-DR: Assessing Early Results for the Costa Rican Economy Figure 5.1: Registration of Active Ingredients With the Ministry of Health in Costa Rica, number 1800 14 1600 12 12 1400 10 10 1200 8 1000 8 800 6 600 4 400 200 2 0 0 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Renewals New product without test data protection New product with test data protection (left scale) Source: Based on information provided by Laura Vargas Sanchez, Legal Counsel at the Health Products Directorate, Ministry of Health. invest in R&D to generate their own information to get a during the same period. This is not surprising because commercialization permit or wait until the five-year period most drugs developed every year and registered in the expires. But as indicated above, the implementation rules world by pharmaceutical companies are new presentations of CAFTA-DR limited the definition of new products and or formulations of preexisting medicine doses, rather than new chemical entities, so this situation has not occurred. new drugs. In the case of the U.S., for example, the Food and Drug Administration (FDA) approved 20 new molecular CAFTA-DR may also affect some innovative companies entities in 2005 and 35 in 2012. 103 Approximately due to the limited definition of what is considered two-thirds of the drugs approved by the U.S. FDA are not a new pharmaceutical product. This means that their new molecular entities but amendments and new uses for rights to exercise exclusive dominion over their test data existing drugs.104 will be restricted when they register certain medicines. CAFTA-DR does not protect test data that has entered the Costa Rica has approved the registration of only four public domain; nor does it protect test data that contains products (two active ingredients) at the Ministry of chemical entities that have already been registered (for Health with patent linkage (see Table 5.1). As mentioned example, a product that contains a combination of a new in the previous section, patent linkage is a mechanism to chemical product and one that was already registered promote effective and adequate IP protection. If a patent would not classify for protection), even if the final product exists, marketing approval will not be granted to a generic is innovative itself. version until the patent has expired or is found to be invalid. Patent linkage is a registered patent “linked” to Data protection, new chemical entities, the product that is covered by the patent in the market.105 and patent linkages after CAFTA-DR Patent requests for all areas grew consistently until One way to illustrate the impact of the clause on 2008, creating a potential backlog for reviews (Figure protection of test data and the narrow definition of 5.2).106 On average, about 590 new patent requests per new pharmaceutical products or chemical entities is year were submitted in 2009-2012. Although data is not to look at registrations for pharmaceutical products 103  See Congressional Budget Office (2006) for 2005 data and Food with the Ministry of Health. Only 30 active ingredients and Drug Administration (2012) for 2012 data. and 39 pharmaceutical specifications have received the 104  Congressional Budget Office (2006). protection of test data for five years in 2009-2012 (Figure 105  Ferriter (2007). 5.1). This amounts to only 1 percent of the number of 106  The list of registered products is available at: http://www. m i n i s t e r i o d e s a l u d . g o . c r / i n d e x . p h p / i n f o r m a c i o n / p ro d u c t o s - active ingredient registrations without test data protection registrados?start=8. Five Years After CAFTA-DR: Assessing Early Results for the Costa Rican Economy 61 Table 5.1: Pharmaceutical Products with Patent Linkage Protection Product name Registry Registry date Patent Linkage Expiration date Test Data Active number number protection ingredient expiration date Champix 0.5 mg 4132-BM-5018 8/15/2007 2645 2/25/2020 8/15/2012 Vareniclina Tartrato Champix 1 mg 4132-BM-5051 8/15/2007 2645 2/25/2020 8/15/2012 Vareniclina Tartrato Celsentri 150 mg 4132-BM-3388 7/16/2008 2688 12/23/2018 7/16/2013 Maravoric Celsentri 300 mg 4132-BM-3369 7/16/2008 2688 12/23/2018 7/16/2013 Maravoric Source: Based on information reported by Costa Rica’s Ministry of Health. available on patent requests for pharmaceutical products, population is one of the most important activities of the 2,410 innovations so far related to pharmaceutical, CCSS, and it requires careful definition and management. biotechnology, and chemical products are under analysis by the Patent Office to determine if they will receive patent The definition of an essential medicine policy has protection or not. This is according to the Costa Rican three aspects:110 National Intellectual Property Strategy of 2012,107 which included a complete study on pharmaceutical patents. • Offer and medicine selection: Many chemical However, it is well known that not all of these will pass pharmaceutical entities exist for therapeutic and clinical the evaluation. uses, but not all of them are essential or necessary to address the country’s health issues. The number of patents issued has risen since 2008, • Quality: The medicine that is going to be prescribed to but approvals are low compared to new patent the population must be safe and efficient. requests. Most patents are issued for pharmaceutical • Sustainability of public health systems with products (Figure 5.3), which could be attributed to efforts limited budgets: International medicine market by the Patent Office to avoid the implementation of the conditions and their costs. patent term restoration. Based on this definition, and following World Health How have CAFTA-DR’s IP rules Organization (WHO) recommendations, the CCSS affected the CCSS? published its essential medicine policy in 1985.111 This policy has two basic components to ensure a rational use As the primary provider of Costa Rica’s health care of medicines: services, the CCSS has developed policies jointly with the Health Ministry to provide universal medicine • Technical/scientific component: Medical coverage under human health rights regulations.108 management will conduct and be responsible for the One of these policies is to define the essential medicine selection, prescription, dispensation, and administration policy and the Official Medicines List, which includes of the medicines, as well as for providing information those medicines deemed necessary to solve the majority and education about them. of the population’s health requirements. This list ensures that Costa Rica has access to the medications needed to 110  CCSS and COMEX (2013). treat the major causes of death and mortality affecting the 111  The essential medicine policy was established by the Executive Decree Number 19343-S, published on Dec 19, 1989. Article 16 of population, and ensures that the medicines are available the Decree states: “Public Health Institutions must have a basic form of medicine with the corresponding administrative regulations and in the quantities and at the time that they are needed.109 therapeutic information, in accordance with the National Therapeutic The purchase and supply of medicines for the national Formulary. For this purpose and to ensure the correct application of this Regulation, each institution will establish a Pharmacotherapy Committee, which will also be responsible for approving the purchase 107  See Castro (2012). of pharmaceutical products that are not included in the National Therapeutic Formulary in cases of exceptional urgency and necessity. In 108  CCSS (2012). any case, this determination must be made known to the Committee 109  Ibid. with information and data necessary to justify such a decision.” 62 Five Years After CAFTA-DR: Assessing Early Results for the Costa Rican Economy Figure 5.2: Costa Rica Patent Requests, 2000-2012 Figure 5.3: Costa Rica Patent Issues, 2000-2012 900 70 791 800 60 669 700 593 615 624 589 21 524 50 600 500 438 40 15 9 4 4 400 318 30 270 300 214 243 20 45 200 31 27 32 33 76 27 21 100 10 4 13 9 5 9 8 2 1 4 1 4 0 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Pharmaceutical Other Source: Based on data provided by Luis Gustavo Alvarez, Director's O ce, Industrial Property Registry. Source: Based on data provided by Luis Gustavo Alvarez, Director's O ce, Industrial Property Registry. • Operational component: Logistics management presentations and 36 active ingredients on medicines not will be responsible for planning, acquisition, quality, registered before the Ministry of Health. which have been storage, and distribution of the medicines. selected and included on the list according to the procedure indicated above.115 The drugs included on the list do not A specific procedure regulates the inclusion of a constitute the totality of the medicines on the Costa medicine on the Official Medicine List, in accordance Rican market, but only the medications that the Central with several criteria. To add a new medicine or product to Committee considers necessary to address the population’s the list, there must be a demonstrated public health need. health issues. Between January 2009 and May 2013, the The analysis is made in accordance with epidemiological, list was updated with seven new active ingredients and 12 clinical, pharmacological, and pharmacoeconomic criteria. pharmaceutical presentations. Also, an analysis of available alternatives—including a review of scientific evidence, clinical trials, and meta- Pharmaceutical innovation drives constant change analysis—is needed to establish efficacy and safety.112 in the medical field, and has a significant impact on the CCSS’s list. The challenge is to define how many and Since 1988, the Central Committee of Pharmacotherapy which of the new medicines introduced to the market really has been responsible for selecting medicines and represent actual progress. Between 2001 and 2010, only keeping the Official Medicine List current. The 2 percent of medicines that entered the market were a Central Committee of Pharmacotherapy is a scientific and real advance to medicine, 14 percent were not acceptable, technical body established in 1982 by the CCSS.113 The 7 percent could offer some advantage over available committee includes 13 national hospital specialist doctors treatment options, 21 percent could offer some help, 52 and three pharmacists. Its main objective is to ensure the percent did not represent any significant advantage, and 5 population’s access to medicine and the rational use of percent showed inconclusive results.116 those medicines. Once committee requirements have been met, they can add to the Official Medicine List, which can The CCSS purchase policy for medicine allows be found on the CCSS webpage.114 the institution to make a careful selection of the medicines required to address public health The CCSS Official Medicine List is continuously problems. The purchase policy avoids the duplication of updated as new medicines are evaluated. Currently, the products used for specific diseases, which in turn creates list includes 455 active ingredients in 641 pharmaceutical an environment for more competitive pricing. This policy 112  CCSS and COMEX (2013). 115  CCSS and COMEX (2013). Those 36 active ingredients were 113  See the Executive Decree # 13878-SPPS of September 22nd, 1982. allowed to enter the country under a special needs waiver from the CCSS. 114  See http://www.ccss.sa.cr/medicamentos 116  Gagnon (2012). Five Years After CAFTA-DR: Assessing Early Results for the Costa Rican Economy 63 Figure 5.4: CCSS Expenditures for Health Care and Medicines 3000 2716 12 2512 2500 10 2161 2000 1748 8 1621 1500 1267 6 1038 1000 817 850 888 885 926 4 747 500 204 2 131 154 124 151 199 70 71 60 70 75 76 92 0 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Medicines expenses (US$ millions) Health care expenses (US$ millions) Medicine expenses as percent of health care expenses (left scale) Source: Based on data provided by CCSS. allows for stability in the official medicine list. For the last of CAFTA-DR did not change the patent process, nor four years, the CCSS has only added 1.6 active ingredients does it prohibit generic medicine production, marketing, per year on average. The implementation of the policy has importation, purchase, or distribution. The treaty simply also demonstrated that not all drugs on the market that establishes five years of protection for all the generated test are considered necessary for public health care need to data in order to protect information on the new medicine’s be incorporated into the CCSS official list of medicines. In safety and efficacy, in accordance with worldwide fact, out of the total number of chemical-pharmaceutical protection standards. However, this information is not entities in the world, only 4.91 percent are included in the exclusive and therefore the protection is for non-disclosure CCSS official list of medicines to address the public health purposes. On data protection of new pharmaceutical problems of the national population. products, CAFTA-DR does not prohibit the production, commercialization, importation, purchase, or distribution For some of the new products included in the of generic medicines. CCSS Official Medicine List since 2009, no generic medicine are registered in Costa Rica. Therefore, To analyze the impact of CAFTA’s data protection rules access to generics is not related to IP, because even when on the Official Medicine List of CCSS, a review of the new products do not have data exclusivity or any other IP list and registered pharmaceutical products over the right, they do not have a generic version in the market. last four years is needed. Between CAFTA-DR’s entry Such is the case for three vaccines, Gadoversetamide into force and May 2013, only seven active ingredients (gadoteric acid), and Levovupivacine. The reasons for this and 12 pharmaceutical presentations have been added to situation are varied. In some cases, the manufacturing the CCSS official medicine list, approximately 1.6 active complexity or low profitability of the drug removes ingredients and 2.7 pharmaceutical presentations per year. incentives for generic pharmaceutical companies to The newly introduced medicine with data protection was produce the generic version. Most of them even wait Tenofovir disoproxil fumarate (Viread 300 mg tablets), for until a medicine is included on the Official Medicine List which data protection will expire in May of 2016. before producing the drug as a generic to ensure that there will be an attractive market. During the first four years of CAFTA-DR enforcement in Costa Rica, data protection and patent linkages Costa Rican law grants the government sufficient were not the determining factors for the inclusion power to adopt all the necessary steps to assure of a product on the CCSS official medicine list. The that the patent process of medicines will not affect inclusion of a medicine on the official list of medicines was its availability to the population. The implementation not impacted by the CAFTA-DR’s rules on data protection 64 Five Years After CAFTA-DR: Assessing Early Results for the Costa Rican Economy Figure 5.5: Percentage Distribution of CCSS Medicine Expenditures by Therapeutic Group, 2007-2012 120 100 80 53 47 71 67 48 57 60 5 1 3 5 5 3 4 3 40 7 4 4 6 6 4 15 15 4 6 7 12 20 5 7 37 2 4 24 22 20 11 11 0 2007 2008 2009 2010 2011 2012 Antineoplastic and Biologic, vaccines, toxoids, Hemostatic drugs Antibiotics Anticonvulsants Other drugs immunomodulatory drugs and antitoxins drugs Source: Based on data provided by CCSS. Note: The data only includes medicines purchases made at the central level, which ranges between 81-89 percent of total medicines purchases by CCSS. Purchases made by executing units (unidades ejecutoras de las unidades de atención) were excluded. or patent linkages, but rather by other considerations, medicines are affecting CCSS expenditure. A recent study including price, production technology, economic viability by the PAHO shows that one of the main determinants of generic medicine pharmaceutical manufacturers, and of the difficult financial situation of CCSS is the high the complexity and quality of the products required by level of staff remunerations (salaries and social security the CCSS. These factors have not been modified after contributions).117 That study also shows that the share CAFTA-DR’s entry into force. Only one product with data of staff remunerations as a percent of total health care protection has been included on the official medicine list of expenditure increased from 54 percent in 2000 to 68.5 CCSS (Tenofovir disoproxil fumarate). The official medicine percent in 2010, illustrating that those expenses have list does not include any of the four products with patent been growing faster than other expenditure categories, linkages in Costa Rica (Table 5.1 for the list of products) including purchase of medicines. and thus the CCSS does not buy them. When examining medicine expenses, a small group Given that very few of the medicines in the official list of medicines account for half of the expenditures. have either data protections or patent linkages, these Antineoplastic products, which are used to treat cancer, rules have not impacted the CCSS. As discussed above, increased to 37 percent of medicine purchases in 2012, the CCSS includes medicines on its official medicine list from 11 percent in 2007 (Figure 5.2). During the same based on the population’s health needs and not according period, the share of biologics and vaccines increased to 6 to any intellectual property requirements. In addition, it is percent. not necessary for a medicine to have patent linkage to be included on the official list. The only products that have Increasing investment in innovative products has patent linkage in Costa Rica were not included on the been largely attributed to production costs rather CCSS official medicine list, since the Central Committee than IP protection. In the past several years, in particular of Pharmacotherapy does not consider them necessary to in 2009, investment in innovative products increased as treat diseases or ensure public health. a result of the entry of biological and biotechnological medicines in Costa Rica.118 This situation has arisen due to Expenditure growth at CCSS cannot be attributed the cost of production for these kinds of medicines, rather to an increase in the prices for medicines. CCSS than to IP protection.119 expenditure on medicines amounted to US$204 million in 2012, accounting for 8 percent of total CCSS 117  PAHO (2011). expenditure (Figure 5.4). This share dropped from a peak 118  CCSS (2013). of 10 percent in 2007, suggesting that factors besides 119  Information obtained from CCSS Budget Direction. Five Years After CAFTA-DR: Assessing Early Results for the Costa Rican Economy 65 Figure 5.6: CCSS Medicine Purchases by Type, millions of US$ 120 120 100 100 80 80 60 60 40 40 20 20 0 0 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Generic medicines Generic medicines Innovative Chemical medicines Biological medicines Foreign Costa Rica medicines Sources: Based on data provided by CCSS. Note: The data only includes medicines purchases made at the central level, which ranges between 81-89 percent of total medicines purchase. Purchases made by executing units (unidades ejecutoras de las unidades de atención) were excluded. When examining CCSS investments in medicines by type some interesting trends emerged. First, the gap between CCSS investments in national and foreign generic medicines has grown since 2009 (Figure 5.6). Furthermore, investments in innovative and biologic/biotechnology medicines are also growing. It is not possible to determine from the data whether CCSS purchases in medicines have shifted from national to foreign markets. In summary, the IP provisions with CAFTA-DR did not diminish the country’s ability to get medicines to ensure the health of the Costa Rican population. The decision to add medicines to the CCSS Official Medicine List depends on specific procedures regarding its efficacy and safety rather than with the IP provisions in CAFTA-DR. 66 Five Years After CAFTA-DR: Assessing Early Results for the Costa Rican Economy References Agüero, M. (2013, August 20). 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