Building on CAFTA

• Author: Alfred Schipke
• Position: Senior Economist in the IMF's Western Hemisphere Department. The article draws from Markus Rodlauer and Alfred Schipke (eds.), 2005, "Central America: Global Integration and Regional Coordination," IMF Occasional Paper 243 (Washington, International Monetary Fund)

How the free trade pact can help foster Central America's economic integration

Regional integration is gaining momentum across the globe. In addition to the well-known integration efforts in Europe, policymakers in Latin America and the Caribbean, Asia, Africa, and the Middle East are considering policies to foster integration and regional coordination. Of course, the scope and rationale for these initiatives differ widely. For smaller countries, such as those in Central America, regional integration is a strategy to maximize economies of scale so that they can participate successfully in a more globalized economy.

Efforts to foster Central American integration started in the early 1960s. The region appears to be a natural candidate for integration because the countries share many of the same characteristics and enjoy a common history and language. At that time, the objective was to create a common market similar to the European model. But this process was interrupted by a period of armed conflict in parts of Central America.

Renewed political and economic stability from the 1990s onward has not only led to a resumption of economic growth and overall macroeconomic stability but also increased integration efforts both among the Central American economies and between Central America and the United States. Integration is taking place against the backdrop of a broadly shared commitment to economic growth, stability, and reducing poverty. However, poverty is still widespread, with about 50 percent of the population living in poverty or even extreme poverty, except in Costa Rica (see Chart 1). The countries also remain vulnerable to economic shocks, and the political process is still fragile in some countries.

[ SEE THE GRAPHIC AT THE ATTACHED ]

While the implementation of a clear reform agenda is often hampered by fragmented and sometimes highly polarized political landscapes, minority governments, entrenched interest groups, short election cycles, and governance problems, there is a growing consensus in favor of more integration and regional cooperation to ensure that the region takes full advantage of its potential. The implementation of the free trade agreement of Central American countries (Costa Rica, El Salvador, Guatemala, Honduras, Nicaragua), the Dominican Republic, and the United States-referred to as CAFTA or CAFTA-DR-is expected to provide an additional boost to Central America's global and regional integration and to serve as an anchor for further economic and institutional development. This article examines the progress to date and where the region is heading.

Progress so far

Central America's integration has been advancing on two fronts. Economic ties with the United States have strengthened over the past decade, especially in trade, with exports to the United States now accounting, on average, for 80 percent of Central America's total exports and 15 percent of GDP (see Chart 2). But strong...