Baptism by fire: the U.S. Central America free trade deal is real. Now what?

There will be no announcer telling people to lake their marks, and no starter's pistol signaling when to run. In fact, Jan. 1, 2006--the day the free trade agreement between three Central American countries, the Dominican Republic and the Untied States takes effect--will probably seem more like a lazy Sunday afternoon than the start of a regional economic revolution.

Doomsday prophets against the deal will awaken to discover the' moon has not crashed into the earth, and those who have fouled free trade as a panacea tier ending poverty win not find formerly impoverished campesinos traveling to the capital to buy a 2006 Toyota truck. The reason: the deal is set up to be a marathon, not a sprint. This is a good thing for Central America, considering many small and medium-sized businesses and producers admit they still don't understand all that the agreement entails. Many are hoping that if they start running with the crowd from day one, they'll eventually find their stride.

There will be some early leaders, however, especially the textile industry, which has been anticipating the deal as Chinese competitors' goods pour into their major market, the United States. Yet the fullness of Cafta won't be implemented for another 20 years, since phase-out periods are built in to provide some protection to vulnerable agricultural sectors.

While these extended grace periods reduce the sense of urgency for some, the challenge for Central American business leaders and policy-makers will be to take advantage of the time they have been given to implement a comprehensive strategy once the safety net is removed. Winners and losers under Cafta will be determined to a great degree by their eventual levels of preparation.

"Cafta is fundamental |or the Central American countries, and it will generate very important benefits," says Anabel Gonzalez, Costa Rica's head trade negotiator. "However, the magnitude of its positive impact will depend on the ability of each country to take advantage of the benefits that the accord generates."

That impact on Costa Rica's economy will also depend on whether or not it's ratified by that country's legislative assembly. To date, Costa Rica and Nicaragua are the only two countries holding out, although Nicaragua at press time was expected to join soon. Whoever is left wailing will have two years to join the pact or forever be left out.

In some sectors of the economy, the benefits of free trade are obvious and already are being felt. This is perhaps most apparent in the textile sector, widely considered the trade pact's big winner, in part because most other Central American products were already being imported into the United States duty-free under the Caribbean Basin Initiative or the U.S. Generalized System of Preferences. With a liberalization of trade duties on textiles, and a relaxation of rules of origin for materials, Central America's recently slumping textile industry gets a strong boost from Cafta's signing.

Hemorrhaging. But don't expect a massive increase in employment. At least not initially. Instead, the first task is to stop the recent hemorrhaging of textile jobs in Central America, say trade lawyers. The trade pact now gives textile plants already operating in Central America a reason not to move their operations to Asia, as some apparel factories have in the last few years, says Chandri Navarro of Washington, D.C. firm Hogan & Hartson.

In time, Navarro says, existing textile companies could expand operations in Central America, while some of the ones that left will start to come back. "One-hundred thousand people in Honduras have lost their jobs in the textile industry, and 120,000 in the Dominican Republic," Navarro said. "These jobs will come back, probably in the first two years."

Textile companies aren't necessarily waiting. A special retroactive clause in Cafta allows for companies already operating in Central America to claim a refund of past import duties dating back to January 1, 2004, according to Navarro. So the first wave of textile companies hoping to take advantage of the new deal made their move months ago in anticipation of cashing in later.

T-shirt giant Gilden Activeware in May decided to expand its production in both Honduras and the Dominican Republic in hopes of reaching an annual production rate of 444 million T-shirts by the end of this year. The company also has a sewing plant in Nicaragua, although it has postponed plans to build a massive new textile plant there.

For Central American economies in general, the degree of success under Cafta will depend on preparation, according to the World Bank. Governments must align policy with reality while spending on ports, roads and customs and making institutional, educational and regulatory reforms, the bank warns.

Interestingly, the only two countries so far to develop Cafta-specific reform agendas are the two final holdouts to ratification: Costa Rica and Nicaragua. The $355 million Costa Rican plan, financed by loans and public funds, focuses on facilitating trade; improving educational quality with more focus on English and encouraging innovation; streamlining government procedures to register a business and access credit; and support for small and medium-sized production and rural development.

Nicaragua's agenda for Cafta includes 23 new laws to improve competitiveness while protecting labor and the environment. As of September, however, only three of the laws had been approved.

Other preparatory efforts in Nicaragua are moving forward, says Azucena Castillo, Nicaragua's Minister of Development, Industry and Trade. The government's plan to prepare for Cafta has four elements: agricultural assistance, support for small and medium-sized businesses, environmental protection, and increasing competitiveness.

Cooperation. With funding from international lending institutions, Managua has started working with the country's 6,000 small and medium-sized businesses to increase public-private cooperation, explain export requirements and paperwork, and provide some technological training to try to close the digital gap. The preparation plan for Cafta is not perfect, Castillo says, but she insists it's a step in the right direction: "The worst thing we could do would be to do nothing."

The private sector, meanwhile, claims that government is just going through the motions. "It's just not sufficient, there a lot of sectors that still don't understand what Cafta is or how it will affect them," says Zacarias Mondragon, president of the Nicaraguan Council of Micro, Small and Medium-Sized Businesses. "There have been some workshops in Managua, and a couple in the outlying departments, where someone from the government shows up and talks about intellectual property rights or access to markets, but the people are understanding very little about what's being said. The education campaign needs to be more effective, more directed and more intense."

What small Nicaraguan producers really need, Mondragon says, is help financing improvements to their businesses. "The government is telling us we need to improve our businesses to become more competitive, but they aren't giving us the resources to do it," he says.

The disconnect between the government's preparedness campaign and what people are actually getting out of it is also apparent in neighboring El Salvador. In September, the Salvadoran Ministry of the Economy organized the country's first "Cafta Fair" aimed at small and medium-sized business owners. The event offered an opportunity to network and learn about various programs offered by the government and international organizations in the areas of training, technical assistance, business management, production, marketing, exporting, financing and market information.

The fair also allowed small businesses to receive a professional "export diagnosis" to give them an idea of their capacity and conditions to export products to the United States or other Central American countries. "The first Cafta fair was born as an immediate response to the micro, small and medium-sized businesses that today, more than ever, are demanding support that will allow them to prepare themselves to take advantage of the free trade treaty with the United Status," says Yolanda de Gavidia, Salvadoran Minister of the Economy.

Judging by a study released in August by the Salvadoran Chamber of Commerce, a fair alone falls far short of the need. Eighty percent of small and medium-sized businesses in El Salvador still don't know what Cafta truly means. Gavidia declined to comment directly on the study, instead saying: "Many businesses are already discovering new opportunities. With or without Cafta, businesses have been preparing themselves."

Nevertheless, the minister says, more needs to be done. "It's important to redouble efforts to take advantage of the treaty in the best way possible," she says.

In Guatemala, the government's Cafta campaign seems to be focusing more on pro-free trade propaganda than useful information, says trade consultant and intellectual property rights expert Marco Antonio Palacios, of Palacios & Asociados/Sercomi.

Insufficient. Guatemala's Ministry of the Economy, in conjunction with other government ministries, is working on an internal study to identify areas that need to be modified or adapted to conform to Cafta, says Palacios. But very little of what the government is doing to prepare the country is known outside of a small circle of ministers. As a result, Palacios says, getting ready in Guatemala is a case of every man and woman for him or herself.

"Some members of the private sector are working to identify in the greatest possible detail elements in the treaty that are relevant to their products and their participation in the market" Palacios says. "Yet despite various efforts, information and analysis is not sufficient."

Small businesses and producers aren't the only ones left out of the loop, Palacios says. The legal system itself is at risk of falling behind for lack of experience. "The countries of Central America have given very little attention to the training of judges, magistrates, state prosecutors and customs employees on intellectual property rights," he says. Intellectual property rights must be better protected in emerging economies so as not to foster a black market, he warns.

Part of the problem in Central America is that the discourse about Cafta has not evolved much over the last two years, making it difficult for the average person to obtain a more profound understanding of what free trade entails. Much of the dialogue on free trade seems to be aimed more at scaring people than informing them.

In Nicaragua, for example, a pro-Cafta group in September put signs up around Managua warning people that Nicaragua's failure to ratify Cafta would be like a return to the U.S. economic embargo of the 1980s. The left-wing Sandinistas responded by organizing a massive protest march on Sept. 8, where Nicaraguans were instructed by vehicles carrying loudspeakers to come out of their homes to march against a treaty that would only bring "misery, hunger, unemployment and death."

Central American infrastructure and customs procedures are another concern. Poor roads, old ports and inefficient customs stations abound. Procedures and paperwork requirements are often determined at the whim of individual customs agents, making trade slow and expensive. Complicating matters is the fact that 80% of Central America's trade is on the Atlantic coast, but the overwhelming majority of production is on the Pacific coast.

Efforts are underway to build a massive new Pacific port on the Gulf of Fonseca, which borders El Salvador, Honduras and Nicaragua, but for now, inadequate roads lead to inadequate ports. Even Costa Rica's Limon-Moin Port, and Honduras' Puerto Cortez--among the largest in Central America--can't handle the trade volume of Panama's Puerto Manzanillo. Shipping out of Central America is more expensive than Panama by $500 per container.

Crossing. Regional customs directors hope to have a uniform customs code ready by this month. But a full Central American Customs Union, which would streamline border-crossing procedures, won't be fully ready for another year.

Oddly enough, Central America's infrastructure problems could benefit its small farmers, which otherwise would find--as did many Mexican farmers under Nafta--that they can't compete with the subsidized agribusiness in the United States. Slow customs procedures, expensive shipping and poor roads could lead U.S. farmers to decide Central America is too small and inaccessible a market to make any serious money exporting their agricultural products, leaving the region to feed itself, at least for some time to come.

While everyone agrees there is lots of work to be done, culture too may be a factor in Central America's current state of preparedness. "In Central America we don't prepare or plan for things the same way as in the United States," notes longtime Nicaraguan journalist and pundit Alberto Reyes. "Before couples get married in the United States, they take blood tests and do financial planning and family planning. Not here. We just get married. Like iguanas."

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U.S. imports from CAFTA-DR

electrical machinery        21.6%
edible fruit and nuts       14.7%
optical/medical equipment   14.4%
apparel                      7.9%
others                      41.4%

Note: Table made from pie chart.

apparel                     44.9%
optical/medical equipment    9.2%
electrical machinery         8.7%
others                      37.2%

Note: Table made from pie chart.

apparel               83.9%
spices, coffee, tea    2.4%
others                13.7%

Note: Table made from pie chart.

apparel                 61.7%
edible fruit and nuts   11.4%
spices, coffee, tea      6.9%
others                  20.0%

Note: Table made from pie chart.

apparel                 75.3%
edible fruit and nuts    4.7%
electrical machinery     4.7%
others                  15.3%

Note: Table made from pie chart.

apparel                60.1%
fish and seafood        7.4%
electrical machinery    7.4%
others                 25.1%

Note: Table made from pie chart.