Order Code RL31870
CRS Report for Congress
Received through the CRS Web
The U.S.-Central America Free Trade Agreement
(CAFTA): Challenges for Sub-Regional Integration
Updated January 6, 2004
J. F. Hornbeck
Specialist in International Trade and Finance
Foreign Affairs, Defense, and Trade Division
Congressional Research Service ˜ The Library of Congress
The U.S.-Central America Free Trade Agreement
(CAFTA): Challenges for Sub-Regional Integration
Summary
On December 17, 2003, the United States concluded negotiations on a U.S.-
Central America Free Trade Agreement (CAFTA) with four of the five Central
American Common Market (CACM) countries (Guatemala, Honduras, El Salvador,
and Nicaragua). Costa Rica has not agreed to CAFTA pending further discussion on
a few sensitive issues, which began on January 5, 2004. The CAFTA text will not
be released until January 2004 at the earliest, but summaries indicate that a
comprehensive agreement was reached. As defined in the Trade Promotion
Authority (TPA) legislation, President Bush must notify Congress 90 days in advance
of his intention to sign CAFTA, which he is expected to do in January 2004. After
that, he must forward to Congress detailed documentation, including the draft
implementing bill. This report provides background and analysis on CAFTA in
support of Congress and will be updated periodically.
Under CAFTA, more than 80% of U.S. consumer and industrial exports would
become duty-free immediately, with all tariffs removed within 10 years. Tariffs
would go to zero on information technology products, agricultural and construction
equipment, paper products, chemicals, and medical/scientific equipment, among
others. Over half of current U.S. farm exports to Central America would become
duty free immediately, including “high quality” cuts of beef, cotton, wheat, soybeans,
certain fruits, and vegetables, processed food products, and wine. At the same time,
the U.S. conceded to slight increases in sugar quotas for the four Central American
countries. Advances were also made in other areas important to the United States
including services trade, intellectual property rights, and government procurement.
For Central America, benefits received under the Caribbean Basin Trade Partnership
Act (CBTPA) would become permanent.
CAFTA, however, is not complete and faces political uncertainty. Work
continues on the environment portion of the agreement and details reportedly must
be clarified in other areas as well. Issues with Costa Rica must be settled
expeditiously if it is to accept the agreement early in 2004. In the United States,
groups oppose liberalizing trade rules for Central America’s major exports, apparel
and agricultural goods, and there is also considerable resistence to the agreement
from labor groups.
For the U.S. Congress, reconciling diverse interests remains a standard, but
challenging, task in consideration of any FTA. This task is complicated by the
competing nature of the negotiating goals. Relaxing trade rules governing agriculture
and textiles, for example, may support trade growth and development in Central
America, but runs contrary to some strong interests in the United States. Labor
advocates argue that CAFTA perpetuates exploitation in Central America, but
proponents assert that U.S. protectionism works against Central America growth and
development and hurts U.S. consumers and exporters. Balancing these perspectives
may prove particularly vexing during a presidential election year. Although CAFTA
has broached new ground in some areas, it is unclear whether it has achieved such
a balance.
Contents
Why Trade More Freely? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
The Impetus for a CAFTA . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
The Quest for Central American Integration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
U.S.-Central American Trade Relations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
U.S. Imports . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
U.S. Exports . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
Status of Trade Negotiations and Policy Issues . . . . . . . . . . . . . . . . . . . . . . . . . . 14
Costa Rica and Unresolved Issues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
Market Access . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
Investment and Services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18
Government Procurement and Intellectual Property Rights . . . . . . . . . . . . 19
Labor and Environment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20
The Special Role of Labor Issues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21
CAFTA Provisions and the Congressional Debate . . . . . . . . . . . . . . . 22
Dispute Resolution and Institutional Issues . . . . . . . . . . . . . . . . . . . . . . . . . 23
Trade Capacity Building . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23
Outlook . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24
Appendix 1. Chronology of CAFTA Negotiations . . . . . . . . . . . . . . . . . . . . . . . 26
Appendix 2. Central America: Selected Economic Indicators . . . . . . . . . . . . . . 27
Appendix 3. U.S. Merchandise Trade with Central America, 1998-2002 . . . . . 28
List of Figures
Figure 1. Central America’s Direction of Merchandise Trade, 2002 . . . . . . . . . 11
List of Tables
Table 1. Central American Exports as % of GDP . . . . . . . . . . . . . . . . . . . . . . . . . 9
Table 2. Top Eight U.S. Imports from CAFTA Countries, 2002 . . . . . . . . . . . 12
Table 3. Top Eight U.S. Exports to CAFTA Countries, 2002 . . . . . . . . . . . . . . 14
The U.S.-Central America Free Trade
Agreement (CAFTA): Challenges for Sub-
Regional Integration
On December 17, 2003, after a year of intensive meetings, the United States
concluded negotiations on the U.S.-Central America Free Trade Agreement
(CAFTA) with four of the five Central American Common Market (CACM)
countries (Guatemala, Honduras, El Salvador, and Nicaragua). Costa Rica has not
agreed to CAFTA pending further discussion on a few sensitive issues, which began
on January 5, 2004 (see section on the Status of Trade Negotiations). President
George W. Bush promoted CAFTA as an ambitious agreement that would
“strengthen the economic ties we already have with these nations...reinforce their
progress toward economic, political, and social reform...and take another step toward
completing the Free Trade Area of the Americas.”1
Despite these bold promises, support by Members of Congress for CAFTA is
far from certain given the diverse constituent interests that they represent. The
congressional debate will likely intensify when CAFTA implementing legislation is
referred from the White House for consideration. As defined in the Trade Promotion
Authority (TPA) legislation, President Bush must notify Congress 90 days in advance
of his intention to sign CAFTA, which he is expected to do in January 2004. After
that, he must forward to Congress detailed documentation, including the draft
implementing bill (see Appendix 1 for a Chronology of CAFTA Negotiations). This
report provides background and analysis on CAFTA in support of Congress and will
be updated periodically.
Why Trade More Freely?
Countries trade because it is in their national economic interest to do so, a
proposition that is supported by both theory and practice. Comparative advantage
has been recognized for nearly 200 years as a core principle explaining the efficiency
gains that can come from trade among countries by virtue of their fundamental
differences. It states that countries can improve their overall economic welfare by
producing those goods at which they are relatively more efficient, while trading for
the rest. Intra-industry trade is the other major insight that explains trade patterns.
Larger markets allow for benefits from exchange among countries to occur based on
specialized production, product differentiation, and economies of scale and many
1 Office of the United States Trade Representative. Proposed U.S.-Central America Free
Trade Agreement Fact Sheet. Washington, D.C. January 17, 2002. It is customary to refer
to the agreement simply as CAFTA.
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Latin American countries have liberalized trade policies recognizing the contribution
that trade (and related investment) can have on economic growth and development.
As an important caveat, trade is at best only part of a broad development agenda,
which must also include promotion of political freedom, macroeconomic stability,
sound institutions, and adequate levels of savings and investment, among many other
factors.2
Comparative advantage and perhaps intra-industry trade provide the rationale
for U.S.-Central American trade. Comparative advantage is at the heart of exchange
between developing and industrialized countries, such as Central America trading
fruit and coffee for U.S. grains, cereals, and capital goods. Intra-industry trade (e.g.
goods within the same harmonized tariff system (HTS) code number) is based on
specialized production, but in this case relies in large part on differences in wages,
skills, and productivity.3 Certain specialized jobs have developed in Central America
(and other developing countries), where they frequently reside in production sharing
(maquiladora) facilities. Economists have come to refer to such specialized
production as “breaking up the value added chain” and it accounts for why products
(and particularly parts thereof) as diverse as automobiles, computers, and apparel are
often made or assembled in Central America and other countries in partnership with
U.S. firms.4 This relationship, discussed in more detail later, provides the basis for
much of the labor policy debate on CAFTA, and FTAs more generally.5
Measuring the benefits of freer trade is another difficult issue. There is a
tendency to count exports, imports, and the oft-misrepresented importance of the
trade balance as indicators of the fruits of trade. This approach tends to give undue
weight to exports at the expense of understanding benefits from imports, where the
2 The role of trade is summarized well in: Rodrik, Dani. The New Global Economy and
Developing Countries: Making Openness Work. The Overseas Development Council,
Washington, D.C. 1999. p. 137 and Bouzas, Roberto and Saul Keifman. Making Trade
Liberalization Work. After the Washington Consensus: Restarting Growth and Reform in
Latin America. Kuczynski, Pedro-Pablo and John Williamson, eds. Institution for
International Economics. Washington, D.C. March, 2003. pp. 158, 165-67.
3 This case differs from the standard intra-industry case between two developed countries
in which goods, such as automobiles, are exchanged based on product differentiation and
economies of scale and where differences in wages levels are not a central factor.
4 For the theoretical foundation, see: Krugman, Paul. Growing World Trade: Causes and
Consequences, in Brookings Papers on Economic Activity (1), William C. Brainard and
George L Perry, eds. 1995. pp. 327-76 and for the case in Central America, see: Hufbauer,
Gary, Barbara Kotschwar, and John Wilson. Trade and Standards: A Look at Central
America. Institute for International Economics and the World Bank. 2002. pp. 992-96.
5 Note that this trend has not been a driving force in the aggregate unemployment rate of the
United States, but does affect the distribution of employment among sectors of the economy.
It is also important to emphasize here that wage levels are only part of the issue. Lower
wages correlate closely with lower productivity, hence an abundance of low-skilled (low
productivity) workers attracts these types of jobs. For a recent overview of the methodology
of measuring the effects of changes in trade policy, see: Rivera, Sandra A. Key Methods
for Quantifying the Effects of Trade Liberalization. International Economic Review.
United States International Trade Commission. January/February 2003.
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gains from trade are better understood by their contribution to increased consumer
selection, lower priced goods, and improved productivity. For example, high-tech
intermediate goods imported from developed countries are the basis for future, more
sophisticated, production in developing countries. In developed countries, imports
from developing countries, whether final goods for consumers or inputs for
manufacturing enterprises, reduce costs and contribute to productivity and economic
welfare. For all countries, exports are the means for paying for these imports and
their attendant benefits.
Three caveats related to negotiating FTAs are important. First, the discussion
of costs and benefits generally assumes that FTAs are executed and implemented in
a multilateral setting. In fact, given the slow pace of World Trade Organization
(WTO) negotiations, many countries are pursuing preferential arrangements, that is,
regional and bilateral agreements like the proposed CAFTA. Latin America is full
of them and depending on how they are defined, they may actually be trade distorting
if they promote trade diversion. This occurs when trade is redirected to countries
within a limited agreement that does not take into account countries outside the
agreement, some of which may be more efficient producers. Preferential trade
agreements are also cumbersome to manage, requiring extensive rules of origin, and
economists disagree over whether FTAs help or hinder the movement toward greater
multilateral trade liberalization.6
Second, trade, much like technology, is a force that changes economies. It
increases opportunities for internationally competitive sectors and challenges import
competing firms to become more efficient or do something else. This fact gives rise
to the policy debate over adjustment strategies, because while consumers and export
sector workers benefit, some industries, workers, and communities are hurt.
Economists generally argue that it is far less costly for society to rely on various types
of trade adjustment assistance than opt for selective protectionism, the frequent and
forcefully argued choice of trade-affected industries. The public policy difficulty is
that both options have costs and benefits, but result in different distributional
outcomes.7 Because trade agreements raise difficult political choices for legislators
in all countries, many of whom represent both potential winners and losers, FTA
provisions are typically limited in scope (so continue to protect partially or
completely certain products, industries, or sectors) and are phased in over time
(typically up to 15 years for very sensitive products).
6 U.S. businesses operating in Latin America have had to interpret a difficult road map when
dealing with multiple arrangements such as the Caribbean Basin Initiative, the Andean
Trade Preference Act, and the North American Free Trade Agreement. Each distorts
investment decisions in the region and can have a countervailing influence on the others.
Adding the many Latin American FTAs only makes the situation more confusing.
7 Importantly, when a staple, such as underwear, is produced abroad and sold in the United
States as a lower-priced import compared to a domestically produced good, it is equivalent
to an increase in real income for the U.S. consumer. This can be significant for low-wage
workers in the United States. The same idea holds true for industrial products and business
consumers. So, there is a “trade off” in the trade policy decision between keeping certain
jobs through protection and losing the income gains, or keeping the income gains and losing
certain jobs. One public policy response has been to pass trade adjustment assistance
legislation to help firms and workers transition more quickly to new opportunities.
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Third, there are clearly implications in the trade negotiation process for smaller
countries’ bargaining leverage when they choose to negotiate with a large country in
a bilateral rather than multilateral setting. Both Chile and the Central American
countries realized early in the process that there were negotiating issues over which
they would be able to exert little or no leverage. Both agreements deal little with
trade remedies (e.g. antidumping and subsidies) and resolving agriculture issues also
has been limited, given the politically sensitive nature of this issue.
The Impetus for a CAFTA
It is clear that the United States has decided to move ahead with preferential
trading agreements. In part, this decision has been influenced by external events, as
well as broader strategic interests. With the proliferation of regional agreements
around the world, trade negotiations for some countries have become a tactical issue
of picking off gains where they are perceived relative to what other countries are
doing. In response to this, it was repeatedly argued by the U.S. business community
that the U.S.-Chile agreement, for example, was necessary to equalize treatment of
U.S. businesses competing with Canadian firms that already enjoyed preferential
treatment with Chile. The case was made for Central America as well, which has
trade agreements with Mexico, Canada, and other countries. The apparent impasse
or delay of WTO and possibly the Free Trade Area of the Americas (FTAA)
negotiations only reinforces this attitude.
In the context of sub-regional trade agreements, history, geographic proximity,
and economic complementarities also combine to make the formal deepening of trade
relations between Central America and the United States an apparently logical step.
At least three cautionary notes, however, bear keeping in mind. First, because of an
historical pattern of U.S. political, military and corporate intervention in the region,
a sense of disparity in power between the two partners lingers, which carried over to
the trade negotiations themselves. Second, intra-Central American squabbles and
instability have at times disrupted regional integration and especially foreign trade
relations. Third, the promise of social, economic, and political reform alluded to by
President Bush’s statement at the outset of this report has proven difficult to achieve
in Central America, perhaps propelling expectations beyond CAFTA’s ability to
deliver.8
Economic fundamentals have shaped Central American trade relations. From
the early days of independence, agricultural exports were the centerpiece of Central
American economic growth. The British controlled primary export production
(coffee, bananas, sugar, and beef) until about 1850, when U.S. interests won over.
This continued until the 1980s when passage of the Caribbean Basin Economic
Recovery Act (CBERA — P.L. 98-67) began to transform the Central American
economies. By becoming eligible for unilateral preferential tariff treatment as part
8 For an excellent economic history of the region, see: Woodward, Ralph Lee Jr. Central
America: A Nation Divided. New York: Oxford University Press, third edition, 1999.
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of the Caribbean Basin Initiative (CBI), U.S. investment fostered growth in light
manufacturing, primarily apparel.9
The U.S.-Central American economic relationship changed dramatically under
the CBI, creating an environment in which businesses forged strategic partnerships
in the increasingly complex world of textile and garment manufacturing. From 1974
until 1995, rules restricting trade in apparel between developed and developing
countries (mostly quotas) were set out in the Multifiber Arrangement (MFA). Its
successor, the WTO sponsored Agreement on Textiles and Clothing (ATC) serves
as a transitional agreement that oversees the reduction and elimination of quotas by
January 1, 2005.10 The preferential arrangements offered under the CBI programs
were defined in this system, which the United States created to help foster Caribbean
economic development, as well as to assist U.S. industry in responding to
competition from similar production-sharing arrangements in Asia that were taking
a toll on U.S. production and employment in the textile and apparel industries.
Both U.S. textile and apparel industries have been hit hard by foreign
competition. The textile industry (e.g., cloth, yarns, thread) has lost jobs, but has
remained marginally competitive internationally through more sophisticated use of
production technologies. The apparel manufacturing industry (e.g., shirts, pants,
undergarments) by contrast, is highly labor intensive, and in striving to reduce costs,
has moved production offshore to lower wage countries, with significant U.S. job
loss in that sector. As part of this process, and with the added incentive of CBI
benefits, U.S. firms invested in Central American and Caribbean countries to develop
assembly businesses that used mostly U.S. textiles as inputs. Although created as a
mutually beneficial pact, it was a controversial move because of the reliance on
foreign low-wage workers to the detriment of some U.S. employment. Many
economists argue, however, that the alternative was even greater loss of textile and
garment jobs to Asian countries that use no U.S. inputs.11
Low-cost labor, however, is not the only, or even the most important, factor
driving competitiveness. Studies suggest that the economic and social networks that
developed between U.S. and Central American firms effectively created a
comparative advantage for the region in apparel exporting that has held up even with
the entry of China in the market.12 The key global challenge to this system comes
9 This legislation was amended twice, most recently by the Caribbean Basin Trade
Partnership Act (CBTPA — P.L. 106-200, Title II), which further loosened restrictions on
apparel imports from the Central American countries.
10 See: CRS Report RL31723, Textile and Apparel Trade Issues, by Bernard A. Gelb.
11 Chacón, Francisco. International Trade in Textile and Garments: Global Restructuring
of Sources of Supply in the United States in the 1990s. Integration and Trade, Vol. 4, No.
11, May-August 2000. Inter-American Development Bank, Washington, D.C.
12 A more subtle distinction made by one economist notes that, “How comparative advantage
is created matters. Low-wage foreign competition arising from an abundance of workers
is different from competition that is created by foreign labor practices that violate norms at
home. Low wages that result from demography or history are very different from low wages
that result from government repression of unions.” See: Rodrik, Dani. “Sense and
(continued...)
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after 2004 when quotas are scheduled to end on textiles and apparel. Whether the
U.S.-Central American production relationship can withstand the expected increased
competition from large low-cost producers, such as China, is unclear, but CAFTA
is seen by some as a logical policy extension of a model intended to do so.13
Broader geopolitical and strategic concerns also sparked interest by all parties
in pursuing CAFTA. For example, proponents expect CAFTA to reinforce stability
in general by providing institutional structures that will undergird gains made in
democracy, the rule of law, and efforts to fight terrorism, organized crime, and drug
trafficking. CAFTA may also be a way to expand support for U.S. positions in the
FTAA, and in the event that the FTAA is delayed beyond its 2005 deadline, help
rationalize the system of disparate preferential trade agreements that currently define
Central American trade relations.
Critics of CAFTA point to equally broad themes, such as the pervasive social
and economic inequality in much of Central America, and so support labor and
environment provisions as important negotiating objectives. There is concern, for
example, over the adequacy of working conditions and basic labor rights and whether
CAFTA can help change the situation, a reflection of the whole issue of “civil
society’s” role in the trade agreement that developed early in the negotiation process.
The broadest possible support for CAFTA is unlikely to materialize unless there is
some credible promise of accelerated social development, even if this is much to ask
of the proposed trade agreement.
Strategic justifications may have helped get the process going, but ultimately it
is fair to ask what each side expects to gain commercially from the detailed
agreement that has emerged. The dollar value of U.S. trade with Central America
makes the region the United States’ third largest Latin American trading partner;
right behind Brazil, although a distant third from Mexico. Still, it represents less than
1% of U.S. foreign commerce so CAFTA may expand trade at the margin, but the
U.S. effects will be small on a macroeconomic level, although no doubt important
to those industries affected by regional trade trends, especially in the maquiladora
trade.
For the United States, an FTA is a more balanced trade arrangement than the
unilateral preferences provided in the CBI. Market access (e.g., tariff rates, rules of
origin) was a core negotiating area. Although Central American tariffs are already
relatively low, they can be reduced further. In particular, U.S. business interests want
equal or better treatment than that afforded to exports from Canada and Mexico
based on their FTAs with Central American countries. Permanent and clarified trade
rules would also support the joint production arrangements already in place between
Central American and U.S. firms. Finally, as highlighted in the negotiations with
Chile, a bilateral agreement offers the United States a chance to address other trade
12 (...continued)
Nonsense in the Globalization Debate.” Foreign Policy. Summer 1997. p. 28.
13 Gereffi, Gary. The Transformation of the North American Apparel Industry: Is NAFTA
a Curse or a Blessing? Integration and Trade. Vol. 4, No. 11. May -August 2000. Inter-
American Development Bank. Washington, D.C. pp. 56-57.
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barriers that affect some of its most competitive industries. This includes clarifying
rules for the treatment of intellectual property, foreign investment, government
procurement, e-commerce, and services.
From the Central American perspective, reducing barriers to the large U.S.
market (especially for textile and agricultural products) and increasing foreign
investment were cause enough to proceed. This point is directed specifically at
making permanent the benefits Central America currently enjoys under the CBI
legislation, but which requires periodic reauthorization by Congress. This could
increase U.S. foreign direct investment (FDI) that developed the maquiladora
relationship in the first place and which supports Central America’s export driven
development strategy. The Central American countries also face important
vulnerabilities, such as the possibility that U.S. agricultural exports of key staples,
such as corn and rice, might overwhelm their small markets, causing huge
displacement issues. Sensitivity to these and other key industry sectors had to be
considered.
Finally, two factors pointed to significant negotiation challenges. The first was
the need for better Central American integration. Individually, the Central American
countries may be too small to justify a U.S. bilateral agreement by themselves, and
also trade has been hampered within the subregion by cumbersome customs and
other rules. For CAFTA to work well, the United States needed some assurance that
goods could flow efficiently within the region. Second, much was made of the
difference in negotiating capacity between Central America and the United States.
U.S. and multilateral offers to assist these countries in developing such capacity were
viewed as generous, but also a little self-serving, which required a sensitive approach
to the whole negotiation process.
The Quest for Central American Integration
Because the Central American countries had to develop a single negotiating
position, cooperation was paramount. This is no small technical point; although the
Central American Common Market (CACM) has been in place for four decades,
historically the member countries have struggled to define unified positions in trade,
a natural consequence of trying to reconcile diverse national interests and economic
capabilities. The fact that Costa Rica did not agree to CAFTA, despite some
expectations that it eventually will, makes the point.14
Since the Spanish colonial period, Central America has been an agricultural
exporting area, which by the modern period became concentrated in five major
commodities: bananas; coffee; sugar; beef; and cotton. The socioeconomic balance
that emerged from this trade regime was far from egalitarian. Economic gains have
been uneven. Concentrated land ownership led to highly skewed patterns of income
and wealth. Although underlying inequality was an inherent part of colonial Central
14 This is not to suggest that all five countries were expected to strike the exact same bargain
with the United States in all cases, but that there was agreement among them regarding how
the final agreement was defined.
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American society, the modern, foreign-dominated agricultural export model did little
to change this reality. The resulting highly stratified socioeconomic structure
fostered social discontent and political unrest, leading directly, and perhaps
unavoidably, to the turbulent 1970s and 1980s (see Appendix 2 for a comparison of
economic data among the five countries).15
There are important implications of this development pattern for regional
integration. The emphasis Central American leaders placed on economic integration
rested largely on expectations that the gains from economic growth and development
would be shared, at least among countries, if not within them. In the first two
decades of the CACM, economic analysis pointed to both static and dynamic gains
from trade. The CACM lowered and equalized external tariffs, expanded the internal
market, and helped diversify production and modernize economic activity. Benefits
arose from more open domestic policies as well as foreign investment and technology
transfer that accompanied trade. One study found that some of these gains were
shared broadly, as seen in lower prices and a greater selection of goods. Economic
integration, however, was not realistically expected to change the underlying social
and economic stratification that had dominated for centuries. What the CACM did
accomplish was to address, in part, the lack of opportunity that defined small closed
economies, presumably without introducing new distortions in trade relations.16
These gains were widely applauded in the first decade and intraregional trade
grew eight-fold from 1960 to 1968, when it peaked at 24% of total Central American
trade. After that, the CACM struggled as a unifying force for the region. Unequal
growth and development patterns eventually undermined the common market, largely
because of disappointment over efforts to achieve its unwritten, but widely accepted
goal of “balanced development.” Historical inequalities among the five countries,
most evident between the two extremes of a relatively wealthy Costa Rica and a far
poorer Honduras, gave rise to chronic balance of payments problems. As economic
growth in Honduras continued to lag behind the rest, it pressured the common market
members to find a policy solution to the growing disparity in economic
performance.17
Unequal economic performance gave way to heated political debate and
eventually military conflict. The “Soccer War” between El Salvador and Honduras,
begun during the 1969 World Cup playoffs, was a major setback for the CACM
because the heart of this conflict was economic, arising out of long-term tensions
over land disputes and immigration pressures. The hostilities, although short-lived,
had lasting economic effects, with Honduras pulling out of the CACM and
suspending trade with El Salvador for over a decade. Despite these setbacks,
15 An excellent discussion on the effects of the agricultural export model from a historical
basis may be found in: Brockett, Charles D. Land, Power, and Poverty: Agrarian
Transformation and Political Conflict in Central America. Boulder. Westview Press,
second edition, 1998. See especially pp. 93-94.
16 Cline, William R. and Enrique Delgado, eds. Economic Integration in Central America.
Washington, D.C. The Brookings Institution, 1978. pp. 405-10.
17 Ibid., pp. 30-45 and Carl, Beverly M. Trade and the Developing World in the 21st
Century. New York, Transnational Publishers, Inc, 2001. p. 106.
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economic analysis strongly suggested that where reduced restrictions to trade were
allowed to operate, net welfare gains could be found for all countries, even if not
shared equally.18
The 1980s led off with the fall of the Somoza dictatorship in Nicaragua, civil
war in El Salvador, the 1982 Latin American debt crisis, and military repression in
other parts of Central America. Between a growing political mistrust and the
collapse of economic fundamentals, intraregional trade was halved by 1986, falling
to 15% of total trade. Policies meant to correct foreign debt buildup and balance of
payments problems resulted in increased non-tariff barriers, reducing trade growth
throughout the region. Over time Central America moved away from low value-
added primary-goods exports, and through this diversification process, there emerged
a renewed sense that the region would be served better by engaging the world as a
bloc, rather than individually.
As with most of Latin America, it took more than a decade for Central America
to recover economically from the 1980s downturn (see Appendix 2). A revived
commitment to deeper integration was codified in the 1991 Protocol of Tegucigalpa
that established the Central American Integration System, which operates as a
regional umbrella organization and includes Panama. Since then, most Central
American countries have experienced noticeable increases in trade as a percentage
of economic activity (see Table 1), although at levels that still leave much room for
growth, especially for countries with small internal markets.
Table 1. Central American Exports as % of GDP
Country
1991 Exports/GDP
2001 Exports/GDP
Costa Rica
22.8
31.0
El Salvador
11.3
20.8
Guatemala
12.8
14.2
Honduras
26.7
31.7
Nicaragua
21.4
32.6
Data Source: IMF, International Financial Statistics, and Central Banks of Costa Rica, El Salvador,
Guatemala, Honduras, and Nicaragua.
In 1993, the Protocol of Guatemala modified commitments of the original
CACM treaty, calling for deeper economic and political cooperation. This took form
in policies such as establishing a new common external tariff (CET) with a floor of
zero and a cap of 15%. This and other rules, however, were phased in at the
discretion of each country, so the prospects for deeper integration rests on a
18 Cline and Delgado, op.cit., pp. 22-23, 39-41, 110-15, and 296-300. Honduras actually
raised its tariffs for all CACM members and then proceeded to negotiate more limited
bilateral agreements with individual CACM countries, with the exception of El Salvador.
The Central American Bank for Economic Integration took responsibility for providing
resources to address uneven development issues. Interestingly, Honduras had the highest
level of outstanding loans (relative to total economic output) in the first two decades, but
this had failed to keep hostilities at bay.
CRS-10
foundation of flexibility that has served to unify the member countries by recognizing
their varying abilities to implement the agreement’s provisions.19
This flexibility has been useful in CACM’s trade agreement negotiation process
as well. The CACM has initiated negotiations for FTAs with both Chile and the
Dominican Republic, among others, setting a precedent for intra-regional cooperation
in trade negotiations. Individual countries, however, are also pursuing bilateral
agreements with various Latin American countries, again pointing to the fluid nature
of the CACM, but also blurring the distinction between the CACM operating as a
free trade area rather than a customs union with a well-defined and fully observed
common external tariff, to which the member states are legally bound. This system
raises a number of potential legal confusions for international firms wishing to trade
or operate in one or more of the Central American countries.20
Such a concern has not been lost on the CACM countries. On March 24, 2002,
they signed a plan of action to move forward on integration issues including tariff
harmonization, reducing non-tariff barriers, finalizing dispute settlement procedures,
and developing a common foreign trade policy.21 Although it is unclear how soon
all these goals can be reached, the continuing commitment to regional integration
remains alive.
U.S.-Central American Trade Relations
Because of its huge size and geographical proximity, the U.S. market has been
a natural destination for Central American exports. Merchandise trade with the
United States has dominated Central America’s foreign commerce for 150 years, and
as seen in Figure 1, remains in that dominant role today. The United States is by far
the largest of Central America’s trading partners, accounting for some 57% of its
exports and 41% of its imports. The rest of Latin America collectively is the next
largest trading partner, accounting for 19% of Central America’s exports and 28%
of its imports. The European Union and Asia together accounted for about 17% of
Central American exports and 19% of imports.
This distribution is not uniform throughout the region. Honduras, for example,
exports 70% of its merchandise goods to the United States, compared to 45% for
Costa Rica. Honduras also has the highest import percentage from the United States
at 55% compared to Nicaragua’s 24%, which is the lowest. Total trade (exports plus
imports) with the United States is also somewhat uneven country by country. Costa
Rica accounts for one-third of total Central American trade with the United States,
whereas Nicaragua amounts to only 7% of the total. Guatemala, Honduras, and El
Salvador account for 25%, 22%, and 12% respectively.
19 Inter-American Development Bank. Integration and Trade in the Americas: Periodic
Note. Washington, D.C. December 2000. pp. 34-35.
20 Ibid., p. 35-36 and Carl, op. cit., pp. 110-11.
21 Inter-American Development Bank. Institute for Integration of Latin America and the
Caribbean. Monthly Newsletter. April 2002.
CRS-11
Figure 1. Central America’s Direction of Merchandise Trade, 2002
Trade volume with the United States varies among countries, but in most cases
the trend has been one of growth at a rate higher than the average for U.S. trade with
the world. Over the past five years, U.S. exports to Central America grew by 17.0%,
compared to 1.6% with the world and 4.8% with Latin America as a whole (see
Appendix 3 for the data). U.S. imports from Central America increased by 28.2%
over the same time period, compared to 27.6% for the world and 40.9% for Latin
America.
Although trade varied among the five countries, in all cases except U.S. imports
from Costa Rica, it was significantly higher than the world average. More recent data
support this trend as well. In 2002, U.S. merchandise exports to the world declined
by 5%, whereas to Central America they grew by 9.4%. This reflects declines of 5%
and 1% with El Salvador and Nicaragua, respectively, and increases of 6%, 9%, and
25% with Honduras, Guatemala, and Costa Rica, respectively. U.S. imports from the
world advanced by 2% in 2002, compared to 7% for the Central American countries,
all of which experienced growth in the U.S. market over the last year.22
U.S. Imports
The major U.S. imports from Central America fall into three main categories:
fruit (mostly bananas) and coffee; apparel; and integrated circuits. These three
22 Calculations are made from trade data compiled by the U.S. Department of Commerce.
Merchandise trade data have a two-month lag time from the time the goods enter the country
until they are reported. Services trade data have a much longer lag time and are not readily
available for small U.S. trading partners, such as the Central American countries.
CRS-12
distinct categories are not traded uniformly by the five countries (see Table 2). First,
Central America has traditionally exported bananas and coffee, which is dominated
by Costa Rica and Guatemala. Coffee has actually declined for all countries except
Costa Rica and constitutes only 3.2% of U.S. imports from the region. This reflects
the competitive nature of trade in coffee, which is grown in vast quantities by Brazil,
Colombia, and countries in Africa as well. Banana trade has also declined in
importance and accounts for only 5.4% of U.S. imports from Central America.
Table 2. Top Eight U.S. Imports from CAFTA Countries, 2002
($ millions)
Product and HTS Number
CAFTA
Costa
Hon
Guat
El Sal
Nic
Rica
Total U.S. Imports
11,861
3,142
3,261
2,796
1,982
680
Knit Apparel (61)
4,534
365
1,801
978
1,259
131
Woven Apparel (62)
2,463
363
700
681
417
302
Edible Fruit & Nuts (08)
987
484
154
338
1
10
Bananas (0803)
(636)
(250)
(120)
(258)
(0)
(9)
Electrical Machinery (85)
723
618
73
0
28
4
Integrated circuits (8542)
(447)
(447)
(0)
(0)
(0)
Spices, Coffee, Tea (09)
387
122
29
173
32
31
Coffee (0901)
(378)
(121)
(27)
(168)
(32)
(30)
Optical/Med. Equip. (90)
369
366
0
3
0
0
Fish and Seafood (03)
325
81
133
19
8
84
Mineral Fuel, Oil
180
12
0
168
0
0
Other
1,893
731
2,890
436
237
118
Top 8 Imports as % of Total
84.0
76.7
88.6
84.4
88.0
82.6
Data Source: U.S. Department of Commerce.
#HTS = Harmonized Tariff Schedule
Second, apparel has become the primary export good for all countries except
Costa Rica and accounted for nearly 60% of total U.S. imports from Central America
in 2002. As discussed above, the United States has encouraged this trade since
including the Central American countries as beneficiaries under the CBI program in
1984. In 2001, Central America accounted for approximately 15% of U.S.
production-sharing imports from developing countries. Most of these imports were
apparel, which amounted to 71% of total apparel imports from CBI countries in
2001, led by Honduras with 25% of the total, followed by El Salvador and Guatemala
each with 17%, Costa Rica with 8%, and Nicaragua with 4%. U.S. content amounted
to 61% of the total value of production-sharing imports from Central America,
significantly higher than from U.S. production-sharing arrangements in Asia and
Europe. In 2002, knit apparel imports from CAFTA countries increased by an
average 10%, whereas woven apparel imports declined by 5%.23
23 United States International Trade Commission. Production-Sharing Update:
Developments in 2001. Industry Trade and Technology Review. July 2002. pp. 39-42, B1-4.
CRS-13
Third, Costa Rica stands alone in having attracted $500 million in foreign direct
investment to construct a computer chip plant, which has become its major export
generator. This investment was augmented by an additional $110 million in October
2003 for the production line of “chipsets” for personal computers. In 2002, U.S.
imports of integrated circuit exports grew by 37% on a dollar-value basis and
constituted 14% of total imports from Costa Rica. Similar growth may also be seen
in imports of Costa Rica’s medical equipment, another indicator of its relatively
sophisticated production capabilities. Costa Rica is the fastest growing and most
diversified trader in Central America, which explains in part why it has outpaced its
neighbors on the development path and was the leading advocate of CAFTA.24
(Note, there is also a small amount of crude oil imported mostly from Guatemala in
the top eight imports.)
Many non-apparel items that the United States imports from Central America
face minimal or no tariffs. Bananas, coffee, oil, most fish products, and Costa Rica’s
integrated circuits and medical equipment enter duty free. Some enter the United
States under preferential arrangements, but the majority is free of duty under normal
(most favored nation) tariff rates. Apparel was technically excluded from preferential
treatment under CBI, but under a special access program (SAP), eligible Central
American apparel exports receive preferential treatment under production-sharing
arrangements (Chapter 98 of the Harmonized Tariff System — HTS). This
arrangement was extended under the Caribbean Basin Trade Partnership Act
(CBTPA) in October 2000 (P.L. 106-200), which allows duty-free and quota-free
treatment of apparel imports if assembled in the Central American countries from
fabrics made in the United States made of U.S. yarns, whether the fabrics were cut
to shape in the United States or Central America.25
U.S. Exports
The major U.S. exports to Central America include: electrical machinery;
apparel; plastic; yarns; and fabric (see table 3). Many of these goods are processed
in some form and re-exported back to the United States under production-sharing
arrangements. For example, nearly 60% of electrical machinery exports to Central
America is integrated circuits going to Costa Rica for processing and re-export. The
same may be said for fabric and yarns that are exported to all five countries, sewn and
otherwise assembled, and re-exported back to the United States. Some of these
goods are consumed in the CAFTA countries along with capital goods (machinery
and parts) and agricultural products.
The same distinctions seen in U.S. import trade are evident in U.S. exports.
Some 70% of yarn exports goes to Guatemala and Honduras and between 85% and
90% of apparel and knit fabric is sent to Honduras and El Salvador. These three
countries are the heart of the maquiladora relationship. Although the United States
exports machinery and parts to all five countries, electrical machinery and
particularly integrated circuits, are sent to Costa Rica. All five countries import U.S.
24 Hufbauer, Kotschwar, and Wilson, op. cit., p. 1003.
25 For the technical details of this arrangement, see: CRS Issue Brief IB95050, Caribbean
Basin Interim Trade Program: CBI/NAFTA Parity, by Vladimir N. Pregelj.
CRS-14
cereals and some, such as corn and rice, are among the more import sensitive
products that the Central American countries would like to continue protecting.26
Table 3. Top Eight U.S. Exports to CAFTA Countries, 2002
($ millions)
Product and HTS
CAFTA
Costa
Hon
Guat
El Sal
Nic
Number#
Rica
Total U.S. Exports
9,833
3,117
2,571
2,044
1,664
437
Elec Machinery (85)
1,411
1,023
86
161
114
28
Integrated circuits (8542)
(823)
(821)
(0)
(1)
(1)
(0)
Knit Apparel (61)
954
102
521
30
293
8
Machinery (84)
940
332
179
240
131
58
Office Mach. Parts (8473)
(171)
(69)
(18)
(52)
(19)
(13)
Computer Parts (8471)
(137)
(51)
(12)
(29)
(24)
(19)
Woven Apparel (62)
597
214
261
30
56
36
Plastic (39)
526
208
90
154
66
8
Cotton Yarn (52)
467
16
207
169
70
5
Knit/Crocheted Fabric (60)
446
30
244
16
153
3
Cereals (10)
400
97
73
117
74
39
Corn (1005)
(175)
(51)
(24)
(59)
(34)
(7)
Wheat and Meslin (1001)
(147)
(31)
(32)
(48)
(24)
(12)
Rice (1006)
(76)
(16)
(16)
(10)
(15)
(19)
Other
4,092
1,095
910
1,127
707
252
Top 8 Exports as % of Total
58.4
64.8
64.6
44.8
57.5
42.3
Data Source: U.S. Department of Commerce.
#HTS = Harmonized Tariff Schedule
The significant aspects of this trade structure are that it reflects: 1) growing U.S.
direct investment; 2) a deepening economic integration; and 3) the continued
historical trend of regional dependence on the large U.S. market as an important
aspect of trade and development policy.
Status of Trade Negotiations and Policy Issues
The ninth and final round of negotiations concluded on December 17, 2003 in
Washington, D.C. Although certain details still need to be worked out, the CAFTA
was agreed to by the United States, Guatemala, Honduras, El Salvador, and
Nicaragua. Costa Rica declined to accept the agreement at that time pending
resolution of a few key sensitive issues. As set out in Trade Promotion Authority
(TPA) legislation, President Bush must provide Congress with at least a 90-day
formal notification of his intention to sign the agreement. Within 60 days of signing
the agreement, the President must submit to Congress a description of changes in
26 USITC, Production-Sharing Update: Developments in 2001. Industry Trade and
Technology Review. July 2002. pp. 39-42, B1-4
CRS-15
existing laws that may be needed for the United States to comply with the agreement.
The President must also submit a draft implementing bill, statement of administrative
action, and supporting information that explains, among other things, how the
agreement meets congressionally mandated objectives and goals. TPA also requires
that within 90 days of signing the agreement, the President submit a report by the
U.S. International Trade Commission (USITC) assessing the likely effects of the
agreement on the U.S. economy.27
Although the CAFTA text will not be released until January 2004 at the earliest,
summaries indicate that a comprehensive agreement was reached. A detailed
discussion of the issues follows, organized topically by the five working groups,
including capacity building, with first an introductory focus on the Costa Rica.28
Importantly, any reference to details of the proposed CAFTA are contingent upon
acceptance of the agreement by Congress.
Costa Rica and Unresolved Issues
The United States and Costa Rica agreed that there were a number of unique
issues that could not be resolved by the December 2003 deadline, leading to Costa
Rica’s early withdrawal from the last round of negotiations. In the meantime, Costa
Rica has reiterated its strong preference to be part of CAFTA and plans to hold two
bilateral meetings with the United States to discuss unresolved issues. The first
began on January 5, 2004 and is addressing nonagricultural issues. The second
meeting is scheduled to begin January 19, 2005 and will take on agriculture and all
other unresolved issues. Both sides hope the second meeting will complete
discussions on CAFTA. Any agreement struck between the United States and Costa
Rica will not likely apply to the other four Central American countries.29
The key unresolved issue was Costa Rica’s resistence to opening its state-run
insurance and telecommunications industries to competition. Unlike the other four
countries, doing so would constitute a major structural adjustment for the Costa
Rican economy, which combined with its politically sensitive nature, would be
difficult for the Costa Rican Congress to support without concrete tradeoffs. Costa
Rica also complained that the U.S. insurance offer was presented too late in the round
for Costa Rica to respond in time. After regrouping, Costa Rica appears prepared to
concede to opening these industries, but would need greater flexibility from the
27 116 STAT. 1013 and 116 STAT. 1012.
28 Bowing to Central America’s limited resources and desire to consolidate negotiations, the
United States agreed to establish only five working groups responsible for: 1) market access
(including agriculture); 2) investment and services; 3) government procurement and
intellectual property; 4) labor and environment; and 5) dispute settlement and other
institutional issues. In addition, there is a non-negotiating multi-agency effort responsible
for supporting trade capacity building (TCB). By contrast, the U.S.-Chile negotiations used
17 working groups and the FTAA negotiations utilize nine, plus three non-negotiating
support groups.
29 This summary is based on news accounts and discussions with representatives of the
Costa Rican government. See: Government of Costa Rica. Ministry of Foreign Trade.
Press Release: Central America – U.S. Free Trade Negotiations. December 18, 2003.
CRS-16
United States on agriculture and textile issues. In agriculture, Costa Rica is pressing
for a “significant” sugar quota, a response to its ethanol proposal, and improved
access for beef and poultry. It would also like to extend the tariff phase-out period
to 18 years for some of its most sensitive products, such as pork, rice, onions, and
potatoes.
In textiles, the issue is use of third country fabrics in goods to be exported to the
Untied States. This would require more generous treatment in rules of origin and
short supply provisions (see Market Access section). Costa Rica would also like
easier rules governing future additions to the short supply list. Costa Rica has argued
that because it does not rely on low-wage labor like other Central American
countries, the cost of materials, such as fabrics, is a more important factor and
therefore it needs greater flexibility to use alternatives to high-cost U.S. fabrics.
There are other issues, such as intellectual property rights, to be addressed that may
be less controversial. The traditionally difficult issues of labor and environment are
not a problem for Costa Rica, which generally has more advanced standards than
many Latin American countries.
Although a general optimism appears to be present regarding the prospects of
Costa Rica and the United States coming to an agreement, the tradeoff between Costa
Rican telecom/insurance and U.S. textiles/agriculture pits four of the most sensitive
sectors against each other in the trade discussions. Given resistence in both countries
to concessions already made in these areas, striking a balance agreeable to both
countries and their respective congresses may be difficult.
Market Access
This working group focused on the key issues determining the tariff structures
and rules that will govern the movement of goods. The Central American countries
had two important goals. First, consolidate access to the U.S. market, which meant
clarifying, making permanent, and improving on preferential tariff treatment
currently applied to many of their major exports under the Caribbean Basin Trade
Partnership Act (CBTPA) and the Generalized System of Preferences (GSP).
Second, increase opportunities for export goods protected by the United States and
specify safeguards to limit the effect on select (mostly) agricultural products of
potentially large increases in U.S. imports. For the United States, seeking equal or
better treatment than what other countries receive (especially Canada and Mexico)
under their FTAs with Central America was a basic goal, including obtaining access
for sensitive agricultural products. Specifically, negotiators had to agree on the list
of goods to be covered, the schedule under which tariffs would be phased out, and
the rules of origin that would apply, all thorny and complicated issues in FTAs.
Upon CAFTA’s entry into force, more than 80% of U.S. consumer and
industrial exports would become duty-free immediately, with all tariffs removed
within 10 years. Tariffs would go to zero on many product categories including
information technology products, agricultural and construction equipment, paper
products, chemicals, and medical/scientific equipment. For the Central American
countries, benefits received under the Caribbean Basin Trade Partnership Act
CRS-17
(CBTPA) would become permanent, allowing most consumer and industrial products
from Central America to enter the United States duty free immediately.30
The most difficult market access issues involved Central America’s major
exports, apparel and agricultural goods. Protection of agriculture includes use of
tariffs, tariff rate quotas, safeguards, and sanitary and phytosanitary regulations.31
Under CAFTA, tariffs on agricultural goods would be phased out based on a
schedule placing most agricultural products in one of four categories or “buckets” in
which tariff elimination occurs: 1) immediately; 2) in five years; 3) in ten years; and
4) in 12-15 years. All products were addressed, but some required special treatment
such as extended tariff rate quotas, special safeguards, or lengthier tariff protection.
Over half of current U.S. farm exports to Central America would become duty free
immediately, including “high quality” cuts of beef, cotton, wheat, soybeans, certain
fruits, and vegetables, processed food products, and wine. At the same time, the U.S.
conceded to slight increases in sugar quotas for the four Central American countries,
which is being challenged by U.S. sugar interests.32
Apparel trade was the other major market access complication, pitting U.S.
domestic industries competing directly with Central American products against
Central American producers who work with U.S. textile manufacturers in production-
sharing arrangements and U.S. importers/distributers of apparel products.
Consumers, no doubt, should also be mentioned as a constituent group (as with
agriculture products). Reconciling these competing interests was a delicate process
and required negotiators to define treatment for every product and material involved
in the manufacture of garments.
CAFTA textile provisions would be retroactive to January 1, 2004, apparently
to encourage U.S. businesses to use Central America sources for apparel, and would
cover three basic issues of central importance. First, Central American apparel has
been entering the United States duty free provided it is assembled from U.S.
materials under the so-called “yarn forward” rule. This rule has been relaxed in some
cases, and would be further relaxed under CAFTA “short supply” and “rules of
origin” provisions. The Central American countries, and particularly Costa Rica,
wanted as much flexibility as possible to use fabrics from third countries. The
compromise appears to be that garments made from materials originating in either
Central America or the United States would enter the United States duty free
immediately. For certain products (e.g., nightwear, boxer shorts), third country
material would be allowed, provided the garments are assembled in Central America.
30 Office of United States Trade Representative. Free Trade with Central America:
Summary of the U.S.-Central America Free Trade Agreement. p. 1. Hereafter cited as the
CAFTA Summary. It may be found at: [http://www.ustr.gov]
31 For more details, see: CRS Report No. RL32110, Agricultural Trade in a U.S.-Central
American Free Trade Agreement (CAFTA), by Remy Jurenas.
32 U.S. Sugar Industry Group. Press Release: Mexican and US Sugar Industries Jointly
Oppose CAFTA Sugar Provisions. December 18, 2003.
CRS-18
This is one of apparently many controversial rules of origin and some U.S. textile
interests have raised objections to CAFTA because of it.33
Second, under the “accumulation of origin” rule, selected apparel made from
NAFTA partner fabrics would also receive duty-free treatment. The Central
American countries wanted to extend the rule to fabrics from other countries, and
apparently there is some room for select use of third country material outside
NAFTA.34 This is a precedent-setting rule and controversial. It effectively would
promote further integration of the textile and garment industries of Mexico and
Central America, which compete for U.S. investment and market access, as well as,
against U.S. fabric producers.
Third, there was considerable debate over the “short-supply” list, or duty-free
access of goods made from a specific list of fabrics that are determined to be in
“short supply” in the United States. A list of some 47 materials was agreed to, but
this also remains a serious point of contention with U.S. textile manufacturers,
because it would be another way for textile exporting countries outside the
agreement, such as China, to sell more material that enters the United States free.35
Investment and Services
In 2001 the United States’ stock of foreign direct investment (FDI) in Central
America was $3.0 billion (down from nearly $4.0 billion the year before), or nearly
half of total FDI in the region. Over half of U.S. FDI went to Costa Rica. The
United States has advocated clear and enforceable rules for foreign investment in all
trade agreements. In the past, as with the U.S.-Chile FTA, this has included limiting
restrictions on capital flows, as well as, defining specific recourse that individual
investors would have should they face any restrictions. In general terms, CAFTA
would protect all forms of U.S. investment in Central America and U.S. investors
would receive the same treatment as local investors “in almost all circumstances,”
except where specifically stated. Transparent and impartial dispute settlement
procedures would provide recourse to U.S. investors.
Services trade presented a number of hurdles given that the Central American
countries have adopted few commitments of the WTO’s General Agreement on
Trade in Services (GATS). There are also many industry-specific barriers that exist,
such as: barriers to foreign insurance companies in Guatemala; “heavy” regulation
licensing of foreign professionals in Honduras; local partner requirements in some
financial services in Nicaragua; and numerous services monopolies in Costa Rica
(insurance and telecommunications—see previous section on Costa Rica).36 CAFTA
would provide broad market access for most industries including
33 Inside U.S. Trade. CAFTA Textile Rules Pave Way for Increase in Foreign Fabric Use.
December 19, 2003 and Press Release. NTA Denounces CAFTA as Threat to U.S. Textile
Industry. December 18, 2003.
34 Ibid.
35 USTR, CAFTA Summary, p. 1.
36 USTR. 2003 National Trade Estimate Report on Foreign Trade Barriers.
CRS-19
telecommunications, financial services, distribution services, computer and business
technology services, tourism, and many others. Banks and insurance firms would
have full rights to establish subsidiaries, joint ventures, and branches. Regulation of
service industries is required to be transparent and applied on an equal basis.37
Government Procurement and Intellectual Property Rights
These two areas were also of particular interest to the United States. CAFTA
was seen as an opportunity to remedy many deficiencies and move toward strong
enforcement of standardized practice in the region. None of the five Central
American countries is a signatory to the WTO Agreement on Government
Procurement and allegations against the various purchasing processes vary from
dissatisfaction with less than transparent and cumbersome procedures in Costa Rica
to outright corruption in Guatemala. El Salvador and Nicaragua passed new
government procurement laws in 2000 and Honduras followed in 2001, and in
general, there have been improvements in all countries in dealing with project
bidding, although transparency issues remain.38
CAFTA would grant non-discriminatory rights to bid on contracts from Central
American ministries, agencies, and departments, with the exception of “low-value
contracts.” It would also call for procurement procedures to be transparent and fair,
including clear advance notices of purchases and effective review. CAFTA would
also make clear that bribery is a criminal offense under the laws of all countries.39
All Central American countries are revising, or have revised, their intellectual
property rights (IPR) laws and some are closing in on complying with the WTO
Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPS). That
said, all countries are subject to criticism for falling short on either clarifying or
enforcing penalties for noncompliance and in some cases have simply not adopted
reforms that many U.S. industries (e.g., sound and video recordings, pharmaceuticals,
book publishing, computer software) consider necessary to protect their intellectual
property. Piracy, incomplete or inadequate legal protection, and enforcement
capacity remain problems and ongoing concerns exist across the range of IPR issues
of patents, trademarks, and copyrights, covering print, electronic, and other media.40
The IPR provisions in CAFTA would provide that U.S. and Central American
businesses receive equal treatment in all areas. Trademarks would benefit from a
transparent on-line registration process and special system to resolve disputes over
internet domain issues, among other benefits. Copyright provisions would clarify use
of digital materials including rights over temporary copies of works on computers
(music, videos, software, text), sole author rights for making their work available on-
line, extended terms of protection for copyrighted materials, strong anti-
circumvention provisions to prohibit tampering with technologies, the requirement
37 USTR, CAFTA Summary, p. 2-3.
38 USTR, 2003 National Trade Estimate Report on Foreign Trade Barriers.
39 USTR, CAFTA Summary, p. 5.
40 Ibid.
CRS-20
that governments use only legitimate computer software, the prohibition of
unauthorized receipt or distribution of encrypted satellite signals, and rules for
liability of internet service providers for copyright infringement. Patents and trade
secrets rules would conform more closely with U.S. norms. End-user piracy would
be criminalized and all parties would be required to authorize the seizure, forfeiture,
and destruction of counterfeit and pirated goods. CAFTA would also mandate
statutory damages for copyrighted material.41
Labor and Environment
Perhaps the greatest challenge to CAFTA comes from the environment and
labor advocacy groups. These issues are complicated because trade agreements have
gone beyond purely commercial interests and now influence domestic social policy,
despite arguments by some that: 1) such worthwhile goals are too much to expect
from trade agreements and are better handled directly; 2) that trade can enhance the
economic welfare of countries even if broad social change does not follow
immediately; or 3) that in some cases, the capacity to meet developed country
standards is simply not immediately available to developing countries.
Labor and environment advocates in the United States argue that developing
countries may have an “unfair” competitive advantage because their lower standards
are the basis for their lower costs, which in turn are reflected in lower prices for
goods that compete with those produced in developed countries.42 Over time, the
argument goes, the difference in costs leads to U.S. investment and jobs moving
abroad. On the other hand, some studies suggest that these costs are usually not high
enough to determine business location alone, and that productivity remains the
primary deciding factor.43 In addition, developing countries have expressed concern
over loss of national sovereignty if FTAs define specific standards and that such
provisions may also be used as a disguised form of protectionism.
For environmental advocates, major goals include protecting and assuring strong
enforcement of existing domestic environmental standards, ensuring that multilateral
environmental agreements are not undermined by trade rules, promoting strong
environmental initiatives to evaluate and raise environmental performance,
developing a systematic program of capacity-building assistance, and assuring that
environmental provisions in FTAs are subject to the same dispute resolution and
41 Ibid., p. 4-5.
42 The difference is that the social costs associated with environmental degradation,
pollution, poor working conditions, and low wages are not captured in the production
process. Through legal and regulatory measures, developed countries require that
businesses bear many of these costs, which are then reflected in the final (relatively higher)
price of the good or service in the market place.
43 See: CRS Report 98-742 E, Trade with Developing Countries: Effects on U.S. Workers,
by J. F. Hornbeck. September 2, 1998, pp 11-13. Productivity and wage levels are,
however, highly correlated. See: Rodrik, Sense and Nonsense in the Globalization Debate,
pp. 30-33.
CRS-21
enforcement mechanisms as are other aspects of the agreements.44 Labor groups
advocate ensuring that all workers can exercise freely their fundamental rights at
work, requiring governments to respect and promote core International Labor
Organization (ILO) principles, and using the same dispute resolution and
enforcement provisions that apply to other provisions in an agreement.45
The USTR summary states that congressional objectives on environmental
issues have been met fully in the proposed CAFTA agreement. It includes language
requiring all countries to enforce their laws and regulations and also creates an
environmental cooperation agreement that entails a framework for establishing a
cooperation commission and a process to conduct capacity building. All parties
agreed to commit to establishing high levels of environmental protection and open
and transparent proceedings in the administration and enforcement of laws and
regulations.
The Special Role of Labor Issues. Arguably, the most contentious issue
of CAFTA will be the extent to which various parties are satisfied with the labor
provisions. In the case of Central America, U.S. labor advocates have focused on
income inequality and working conditions, charging that none of the countries “come
close to meeting a minimum threshold of respect for the ILO’s core labor standards.”
Further, systematic infractions at maquiladoras are provided as prominent examples,
and it has been argued that CAFTA “could dramatically and irreversibly weaken
current labor rights conditions contained in the GSP and CBTPA,” particularly if
language goes no further than requiring countries to enforce their existing laws,
which fall far short of ILO standards.46
Still others maintain that despite clear problems with inequality and workers’
conditions, which actually vary among the five countries, these are complex issues
resulting from many factors, including cultural and historical circumstances,
requiring multiple long-term policy responses that go far beyond trade policy. A
recent ILO study has documented the extent to which the five Central American
countries have, to varying degrees, codified basic labor rights.47 Although still
criticized as inadequate and in many cases poorly enforced, there appears to be some
recognition that change is necessary, and perhaps occurring. The results of one case
44 See: [http://www.sierraclub.org/trade/fastrack/letter.asp], Principles for Environmentally
Responsible Trade. Another important issue for the United States is ensuring that its higher
environmental standards defined in law and regulation not be compromised by challenges
of protectionism. See: CRS Report RS20904, International Investor Protection: “Indirect
Expropriation” Claims Under NAFTA Chapter 11, by Robert Meltz. May 3, 2001.
45 See: [http://www.aflcio.org], Off the Fast Track — On the Right Track.
46 Lee, Thea M. Assistant Director for International Economics, AFL-CIO. Comments on
the Proposed U.S.-Central American Free Trade Agreement, before the USTR Trade Policy
Committee, November 19, 2002.
47 A recent review of the Central American labor laws found that all five countries basically
address the four major categories of ILO rights and principles. This is not to say that
enforcement or labor conditions are adequate, but that the laws appear to be in place. See:
International Labor Organization. Fundamental Principles and Rights at Work: A Labour
Law Study: Costa Rica, el Salvador, Guatemala, Honduras, Nicaragua. Geneva, 2003.
CRS-22
study in Honduras also raise the question of whether alternative employment to
maquiladora work is largely available, better, or even preferred by job seekers.48
Most economic literature also suggests that restricting trade is an ineffective policy
response for addressing social inequality issues such as child labor and bargaining
rights. Rather, much of the literature characterizes trade liberalization as playing a
potentially constructive role in long-term growth and development, if combined with
internal economic and social policy changes.49
CAFTA Provisions and the Congressional Debate. The USTR, in its
summary of the CAFTA provisions, makes three important claims with respect to the
agreement as concluded, that it:
! “fully meets the labor objectives set out by Congress in the Trade
Promotion Act of 2002 and makes labor obligations a part of the
core text of the trade agreement;”
! “includes unprecedented provisions that commit CAFTA countries
to provide workers with improved access to procedures that protect
their rights;”
! “goes beyond Chile and Singapore FTAs through a 3-part
cooperative approach to improve working conditions by: 1) ensuring
effective enforcement of existing labor laws; 2) working with the
ILO to improve existing labor laws and enforcement; and 3) building
local capacity to improve workers rights.”
All three broad statements may be defensible, including meeting congressional
objectives as defined in TPA.50 A key issue, however, has been that the objectives,
as carefully worded in TPA, do not fully satisfy the concerns of labor. Labor
advocates argue that the provisions are a step backward from those agreed to in the
U.S.-Jordan bilateral agreement, as well as, the Generalized System of Preferences,
and Caribbean Basin Trade Partnership Act, which currently govern much of the U.S.
trade with Latin America. Although failure to enforce domestic labor laws can be
formally challenged in the dispute resolution, labor advocates have noted that
provisions committing CAFTA countries to work with the ILO to improve existing
labor laws and enforcement, and the U.S. commitment to help develop local capacity
to improve worker rights with grant aid are not so enforceable, raising the issue of
whether enforcement of ILO provisions should be the responsibility of FTAs.
This difference in treatment stems from similar treatment in the TPA language.
Section 2102(b)(11) of the Trade Act of 2002 (TPA) states that among the principal
labor negotiation objectives is the provision “to ensure that a party to a trade
48 Ver Beek, Kurt Alan. Maquiladoras: Exploitation or Emancipation? An Overview of the
Situation of Maquiladora Workers in Honduras. World Development, 2001.
49 The literature is vast. For a good and easily digestible summary, see: Birdsall, Nancy.
Life is Unfair: Inequality in the World. Foreign Policy, Summer, 1998. pp. 84-87.
50 Labor and environment trade negotiating objectives may be found in P.L. 107-210, sec.
2102, 116 STAT. 994, 116 STAT. 1000, 116 STAT. 1002, 116 STAT. 1003.
CRS-23
agreement with the United States does not fail to effectively enforce the
environmental or labor laws.” This may be contrasted with the apparently weaker
objectives in the same Act “to strengthen the capacity of United States trading
partners to promote respect for core labor standards,” and, in Sec. 2102(a)(1)(7) to
“strive to ensure that they do not weaken or reduce the protections afforded in
domestic environmental and labor laws as an encouragement for trade.”
Therefore, the USTR argues that CAFTA meets congressional negotiating
objectives and takes a new step toward providing direct input into the labor code and
enforcement of U.S. trading partners that appears to go beyond commitments in the
U.S.-Chile FTA, and hence, the claim to precedent-setting language. Whether these
provisions strike the right balance to garner sufficient congressional support for the
implementing legislation is another matter.
In addition, the dispute resolution process has been criticized as ineffective by
relying on monetary assessments rather than trade sanctions or other measures to
address noncompliance with FTA labor provisions. Details are not available yet to
make a determination with respect to CAFTA, but the USTR summary suggests the
enforcement mechanism has similar attributes for labor, environment, and
commercial disputes.
Dispute Resolution and Institutional Issues
This negotiation group focused on numerous aspects that define how the trade
agreement will operate. Dispute resolution appears to be modeled on previous FTAs,
in which disagreements are intended to be resolved cooperatively with some type of
consultative process, relying on suspension of tariff benefits (return to MFN
treatment) if the dispute is not settled otherwise. Resolving labor and environmental
disputes is trickier and may build on work done in the Chile agreement. This
category of dispute is likely to be included as part of a single dispute resolution
chapter and process, but with the stipulation of reliance on monetary assessments in
cases of noncompliance with labor and environment commitments. Administrative
and other technical matters (e.g. transparency issues) of trade agreement
implementation were also addressed by this working group.
Trade Capacity Building
Even before detailed discussions began on the CAFTA, the Central American
countries expressed a strong apprehension of being overwhelmed by the resources
and experience that the United States could muster to negotiate and comply with
liberalized trade rules. Hence, the need for trade capacity building, which, now that
the negotiation process is effectively over, may be classified into three distinct areas
beyond trade negotiation capabilities. First, the ability to identify priorities, including
where the major adjustment costs (losers) are expected to be and how to respond to
them. Second, the ability to develop resources to implement the agreement,
including institutional, financial, and analytical resources. Third, the capacity to
CRS-24
benefit from CAFTA.51 CAFTA provides for the creation of a permanent Committee
on Trade Capacity Building to continue work begun in the negotiation process.
The third category is arguably the most important. Also referred to as “supply
side” capacity, it refers to the ability of a business to: compete in a larger market;
learn how to export and use imports (as inputs) more to its advantage; tap into global
finance; navigate customs and trade logistics problems; and in other ways make the
transition from local producer to international player.52 This will be a difficult
challenge for many Central American firms, particularly if barriers to world trade are
reduced outside the U.S.-Central American relationship (WTO/FTAA) putting
increasing pressure on marginally productive businesses. The joint-production
relationship already established in textiles and garments suggests that certain firms
have already developed some expertise in meeting these challenges.
From the outset of negotiations, the United States advocated assisting the
Central American countries. Each Central American country prepared a National
Action Plan based on a review of its “trade-related” needs. Assistance is being
provided by the United States, private groups (corporate and non-government
organizations — NGOs), and five international organizations (the Inter-American
Development Bank — IDB, Central American Bank for Economic Integration —
CABEI, United Nations Economic Commission on Latin America and the Caribbean
— ECLAC, Organization of American States — OAS, and the World Bank).53
Outlook
The CAFTA negotiations moved quickly and met the anticipated year-end 2003
deadline, with the exception of Costa Rica. CAFTA was ambitious and innovative
in melding the interests of the United States with those of five smaller countries that
vary significantly among themselves. In so doing, one expectation is that CAFTA
could improve trade relations not only between the United States and Central
America, but within the isthmus as well. To the extent that the United States is able
to open its markets further to the employment-generating sectors of the Central
American economies (agriculture and textiles), CAFTA may assist with the
development process.54
51 This typology of capacity issues was developed by Bernard Hoekman of the World Bank.
Earlier versions of this report mentioned a fourth area, trade negotiation capacity.
52 Ibid.
53 Details of the program and the Central American National Action Plans may be found at
the USTR website: [http://www.ustr.gov].
54 Reducing rich-country protectionism is a critical goal set out by a study aimed at
highlighting policies that may effect social development and equity in Latin America. See:
Birdsall, Nancy, Augusto de la Torre, and Rachel Menezes. Washington Contentious:
Economic Policies for Social Equity in Latin America. Carnegie Endowment for
International Peace and Inter-American Dialogue. Washington, D.C. 2001. pp. 65-66.
CRS-25
CAFTA, however, is not complete and faces political uncertainty. Work
continues on the environment portion of the agreement and details reportedly must
be clarified in other areas as well. Issues with Costa Rica must be settled
expeditiously if it is to accept the agreement early in 2004. The timetable calls for
discussions to occur during the weeks of January 5 and 19, 2004. The Bush
Administration has signaled its expectation to notify Congress of its intention to sign
the agreement, a formal step that would have to be taken relatively soon if Congress
is to act by mid year.
For the United States, reconciling diverse interests remains a standard, but
challenging task in consideration of any FTA. This task is complicated by the
competing nature of negotiating goals. Relaxing trade rules governing agriculture
and textiles, for example, may support trade growth and development in Central
America, but runs contrary to some strong interests in the United States. Labor
advocates argue that CAFTA perpetuates exploitation in Central America, but
proponents assert that U.S. protectionism works against Central America growth and
development and hurts U.S. consumers and exporters. Balancing these perspectives
may prove particularly vexing during a presidential election year. Although CAFTA
has broached new ground in some areas, it is unclear whether it has achieved such
a balance.
CRS-26
Appendix 1. Chronology of CAFTA Negotiations
Date
Milestone
January 16, 2002
President George W. Bush announces his intention to
explore a free trade agreement (FTA) with Central
America.
August 6, 2002
President Bush signs the Trade Act of 2002 (P.L.107-
210), which includes Trade Promotion Authority
(TPA).
October 1, 2002
President Bush, as required under TPA, formally
notifies Congress of his intention to negotiate a U.S.-
Central America Free Trade Agreement (CAFTA)
with the five Central American Common Market
(CACM) countries (Guatemala, El Salvador,
Honduras, Costa Rica, and Nicaragua).
November 19, 2002
USTR holds public hearings, accepting written and
oral testimony on CAFTA.
January 27, 2003
The first of nine negotiation rounds begins in San
Jose, Costa Rica.
December 17, 2003
CAFTA negotiations concluded in Washington, D.C.
Costa Rica decided not to accept the agreement at that
time pending further discussion on insurance,
telecommunications, and agriculture and textile
market access issues.
January 5, 2004
Costa Rica and the United States begin bilateral
discussions on CAFTA provisions.
CRS-27
Appendix 2. Central America: Selected Economic
Indicators
(year 2001 data, except where otherwise indicated)
Costa
El
Guatemala
Honduras
Nicaragua
Rica
Salvador
GDP ($ billions)
15.7
13.0
19.6
5.9
2.5
GDP Growth (%)
1.1
2.0
1.9
2.6
3.3
GDP Growth 1980-
3.0
0.2
0.8
2.7
-1.9
1990 (%)*
GDP Growth 1990-
5.1
4.5
4.1
3.1
2.8
2001 (%)*
PPP Per Capita Gross
9,260
5,160
4,380
2,760
2,080
National Income ($)**
(yr. 2000)
Inflation - CPI (%)
11.0
1.4
8.4
10.0
7.4
Current Account
-4.6
-1.3
-4.6
-4.9
-38.1
Balance (% of GDP)
Pop. Below $1 per
6.9
21.4
16.0
23.8
82.3
day (%)***
Human Development
43
104
120
116
118
Index (HDI)#
Sources: World Bank, World Development Indicators, 2003, United Nations, Human Development
Report, 2002, and IMF web site.
* Average annual percent growth.
** Gross national income (GNI) converted to international dollars using purchasing power parity rates.
An international dollar has the same purchasing power over the GNI as a U.S. dollar has in the United
States. GNI is a different, but similar measure as GDP.
*** Percentage of population living on $1 per day or less, most recent survey year.
# HDI is a composite measure (education, income, and life expectancy) of average achievement in
human development. A lower ranking is better: e.g. United States (6), Italy (20), and South Korea
(27).
CRS-28
Appendix 3. U.S. Merchandise Trade with Central America,
1998-2002
($ millions)
% Change % Change
Country
1998
1999
2000
2001
2002
2001-2002
1998-2002
U.S. Exports
Costa Rica
2,296
2,381
2,460
2,502
3,117
24.6%
35.8%
Honduras
2,318
2,370
2,584
2,416
2,571
6.4%
10.9%
Guatemala
1,938
1,812
1,901
1,870
2,044
9.3%
5.5%
El Salvador
1,514
1,519
1,780
1,760
1,665
-5.4%
10.0%
Nicaragua
336
374
379
443
437
-1.4%
30.1%
Total CAFTA
8,402
8,456
9,104
8,991
9,834
9.4%
17.0%
Mexico
78,772
86,909
111,349
101,296
97,470
-3.8%
23.7%
LAC*
63,396
55,153
59,283
58,157
51,551
-11.4%
-18.7%
Latin America
142,168
142,062
170,632
159,453
149,021
-6.5%
4.8%
World
682,138
695,797
781,918
729,100
693,103
-4.9%
1.6%
U.S. Imports
Costa Rica
2,745
3,968
3,539
2,886
3,142
8.9%
14.5%
Honduras
2,544
2,713
3,090
3,127
3,261
4.3%
28.2%
Guatemala
2,072
2,265
2,607
2,589
2,796
8.0%
34.9%
El Salvador
1,438
1,605
1,933
1,880
1,982
5.4%
37.8%
Nicaragua
453
495
589
604
679
12.4%
49.9%
Total CAFTA
9,252
11,046
11,758
11,086
11,860
7.0%
28.2%
Mexico
94,629
109,721
135,926
131,338
134,616
2.5%
42.3%
LAC*
50,266
58,464
73,348
67,370
69,503
3.2%
38.3%
Latin America
144,895
168,185
209,274
198,708
204,119
2.7%
40.9%
World
911,896
10,024,618
1,218,022
1,140,999
1,161,366
1.8%
27.4%
U.S. Balance of Trade
Costa Rica
-449
-1,587
-1,079
-384
-25
Honduras
-226
-343
-506
-711
-690
Guatemala
-134
-453
-706
-719
-752
El Salvador
76
-86
-153
-120
-317
Nicaragua
-117
-121
-210
-161
-242
Total CAFTA
-850
-2,590
-2,654
-2,095
-2,026
Mexico
-15,857
-22,812
-24,577
-30,042
-37,146
LAC*
13,130
-3,311
-14,065
-9,213
-17,952
Latin America
-2,727
-26,124
-38,642
-39,256
-55,103
World
-229,758
-328,821
-436,104
-411,899
-468,263
Source: Table created by CRS from U.S. Department of Commerce data.
* Latin America and the Caribbean, except Mexico.