Right now, through one means or another, 75% of products originating from Central America or the Dominican Republic have duty-free access to the US. The US market, in other words, is already fairly open to imports from Central American countries.
So why are executives at Russell Corporation, an athletic apparel and sports shoe manufacturer that sources much of its product from Central America, thrilled that the US Congress has passed legislation to create a free trade area with five Central American countries (El Salvador, Nicaragua, Guatemala, Honduras and Costa Rica) and the Dominican Republic?
Because Russell Corporation also manufactures some of its product in the US for export to Central America to be completed in its factories in Honduras and Mexico. And those products can be subject to significant tariff rates.
Without the Dominican Republic-Central America Free Trade Agreement (DR-Cafta), the Atlanta-based company would eventually have had to move its sourcing and manufacturing operations to Asia to remain competitive, possibly closing down its US textile and Latin American assembly operations, says spokesperson Nancy Young. “There definitely would have been changes,” she says.
At the moment, the company can cost-effectively source certain products in Central America, manufacture fabric in the US, then send the material to its factories in Honduras and Mexico for assembly, she says. Once the products are completed, they are re-exported to the US for distribution.
“We would not be able to make fabric in the US, export it to Asia, have the products manufactured there and then re-exported back. We probably would have done everything in Asia in that scenario.”
The market could shift again, even with DR-Cafta in place, Ms Young acknowledges. “But right now it will help us consolidate our manufacturing model.” The company might eventually expand its plant in Honduras, she says: “Now that Cafta has passed, we have more options.”
The Nafta model
If proponents of DR-Cafta could invent a company to illustrate why the trade agreement is essential for the region’s economic prosperity, it would be Russell Corporation.
DR-Cafta will expand the number of exports from Central America that can enter the US basically tariff-free and increase the current import quotas per product. Central American countries will make similar concessions. Advocates say that these reductions are essential if the region wants to compete with China – in particular on the textiles front – since the Multi-Fiber Agreement ended in 2004.
It is estimated that a year after the trade agreement is implemented, US exports will have increased by about $3bn per year and agricultural exports by $1.5bn per year. New foreign investment in Central America and the US by European, Asian and Canadian firms will follow.
Tony Villamil, the Greater Miami Chamber of Commerce’s lead volunteer for advocacy and CEO of Washington Economics Group, likens DR-Cafta’s effect on FDI to that of the North American Free Trade Agreement (Nafta) 10 years ago. A deeper and more formal trade relationship typically results in more value-added trade, he says. “Company subsidiaries are able to exchange knowledge and technology and capital goods for production more easily.”
With Nafta, much of that investment was integrated production, he says, such as automobile manufacturing operations in which a component is finished in one country, then exported or re-exported to another for assembly. “We will probably see the same thing in Cafta within the next 10 years.”
Mr Villamil singles out Florida as a major beneficiary of such a shift. Companies from as far away as Europe and Asia are already investing in the state so that they will be optimally positioned. “We are now increasing our marketing dollars to attract FDI from Europe and Asia and we plan to use the DR-Cafta as one of the tools,” he says.
DR-Cafta’s impact will be selective. It will not have the economic might of the combined US-Mexican-Canadian trade economies.
“Some sectors of the economy will benefit more from Cafta than others,” says Jon Schmid, manager of public sector services at BG Consulting in the US city of Alexandria, Virginia. He cites the agriculture, service, consumer and technology sectors as main beneficiaries.
“We have seen some interest from the telecom sector and also textile and apparel,” says Mr Schmid. However, he does not believe that the textile and apparel industries can remain competitive in Central America, even with Cafta, except for specialty apparel items. “For these companies, I think it will be difficult, regardless of the treaty, to realise significant growth in Central America.”
Roberto Sifon Arevalo, associate in Standard & Poor’s (S&P) Latin America Sovereign Ratings Group, agrees that the non-traditional products are most likely to benefit. “Even though there will be an increase of quotas under DR-Cafta [for traditional products], those areas are not where I think we will see a major influence.” Most of these products, such as sugar, are already entering the US free of tariffs anyway, he says.
“The most interesting impact will result from investment in new technologies and a better educated labour force in the region,” he says, pointing to the growing number of multinationals that are setting up call centre operations in the area.
However, Mr Sifon Arevalo says that perhaps the best legacy that DR-Cafta will bestow is its strengthening of the legal framework for inter-region investment. “The business environment will be far better for foreign investors – no matter what sector they are in. That is why we are projecting considerable improvement for the region’s growth.”
S&P’s ratings service is not expecting that entry into DR-Cafta would lead to any sovereign rating changes in the short term, he says.
On the other hand, if the agreement is not ratified, “an opportunity for higher medium-term growth would be missed and some sovereigns could come under downward rating pressures,” S&P warned in a recent ratings note.
The politics of Cafta
For all the enthusiasm in the trade community over DR-Cafta, its final implementation – at least in its current incarnation – is not definite. As with all trade agreements, there has been much controversy. In the US, it passed by the thinnest of margins in Congress, after much arm twisting by the Bush Administration. US textile and sugar industries and trade unions had argued that heavy job losses in the US could result because of competition from countries where workers’ rights are poorly protected.
The agreement has not yet been passed by the Costa Rican, Nicaraguan or Dominican Republican legislatures, all of which are bracing for strong opposition. In Costa Rica, which has tabled a vote on DR-Cafta within the next 18 months, the trade agreement will be a big topic of debate in the coming presidential elections.
That has not stopped US companies from exploring Costa Rican trade and investment opportunities, says Juan Luis Castro, head of the Costa Rican Trade Commission. “Many of these companies would investigate Costa Rica no matter what the status of DR-Cafta,” he says. At the same time, trade proponents hope to leverage DR-Cafta to entice investment by companies that wish to ship their products to the US tariff free.
If Costa Rica ratifies DR-Cafta, Mr Castro predicts that its textile and food sectors would be among the first to benefit. “China is basically flooding the US with its textiles, so DR-Cafta would help. In the food sector, more types of food could be exported tariff free, and in the case of sugar, the quotas would rise.”
Such advances, though, pale into insignificance in comparison with the larger implications of DR-Cafta. “It locks in the liberalisation that has been under way in the region and commits the governments in the region to keeping on this track, even in traditional public sectors such as telecoms,” says Mr Schmid. On this scale, DR-Cafta is a greater symbolic victory than a trade or economic one, he says.
If the treaty is not ratified by the rest of the signatories, however, that victory may ultimately prove to be more pyrrhic than anything else.