| How to Ruin an Economy? | | | | Argentina in 2001-2003. That country experienced a |
| The short answer to that question is: overvalue the | | | | complete economic collapse due in good part to |
| national currency. That is exactly what Costa Rica | | | | pegging the peso to the dollar so that the peso was |
| has been doing for more than two decades. | | | | overvalued by a wide margin. Dollarizing meant |
| Throughout the years since 1984, under a system of | | | | surrendering control over monetary and fiscal policy. |
| daily mini-devaluations, the dollar exchange rate for | | | | Then to make matters worse productive state |
| the Costa Rica colon was gradually increased. But in | | | | enterprise were privatized at bargain prices to local |
| most years the domestic rate of inflation exceeded | | | | and foreign capital. State policies allowed a great |
| by several percentage points the devaluation rate. In | | | | inflow of foreign loans and speculative capital. |
| 2006 the Central Bank replaced the mini-devaluations | | | | Argentina under the left of center Kirchner |
| with a system of bands in which the colon was | | | | government recovered in subsequent years by |
| allowed to float between lower and upper limits with | | | | devaluing the peso, defaulting on foreign debt, ending |
| the upper limit gradually increasing, in July 2010 | | | | speculation, renouncing the neo-liberal policies that |
| reaching 610 colons for one dollar with a floor of 500. | | | | created the disaster and reorienting its monetary and |
| Then, beginning in October 2009 the colon gained | | | | fiscal policy toward national development. |
| value precipitously, the exchange rate falling from 590 | | | | The overvaluation of the colon is a direct |
| in October 2009 to 510 in May, 2010. From May to | | | | consequence of the policy of the Central Bank. |
| July 2010 the rate has fluctuated between 515 and | | | | According to the President of the Central Bank |
| 530. If this continues for any length of time the | | | | where the colon falls within the band is a strict |
| Costa Rican economy will greatly suffer. | | | | function of the number of dollars as versus the |
| An overvalued currency harms exports, subsidizes | | | | number of colons in circulation. More dollars |
| imports, exacerbates balance of payment problems, | | | | exchanged on the Monex, the money market for the |
| negatively effects tourism and foreign residents with | | | | large players, and at the state and private banks, |
| dollar incomes, deters foreign investment, inflates real | | | | means a fall in the value of the dollar. |
| estate prices, and invites currency speculation. | | | | I suppose such narrow criteria for establishing the |
| Costa Rica has an economy highly dependent on | | | | exchange rate is to be expected from Costa Rican |
| export earnings. If exporters try to increase their | | | | economists with a U.S. education and business |
| prices to compensate for a weak dollar a strong | | | | administration graduates of Harvard, Wharton or |
| colon means less competitively priced products on | | | | other bastion of monetary orthodoxy. They are fully |
| international markets. If prices cannot be increased, | | | | indoctrinated in the conventional wisdom of |
| as is usually the case, businesses must nevertheless | | | | neo-liberalism. Two of key elements of this narrow |
| pay their operating costs in colons while receiving | | | | thinking are that the purpose of monetary policy is to |
| fewer in return for the dollars earned-- 92% of | | | | control inflation and that state guidance of the |
| export earnings are in dollars, but 70% of costs are | | | | economy is contrary to the economic principles of |
| in colons. | | | | free enterprise. |
| With an overvalued colon imports become relatively | | | | Central Bank officials have stated that the elimination |
| cheaper. This has the adverse consequence of | | | | of the mini-devaluations and adopting the system of |
| encouraging import of goods that compete with | | | | bands was to have better control of inflation, |
| locally based production. The consumer goods | | | | moderate the trend toward dollarization, and to avoid |
| industry in Costa Rica is relatively well-developed, | | | | Central Bank injection of dollars to protect the |
| with some sectors also geared to exporting to | | | | exchange rate, causing Central Bank deficits. Actually, |
| Central America. Historically, national production has | | | | the mini-devaluations worked reasonably well. For |
| been to some extent protected by import tariffs. | | | | businesses the rate was predictable and it facilitated |
| These are now largely being eliminated under the | | | | the export development strategy adopted since the |
| provisions of CAFTA, the Central American Free | | | | 1980s. The rate was adjusted on the value of dollars |
| Trade Agreement with the United States | | | | and other traded currencies in relation to domestic |
| implemented under the Arias Administration. The | | | | inflation, although the spread between inflation and |
| combination of an overvalued colon and the | | | | devaluation in most years meant an appreciation of |
| elimination of protective tariffs could mean that some | | | | the colon. Contrary to Central Bank spurious |
| sectors of domestic industry will go under. | | | | rationales, Costa Rica's high rates of inflation, as well |
| While the economy began to recover in late 2009 | | | | as the partial dollarization of the economy, have been |
| from the internationally induced recession, Costa Rica | | | | consequences of its export-led integration into the |
| maintains a chronic problem with balance of payment | | | | global economy and really not to exchange rate |
| deficits. The combination of reduced or lower valued | | | | policies. The current 4% rate of inflation, down from |
| export earnings and increased import expenditures | | | | double digit levels previously, is a consequence of the |
| impels the balance of payments into further deficit. | | | | slow economy, certainly not an overvalued colon. |
| During the first Quarter of 2010 exports, lead by | | | | One of the more absurd pronouncements by |
| pineapple and bananas, grew 11% with respect to | | | | international business publications espousing the |
| Q1, 2009. However, as might be expected with | | | | doctrines of monetarism and globalization is that |
| cheapened dollars, imports increased 24% in the | | | | every country should peg its exchange rate for |
| same period, widening the current account deficit. | | | | dollars to the price of a McDonalds hamburger in the |
| The principal foreign exchange earner in Costa Rica is | | | | United States. Well, today a Big Mac in Costa Rica is |
| tourism, an industry with income in dollars but | | | | about the same price as in the U.S. In this wisdom, it |
| expenditures in colons. For visiting foreigners Costa | | | | does not matter that the cost of labor that serves |
| Rica is no longer a bargain. When word gets around in | | | | up the burger in a local franchise is 1/5 the cost in the |
| the United States and elsewhere that their dollars | | | | U.S., or that the cost of constructing a fast food |
| don't go very far, tourism will suffer. | | | | joint is 1/5 that in the U.S., or that buns and meat are |
| An overvalued currency is a deterrent to foreign | | | | lower priced, or that commercial land to locate a |
| investment, a central element in the development | | | | franchise is cheaper. |
| strategy of the Arias government and the current | | | | The McDonalds idea has more relevance if it is |
| administration. For a foreign company to establish and | | | | reversed. An intelligent exchange rate policy would at |
| operate a business in Costa Rica they must | | | | least in part evaluate the cost of the factors of |
| exchange dollars for colons and these won't go | | | | production-- labor, materials, and capital--in the |
| nearly as far as they should. | | | | national economy in relation to the values in the |
| There are many thousands of foreigners resident in | | | | economies of trading partners. If these were the |
| Costa Rica that depend upon pensions or other | | | | criteria than a $3 Big Mac in the United States would |
| income in dollars. In the months since late 2009 | | | | cost the equivalent of $.60 in colons. This price would |
| foreign residents have been hit hard in their pockets, | | | | have the added virtue of making the Big Mac |
| a 15% decline in value of the dollars they exchange, | | | | affordable for the low-waged Costa Rican servers |
| plus suffering additionally from a 4% domestic | | | | who dish out the burger. It would also help the |
| inflation in the cost of goods and services. The nation | | | | deteriorating standard of living of ordinary Costa |
| has programs to attract foreign retirees that will fail if | | | | Ricans if the government development strategy |
| their dollars won't go very far. So too will programs | | | | would provide incentives for domestic production of |
| like medical tourism suffer. | | | | food staples like rice and beans, also helping to keep |
| The real estate market is negatively effected by | | | | famers on the land and out of the urban slums, |
| overvaluation of the colon. Sellers almost always list | | | | instead of removing tariffs on the import of foreign |
| their property in dollars, so there is now a higher | | | | foodstuffs. |
| price. This is a problem in that many real estate sales | | | | Certainly controlling inflation and adjusting |
| are to foreigners. This problem is seriously | | | | disequilibrium's in the supply of currencies need be |
| compounded by the appreciation of real estate | | | | factors in monetary policy. But the essential goals of |
| values over the last decade. Even during the 2008 | | | | the policies of the Central Bank should be those of |
| and 2009 financial bust and international recession, | | | | development of the national economy. This is |
| when real estate most everywhere in the world was | | | | accomplished by fiscal policies that allocate resources |
| falling in price, this was not generally the case in | | | | into chosen sectors vital to economic and social |
| Costa Rica. There has been a highly inelastic price | | | | development and monetary policies that support the |
| response to abundant offerings of properties of all | | | | development goals established. The current and past |
| types and falling demand. All real estate companies | | | | political administrations in Costa Rica, blinded by their |
| report a substantial decline in business. | | | | neo-liberal ideology, have no idea how to go about |
| The current exchange rate opens the door to | | | | this. |
| currency speculation. Windfall profits will accrue to | | | | An undervalued national currency is better than an |
| those who buy dollars when the rate is near the floor | | | | overvalued currency, at least in relation to export |
| and sell them for colons when the rate returns | | | | booms. Perhaps Costa Rica should look closer at the |
| toward the upper limit, as should eventually happen, | | | | example of China. The United States charges that |
| assuming the Central Bank authorities have any | | | | China undervalues the Yuan to the detriment of the |
| sense. | | | | U.S. economy by the flood of cheap Chinese imports. |
| In fact, the drop in the value of the dollar when the | | | | While this is no doubt overstated, it is true that China |
| same currency is strengthening against the Euro is | | | | carefully controls its currency exchange to promote |
| related to an apparent influx of speculative capital | | | | its own economic development. Of course, this is not |
| and wealthy Costa Ricans changing currencies. In the | | | | the main factor in China's unparalleled success story. |
| United States and Europe interest rates are very low | | | | China rather turned Marx on his head; socialism laid |
| and the economies stagnant, whereas in Costa Rica | | | | the groundwork for a transition to a raw but vital |
| interest rates are quite high and the economy, so far | | | | capitalism. Not the neo-liberal global capitalism of the |
| at least in spite of high interest rates and tight credit, | | | | West, but a capitalism that utilizes the socialist |
| is modestly recovering. | | | | tradition of strong state institutions that centrally plan |
| Why the Central Bank maintains high interest rates | | | | the social and economic development of the nation. |
| while the economy needs stimulation is one more | | | | Establishing an exchange rate that makes economic |
| indication that something is wrong in the higher circles | | | | sense is just a first step for national development. |
| of power. So dollars and Euros enter and the local | | | | Costa Rica would do well to strengthen its state |
| moneyed elite move around their liquidity, but not | | | | institutions and define development goals, not by |
| necessarily into productive investments. The interest | | | | emulating China, but by leaving aside the dogmas of |
| rate on bank issued Certificates of Deposits has | | | | monetarism and neo-liberalism and replacing the |
| fallen in the last nine months to an average of 2.5% | | | | Central Bank personnel with figures that look to |
| so this is not where capital is flowing. Both private | | | | Costa Rica's strong tradition of social democracy and |
| and state banks here carry their accounts in dollars | | | | social justice and to its South American neighbors |
| and banking assets have fallen as the devaluation is | | | | who have learned their sad lessons from 20 plus |
| recorded as operating losses. However, this does not | | | | years of globalization orthodoxy and taken new, |
| mean that banks and other financial entities are not in | | | | progressive directions. |
| receipt of these dollars. Data is just not publically | | | | China's export-led development has meant that tens |
| available to determine where the dollars are coming | | | | of millions of peasants are displaced to barracks in |
| from and where they land-- or how much money is | | | | the industrial centers, work for a pittance and live in |
| entering and being laundered from illicit activities. | | | | the most unjust of social conditions, while the |
| In reading what little is available on the Costa Rican | | | | bureaucrats and businessmen accumulate incredible |
| exchange rate there are some innuendos that the | | | | wealth. On a lesser scale than China, growing |
| wealthy friends of Central Bank officials and the PLN | | | | inequality and social injustice are prime features of |
| hierarchy are scheming to enrich themselves through | | | | Costa Rican society. And this is mainly a result of the |
| currency speculation. It is certainly the case that PLN | | | | export-led development strategy, the abandonment |
| personalities have a cozy relationship with the | | | | of programs of genuine national development, such |
| moneyed interests; this became very clear in the | | | | as food sovereignty, the permissive attitude toward |
| great debate over CAFTA. However, I have found | | | | business regulation and business activity while strong |
| no evidence to lend these assertions any credibility. | | | | arming labor unions, the lack of effective ameliorative |
| After all, Costa Rica has indicted three former | | | | programs for the increasing problems of social |
| presidents for graft, so it is difficult to believe that | | | | inequality, and now the privatization of the very |
| corruption on this scale could be involved. Rather, it is | | | | state enterprises that once formed the economic |
| the ideological blindness of official thinking that is the | | | | basis of Costa Rica's social democracy. It is time for |
| problem. | | | | real change. |
| It is important to keep in mind the experience of | | | | |