Costa Rica, an upper middle-income developing country of 4 million inhabitants, is well known for its socio-economic achievements. Its life expectancy is substantially higher than in comparable countries, while infant and child mortality rates are significantly lower. Costa Rica had the second lowest poverty headcount in Latin America in 2004, with just 9 percent of households below the $2 per capita per day poverty line. Income inequality is also among the lowest in Latin America.
Costa Rica’s economic growth has averaged 4.7 percent annually over the last 15 years, about 2 percentage points above the rest of Latin America, reflecting its stable macroeconomic and political environment, strong institutions, and a well-educated work force. During this period, Costa Rica has followed a successful strategy of outward-oriented export-led growth, openness to foreign investment, and gradual trade liberalization that transformed the economy from one highly dependent on agriculture and agro-industry to one that is now led by high-tech computer and electronic industries, services such as transport, communications and banking, non-traditional agriculture, and tourism.
Despite these achievements, several challenges remain.
Firstly, notwithstanding recent gains, Costa Rica’s poverty and inequality levels have shown little improvement since 1994. This suggests that Costa Rica’s economic growth may not be broad based and raises concerns as to the efficacy of its social sector expenditures. Costa Rica is falling behind in some public health areas and its performance on secondary education—vital to benefiting from globalization—has not kept pace with countries spending similar amounts on education per capita. Secondly, the quality of the country’s infrastructure is deteriorating. For instance, less than 12 percent of the national paved road network is estimated to be in good condition, while 64 percent is in poor or very poor condition. This helps explain why Costa Rica scored well below average in a survey of infrastructure quality. Thirdly, while its fiscal balances and debt situation have improved in recent years, Costa Rica is still vulnerable to deterioration in the external environment from: (i) an economic slowdown in the United States; (ii) tighter global financial market conditions, and (iii) sharp increases in fuel and commodity prices.
The government of Costa Rica realizes that continued economic growth and poverty reduction require an improvement in the quality of infrastructure and social sector services, particularly if Costa Rica is to take full advantage of the greater global market opportunities in the context of DR-CAFTA and other free trade initiatives. To improve the quality of public services while simultaneously reducing its fiscal vulnerability is challenging, especially since reaching a political consensus on revenue enhancing tax reform has proven difficult.
This report is the outcome of the government’s request to the World Bank (WB) and Inter-American Development Bank (IADB) to identify possible reforms in policies and institutions to enhance the effectiveness, efficiency, and equity of public xiii expenditures. Such reforms will support Costa Rica’s efforts to ensure sustainable fiscal balances and establish effective and transparent mechanisms to allocate public resources so as to promote broad-based economic growth, improve social indicators, and reduce poverty.
The report has been produced in close consultation with authorities in several relevant government ministries and public institutions, including the Minister of Finance, Minister of Education, Minister of Health, and Minister of Public Works and Transport. In particular, the sectors, programs and issues addressed in the report—education; health; social protection, with an in-depth analysis of the childcare and school lunch programs; roads; the budget process; and procurement—were requested by the authorities at the start of the exercise. The study also addresses specific questions posed by the authorities during the joint WB-IADB consultation mission of July 2007 where the preliminary findings of the study were presented.
In light of the concerns above, the study focuses on how to improve public services while maintaining the share of overall public expenditures in GDP. This will require eliminating ineffective spending, mainly by implementing measures to enhance efficiency, especially in education, health, roads, and public procurement. It will also require measures to improve targeting, especially in social protection programs and health.
The study also suggests that there is room to increase public funding in certain neglected areas without sacrificing fiscal stability and while continuing to consolidate gains in poverty reduction and social outcomes. This will require selected expenditure reallocations that are likely to be challenging due to fiscal rigidities caused by widespread earmarking as well as some issues relating to the budget process. In addition, institutional and technical capacity constraints may make it hard to implement the reforms as envisaged or to achieve the desired results from scaling up expenditures. Addressing these constraints and improving the budget process will be key to reform implementation and enabling the needed expenditure reallocations.
After describing recent economic developments, the rest of this executive summary will discuss in turn the four themes identified above that run through most of the chapters: (i) efficiency of public expenditures; (ii) institutional and technical capacity constraints; (iii) fiscal rigidities and the budget process; and (iv)targeting and equity. The political economy of introducing and implementing suggested policy options are also discussed.
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