Politics, Business & Culture in the Americas

CAFTA-DR Pact:Opening up new frontiers

Reading Time: 3 minutesCAFTA Tangles: After a rocky start, the free trade pact linking the U.S., Central America and the Dominican Republic finally takes off.
Reading Time: 3 minutes

As President George W. Bush pressures Congress to ratify the U.S.-Colombia Trade Promotion Agreement, it is worth examining the results to date of the Dominican Republic-Central America-U.S. Free Trade Agreement (CAFTA-DR). That agreement, involving the United States, five Central American countries (Costa Rica, El Salvador, Guatemala, Honduras, and Nicaragua) and the Dominican Republic has taken a roller coaster ride since initialed in 2004.

CAFTA-DR does not fundamentally change tariff rates for exports to the U.S., since partner countries already enjoyed wide access through the Caribbean Basin Initiative (CBI). Instead, it allows Central American and Dominican Republic companies to build on existing trade preferences by ensuring predictable access to the U.S. market.

Yet passage was politically contentious in several countries, including the U.S., where Congress ratified it by a narrow two-vote margin. In Costa Rica—once one of the staunchest free-trade supporters—a referendum to approve the agreement passed by a thin 51.6 percent margin in October 2007, and the government was still scrambling in February 2008 to approve laws necessary for the agreement to enter into force. Approval is not a foregone conclusion: opposition groups have been given the green light by the Supreme Electoral Court to organize a new referendum on implementing the agreement. In Nicaragua, despite implementation, President Daniel Ortega threatened to pull out of the agreement upon taking office in January 2007.

U.S. entry into force for each partner coincides with that partner’s entry date. (See table).

It is too early to make definitive statements about the impact of CAFTA-DR on trade. The pact has been in force between the United States and El Salvador, the earliest adopter, only since March 2006. The table shows a varied record in terms of goods trade between each member and the United States. With the exceptions of the Dominican Republic and Guatemala, exports to the U.S. through October 2007 have grown since ratification.

Developing an Export Platform

Importantly, CAFTA-DR allows Latin American partner countries to better exploit comparative advantages, including proximity to the United States and relatively low labor costs, by bringing reciprocity to the trade mix. As a result, a wide range of intermediate goods and services are available to local firms. The Inter-American Development Bank (IDB) observes that U.S.-bound exports of nontraditional goods, such as okra from El Salvador, have increased significantly. CAFTA-DR may also help the region to become an export platform.

Between March 2006 and October 2007, intra-Central American exports grew by 17 percent, compared to a 7 percent growth of exports to the world. U.S. exports to the six CAFTA-DR countries grew 25 percent over the same period, compared with 16 percent for U.S. exports to the world.

Beyond consolidating and expanding market access for goods, CAFTA-DR increased access for service providers and eliminated investment barriers while establishing a more predictable legal framework for business transactions.

Guatemala’s foreign direct investment inflows increased by one-third in 2006, according to the United Nations Conference on Trade and Development. In addition, the government reports 3,000 new jobs created in the textile sector as a result of the agreement. Nicaragua attracted a $100 million investment by ITG-Cone Denim, a U.S. fabric producer, to take advantage of textile provisions in CAFTA-DR. In 2007, Honduras gained Brazilian and Canadian textile-focused investment. Meanwhile, Wal-Mart, the U.S. retail giant, increased the size of its Central American network by 13 percent between July 2006 and June 2007 and announced that it would open 12 new stores in Honduras in 2008.

Trade and investment growth is usually accompanied by more disputes, and investors have already resorted to the CAFTA-DR investor-state dispute settlement mechanism (DSM). In the first case, announced in March 2007, a U.S. railway company sued the Guatemalan government for indirect expropriation. It claimed that a law passed the month after CAFTA-DR implementation devalued its investment. Another U.S. company has initiated a dispute against the Dominican Republic, asserting that regulatory changes in the electrical sector damaged investments. The DSM is essential, particularly as nationalization and expropriation are again becoming fashionable in parts of Latin America. However, the mechanism could become a victim of its own success. A blockbuster oil exploration claim by Harken Holdings against Costa Rica is lurking in the wings, and, if pursued, it could inflame region-wide public opinion.

CAFTA-DR has also promoted large-scale regional projects. Plan Puebla Panama, largely financed by the IDB and the Central American Integration Bank, will link electricity grids and transportation infrastructure in the region. The World Bank will finance infrastructure development and rural development and foster measures to improve the investment climate.

After a rocky launch, CAFTA-DR finally looks like it is off the runway. Trade and investment are flowing to and within the region. Many challenges remain, including political and commercial disputes, difficulties in managing regional projects, and continuing the arduous process of internal reform, but if CAFTA-DR serves as the catalyst for meeting these challenges, growth in the region could increase from 3 percent annually to a more promising 5 percent.

Tags: CAFTA, CAFTA-DR, Canada, Caribbean Basin Initiative, CBI, Central American, Costa Rica, Dominican Republic, George W. Bush, Guatemala, Harken Holdings, Honduras, investment, oil, textile, trade, United Nations Conference on Trade and Development, Wal-Mart
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