Adriana Castro and Adelina Villalobos of BLP explain why the presence of Costa Rica's free trade zone since 1980 has helped to make it one of the most desirable capital destinations in the region
In the 1980s, the Costa Rican government started to diversify the country's production model by aggressively promoting foreign trade. The intention was to provide more stability to the economy, which by that time, was highly dependent on the export of traditional goods such as coffee, bananas, sugar and meat. During that decade, the country was also facing the effects of a serious recession and needed to attract foreign direct investment (FDI) as a method of recovering the economic development path. With this objective in mind, in 1981, the first Free Trade Zone (FTZ) Regime Law was enacted (Ley de Zonas Procesadoras de Exportación y Parques Industriales, No 6695). This law granted tax incentives to manufacturing companies exporting to markets outside Central America; commercialisation companies manipulating, repacking or redistributing non-traditional goods to markets outside Central America; and companies providing services to those established under the FTZ regime.
The FTZ model suffered relevant transformations during its lifetime. Finally the law was derogated and replaced in 1990 by Law No 7210 (Ley de Régimen de Zona Franca, No 7210), which is the legal instrument that now regulates the FTZ regime.
Initially, the FTZ regime was conceived to be controlled and operated by the government, and the manufacturing zones were state-owned. This changed notably with the amendments to the FTZ legislation, which first created the possibility of granting concessions to third parties for the administration of those zones; then the FTZ model gradually changed to the extent that the government's role became purely one of administration and supervision. FTZ parks were no longer a task for the government but the private sector. This important transformation of the FTZ model during the mid-nineties was further revitalised with the creation of the Ministry of Foreign Trade (COMEX) and Agency for the Promotion of Costa Rican Foreign Trade (PROCOMER) in 1996 (Law No 7638).
Since these important amendments to the law, the FTZ regime has been continuously updated by the correspondent authorities and this is probably one of the reasons why it has remained successful throughout the years.
Success of the regime
According to the statistics of the Costa Rican central bank (BCCR), during the 1980s the FTZ regime had an important impact on the textile sector. This started to change during the 1990s when the government focused its efforts on attracting FDI that required a qualified labour force. To illustrate the impact this had, the textile sector represented 35% of total exports in 1997, but this figure decreased to 9.5% in 2003. The position in the market that in the past was occupied by the textile segment, is nowadays taken by the medical devices and electronics sector. In 2013 Costa Rica was positioned as the highest exporter of high-technology industrial goods and as the second-place exporter of medical devices in Latin-America (source: CINDE, based on World Bank data).
But Costa Rica has been successful not only in diversifying the type of goods exported but also in increasing the amount of FDI and its geographic origin. In the quadrennial 1998-2001 the FDI represented $2.1 billion and for the period 2010-2013 it increased to $8.66 billion. Of this amount $2.6 billion corresponded to the FTZ regime. As per the data of the COMEX, in 2013 the FTZ regime was the third-highest source of FDI in the country, right after real estate and the non-FTZ companies sector. In that year, the investment of companies operating under the FTZ regime totalled $528 million. Additionally, in 2004 the origin of FDI was highly dependent on the US, with 70% of the FDI coming from that country. In 2013 the outlook changed, and while we continued to receive an important amount of FDI from the US, we also receive 54% of FDI from other countries around the world.
As the statistics demonstrate, the FTZ regime continues to be a predominant source of FDI into the country. In the manufacturing and IT service sectors, $3 of every $4 of FDI corresponds to FTZ companies. Manufacturing companies operating in the country increased from 38 in 2000 to 120 in 2013; while in the service sector, the companies operating in the country increased from 6 in 2000 to 142 in 2013 (source: CINDE).
Amendment to the FTZ Law by President Arias' administration
Part of the prevailing success of the FTZ regime is attributable to President Arias' administration, which in 2010 made an important amendment to the FTZ Law No 7210 and its regulations. This last amendment to the Law prepared the FTZ regime for attracting new investment for years to come, creating a new manufacturing FTZ category specially designed to avoid export contingency (companies operating under this new category are not contingent in law or fact to exports). All changes were in accordance with the export subsidy phase-out rules of the World Trade Organisation that gave developing countries until 2015 to eliminate these schemes.
The prompt approach of the Costa Rican Government to adapting the local legislation to the requirements of the World Trade Organisation, helped revitalise this successful channel for attracting FDI. Moreover, the amendment favoured three aspects that would be important for the economic development of the country: i) it defined the type of industries that would be eligible for the FTZ regime, ii) it offered particular incentives to large projects, and, iii) it promoted, through specific incentives, investment in less-developed geographic areas of the country.
Politics for business
Costa Rica did not escape the effects of the 2007-2008 financial crash. At that time, President Arias from the National Liberation Party (PLN) was in power. His administration turned to neoliberal politics to mitigate the effects of the crisis. Neoliberal reforms included amendment of the FTZ regime as well as the implementation through a referendum of the DR-CAFTA (Dominican Republic-Central America Free Trade Agreement), which was approved by 51% of the popular vote, the liberalisation of the insurance, electricity and telecommunications sectors, all of which were implemented by the Arias administration. Laura Chinchilla, Arias's vice president, was elected after Arias, maintaining the neoliberal political approach.
Costa Ricans have always taken pride in being a 'centre-policy' country. As the number of neoliberal policies increased, so did the desire for a shift. The 2014 elections in Costa Rica were essentially a poll for public opinion on these neoliberal policies; the people wanted a change.
2014 marked a paradigmatic change in the history of Costa Rica's politics. Ever since 1948, the country had been run by two traditional parties: the National Liberation Party (PLN) and the Social Christian Unity Party (PUSC). With an historic victory of 77.8% of votes cast, Luis Guillermo Solís became the first president from the Citizen's Action Party (PAC). PAC came into government with the motto 'it is time for a change'.
Business players and foreign investors cautiously analysed this change. During his campaign, Solís hinted that he would be shifting his attention to Costa Rica and that he would have the economy depend less on foreign investment. Some feared the FTZ regime would be in danger and investment promotion entities were skeptical about what this meant. Nonetheless, after almost a year in power, actions have proven that the change has not been as dramatic as some might have expected.
Just one month after his inauguration, Solís, sought to increase FDI and trade between Costa Rica and the US. Later that year, he appeared in a news conference clarifying his intention to promote foreign investment. Following his visit to China in January 2015, it was announced that priority would be given in the legislature to the Bill on Protection of Investments between the two countries.
FTZ as a business success
Concentration control approval was implemented in Costa Rica in April 2013. Under an amendment to the Law to Promote Competition and Effective Consumer Defense, the consolidation of corporations must be approved by the Commission to Promote Competition. Consolidation is defined as the merger, purchase and sale of commercial establishments or bulk sales, or any other act or contract by which corporations are concentrated, or any transaction whereby any individual or legal entity, public or private, acquires the control of two or more economic agents that are existing or potential competitors until the moment the agreement is executed.
According to data obtained from the Commission to Promote Competition, no transactions involving FTZ regime entities were approved during 2013. Nonetheless, 21% of the approved transactions in the last year relate to companies in the FTZ regime. This is evidence that the modifications to the FTZ Law and the open approach to foreign investment of the Solis administration have proven successful for the promotion of FTZ business.
First published by our sister publication IFLR magazine. Take your free trial today.
About the author
Adriana Castro works mostly on business, corporate and commercial law. Her areas of expertise include acquisitions, restructurings, asset purchases, and debt financings. She has broad experience in due diligence, design and implementation of corporate, tax, and labour structures, as well as contract review and implementation and corporate governance. She has been involved in several complex transactions over recent years, including the acquisition of the majority of the shares of the ArcelorMittal steel wire plant in Costa Rica by Bekaert.
Castro obtained her law degree from the University of Costa Rica where she graduated with honours. She obtained her LLM degree from Northwestern University, where she also graduated with honours. She has a Certificate in Business from IE Madrid.
About the author
Adelina Villalobos works mostly on corporate and commercial law as well as international trade law and free trade zones (special export regimes). Her areas of expertise include advising national and foreign companies in starting and developing their operations in Costa Rica, contracts, due diligence procedures, corporate restructurings, stockholders agreements, corporate governance, and mergers and acquisitions. She has been involved in several complex transactions, including the acquisition of Chicago Miniature Lighting by AGM Automotive in a transaction of over $25 million.
Villalobos obtained her law degree from the University of Costa Rica where she graduated with honours. She is a public notary and obtained her masters degree in corporate law from the University Carlos III de Madrid, where she graduated with honours and top of her class.