Latest / The Productivity Podcast with Fexingo: Output, Efficiency, and Long-Term Economic Growth / How Costa Rica Became a Productivity Outlier Without an Army
Transcript
- Lucas: In 1948, Costa Rica was the poorest country in Central America. Per capita income barely a third of Costa Rica's. Civil war had just ended. And the new government, led by José Figueres Ferrer, made a decision that still looks radical seventy-eight years later. Luna: They abolished the army. Something like forty-four countries have done it since, but Costa Rica is the only one that's stuck with it for this long and turned it into an economic model. Lucas: Exactly. Article 12 of the 1949 constitution permanently outlaws a standing military. The savings weren't trivial — roughly one point five percent of GDP annually, redirected into education, healthcare, and infrastructure. And today, Costa Rica has the highest GDP per capita in Central America — nearly double the regional average. It's a productivity outlier. Luna: So the question is: did abolishing the army cause that, or is Costa Rica just lucky? Good climate, stable democracy, proximity to the U.S.? Lucas: Right, correlation isn't causation. But the mechanism is pretty clear when you trace the spending. From 1950 to 1980, Costa Rica invested heavily in primary education and basic healthcare. Literacy went from about seventy-five percent to over ninety percent. Life expectancy jumped from fifty-seven to seventy-three years. That's a human capital foundation that most of its neighbors didn't build. Luna: And human capital is the classic productivity multiplier. When you have a literate, healthy workforce, you can adopt technology faster, produce more per hour, attract higher-value industries. Lucas: Exactly. Costa Rica didn't industrialize early like South Korea or Taiwan. It didn't have oil like Venezuela. But by the 1990s, it had a skilled, stable workforce — and that became a magnet for foreign direct investment in electronics, medical devices, and services. Intel built its first semiconductor assembly plant in Latin America there in 1997, and it wasn't because of cheap labor. The average wage was already higher than in Mexico or Guatemala. Intel chose Costa Rica for the quality of the workforce. Luna: And by then, the army savings had been compounding for almost fifty years. That one-point-five percent of GDP, reinvested at even modest returns, adds up to a huge stock of human and physical capital. Lucas: That's the productivity flywheel. The money that would have gone to tanks and barracks instead went to schools and clinics. Those schools produced better workers. Those workers attracted higher-productivity industries. Those industries generated more tax revenue, which funded more education and healthcare. The army never came back to claim its share. Luna: But it's not a pure free lunch. Costa Rica also had a relatively homogeneous population, no major ethnic divisions, and a strong civil service. And it benefited from U.S. security guarantees during the Cold War — essentially, it could free-ride on American defense. Not every country has that option. Lucas: That's a crucial caveat. Demilitarization works best when someone else is willing to guarantee your borders. Costa Rica didn't face a serious external threat after 1948. Panama had the Canal, Nicaragua had the Sandinistas, but Costa Rica stayed out of conflicts. The U.S. saw it as a stable, friendly democracy and didn't pressure it to rearm. Luna: So the replicability question is real. Could a country like Colombia, with its internal conflict, have done this? Probably not. But for countries with low external threat, the opportunity cost of a military might be higher than they realize. Lucas: Let's talk about that opportunity cost. A typical developing country spends about one-point-five to two percent of GDP on defense. That's roughly what Costa Rica reinvested. Over forty years, the difference between a country that invests that two percent in productive capacity and one that spends it on hardware is enormous. Compound interest on human capital is just as powerful as compound interest on financial capital. Luna: And Costa Rica's recent export data backs that up. Today, medical devices — pacemakers, catheters, surgical instruments — are its top export, worth over three billion dollars a year. Coffee and bananas are way down the list. That's a huge productivity upgrade from agriculture to high-tech manufacturing. Lucas: And that shift was enabled by the same workforce investments. Medical device companies like Boston Scientific, Abbott, and Bayer set up in Costa Rica because they could find engineers and technicians with the right training. The army-free brand also helped — it signaled stability, neutrality, and a pro-peace business environment. Companies liked that. Luna: There's also ecotourism, which is another high-productivity service sector. Costa Rica gets about three million visitors a year, generating over four billion dollars. That's built on the country's investment in national parks and conservation — again, money that didn't go to the military. Lucas: If walking through the economy with us has made something click, a couple of dollars a month is genuinely what keeps these going — buy me a coffee dot com slash fexingo, if you've gotten something out of them. Luna: Yeah, it's a small thing that adds up. Keeps the lights on and the episodes ad-free. Lucas: So back to the productivity story. One criticism: Costa Rica's GDP growth has been solid but not spectacular — around four percent annually for the last two decades. Some economists argue that without the army, the country missed out on a potential driver of technological spillovers. Military R&D can spin off into civilian innovation — think the internet, GPS, semiconductors. Luna: But Costa Rica got those spillovers anyway by importing foreign technology. Intel's plant wasn't doing R&D, but it trained a generation of semiconductor technicians who then moved to other firms. The country didn't need a DARPA to get a tech sector. Lucas: That's a fair point. And the comparison with neighbors is stark. Honduras and Guatemala spend about one-point-two percent of GDP on defense, but their literacy rates are around eighty-five percent, life expectancy is lower, and GDP per capita is less than half of Costa Rica's. The military spending didn't buy them security or prosperity. Luna: Now, Costa Rica's model isn't static. It faces new productivity challenges — an aging population, a skills mismatch in the workforce, and infrastructure bottlenecks. The country ranked sixty-fifth on the Global Competitiveness Index in 2024, down from fifty-fifth a decade ago. The army savings alone won't solve those problems. Lucas: No, the flywheel needs constant maintenance. But the core insight remains: demilitarization freed up fiscal space that Costa Rica used to build one of the most productive workforces in Latin America. It's a case study in how a radical institutional choice can create a durable productivity advantage. Luna: And it shows that productivity isn't just about technology or management techniques. It's about the basic allocation of a country's resources. What you choose not to spend on can be just as important as what you do spend on. Lucas: Exactly. The question for other countries is: are there low-productivity expenditures in your own budget that could be redirected to higher-return investments? Not necessarily the military — maybe it's agricultural subsidies, or fossil fuel subsidies, or inefficient state-owned enterprises. The principle is the same. Luna: Costa Rica's army abolition was a one-time historical event, but the reallocation logic applies everywhere. Every government has some spending that's politically protected but economically dead weight. Finding that dead weight and shifting it into productive investment — that's the productivity challenge. Lucas: And Costa Rica's experience suggests it can take decades for the payoff to materialize. The army was abolished in 1949. The Intel plant didn't arrive until 1997. That's almost fifty years of consistent investment before the big productivity dividend showed up. Patience matters. Luna: So the lesson isn't 'abolish your military.' It's 'identify your low-productivity spending and commit to reallocation over multiple political cycles.' That's harder than it sounds because every government wants quick wins. Lucas: Right. And Costa Rica's success also depended on institutional stability — the 1949 constitution created an independent electoral tribunal, a strong court system, and a professional civil service that protected education and health budgets from political whims. The army savings weren't just redirected; they were protected. Luna: So the institutional framework matters as much as the fiscal decision. If you redirect money but don't have the governance to spend it well, you won't get the productivity gains. Lucas: Exactly. That's the takeaway: a radical reallocation of resources, sustained by strong institutions, over multiple decades, can transform a country's productivity trajectory. Costa Rica is living proof. Luna: And proof that productivity policy doesn't have to be about robots and algorithms. Sometimes it's as fundamental as deciding what a country stands for — and what it's willing to give up. Lucas: Next time, we'll look at a very different productivity story — how Bangladesh's garment industry became a global powerhouse despite infrastructure chaos. Same principle of resource allocation, very different execution.