Foreign Trade Policy and Growth: A Comparison of Mexico and Costa Rica

Seminar Paper, 2005

33 Pages, Grade: A-


Table of Contents

I. Introduction

II. The Comparability of Mexico and Costa Rica

III. Illustration of the Foreign Trade Policies in Mexico and Costa Rica
1. Mexico
1.1. The four decades of import-substituting industrialisation
1.2. The era of extensive trade liberalisation
1.3. NAFTA and the post-liberalisation era
2. Costa Rica
2.1. Implementation of a strategy of import-substitution
2.2. Import liberalisation and the export-led-growth strategy
2.3. Trade policy since the accession to GATT
3. Similarities and differences

IV. Growth
1. Mexico
2. Costa Rica
3. Comparison

V. Conclusion

Foreign Trade Policy and Growth

A Comparison of Mexico and Costa Rica

I. Introduction

There has been a lot of work on the relation between openness and economic growth, with results being ambiguous. A study done by Sachs and Warner (1995), using a sample of 135 countries, has shown that there is a positive correlation between openness and growth, e.g. that trade liberalisation fosters economic performance. The assumptions and country categorisations of this study have been criticised by Rodriguez and Rodrik (2000); they concluded that low tariff rates do not necessarily imply higher growth rates but that tariff protection exceeding a certain level stifles growth. Dollar and Kray (cited in Santos-Paulino and Thirlwall, 2004) compared different sets of countries with each other and found out that changes in growth rates are positively correlated with the share of trade and thus greater openness has accelerated economic growth.

This essay compares the foreign trade policy of Mexico and Costa Rica. Even though both countries pursued the same policies, some differences can be found. Both implemented a strategy of import-substituting industrialisation until the serious crisis at the beginning of the 1980s, followed by a period of extensive trade liberalisation. This was due to pressure put on by the international institutions such as IMF or World Bank. While Mexico opened up its market, Costa Rica went further and lowered the import barriers. They put a strong emphasis on attracting foreign direct investment. With an average annual growth rate of 4.78 percent in Costa Rica and 4.43 percent in Mexico over the last four decades both countries achieved a strong economic growth exceeding the average of all other Latin American countries. However a positive interrelation between openness and growth could not be found in this study.

This essay is structured in four main parts. Section II of this paper deals with the fundamental comparability of Mexico and Costa Rica. Section III portrays the foreign trade policies of both countries and illustrates the main similarities and differences. The development of growth is outlined in Section IV. Section V concludes the paper.

II. The comparability of Mexico and Costa Rica

A variety of factors influence the economic performance of a specific country. Economic policy forms only a fraction of this. Trade policy in turn encompasses only a portion of these policy-setting levers. Therefore the exclusive examination of trade policy measurers and economic growth has to be observed critically. Even more if the comparison is based on two countries only. Political issues aside, there are a multitude of other aspects affecting the economic development. Examples of these are the geographical position, the endowment with natural raw materials, the existence of functioning institutions and the size of the domestic market, just to mention a few. Because of these multiple linkages it is hard to disentangle the effect of trade policy from other policies and influencing factors.

Mexico and Costa Rica have some similarities but also show a couple of important differences. For similarities, both are situated in Central America in a tropical climate. They both obtained their independence from the European colonial power in 1821 as a part of the viceroyalty of New Spain. Both Mexico and Costa Rica are members of the GATT and the WTO. The most important trade partner for both countries is the USA.

Some notable differences would be that the domestic market of Mexico exceeds the Costa Rican market by far with a population of 102 million and GDP of 626 billion USD. Mexico has the biggest economy in Latin America and the number eight economy worldwide in terms of exports. Costa Rica has 4 million inhabitants and a GDP of 17 billion USD. This makes it an unimportant country from a global perspective. Also the GDP per capita in Costa Rica is 4.300 USD lower compared with 6.230 USD in Mexico (World Bank, 2005a). Whilst Mexico disposes of extended natural resources like oil, gas and coal Costa Rica is dependent on importing resources. Mexico shares a border of more than 3.000 km with the United States, the richest nation worldwide, while Costa Rica abutts to the poor nations Nicaragua and Panama.

Despite these differences, a comparison makes sense as both countries have a great deal in common and though trade policy is only a partition of influencing factors on economic growth it is a rather important one.

III. Illustration of the Foreign Trade Policies in Mexico and Costa Rica

1. Mexico

Mexico’s foreign trade policy in the last 80 years can be structured in three main phases. Even though the beginning and the end of each phase are not marked by fixed dates there are some fundamental shifts which distinguish these phases. The first phase concerns the era of import-substituting industrialisation (ISI) lasting from 1940 to 1982 followed by a phase of extensive trade liberalisation until 1994. The third and last stage marks the post-liberalisation era.

1.1. The four decades of import-substituting industrialisation

The policy of import-substituting industrialisation was firstly applied by President Lázaro Cárdenas during his presidency 1934-1940 in order to obtain the loyalty of the business sector by providing state-supplied rents through import barriers and subsidies. Another motivation to reduce the dependency from foreign trade was the fear of economic dominance by the United States (Lusztig, 2004).

The aim of an ISI development strategy is to foster industrialisation by protecting domestic manufacturers through high import barriers which hamper or obviate the market access of foreign contractors. In this uncompetitive environment domestic manufacturers are able to survive even if they would not be able to do so in an open economy. Typical measures of an ISI policy are the levy of import tariffs and the quotation of imports in combination with subsidies for domestic producers (Yarbrough, Yarbrough, 2000). The implementation of an ISI development policy is very attractive for countries which are not industrialised to a large extent. For this reason all Latin American countries have applied this strategy which is rather successful in the short-term but implies severe limitations in the long run (Lusztig, 2004). One of the most important weaknesses is the problem that a once introduced ISI policy is not easily abolished without competition. There is no incentive for domestic manufacturers to increase productivity and foster innovations in order to become competitive. The shortage of functioning institutions like well-enforced property rights, domestic competition or skilled workforce hinders the development of successful enterprises. Under these conditions import barriers and subsidies simply enabled the inefficient local industry to endure (Yarbrough, Yarbrough, 2000). The concept of infant industry protection which was developed by Friedrich List envisions a protection of domestic industries for a limited period of time to give them the opportunity to gain international competitiveness. However with the introduction of ISI in many Latin American countries no exit strategy was included in their development plans (Lusztig, 2004). Another weakness is the distribution of subsidies by the government which regularly leads to an overemphasis on symbolic national industries, such as steel or national airlines and a simultaneous disregard of the agricultural sector. Politicians regularly are unable to select the most suitable industries for subsidising especially since they are under pressure from special interest-groups. These groups also stifle the reduction of subsidies even after the failure of an import-substituting strategy becomes obvious. Instead of decreasing the dependence of imports, the ISI policy actually increases the dependence from foreign markets as capital goods have to be imported to build up capacities and to keep the production process running. In combination with lesser foreign currency income, due to a neglected exporting industry, this leads often to a steady rise in foreign indebtedness (Yarbrough, Yarbrough, 2000). Since capital goods have to be imported they are at least well tested, but regularly even outdated, hampering the ability to produce world-class products with sales potential in overseas markets (Lusztig, 2004).

The ISI can be structured in three phases which are clearly defined. Their occurrence in Mexico is illustrated by the following. During the first stage from 1935 to 1950 many industries producing durable consumer goods for the domestic market were founded. The lack of effective foreign competition and the easy access to subsidises and other forms of capital through national banks provided a very conducive environment. In Mexico the number of small and medium sized firms jumped from 7,619 in 1935 to 74,252 in 1950. This economic expansion fostered growth and generated further incentives for investments and thereby for a continued extension of the industrial sector. This also caused fiscal and monetary stability, which in turn drew foreign direct investments. The economic prosperity also merged in the agricultural and the service sector (Lusztig, 1996). These developments are characteristics of the second phase lasting from 1950 to 1972. To protect the domestic market from foreign competition Mexico’s government not only levied high tariffs but also relied on import licenses. The percentage of imports covered by licences rose from 28 percent in 1956 to 60 percent, on average, in the 1960s to 70 percent in the 1970s (Lusztig, 2004). By 1983 100 percent of all imported goods required licenses (OECD, 1996). The development of external and domestic demand for Mexican manufactures reflects the increasing hindrances for imports. Whilst the domestic demand for goods produced in Mexico increased by an annual average rate of 71.8 percent in the 1950s, the exports only grew by 3 percent. During the 1960s these figures were 86.1 and 4 percent, respectively. With 81.5 and 7.7 percent the trend continued in the first half of the 1970s (Lusztig, 2004).

At the end of this period the first indices of the limitations of the ISI strategy became apparent: Due to the limited sales potential on the domestic market the growth rates declined, triggering a reduction of investments. Consequences included a growing obsolescence of the industrial structure and a rise of unemployment. Mexico was faced with an increasing degree of negative trade balances and a growing foreign indebtedness, as were many others countries that practiced ISI. Since the domestic industry matured in a protected environment and was not forced to be competitive in global markets, it was reliant on a continued flow of subsidises and the maintenance of import barriers. The strong lobby of Mexican manufacturers prevented the politicians from abolishing these expensive privileges even as the failure of the ISI strategy became apparent. It was also the pressure of this group which frustrated President López Portillo’s plans in 1980 to sign the GATT accession agreement. This exhaustion phase lasted in Mexico from 1970 to 1982, but the effects on economic growth had been not as dramatic as in other Latin American countries. This was because of the discovery of new exploitable oil reserves in combination with the rapid rise of petroleum prices during the second oil crisis in1979 (Lusztig, 1996). Chart 1 in the appendix shows the share of oil exports of total merchandise exports. This new source of revenues also enabled President López Portillo to avoid drastic economic reforms and fostered the continued rise of government spending. The Mexican economy became extremely dependent on oil to sustain growth and public-sector borrowing which was facilitated by the global excess of capital resulting from rising oil revenues of OPEC countries (Lusztig, 2004). In the last four years of the exhaustion phase, from 1978 to 1982, the public sector deficit rose from 7.4 to 17.9 percent of GDP (Lusztig, 1996). Chart 3a in the appendix illustrates the development of the external debts and shows the steady rise of indebtedness in the 1970s with a large share of short term debt mainly provided by U.S. banks. This continuous augmentation finally resulted in Mexico’s declaration of insolvency in 1982.

As Chart 5a in the appendix illustrates the external balance of goods and services have been negative throughout the 1960s and 70s, e.g. Mexico has imported goods and services of greater value than it has exported. Neglecting export promotion is a pattern typical for an ISI strategy. It can be seen that the deficit began to increase strongly from 1978 despite of strong export growth rates due to oil sales.

It was the reliance on foreign capital and the government deficit which brought the ISI era to an end and paved the way for trade liberalisation (Lusztig, 2004).

1.2. The era of extensive trade liberalisation

This period lasting from 1982 to 1994 can be divided into two episodes. In the years leading up to 1985 the situation was determined by the urgent need to get reforms started and at the same time strong resistance against liberalisation and reduction of subsidies by several ministries; for example the Ministry of Commerce and Social Development and the Ministry of Energy, Mines and Parastate Industry who feared losing their rents (Teichmann, 2001).

1982 marked a turning point in Mexico’s recent economic history as it was the year of a devastating crisis caused by a sharp drop in petroleum prices, an increase of interest rates and an increase of inflation rates. The increase of foreign short term debts and the billing in USD worsened the effects of the global rise of interest due to a change in the fiscal and monetary policy in the United States. Chart 2 in the appendix shows the development of the inflation rate which increased steadily since the early 1970s and reached, fostered by several devaluations of the peso since 1976, its first peak with over 91 percent p.a. in 1983. Consequences were an immense capital flight and a further destabilisation of the business environment (Lusztig, 2004).

The crisis had several effects on Mexico’s economic and foreign trade policy: On the one hand the increasing government deficit obliged the administration to disencumber the national budget from inefficient public and, due to constant subsidies, private companies (Lusztig, 2004). On the other hand, even more important, the debt crisis increased Mexico’s dependence on foreign funds and thereby enhanced the power of World Bank and IMF (Teichmann, 2001). The concurrence of the strong commitment of Mexico’s elites toward changes and the extended power allowed the opposition of strong resistance mentioned above and to launch the “Immediate Program of Economic Recovery” (Programa Inmediato de Reordenación Económica - PIRE), which included many reforms that have been set as conditions by IMF and World Bank. In the IMF bailout agreement which was reached in November 1982, Mexico agreed to abolish exchange controls and to bring down its public debt. The World Bank insisted not only on fiscal reforms, but also on deregulation, privatisation, elimination of price controls, and liberalisation of foreign investment and trade. Furthermore, both institutions applied a policy of cross-conditionality, whereby no loans would be given unless the specifications were met (Lusztig, 2004).


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Foreign Trade Policy and Growth: A Comparison of Mexico and Costa Rica
University of Auckland  (Business School - Faculty of Economics)
Trade & Development
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ISBN (Book)
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Foreign, Trade, Policy, Growth, Comparison, Mexico, Costa, Rica, Trade, Development
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Fabian Barthel (Author), 2005, Foreign Trade Policy and Growth: A Comparison of Mexico and Costa Rica, Munich, GRIN Verlag,


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