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September 21, 2004No. 21
The next major trade agreement likelyto come before Congress will be theCentral American Free Trade Agree-ment. The agreement would eliminatealmost all trade barriers between theUnited States, Costa Rica, El Salvador,Guatemala, Honduras, Nicaragua andalso the Dominican Republic.If approved, CAFTA would establishfree trade with nearby countries thattogether make up the United States’13th-largest trading partner and second-largest export market in Latin America,behind only Mexico. Upon implementa-tion, goods in 98 percent of the productcategories from which the CAFTA coun-tries could export to the United Stateswould enter duty-free. For U.S. compa-nies, CAFTA would offer guaranteedreciprocal access for our most competitiveexports, including agricultural products.Two glaring exceptions to free trade inthe agreement are sugar and apparel.CAFTA grudgingly expands the existingquota on sugar imports from the region,denying U.S. consumers and sugar-usingindustries the benefits of lower prices. Itsapparel provisions contain restrictive“rules of origin” requiring use of U.S.-made textiles, which will add to the costof production in the region and ultimate-ly undermine demand for U.S. inputs.Nonetheless, CAFTA marks a major steptoward liberalizing trade.CAFTA would enhance importantU.S. foreign policy goals by promotingfreedom and democracy in a region thathas been troubled in the recent past bywars and political oppression. Today, all sixCAFTA partners are democracies pursu-ing political, economic, and trade reforms.Objections that the agreement doesnot adequately protect environmentaland labor standards are unwarranted. Allsix countries have adopted laws consis-tent with core labor standards as estab-lished through the International LaborOrganization. All six have made measur-able progress on a range of social indica-tors. Promoting trade and developmentthrough CAFTA would further thatprogress.
The Case for CAFTA
Consolidating Central America’sFreedom Revolution
by Daniel Griswold and Daniel Ikenson
 Daniel Griswold is director of the Cato Institute’s Center for Trade Policy Studies,and Daniel Ikenson is a trade policy analyst with the center.
Executive Summary
 
Introduction
One of the most controversial trade agree-ments to come before Congress in several yearswill be the Central American Free TradeAgreement. Signed on May 28, 2004, the agree-ment would liberalize trade between the UnitedStates and five Central American countries—Costa Rica, El Salvador, Guatemala, Honduras,and Nicaragua. An agreement with theDominican Republic was signed two monthslater, on August 5, and will be “docked” withCAFTA and presented to Congress as a pack-age, perhaps by the end of 2004.Four free-trade agreements have alreadysailed through this Congress. In July 2003comfortable majorities in the House and theSenate approved free-trade agreements withChile and Singapore, and in July 2004 evenlarger majorities approved such agreementswith Australia and Morocco. But enactment of CAFTA will not be so easy.Critics of trade liberalization offered onlytoken opposition to the previous agreements,but they have drawn a line in the sand onCAFTA. The most commonly articulated crit-icism is that CAFTA as it currently standsdoes not adequately protect labor and environ-mental standards in the Central Americancountries. Democratic presidential nomineeJohn Kerry has threatened to veto the currentagreement if it is not renegotiated to include“stronger” labor and environmental standards.The economic and foreign policy stakes inthe CAFTA debate are high. Central Americashares a border with Mexico, already a free-trade partner of the United States, making theproposed agreement a logical extension of theexisting North American Free TradeAgreement. Economic, historical, and culturalties are strong between the United States andthe countries of Central America, many of which have sizable immigrant populations inthe United States. The region was a thorn inthe side of U.S. foreign policy during the1980s, when it was plagued by civil strife, com-munist insurgencies, and human rights abuses.A free-trade agreement could be a powerfultool for promoting peace, stability, and democ-racy in the region.As for trade, critics argue that the popula-tions and incomes of our partners in the agree-ment are too low for them to buy U.S. productsin any significant amount. Although none of the five CAFTA countries or the DominicanRepublic is a sizable economic entity by itself,when combined they are surprisingly large as aU.S. economic partner. The total population of the six countries is 45 million and total GDPin 2003 at purchasing power parity was $204billion.
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Because of proximity, U.S. trade with theregion is already robust. In 2003 America’stwo-way trade in goods with the CAFTAcountries and the Dominican Republic totaled$31.9 billion—an amount that would rank those countries together as our 13th-largesttrading partner, ahead of Brazil, Singapore, andAustralia. The CAFTA countries and theDominican Republic make up the second-largest market for U.S. goods exports in LatinAmerica, behind only Mexico.
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This study weighs the impact of the CentralAmerican Free Trade Agreement on the U.S.economy and on U.S. foreign policy. The studyconcludes that, despite its imperfections,CAFTA would promote freedom, develop-ment, and stability in a region vitally importantto America’s national interests.
Trade Barriers Eliminated—With Two GlaringExceptions
From economic stabilization to regionalintegration and security, there are many com-pelling reasons to adopt CAFTA. But the pri-mary purpose of a free-trade agreement is tospur cross-border trade and investment byreducing and ultimately eliminating marketbarriers. CAFTA will undoubtedly advancethose objectives.Technically, for an agreement to truly war-rant the “free-trade” modifier, all trade restric-tions—tariffs, quotas, import licensing pro-
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The CAFTAcountries and theDominicanRepublic make upthe second-largestmarket for U.S.goods exports inLatin America,behind onlyMexico.
 
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grams, and other discriminatory regulations—should disappear, and foreign and domesticcompanies in each market should enjoy the priv-ileges of national treatment. Although CAFTAfeatures significant market access improvementsfor most products, certain quantitative restric-tions and long tariff phase-out schedules existfor a variety of products, and the agreement con-tains a labyrinth of technical provisions used todetermine whether a product qualifies as origi-nating in the region, which is a requirement of preferential treatment. Those “rules of origin” areparticularly cumbersome in the textile andapparel sectors and are sure to impede thepotential growth of trade in those sectors.In that sense, CAFTA (like all of the other“free-trade agreements” of the United States) isnot really a free-trade agreement. The tariff lib-eralization schedule is managed, quotas remainon several products, a safeguard trigger mecha-nism is specified, content requirements to conferlocal origin are mandated, compensation in lieuof market access for sugar is stipulated, and soon. The agreement is less ambitious than itcould and should have been. But despite thoseshortcomings, CAFTA is an affirmative steptoward the policy goal of free trade.
Immediate and Reciprocal Access
By eliminating or at least reducing tariffsand increasing quota allowances, CAFTA islikely to lead to increased trade and to spurinvestment within the region. The lower costsof cross-border transactions will mean lowerprices throughout the supply chain and thepotential for a more optimal allocation of resources. Meanwhile, the reciprocal nature of liberalization will present U.S. exporters withgreater sales opportunities, a dynamic that islikely to accelerate as Central Americans andDominicans earn more foreign exchange, raisetheir own incomes and living standards, andultimately purchase more U.S. products.Contrary to what some of CAFTA’s detrac-tors have been saying, trade between the UnitedStates and the six CAFTA partners is signifi-cant. In aggregate, America’s CAFTA partnerspurchased $15.1 billion worth of U.S. exports in2003, an increase of 11 percent from 2000, mak-ing the region the 13th largest market for U.S.exporters and four times larger than Chile, withwhom the U.S. signed a free-trade agreement in2003.
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Meanwhile, U.S. imports from the regiontotaled $16.8 billion in 2003, up 4 percent from2000, making it the 15th-largest supplier to U.S.consumers and businesses.
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Opponents of the agreement suggest thatCentral Americans cannot afford U.S. productsand that “surrendering” access to the U.S. mar-ket without complete reciprocity will exacer-bate the trade deficit. The reality, however, isthat each of the six CAFTA partners alreadyhas duty-free access to the U.S. market underthe Caribbean Basin Trade Partnership Actprogram. In fact, most of the products onwhich U.S. tariffs go to zero immediatelyunder CAFTA are already afforded duty-freeaccess under the provisions of the CBTPA.Under CAFTA, however, there will be fewerrestrictions and lower compliance costs associ-ated with qualifying for preferential access.For those who are inclined to keep scorefrom only the perspective of market accessabroad (an accounting method that discountsentirely the benefits of imports), the differencebetween the CBTPA and CAFTA is thatCAFTA is reciprocal. It will grant U.S. compa-nies duty-free access to the Central Americanmarket for a variety of products, which are atpresent subject to tariffs.CAFTA would reinforce and accelerate thetrend in the region toward more open markets.All of the trade-agreement partners havemoved decisively to open their economies totrade in the past decade, lowering tariffs andother trade barriers to imports from each otherand the rest of the world. The result has been avisible increase in import competition. In everyone of the CAFTA countries, imports of goodsand services as a share of GDP have risensharply in the past decade. Between 1991 and2001 the average ratio of imports to GDP forthe six countries rose from 33 percent to 49percent.
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A free-trade agreement would buildupon that progress by expanding and solidify-ing gains in market access.With certain industry exceptions, tariff elim-ination under CAFTA is actually quite liberal.
The reciprocalnature of liberalization willpresent U.S.exporters withgreater salesopportunities, adynamic that islikely to accelerate.
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