Costa Rica, their dilemma, and their neighbors

Panama and Costa Rica have a lot of history together. We are neighbors, we had a border “war” 100 years ago, there are families of the same kind in both countries, there is a lot of trade between both countries. We both became independent from Spain in 1821, Costa Rica along with the other Central American nations, and Panama as part of Bolívar's dream, which made us join Gran Colombia until we were able to become independent from Colombia in 1903.

They have many similarities, the tropical climate (even though San José has a more pleasant climate), they are the southernmost nations of the Central American isthmus and that is why they are something apart from the other Central American nations, they have coasts in the Pacific Ocean and in the Caribbean, and are strategically located so that the hurricanes that devastated the Caribbean do not touch them. However, they are also very different. Their idiosyncrasy/culture is somewhat different, their capital cities have developed differently, Panama has the Canal, and Costa Rica has a large manufacturing sector that exports a lot. Neither of them has an army, even though Costa Rica has had a democracy for more than 70 years, Panama only for the last 30 years.

During the last weeks, you see people on the social networks who say, as always, without any type of study and research on the subject, that Panama is heading towards what Costa Rica is going through at this moment, so I dedicated myself to analyze the subject, to expose you to the data, and my objective opinion about it.

The protests in Costa Rica, without going into politics, which have a specific weight in the problem, are based on “violent protests against the intention of President Carlos Alvarado to seek a financing agreement with the International Monetary Fund (IMF), such as part of a plan to alleviate the effects of the coronavirus pandemic on the economy. The manifestations of discontent persist despite Alvarado's decision at the weekend to withdraw his proposal to negotiate with the IMF for a support package for 1,750 million dollars. The protesters are now asking the Government to discard any agreement with the IMF."

The government has already backed down on this decision, but the protests persist, and there is even a political group that abrogates the negotiation of the people, and they say that they only leave the streets if the government negotiates with them. It is obvious that there is a political flavor in this, but let's really see if the economy of Costa Rica is as disastrous as they want to make it look.

While Costa Rica has more than 5 million inhabitants, Panama is scratching at 4.3 million. But our stories, which were more or less parallel, began to change little by little. Because of having more inhabitants, Costa Rica always had a higher GDP, until 2015 Panama turned it around completely. Now, according to the GDP/capita, the turnaround began in 2003, the year in which the economic revolution began in Panama.

Panama has always had less inflation than Costa Rica (in the last 21 years, Panama has had an average inflation of 2.4% while Costa Rica has had average inflation of 7.6% and an average devaluation of the Colon of approx. 3.4%), in addition to the fact that Costa Rica has Colones and Panama has US$, and although the Colones have had some years of stability and even revaluation, most of the time the currency is devalued which negatively impacts its economy, but makes its exports tend to be cheaper.

Costa Rica's GDP for 2019 closed at US$61,773 million, while Panama's GDP closed at US$66,800 million, with Costa Rica's growing at a yearly average of 7.8%, while Panama's grew 9.3% during the last 20 years (inflation not included). The 5 largest sectors of the Costa Rican economy accounts for 55% of GDP - teaching, professional activities, manufacturing, commerce, and real estate activities; while the Big 5 of Panama generate 75% of the GDP - Transportation, construction and real estate, commerce, financial intermediation, and manufacturing.

Costa Rica, having its currency, the Colon, has its monetary policy, and faces the challenges of the devaluation of its currency; However, Panama, since its independence from Colombia in 1903, has used the dollar as its legal tender, and we are piggyback on the US monetary policy, in some way, with a hard currency, and of the first order and considered the one with the greatest acceptance and demand in the economic and financial world.

Government spending is probably one of the most important themes in this economic contrast. Central government revenues reach US$8,873 million in Costa Rica, 14.4% of GDP, while in Panama it is 18.4% and reached US$12,186 million in 2019. Revenues, during the last 21 years, have remained less, than according to these same percentages, 13.8% for Costa Rica and 20.3% in Panama.

Of the central government expenditures, in Costa Rica, government investments only reached 6.6% in 2019, while in Panama they reached 24.8% (the lowest percentage in the last 10 years), but in the last 10 years the average it has been 34.8%, while the average for the last 21 years has been 8.6% for Costa Rica and 25.3% in Panama during the same period.

The other issue of expenses is that of interest paid on the foreign debt, and while in Costa Rica they paid in interests the sum of US$2,917 million in 2019, which represents an effective rate of 8.2%, in Panama the sum of US$1,265 million was paid with an effective rate of 4.4% for the same year.

While Panama's debt has grown at a rate of 6.8% in the last 20 years, that of Costa Rica grew at an average of 10% during the same period. And as a response to the best macroeconomic practices in Panama, the rating of our debt has improved substantially over that of Costa Rica, and from there we can obtain better conditions that have translated into an effective interest rate below 5% from in 2014, and the last placements in Panama already reach 2.88%.

Costa Rica ended 2019 with some 325,000 public employees, against the close to 250,000 that Panama has (including what they call “bottles” or employees that do not go to work but still, get paid), and this translates into 17.5 inhabitants per public employee in Panama, 15.5 inhabitants per public employee in Costa Rica, and just to contrast, the United States has 19.7 inhabitants per public employee.

As for the most important taxes in both countries, the VAT in Costa Rica is 13%, and in Panama, it is 7%. While the Income Tax to companies in Costa Rica has remained with a table of 10%, 20%, and 30% over the years, and what varies are the amounts in it. For 2020, up to 54,303,000 Colones (US $ 94,700 approximately) pay 10%, up to 109,228,000 Colones (US $ 190,500 approximately) pay 20% and above this figure they pay 30%. In Costa Rica, the basis for the table is the gross income, and the calculation of the income tax is based on net taxable income. In Panama, it is a flat fee of 25% for companies, on the taxable net income.

What does the future hold for both countries? Let's use the data from Focus Economics (FE):

·       Regarding GDP, FE predicts a decrease of 4.6% in 2020 and a growth of 2.9% in 2021, while for Panama FE expects a decrease of 7% and a growth of 5.4% for 2021.

·       Panama is expected to continue its GDP growth path by approximately 5%, remaining second to Guatemala by very little (growing by approximately 3%), despite the fact that Guatemala's population is three times that of Panama. while Costa Rica remains solid in third place (growing at a rate of 3.5% on an annual average).

·       The above leads us to maintain Panama and Costa Rica with the highest GDP/Capita in the region, and even on the continent, Costa Rica above US$11,000 in 2020 and Panama closer to US$15,000, and both more twice the average for the region.

·       Inflation in Costa Rica is expected at 0.7% for 2020 and 2.4% for 2021, while for Panama FE thinks that for 2020 it will be -0.6% and for 2021 it will be 0.6%.

·       For the next few years, Costa Rica will remain at its annual average of 2.5%, while Panama will tend to remain well below 1% to 2% annually in the same period.

·       For the Fiscal Balance, Focus Economics forecasts a deficit of 9.4% and 7.9% for 2020 and 2021 respectively, while for Panama it is forecast -7.3% for 2020 and -4.8% for 2021.

·       Regarding the fiscal balance, it is expected that Panama will be closer to its limit of -2.5% by 2024, while Costa Rica will remain high at -4.4% for the same date. Another inflationary issue in Costa Rica, its currency, is expected to continue devaluing above 1% per year in this period.

·       Exports in Costa Rica are a large component of GDP and are expected to continue growing by 6% on average for the next 5 years, while exports from Panama, after falling by 11% in 2020, are expected to grow by above 4% for the next 5 years (although the effect of the same in the economy of Panama is small).

Another interesting factor in the economy of both countries is the national debt. However, Panama will end in 2020 with 56% Debt/GDP while Costa Rica's could become 65%.

Costa Rica's problems begin with the fact that close to 93% of its expenses are allocated to operating expenses, and even though its income does not cover its operating expenses, it does nothing to balance its budget and tie its belt. And this becomes a fiscal deficit and financing its deficit with debt.

The bad thing about Costa Rica's financial situation is its deficit and its increase in debt, and that is that they have brought its Debt/GDP ratio to levels above an optimal 40% (pre-pandemic) trying to cover annual fiscal deficits above 5% and the worst thing is that they cannot demonstrate these increases in debt with infrastructure investments that could enhance the life of Costa Ricans.

However, its social statistics are the envy, not only of the Central American region but of the rest of Latin America. But in their “eagerness” to have good social statistics, they maintain high levels of subsidies, on the one hand, and government companies that should be public. Hence, its level of public employees is excessive, and well above that of Panama, which in itself is too high.

The future is a bit uncertain, since Costa Rica cannot maintain its level of expenses without borrowing, and that is where its problems lie, since the population, let's say, has had enough of this. It is up to the government to tighten its belt and lower its expenses substantially, but in times of pandemic it means touching public employees or social expenses, which the people themselves will not accept either.

Their income could increase if private companies reactivate manufacturing and exports in record time, but their tourism, which also brings them hard currency, will not be able to reactivate so quickly.

The case of Panama is somewhat different, and that is why I conclude that we are going in totally opposite directions. Panama can recover its GDP growth quickly. Panama can  maintain its economy based on the US$, and have not lost their Panama Canal business and its income (direct and indirect), and they have a private sector, which, although it is hit by the pandemic, is enthusiastic about getting out of this crisis.

Our inflation is in a deflation state, and most likely it will end like this, in December 2020 and will remain at a rate of less than 1% for the next 5 years. Panama has to grow its GDP at a rate of no less than 5% and this can also be achieved. Its unemployment, which currently stands at 25%, may drop to 10% by December 2020 and by 2021 it could reach 7% - as before the pandemic (Costa Rica's was around 11% before the crisis), and in 5 years it could be between 4% and 5%.

The Debt/GDP ratio will be adjusted to 40% indicated by the Fiscal Law, and a deficit of less than 2.5% per year, but for this, the government of Panama must choose the infrastructure works that really become economic development, and eliminate unnecessarily expenses - as soon as possible - and that includes the elimination of around 50,000 “bottles” employees and some 75,000 totally unnecessary public employees. And maintain an operating expense/investment ratio of 65%/35% for at least the next 5 years.