Proponents of the soon-to-be-implemented Dominican Republic-Central American Free Trade Agreement (DR-CAFTA), which includes the US, Costa Rica, El Salvador, Guatemala, Honduras, Nicaragua and the Dominican Republic, tend to hold one of two views about the forthcoming trade agreement.

One view is that, while it is an advantageous and even necessary step for the participating countries, it is not as momentous a development as, for example, the North American Free Trade Agreement (NAFTA) or the establishment of the World Trade Organization. “It’s important not to oversell what CAFTA will mean,” says Eric Jacobstein, manager of legislative affairs of Inter-American Dialogue, a Washington, DC-based think tank. “Extreme positions have been staked out by both critics and proponents. It is not a panacea for the sub-region as some proponents have said.” Conversely, he says, the dire picture painted by critics about the impact of the trade agreement on labour and environmental standards in the region is not accurate either.

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In short, according to this view, DR-CAFTA is what it is – a relatively small area in which 75% of the products originating from the countries were already duty free. The advantages of the agreement are therefore straightforward: investment in the region by US companies and even other DR-CAFTA country companies is expected to increase once the protections and opportunities provided by the regime are in place. Also, trade flows are expected to increase once the remaining tariffs are removed.

Another, more intriguing and nuanced view is that at face value DR-CAFTA is a typical trade agreement – much like the bilateral agreement negotiated by the US with Singapore or the one pending with Panama – but with far greater implications for sourcing and site selection decisions. For instance, the end of the Multi Fibre Agreement in 2004 catapulted China into the top spot for textile manufacturing.

Without DR-CAFTA, textile investment and sourcing in the Central American region would have disappeared. Now, these countries are still able to offer a viable alternative to China, not only in textile manufacturing, but also in other areas such as high tech.

“Much of CAFTA’s negotiations were driven by the tremendous growth of the Chinese textile sector and the need to offset it with alternative, low-cost sources of textile manufacturing in other areas of the world,” says Larry Pascal, a Dallas-based partner at law firm Haynes and Boone and chair of its Americas Practice Group.

“CAFTA will make Central America more cost competitive and enable US textile companies to use it as a manufacturing base and enjoy preferential duty rates,” he says.

Far reaching

More far-reaching and less tangible are the implications that a successful DR-CAFTA has for a hemispheric-wide free trade agreement.

“Had DR-CAFTA not been ratified, I think the free trade movement in the Americas would have effectively stalled,” says Jorge Arrizurieta, executive director of Florida FTAA, a Miami-based organisation set up to promote Miami as the location for the Free Trade Area of the Americas (FTAA) Permanent Secretariat.

Other countries would have lost faith in the US’s ability to negotiate trade treaties if Congress had failed to ratify the administration’s negotiated terms, Mr Arrizurieta says. With a successfully functioning DR-CAFTA, South American nations would be more inclined to follow suit. “That is why this agreement was so polemic,” he says.

In the current geopolitical environment, it is difficult to imagine anything acting as a bridge to the FTAA, much less a trade agreement that was barely passed by the US Congress and has not been ratified by one of the signatories, Costa Rica.

Free trade opponents

At the beginning of November, in the Argentine tourist resort of Mar del Plata, the Fourth Summit of the Americas convened. The results could not have been more discouraging for FTAA proponents, with huge crowds demonstrating against it in general and against the Bush Administration’s policies specifically. Little was done to advance the agreement and commentators declared the FTAA, if not dead, essentially stalled given Venezuela’s and the Mercosur countries’ fierce opposition to it.

Observers counter, though, that the initiative is hardly dead, although it is clear that approaching the agreement in a straightforward fashion is unlikely to yield any meaningful results. Instead, the US and other free trade advocates in the western hemisphere – 29 countries in the region have endorsed the FTAA – are quietly attempting to form an Americas free trade area by default, through the use of bilateral and sub-regional trade agreements. DR-CAFTA, thus far, has been the most ambitious.

“CAFTA is the camel’s nose under the tent,” says John Burford, vice-president and investment portfolio manager at The International Bank of Miami. FTAA advocates, he says, want to use DR-CAFTA as an example for the rest of the region. “They want to show how beneficial it can be and then use it to convince the rest of Latin America that free trade is a good thing.”

Currently, free trade negotiations between the US and Panama are under way. Once those are complete, with the exception of Belize, every country in central America will be part of a bilateral agreement, says Stuart Seidel, a partner at Baker & McKenzie and 32-year veteran of the US Customs Service.

Reaching into South America, the US is also negotiating a free trade agreement with the Andean nations, although only Colombia, Ecuador and possibly Peru are in active talks (disagreement over agriculture issues is one sticking point). Assuming these negotiations are successfully completed, there will be a de facto FTAA, with the exception of the Mercosur countries and Venezuela.

Risk of stagnation

Granted, Mr Seidel says, these are major economies. “But they will become stagnant unless they start loosening their restrictions to free trade.” Eventually, they will be forced to realise that free trade is essential to their economic prosperity, he says.

Chile, for instance, has flourished in large part through the myriad free trade agreements it has formed in the past decade or so. “It is the Singapore of South America, whereas Argentina, Brazil and, to a lesser extent, Paraguay and Uruguay have all run into problems, even within Mercosur,” says Mr Seidel.

Not all regional observers support this theory, which is predicated on the completion of pending trade agreements. “CAFTA as a prelude to a FTAA is not realistic,” Mr Jacobstein, of the Inter-American Dialogue, says flatly. “The FTAA is stalled.” Free trade in the Americas will continue to form on a bilateral and piecemeal basis, he agrees. But this will be a poor substitute for a region-wide agreement.

CAFTA versus China

DR-CAFTA is already having an immediate and tangible impact, though, on several site selection, sourcing and investment decisions. It is already clear, even before it has been implemented, that many US firms that would have gone to China to set up textile and other manufacturing operations are now staying in the region because of the agreement, which is expected to go into effect in January.

Mr Arrizurieta of the Florida FTAA says that before DR-CAFTA was ratified, El Salvador was losing 10,000 textile-manufacturing jobs a month to China. “Once it was clear it was going to be ratified, a lot of the companies that were planning to relocate their operations in China decided it was still cost effective to stay where they were,” he says.

Since DR-CAFTA was ratified, the flow of jobs to China from El Salvador has virtually ceased, he says.

“China will still take a lot of business out of the hemisphere,” says Mr Jacobstein. “But it will also keep some investments in place. Without it, the region would not have remained competitive.”

Baker & McKenzie’s Mr Seidel notes that even with DR-CAFTA, China still has a relative advantage. “China has better and newer production equipment. So firms will still have to invest in [production equipment and other infrastructure] in the DR-CAFTA countries. But once that is complete, the location and free trade agreement will prove to be an advantage.”

Chile, for instance, has been able to stay competitive in many products and it is further away from the US than the DR-CAFTA region. “But the country has tripled its exports to the US,” Mr Seidel says. “It has been able to keep up with competition from Asia.”

Other sectors besides textiles are also expected to benefit from DR-CAFTA. “We will definitely see a pick-up in manufacturing and sourcing activity in CAFTA countries,” says Mr Pascal of Haynes and Boone, although the level of investment will differ from country to country. “Besides textiles, Guatemala, Honduras and Nicaragua will also benefit from further investment in light manufacturing.”

Sector opportunities

 

In general, trade and investment opportunities for US businesses under DR-CAFTA include the agriculture, capital goods, infrastructure, textiles, IT, pharmaceuticals, energy, transport and financial services sectors, says Mr Pascal. These opportunities are not limited to DR-CAFTA signatories though, which is one reason why he believes that DR-CAFTA is an important step in forming a FTAA. Panama, for instance, is strong in the financial services sector.

“Two of the more interesting countries in Latin America [in terms of their investment potential for US companies] are Panama and El Salvador because their economies have been dollarised,” he says. “Currency risk has been taken out of the equation.”

Within DR-CAFTA, Costa Rica is the country that is probably furthest along in its economic development, says Mr Pascal. In the 1990s, it landed the now iconic Intel plant. “It was the first plant Intel established in Latin America, and Costa Rica won it over Mexico for several reasons: its overall competitiveness, wage rates and qualified labour,” he says.

Also, the Costa Rican hospitality market has experienced a boom lately, he reports. “It has always been known as a nice, mid-tier destination, but not a five-star locale. Recently, though, we have been seeing more activity in this area as Costa Rica moves up the luxury food chain. I think CAFTA will add further impetus to this movement.”

In general, free trade agreements with the US tend to bestow a “halo effect” or seal of approval on the signatory country, says Mr Pascal. It is a phenomenon that is partly psychological and partly practical: such trade agreements establish comprehensive frameworks for investment, including national treatment for foreign companies and a dispute mechanism.

“It provides a higher level of comfort to US businesses,” Mr Pascal says. “We saw that with Chile and we will see it happen with CAFTA, too.”

In some aspects DR-CAFTA countries are better off than countries operating under earlier free trade agreements. Mr Seidel says that, for instance, NAFTA was unduly complicated. “The rules of origin were simplified in the Singapore and CAFTA agreements. I think each subsequent free trade agreement that is negotiated learns from the complications and errors made in the previous agreement.”

DR-CAFTA has gone beyond NAFTA in many of the protection agreements, such as in intellectual property rights (IPR), he says.

According to Mr Pascal, DR-CAFTA offers a number of investor protection clauses besides IPR. These include non-discrimination, ‘most favoured nation’ status, the altering of disadvantageous ‘dealer laws’, increased market access in certain sectors such as Costa Rica’s telecoms, energy and insurance sectors, and new government procurement opportunities.

Trade as a focus

 

Perhaps the most fundamental advantage – and one that is easily overlooked – is the tariff reductions afforded under DR-CAFTA. “The essence of CAFTA was to extend and lower the tariff reductions that were already in place,” says Mr Pascal. “This may be a free trade agreement that actually leads to an improved trade balance for the US.”

Mr Burford of The International Bank of Miami is counting on it. “We do a lot of trade finance and one of our main markets is Central America,” he says. “A lot of the benefits of the formal agreement were already in place before. So it is easy to overlook the fact that CAFTA will reduce tariffs even further, making it easier for these countries to trade back and forth.”