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American Diplomacy
Commentary and Analysis

June 2005

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The analysis below on the important but often overlooked topic of trade policy is one of three published in May-June 2005 by the World Trade Center N.C. in its journal IMPACT ANALYSIS. article deals with a trade association of the Dominican Republic and five Central American nations and how that pact affects the United States.— Ed.

The Democratic Benefits of a Free Trade Agreement with Central America

by Ana Isabel Eiras
The Heritage Foundation
Washington, DC

Increasing economic opportunity and strengthening homeland security are the two major goals of the U.S. government. Advancing free trade is essential to reaching both of these goals. Hence, the Bush Administration and Congress should be praised for significantly advancing free trade with Australia, Morocco, Chile and Singapore.

The U.S. now has an even more important opportunity to expand trade with countries right on its doorstep through DR-CAFTA, a free trade agreement with the Dominican Republic, Costa Rica, Guatemala, Honduras, El Salvador, and Nicaragua. The Administration should push Congress to approve this free trade agreement promptly.

The DR-CAFTA countries have made enormous progress toward democracy and economic liberalization since the 1970s, when almost all of them were ruled by dictators who opposed free markets. In recent years, each of these countries has implemented positive institutional reforms.

Approving DR-CAFTA would lock in these reforms and encourage them to continuing reforming. America would benefit greatly from a more open, institutionally stronger Central America, not just by opening a myriad of investment and trade opportunities to U.S. business and individuals, but also because these reforms will foster long-term peace and prosperity in the DR-CAFTA countries.

From War to Democracy
Throughout the 1970s and into the 1980s, every DR-CAFTA country except Costa Rica was ruled by a dictator or in a state of civil conflict, or both. The countries suffered from great political instability. The economies focused inward, and protectionist policies perpetrated widespread poverty.

Eventually peace accords were signed, democratic government returned, and all of these countries began to promote more open-market policies. According to the annual Index of Economic Freedom, published by The Heritage Foundation and The Wall Street Journal, all the DR-CAFTA countries have advanced economic freedom since 1995 at different paces.

Advancement occurred primarily in trade policy and monetary policy. Since 1995, tariffs, non-tariff barriers, and inflation rates have declined in each country. Government intervention which essentially assesses the degree of privatization in the economyalso has improved in all the countries except Honduras. In most DR-CAFTA countries, many businesses formerly owned and run by the state have been privatized. Except in the Dominican Republic, the banking and financial sectors have been improved in terms of regulation and privatization. Wages and prices in El Salvador, Costa Rica and Guatemala are set freely by the market, but Honduras and Nicaragua still control prices to some degree. From dictators, civil chaos, and conflict, the DR-CAFTA countries have come a long way. Yet more reform is needed and should be encouraged. For example, none of the DR-CAFTA countries has a strong rule of law, and the maze of business regulations (e.g., labor, zoning and licensing) makes operating a business excessively complex and encourages corruption. With the exception of Costa Rica and El Salvador, all of the countries have extensive barriers to foreign investment and capital flows. Because these barriers make participation in the economy difficult, many of these economies still have large informal economies.

Benefits for DR-CAFTA Countries
DR-CAFTA is a comprehensive agreement. It would not just reduce tariffs and eliminate quotas, but also deregulate the services sector, for example, by removing local residency requirements. The agreement expands access to foreign direct investment and fosters transparency rules, essential for doing business in the DR-CAFTA countries. According to the International Trade Administration, the agreement "requires regulatory authorities to use open and transparent administrative procedures, consult with interested parties before issuing regulations, provide advance notice

Congress should promptly approve DR-CAFTA not just to open a myriad of investment and trade opportunities to millions of U.S. businesses, but also because DR-CAFTA would foster long-term peace and prosperity in these Central American countries

and comment periods for proposed rules, and publish all regulations."

Clearly, deregulating the services sector would benefit U.S. companies that are competitive in this area. In addition it would be equally if not moreimportant to the DR-CAFTA countries' own businesses, enabling them to increase productivity, and increasing the skills of millions of workers in their countries as new foreign businesses and new technologies enter their economies. With higher skills, workers will be more valuable and earn more money, improving their living standards.

As living standards rise and people enjoy better lives, their interest in preserving those lives also will increase. And because they have more to lose from a crisis, they will strive to preserve peace and stability. As a result, the likelihood of civil conflict decreases. At the same time, the improved domestic situation reduces the incentives to leave home in search of a better life elsewhere. Therefore, these people are less likely to emigrate illegally to other, more prosperous countries like the U.S.

Benefits for America
From an economics standpoint, DR-CAFTA would open a myriad of business opportunities for many American businesses, from exporting to the region, to new markets for investment opportunities. In addition, it would decrease the flow of illegal immigration to the U.S. However, the ultimate benefit would come from the economic and political stability the agreement would bring to the region. As the living standards of the DR-CAFTA countries' citizens rise, so will their economic stability, and therefore, their ability to preserve a less volatile political environment.

Congress should pass this agreement not just for the sake of the U.S. economy, which would benefit from expanded markets and lower costs for millions of imported products, but also for security reasons. A more stable Central America is key to the long-term fight against terrorism and anti-American sentiment.

DR-CAFTA Should Be Approved
DR-CAFTA is an extremely important agreement for the United States, for both economic and security reasons. Advancing free trade is one of the best foreign policy tools to help the U.S. economy and improve homeland security. The DR-CAFTA countries have made enormous progress toward democracy and economic liberalization since the 1970s, and the free trade agreement would consolidate their democracies and institutional reforms.

Congress should promptly approve DR-CAFTA not just to open a myriad of investment and trade opportunities to millions of U.S. businesses, but also because DR-CAFTA would foster long-term peace and prosperity in these Central American countries.

Republished by permission of the author, The Heritage Foundation, and the World Trade Center North Carolina.


Ana Isabel Eiras is Senior Policy Analyst for International Economics in the Center for International Trade and Economics at The Heritage Foundation.

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