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Economic Research


Understanding CAFTA: Perspectives From All Sides

 

Free trade agreements are an important yet controversial step toward economic growth and development. Opening markets in the Central American region is expected to boost export growth for the United States and especially the Southeast.

In January 2003 the United States and five Central American countries—Costa Rica, El Salvador, Guatemala, Honduras, and Nicaragua—began negotiations for the U.S.-Central American Free Trade Agreement (CAFTA). In January 2004 the United States and the other five countries (CAFTA-5) finalized an agreement to eliminate barriers to trade, open markets, enforce fair labor conditions, and promote investment and economic growth. Concurrently, the Dominican Republic negotiated a bilateral free trade agreement with the United States with the intention of joining CAFTA. In March, negotiations concluded to include the Dominican Republic into CAFTA, but the U.S. congressional consultation has not yet ended. The official signing of the final CAFTA agreement took place on May 28, and currently the agreement is in each country’s respective legislatures for approval.

The CAFTA agreement is important to the United States and the Southeast. With the future of the Free Trade Area of the Americas (FTAA) negotiations currently uncertain because of continued disagreements between U.S. and Latin American leaders on agricultural subsidies, CAFTA may create momentum for such an agreement. Additionally, because exports continue to be an important driver of growth in the Southeast, opening the Central American market for U.S. businesses, farmers, and producers would further enhance economic growth and development in the region.

Free trade agreements—pacts between two or more countries to reduce or eliminate trade barriers—have been a priority for countries in the Americas. After the introduction of the North American Free Trade Agreement (NAFTA), efforts to establish free trade areas throughout the Western Hemisphere, the FTAA, began at the Summit of the Americas in December 1994 with a goal of completing negotiations by 2005. In addition, the U.S. government has also simultaneously pursued bilateral agreements, such as the one between the United States and Chile in July 2003.

In contrast to the FTAA negotiations, the CAFTA negotiating process lasted only one year. Five main working groups were established to help negotiate critical issues for the region: market access (including agriculture), investment and services, government procurement and intellectual property, labor and environment, and dispute settlement and other institutional issues. In the end, all parties agreed to eliminate most tariffs and nontariff barriers immediately while integrating a phaseout plan of increasing quota limits and eliminating tariffs for sensitive products (such as sugar and textiles) within 15 years.

Gains on both sides
From the Central American perspective, reducing barriers to trade and attracting foreign investment is important for future growth and development. Partly because of geographic proximity and partly because of the large U.S. market, the United States is this region’s main trading partner. Currently, about 50 percent of the CAFTA-5’s exports are shipped to the United States, and 40 percent of their imports come from the U.S. market. Most of the exports to the United States are apparel articles and accessories, fruit (primarily bananas) and nuts, and electric machinery. A majority of imports, which are mostly processed in some form and re-exported back to the United States under production sharing arrangements, are electrical machinery parts and apparel articles and accessories, such as plastic, yarns, and fabric.

Photo courtesy of U.S. Department of Agriculture
Ratification of CAFTA would mean eventually eliminating the signatories’ trade barriers, benefiting industries including agriculture and apparel. The Southeast already has a robust business relationship with Central America, and CAFTA would further enhance the region’s trade prospects.

Efficient and stable intraregional trade laws are also an important benefit for the CAFTA-5. Currently, the majority of these countries’ trade, if not with the United States, is with each other. Even though this region established the Central American Common Market (CACM) in 1963 to facilitate trade within the region, trade barriers still exist. The region has struggled to find a unified position in trade because each country has its own economic capabilities. But the continuing commitment to regional integration remains important. An example of this commitment is the recent formation of the Central American Council of Bank Superintendents. The banking supervisory agencies of CAFTA-5, the Dominican Republic, and Panama agreed to consolidate supervision regionally to unify legislation, promote effective supervision, and improve transparency within each banking system.

From the U.S. perspective, trade with the five Central American countries is small in dollar figures. According to the U.S. Census Bureau, exports to the region amounted to $10.8 billion at the end of 2003, equivalent to 1.5 percent of total U.S. exports. Imports from the region reached $13.1 billion, a little less than 1 percent of total imports. Although the region composes only a small portion of total trade for the United States, that share has doubled since 1990 (see chart 1).

Despite the small size of the CAFTA market, U.S. interests in CAFTA are broad. Market access, especially for agricultural products, and securing a level playing field for U.S. business are key issues. Presently, 99 percent of CAFTA-5’s agricultural exports enjoy duty-free access to the United States under the Caribbean Basin Trade Partnership Act. U.S. exports, however, generally face tariffs ranging from 35 percent in Honduras to 60 percent in Nicaragua. CAFTA would lower or eliminate many of these tariffs. Similar barriers also exist to U.S. investment in the region. While some U.S. companies, such as Intel Corp. in Costa Rica, are already established in the region, many sectors, especially service sectors, have been closed to foreign investors. With CAFTA, all barriers to U.S. investment will eventually be eliminated and U.S. companies will be treated the same as locals.

CAFTA and the Southeast
The Southeast plays a disproportionately large role in U.S. trade with Central America. State export statistics from the U.S. Census Bureau indicate that exports from the Southeast totaled approximately $3.9 billion in 2003, or 36 percent of total U.S. exports to CAFTA-5. Florida alone represented approximately 19 percent, or $2.1 billion, of U.S. exports to the region, the largest share among the 50 states. The main export goods to the CAFTA area include electronic equipment, appliances, and parts; crop production; nonapparel textile products; apparel manufactures; and other products (see chart 2). As noted earlier, many of these goods are processed further in Central America and then re-exported to the United States.

Chart 1
U.S. Trade with CAFTA

Source: U.S. Census Bureau

More than half of Alabama’s exports to CAFTA-5 in 2003 were apparel manufactures, followed by fabric mill products (27 percent). Since 1999, total Alabama exports to the region grew 85 percent. The majority of the increase came from apparel manufactures. In 2003 alone, exports of apparel manufactures and fabric mill products rose 12 percent and 57 percent, respectively, from the previous year.

Computers and electronic products were Florida’s leading exports to CAFTA-5 in 2003, equivalent to around 23 percent of total Florida exports to CAFTA-5. Since 1999, total exports from Florida to the Central American region have declined almost 5 percent while exports of computers and electronic products and fabric mill products have increased 52 percent and 386 percent, respectively.

Fabric mill products and paper products composed approximately 32 percent and 15 percent, respectively, of Georgia’s total exports to the Central American region in 2003. Total exports to the region have increased 21 percent since 1999, mainly from fabric mill products.

In Louisiana, exports of crop production and processed foods represented 56 percent and 24 percent, respectively, of total exports to CAFTA-5 in 2003. Since 1999, exports have increased 11 percent, mostly from crop production. Processed foods exports have also increased.

Paper products and fabric mill products made up 22 percent and 18 percent, respectively, of Mississippi’s total exports to CAFTA-5 in 2003. Showing the second-largest growth trend in the Southeast, Mississippi’s exports to CAFTA have increased 40 percent since 1999. While apparel manufactures were the state’s largest export to Central America in 1999, representing almost 60 percent of total exports, these goods accounted for only 12 percent of total exports in 2003. Mississippi’s export growth during the 1999–2003 period was mostly in paper products, processed foods, and petroleum and coal products.

Chart 2
Southeastern Exports to CAFTA in 2003

Source: U.S. Department of Commerce

In Tennessee, 31 percent of total exports to CAFTA-5 in 2003 came from apparel manufactures and 11 percent came from computers and electronic products. Over the last four years, total exports to CAFTA increased 18 percent. The sectors demonstrating noteworthy growth were computers and electronic products and crop production. Although apparel manufactures continue to represent the largest share of total exports, these goods’ share has declined almost 20 percent since 1999.

The promise of CAFTA
Currently, CAFTA is being reviewed by each country’s respective legislatures for approval. In the United States, Congress is not expected to make a final decision until after the presidential election in November because some politicians’ concerns over weak labor and environmental provisions have increased significantly.

Although CAFTA is a relatively small market for the United States, it is nonetheless a significant destination for the Southeast. As trade barriers disappear, the Southeast will be able to take advantage of the growing Central American market by increasing exports and investment to the region.

For the Central American countries, opening the U.S. market should spur economic growth and development in the region. Many sectors of the area’s economy, such as the apparel and textile industries, rely on U.S. consumers to buy their products. Easier access to these industries will only enhance those industries’ growth. Furthermore, U.S. investment in the region is expected to provide job opportunites and inject much-needed capital into a region fighting poverty. Overall, CAFTA is seen as a way to boost economic development, bolster democracy, promote transparency, and establish rules and regulations similar to those of the rest of the world.

This article was written by Elena Casal, an economic analyst in the regional group of the Atlanta Fed’s research department.

Sugar Is a Sore Point

Sugar is a sensitive product for U.S. producers. Since the end of the War of 1812, the U.S. government has guaranteed a minimum price for sugarcane and sugar beets above world prices. This guarantee is enforced by placing a ceiling on sugar imports and buying and storing excess production.

The U.S. sugar industry argues that CAFTA would have a detrimental impact on domestic sugar prices and producers’ incomes. The industry estimates that CAFTA would result in an additional 140,000 metric tons of sugar imports over 15 years, forcing U.S. sugar production or prices to decline. Furthermore, the sugar industry fears that the current U.S. agenda for bilateral and regional free trade agreements will open the U.S. market to a flood of market-priced sugar. Even though sugar imports from CAFTA-5 are relatively small, the U.S. sugar industry sees CAFTA as a threat to their livelihoods.

However, the Office of the United States Trade Representative argues that increased sugar market access for CAFTA-5 would amount to only 1.1 percent of U.S. sugar consumption in the first year, growing only to 1.6 percent by year 15. Additionally, under the current Farm Bill, Congress set an import ceiling of about 1.4 million metric tons of sugar. In 2003, the United States imported only 1.1 million metric tons, leaving room to increase sugar imports. Overall, U.S. sugar imports from CAFTA represent a very small portion of the sugar market. Also, the United States has placed safeguards in the CAFTA agreement to protect the U.S. sugar industry. The agreement states that the U.S. administration can restrict sugar imports from CAFTA-5 if it destabilizes the U.S. sugar industry although the United States would then have to pay compensation to the countries involved. The agreement also states that the Central American region cannot import sugar at world prices for domestic consumption and then export their sugar to the United States at world prices.

Under CAFTA, the United States will increase its tariff-rate quota for sugar to 97,000 metric tons, growing to almost 140,000 metric tons in year 15 and thereafter growing by 2 percent a year in perpetuity. In addition, the Central American countries will phase out their tariffs over 15 years.

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