INTERNATIONALBANK FOR WORLD BANK R E T C N O E N STRUCTION PM AND DEVELO October 2003 No. 33 A regular series of notes highlighting recent lessons emerging from the operational and analytical program of the World Bank`s Latin America and Caribbean Region CAFTA: CHALLENGES AND OPPORTUNITIES IN THE AGRICULTURAL AND AGRO-INDUSTRIAL SECTORS Ricardo Monge-González, Miguel Loría-Sagot, Claudio González-Vega Context: The CAFTA negotiations Agricultural and Agroindustrial Sectors of Central America from a Free Trade Agreement with the United Since 1984, various trade liberalization reforms have States of America" examines how a FTA between the US increased trade flows with the US and revealed actual and and CA countries might affect the agricultural and agro- potential comparative advantages of industrial sectors of Costa Rica, El the Central American (CA) countries. Salvador, Guatemala, Honduras and Reforms include: those implemented Nicaragua. Two main questions are unilaterally by CA countries; the US's addressed: (i) how to guarantee better Caribbean Basin Initiative (CBI); CA US market access for CA's agricultural adherence to the Uruguay Round and agro-industrial exports, and (ii) (1986-1994); membership in the World how to promote greater openness to Trade Organization (WTO); and Free imports from the US of food products Trade Agreements (FTAs) with Mexico that are "sensitive" in each CA from 1995, when Mexico joined domestic market. NAFTA. The authors analyze the structure of Yet protectionist pressures persist in CA and the US. In agricultural and agro-industrial exports and patterns of response to strong lobbying, some agricultural and agro- revealed comparative advantages in CA, and tariff and industrial products were excluded from existing FTA lists of non-tariff barriers (NTBs) these exports face in the US. goods subject to tariff reductions. Non-tariff barriers in the The report suggests that the CAFTA negotiations consider US still block imports of commodities for which CA (i) lessons from Mexico's entry into NAFTA, (ii) existing possesses comparative advantages and high export potential. protectionism in the US, and (iii) specific features of each In CA and the US, reactions to new trade negotiations are CA country. It recommends domestic policy reforms to likely from exporters of traditional (coffee, bananas, sugar, improve the competitiveness of CA producers of and beef) and non-traditional commodities and producers "sensitive" and new export goods. engaged in import substitution agriculture or non-tradable goods. Central American Trade with the United States World Bank Analysis of CAFTA Challenges and Opportunities The US is CA's main trade partner. The share of total exports to the US ranged from 23 percent (El Salvador) to 53 percent (Honduras); the share of total imports coming A Central America Free Trade Area (CAFTA) has been from the United States ranged from 24 percent under negotiation since January 2003. A World Bank (Nicaragua) to 51 percent (Costa Rica). report, "Opportunities and Challenges for the 1 CA economies show high but diverse degrees of openness. In going to the US increased from 37 percent (1982) to 55 2000, exports ranged from 10 percent (El Salvador) to 34 percent (1988). Costa Rica enjoyed early-learning percent (Costa Rica) of GDP and imports from 27 percent advantages, and has taken the greatest advantage of CBI (Guatemala) to 72 percent (Nicaragua) of GDP. The trade preferential treatment for agricultural imports, followed openness index [(exports+imports)/GDP] was 0.39 (El closely by Guatemala and Nicaragua. From 1989 to 2001, Salvador) and 0.41 (Guatemala) at the lower end, and 0.71 Costa Rica's agricultural exports to the U.S. grew from US$ (Honduras), 0.72 (Costa Rica) and 0.98 (Nicaragua) at the 517 million to US$ 1,063 million (6.2 percent average higher end. annual increase), Guatemala's from US$ 454 to US$ 731 million, and Nicaragua's, from almost nothing to US$ 205. The share of primary commodities in total exports declines In contrast, Honduran agricultural exports to the US with development. This share was highest (85 percent) in stagnated, El Salvador's declined. The coffee crisis Nicaragua, and lowest (33 percent) in Costa Rica where exacerbated these outcomes. manufactured goods exports expanded rapidly from the mid- 1980s and investments in human capital and institutional Determinants of Export Success infrastructure have recently attracted foreign-owned high- technology firms (e.g., INTEL). In 2001, Costa Rica's exports (US$ 5,043 million) were over five times greater Although no formal studies have been conducted, numerous than in 1985 (US$ 976 million). circumstances may explain Costa Rica and Guatemala's relative success in taking advantage of the CBI. All CA countries (except El Salvador) are net Impressive human capital and institutional exporters of agricultural and agro-industrial infrastructure increased Costa Rica's readiness. products to the world and to the US. The US is the Trade policy reforms, including export subsidy main destination ­ shares range from 36 percent schemes, paid off. Guatemala relied less on (El Salvador) to 63 percent (Honduras). In subsidies and more on domestic policies and absolute value, Costa Rica is by far the largest programs to support the export drive. exporter of primary products to the US. The US is also a key source of CA food imports; shares Agricultural protectionism range from 29 percent (Nicaragua) to 46 percent (Costa Rica). Simply put, the US market matters for Central America. Exports of 48 agricultural commodities from CA to the US encounter tariff peaks ranging from 21 to 121 percent. Despite CBI and other preferences, the US The Caribbean Basin Initiative maintains tariffs and NTBs against imports of US domestically "sensitive" goods. Clark and Zarrilli (1994) The US unilaterally enacted the Caribbean Basin Economic found that 48 percent (Costa Rica), 68 percent (El Salvador), Recovery Act (1983), granting preferential tariff treatment to and 45 percent (Guatemala and Honduras) of the value of CA most imports from CA. Intended to last 12 years (through exports faced some NTB in the US. The US applied import 1995), it was extended through 2008, with approval of the quotas and seasonal tariffs according to Section 22 of the Trade and Development Law HR1594 (NAFTA parity) in 1993 Farm Law. For Costa Rica, it applied tariff-rate quotas 2000. on chocolate and other processed foods, automatic licensing procedures on meat and preparations made of meat, anti- The CBI and NAFTA parity granted most goods produced in dumping duties on flowers, increased tariffs on ethyl alcohol CA duty-free access to the United States, when: (i) goods are and seasonal tariffs on imports of a large variety of fruits and cultivated or manufactured in one or more CBI countries; (ii) vegetables. El Salvador, Guatemala and Honduras faced imported raw materials undergo substantial transformation; automatic licensing for meat and preparations made of meat (iii) local value added accounts for 35 percent or more of and quotas on cheese. total production costs, and (iv) if raw materials from the United States are used, and national or regional value added In CA countries, "sensitive products"--key agricultural is at least 20 percent. Before NAFTA parity, the CBI commodities for domestic consumption (e.g., dairy products, excluded canned tuna. The CBI also established tariff-free yellow corn, rice, beans, sugar, beef, pork and poultry)-- quotas for meat, dairy products, sugar, peanuts, tobacco and enjoy some form of protection. Effective rates of protection cotton, and most-favored-nation tariff for over-quota vary greatly across products and countries. Products imports, although the US can adopt safeguards when excluded from recent FTAs differ across countries. There massive imports cause proven harm to US domestic are arguments for trade liberalization in these commodities producers. across CA. Trade restrictions are not an appropriate tool to deal with the problems and lack of competitiveness CBI preferences and trade policy reforms resulted in associated with these products. The paper suggests substantially increased trade flows. Costa Rica's non- alternative mechanisms to enhance competitiveness, guided traditional exports grew 31 percent per year and the share by Mexico's successes and failures. 2 Domestic Subsidies to Agriculture Any FTA negotiation should focus on these commodities, when there are entry barriers in the U.S. market. For each CA country, RCAIs were computed both for the United States Direct subsidies to agricultural production abroad--which and the world. A presumption of barriers to trade in US depress world prices and increase their volatility--affect 42 market emerges when the RCAIs for the world are equal or percent of CA exports and 8 percent of imports. Trade higher than 1 but not for the US. This presumption was then barriers, which are more harmful to developing country verified by looking at the existence of domestic production exports, may further protect domestic production of subsidies and tariffs and NTBs in the United States and at the subsidized goods. possibility that the U.S. is a pure net exporter of those commodities. For CA, reducing tariffs and NTBs should take precedence over reducing US domestic production subsidies in CAFTA At the 8-digit level, Costa Rica possesses revealed negotiations. A 50-percent reduction in WTO-country tariffs comparative advantages in the world for 267 line items, with would increase CA agricultural exports between 14.6 percent average exports of $ 1,536 million, but this is not the case for (Costa Rica) and 3.4 percent (El Salvador) and CA imports 136 line items in its exports to the U.S. market. That is, for between 4.5 percent (El Salvador) and 2.9 about one-half of the line items for which percent (Nicaragua). A 50-percent reduction Costa Rica has been a successful exporter in WTO-country production subsidies to the world, it has not had the same would increase CA exports only 1.7 percent relative success in the US market and (Costa Rica) to 1.0 percent (El Salvador) there is unused export potential. In the and leave imports almost unchanged. Lower majority of these cases (83 percent of the trade barriers would also have more impact 136 line items), there are exports to the on CA countries' terms of trade and welfare world but none to the United States, levels (following Hoekman et al., 2002). mostly because of some barrier. Thus, Costa Rica gains more than other CA excluding a few commodities for which countries because of higher price elasticity the United States is a pure net exporter, of its exports supply, so is better prepared to this constitutes Costa Rica's shopping take advantage of greater market access. list. It includes some dairy products, edible plants and fruits, seeds, preparations with meat and fish, processed sugar and Revealed Comparative Advantage of CA others. Countries El Salvador possesses revealed comparative advantages in the world for 200 line items, with average exports of $ 542 The main contribution of the document is the identification million, but this is not the case for 116 line items in exports of shopping lists for each CA country, based on their to the U.S. market. That is, for over one-half of the items for revealed comparative advantages and the corresponding which E.S. has been a successful exporter to the world, it has barriers to access in the U.S. market. Using data for 1998- not had the same success in the U.S. market. In 94 percent of 1999-2000, revealed comparative advantage indexes (RCAI) these cases there are exports to the world but none to the were computed for each country (following Balassa, 1967). United States, mostly because of similar barriers as those The RCAI compares a given country's share (e.g., for El faced by Costa Rica. Excluding commodities for which the Salvador) in exports of a given commodity (e.g., coffee), to US is a pure net exporter, this constitutes El Salvador's the same destination (e.g., the United States), by a group of shopping list. Central American countries, with the country's share in the total exports of a set of commodities (e.g., agricultural Guatemala possesses revealed comparative advantages in the goods) by the same group of countries. If the ratio is higher world for 261 line items, with average exports of $ 1,236 than 1, the country possesses a comparative advantage in this million, but this is not the case for 184 line items in exports commodity, as revealed by its relative success in exporting it to the U.S. market. For 70 percent of the items for which (see Table 1). Guatemala has been a successful exporter to the world, it has not had the same success in the U.S. market. In 89 percent of these cases, there are exports to the world but none to the Table 1 # RCA items Average # Items with % items in (world exports of RCAI index = previous United States. Excluding commodities for which the United Country trade) RCA items ($ 1 for world column with no States is a pure net exporter, this constitutes Guatemala's millions) but not US exports to US shopping list. Costa Rica 267 1,536 136 83 El Salvador 200 542 116 94 Honduras possesses revealed comparative advantages in the Guatemala 261 1,236 184 89 world for 132 line items, with average exports of $ 494 million, but this is not the case for 75 line items in exports to Honduras 132 494 75 85 the U.S. market. That is, for over one-half of the items for Nicaragua 140 401 82 81 which Honduras has been a successful exporter to the world, 3 adapted to focus more directly on the immediate challenges it has not had the same success in the U.S. market. In 85 posed by CAFTA. Additionally, a new competitiveness percent of the cases, there are exports to the world but none project for Honduras will be presented to the Bank's board to the United States. Excluding commodities for which the in 2003. For more information on these projects please go to United States is a pure net exporter, this constitutes http://www.worldbank.org/projects Honduras' shopping list. Beyond financing, the Bank is responding to Central Ameri- Nicaragua possesses revealed comparative advantages in the can Governments' requests for analytical and advisory sup- world for 140 line items, with average exports of $ 401 port through studies of strategic CAFTA-related issues, that million, but this is not the case for 82 line items in exports to emerged in consultations held across the region in Decem- the U.S. market. That is, for over one-half of the items for ber 2002. These efforts build on the "Lessons from which Nicaragua has been a successful exporter to the world, NAFTA" studies recently published by the Latin America it has not had the same success in the U.S. market. In 81 Chief Economist Office. See http://www.worldbank.org/ percent of the cases, there are exports to the world but none laceconomist to the United States, mostly because of trade barriers. Excluding commodities for which the United States is a pure The Bank obtained grant resources to strengthen the in- net exporter, this constitutes Nicaragua's shopping list. stitutional capacity of the Central American governments to facilitate policy implementation related to the CAFTA. Thus, despite the CBI, there is still a long list of CA Potential areas of support include systems development and agricultural and agro-industrial products (over one-half of training of government officials, among others. goods exported to the world but not the United States) that face important barriers in the U.S. market. Indeed, most of About the Authors these goods were excluded from the CBI. There are differences in the shopping lists of the various countries. The authors are Executive Director of CAATEC Foundation, Professor of Economics at the University of Costa Rica, and Sensitive Products Professor of Agricultural, Environmental and Development Economics at The Ohio State University. A number of key agricultural commodities for domestic See Also consumption (e.g., dairy products, yellow corn, rice, beans, sugar, beef, pork and poultry) enjoy some form of protection Lessons from NAFTA and other Free Trade in the CA countries, designated here as sensitive products. Agreements Effective rates of protection are highly dispersed across products and across countries. Products excluded from The purpose of this study (available at http:// recent FTAs differ across countries. There are arguments; www.worldbank.org/laceconomist) was to derive lessons for moreover, for the liberalization of trade in these commodities policy makers in the region regarding the likely design and across CA. Trade restrictions are not an appropriate tool to economic effects of future free trade agreements (FTAs) deal with the problems and lack of competitiveness with the United Sates. This in turn involves a triple objec- associated with these products. The paper suggests tive: (1) an assessment of the Mexican experience with alternative mechanisms to enhance competitiveness in these NAFTA, to evaluate what countries can expect from such areas. The successes and failures of the Mexican experience FTAs, especially in terms of speeding up convergence with are reported as a guide for these exercises. the U.S., and how that may depend on their institutional and policy framework; (2) an evaluation of how key features of Download the full report at http://www.worldbank.org/lactrade NAFTA, likely to be replicated by future FTAs with the U.S., would affect other countries in the region choosing to ******** join in but starting from initial conditions possibly very dif- ferent from Mexico's; and (3) an assessment of the impact The World Bank and CAFTA of NAFTA on excluded LCR countries, to gain a regional perspective on the impact of NAFTA beyond Mexico, as As Central American countries engage in free trade negotia- well as to inform policymakers about the issues that would tions with the United States, the World Bank has designed a arise from the inclusion or exclusion of countries during the support strategy to ensure that an agreement would fulfill its transition towards the Free Trade Area of the Americas potential to reduce poverty and spur growth in the region. (FTAA). The Bank's assistance strategy includes loans, analytical and advisory support, as well as grant funds. About "en breve" "en breve" appears every two weeks in English and Span- A key element of the Bank's strategy is the support offered ish (occasionally Portuguese). To subscribe send and email through a portfolio of $41.3 million in ongoing loans to to "en_breve@worldbank.org" Visit the archive at: enhance the competitiveness of firms in Nicaragua, Gua- temala and El Salvador. These loans are currently being http://www.worldbank.org/en_breve 4