Central American–Dominican Republic Free Trade Area (CAFTA-DR)
On May 28, 2004, after a year and a half of intense negotiations, the United States and five Central American countries (Costa Rica, El Salvador, Guatemala, Honduras, and Nicaragua) signed the Central American Free Trade Agreement (CAFTA). The Dominican Republic joined the agreement on August 5, 2004, and to reflect this, the acronym was changed to CAFTA-DR. Like other recent free trade agreements (FTAs) signed by the United States, CAFTA-DR is a comprehensive agreement that goes far beyond traditional FTAs. Once fully implemented the agreement will bring about the elimination of barriers to virtually all trade and investment, and each member country will have implemented legal and regulatory reforms designed to protect intellectual property, raise and enforce labor and environmental standards, improve customs administration, and open up government procurement.
By December 2007, the treaty had been implemented between the United States and four countries and implementation with the Dominican Republic was imminent. Costa Rica had yet to submit the treaty to its congress for a vote, but ratification was certain following approval on October 7, 2007 by 51.6 percent of Costa Rican voters of a referendum supporting the treaty.
Challenges and Opportunities
For the Central American (CA) countries, the FTA offered an opportunity to enhance their protrade,market-oriented development strategy by locking in the strategy with a trade agreement with the United States, their principal trading partner aswell as the world’s largest market. In 2004, the United States accounted for 56 percent of the region’s exports and 44 percent of the region’s imports. The agreement would also secure access on a reciprocal and more permanent basis. Eighty percent of the region’s exports to the United States already entered duty free, but under the Caribbean Basin Initiative and General System of Preferences, tariff programs are one way, highly limited, and subject to periodic review and approval by the U.S. Congress.
U.S. policymakers sawan opportunity to improve national security because boosting regional prosperity would strengthen the region’s ability to cooperate on security. They also saw an opportunity to pry open globalmarkets for U.S. exporters and investors. The U.S. Trade Representative (USTR) notes that in 2004 the region represented the 2nd largest U.S. export market in Latin America behind Mexico and the 14th largest worldwide, ahead of India, Indonesia, and Russia combined.
The treaty posed two major challenges. First, it had to be perceived as balanced and not one in which theUnited States used its large economic size to gain the bulk of concessions. In 2004, the six countries had a combined population of about 45million and a joint gross domestic product (GDP) of $90.7 billion, whereas the U.S. population stood at 294 million and GDP amounted to $11.7 trillion. Second, the treaty needed to balance the beneficial competitive pressures that come from freer trade with a recognition that the burden of adjustment would fall heaviest on the Central American countries since their economies were relatively more closed. Their average rate of protection was estimated to be more than three times that for the United States. Also, a high share of their economywas vulnerable. In 2004, the trade exposure index (the ratio of exports and imports to GDP) ranged froma low of 49.4 percent for Guatemala to a high of 94.3 and 95.8 percent, respectively, for the Dominican Republic and Costa Rica. Yet the Central American countries were least able to counteract the harmful adjustment effects. In 2004, per capita incomes (valued at purchasing power parity, or PPP) ranged from a high of $9,887 for Costa Rica to a low of $2,677 for Nicaragua, whereas the U.S. per capita GDP (valued atPPP)was $39,710.
Agreement Highlights
The treaty commits the signatories to the elimination of import tariffs on nearly all goods traded among member countries. The only products exempted from tariff reductions are imports of sugar by the United States, white maize by El Salvador, Guatemala, Honduras, and Nicaragua, and potatoes and onions by Costa Rica.
The majority of products will receive zero-duty status immediately on the treaty’s entry into force. According to estimates provided by USTR (2005), nearly 80 percent of U.S. exports of consumer and industrial goods to the region and 50 percent of its agricultural exports will receive immediate duty-free access. The tariffs on the remaining exports of industrial goods would be phased out in 10 years, whereas those facing U.S. agricultural products would be subject to tariff phase-out periods ranging from5 to 20 years. For regional exporters, nearly 100 percent of their exports to the United States will receive immediate duty-free access, with only 19 products restricted to a 10-year phase-out period.
In addition to the lengthy transition provisions for duty reductions in order to lessen adjustment effects, the treaty permits tariff-rate quotas (TRQs) to be established for sensitive agricultural products. TRQs provide immediate zero-duty access to the quota amount of imports, but above-quota imports are assessed a higher, prohibitive rate. A special temporary safeguard rule was also established to prevent harm to domestic agriculture during the transition.
The United States made two important concessions in terms of market access. First, it agreed to double the region’s sugar quota allocation over a 15- year period. Second, it relaxed the rules of origin pertaining to apparel, allowing certain apparel to enter duty-free even if the fabric was not produced in the United States. Eligible textile and apparel imports would also receive duty-free treatment retroactively to January 1, 2004.
In the services area, the treaty commitments go beyond those under theWorldTradeOrganization’s General Agreement on Trade in Services. Most industries receive broad market access. United States negotiators were also successful in opening access to sensitive sectors such as the telecommunications and insurance industries in Costa Rica. By late 2007 all that remained was passage of the necessary implementing legislation, considered a virtual certainty given the composition of the legislature. The related investment provision locks in rights for foreign investors that are already recognized in the region, such as the right to national treatment and nondiscrimination, fair compensation for expropriation, free transfer of profits, third-party arbitration, etc. A unique feature of this FTA is that it provides for a tribunal to review decisions by arbitration panels to ensure that foreign investors are not using them to circumvent domestic judiciaries (World Bank 2006).
The treaty includes detailed rules for improvement of customs procedures, enhancing transparency and access to government procurement bidding, and the monitoring and enforcement of labor and the environment standards. Unique aspects of the treaty related to the latter include: (1) establishing the right of citizens to request investigations if they believe environmental laws have been violated, (2) a commitment from the United States to strengthen the region’s capacity to monitor labor and environment standards, and (3) the establishment of fines of up to $15 million for each instance of nonenforcement of labor laws.
Several studies have developed estimates of the likely economic effects on member countries of forming CAFTA-DR. Despite differences in techniques and scope, the conclusions are broadly similar. For the United States, they show that the aggregate economywide effect will be positive, but negligible. According to the largest estimate of the economic effects, by Brown et al. (2005), liberalizing trade in goods improves U.S. economic welfare by 0.04 percent of U.S. gross national product (GNP), while liberalization in services adds an additional 0.13 percent of U.S. GNP. The remaining studies, though limited to the effects of removing barriers to trade in goods, project a positive and even smaller impact on the U.S. economy. Two other studies (surveyed in Brown et al. 2005) project an improvement of GDP of 0.02 and 0.01 percent, whereas USITC (2004) obtains a positive impact on U.S. welfare of $166 million which, when rounded, amounts to 0.00 percent of GDP.
The consequences for the regional economies are projected to be more significant. Brown et al. estimate an increase of 4.4 percent in Central American countries’ GNP, whereas the other two studies calculate a rise of 2.4 and 1.5 percent in GDP.
It is important to note that the projections just cited for the Central American countries may be viewed as ‘‘minimum’’ estimates since they do not take into account the likely impact on foreign investment flows. Nor do they take into account the effects of locking in access to the U.S. market and providing amore stable regulatory environment.On the other hand, as underscored by the World Bank (2006), for these gains to be fully realized and spread equitably, the Central American countries will need tomake complementary investments in areas such as infrastructure and create programs to assist the most vulnerable groups, that is, the poor, so they ‘‘have the means to take full advantage of the new opportunities.’’ See also Central American Common Market (CACM); free trade area; Free Trade Area of the Americas (FTAA); regionalism; tariff rate quotas