Trade, Equity, and Development Project
July 2003
How to Build a Better Trade Pact
with Central America
By Sandra Polaski
INTRODUCTION
T
he United States is negotiating with
five Central American countries to
create a new free trade zone—the U.S.–
Central American Free Trade Agreement
(CAFTA).1 This marks the first time the
United States has attempted such an
economic feat with countries ranked
among the poorest in the world. By
comparison, when the United States
negotiated to create the North American
Free Trade Agreement (NAFTA),
Mexico’s gross national income per capita
was $4,230.2 However, today in Nicaragua,
annual income per capita stands at about
$400, one tenth that level. In Honduras, it
is about $900 per year,3 and El Salvador
and Guatemala have only slightly higher
per capita incomes. In all four countries,
most people live in poverty, with the
proportion ranging from 50 percent in El
Salvador to 80 percent in Honduras.4
Annual income is not the only measure
that differentiates the pact being
negotiated from anything attempted
before. Mexico, before NAFTA, had a
developed industrial structure, producing
steel and automobiles as well as laborintensive products such as televisions and
clothing, while less than a quarter of the
population was engaged in agriculture.
That level of economic diversification and
worker skills is a distant dream for Central
America today. Almost half the population
there now works in subsistence
agriculture. The only significant export
industries in four of the five countries—
Costa Rica being the exception—are
agriculture and apparel. Of course,
economic integration is intended to speed
development in the region. However, the
starting point is a sobering reminder that
the Central American countries have
extremely limited capacity to adjust to the
dislocations that always follow economic
opening. This will be particularly true for
countries opening to an economic
powerhouse like the United States.
Sandra Polaski is a senior associate with the Trade, Equity, and Development Project at the Carnegie
Endowment for International Peace. She served from 1999-2002 as the Special Representative for International
Labor Affairs at the U.S. Department of State, the senior official handling labor matters in U.S. foreign policy.
This publication is also available in Spanish at www.ceip.org/trade
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As a result, the proposed free trade zone
with Central America will require an
economic bargain that takes into account
the poverty and fragility of those
economies. A poorly constructed
CAFTA—for example, one that allows
U.S. corn and beans to flood those
countries and wipe out subsistence
farmers—will be a development disaster
for Central America. On the other hand, a
well-constructed CAFTA must take a
gradual, developmental approach that
allows the countries of the region to adjust
at a pace that is bearable for their
populations. It must help them build the
economic, governmental, and human
resources necessary to succeed in a
modern open economy.
HEADING THE WRONG WAY
Unfortunately, the current proposals that
the United States has tabled in those
negotiations, instead, appear to reflect a
latter-day mercantilism aimed at
maximizing the profits of U.S. investors,
firms, and agricultural interests—or, at
least, politically well-connected U.S.
interest groups. For example, the United
States is currently proposing that its corn,
beans, and beef be allowed into Central
America duty-free immediately, while
delaying the import of Central American
sugar into the United States until the
distant future. On other fronts, such as the
laws and regulations that will prevail in the
integrated economic space of the free
trade area, the United States, so far, has
taken a cookie-cutter approach, insisting
that terms negotiated with the much more
developed countries of Singapore and
Chile also be applied to Central America,
even though the circumstances are vastly
different. At present, the United States is
on a course that will produce a deeply
flawed trade agreement that may spell
economic catastrophe for much of Central
America.
Why should the United States care about
what happens to poor Central Americans?
Because the United States has enormous
interests in the world that go beyond the
profits of particular firms. Economic and
political instability around the world have
a deep, and sometimes dramatic, impact
on U.S. security and on immigration flows
to the United States. This is especially true
with a near neighbor like Central America.
Further, poor farmers who lose their
legitimate incomes may turn to the drug
trade that already menaces the region. The
United States also claims to a be a world
leader in fighting poverty and helping poor
countries climb out of underdevelopment
through economic engagement with its
own giant economy. The CAFTA talks
present an opportunity for the United
States to show that it knows how to do
that—and is willing to do so. On the other
hand, a CAFTA that lopsidedly extends
most advantages to U.S. firms at the
expense of struggling campesinos and
young women working at poverty wages in
export assembly plants will produce a
development setback for the world to see.
It could also produce increased
immigration to the United States and
provide fertile ground for the
encroachment of the drug trade.
A TRADE PACT THAT FOSTERS
DEVELOPMENT
To make this trade agreement a success,
the United States will have to do things it
has not done before in free trade
negotiations. The United States must
break new ground in four key areas if it
wants to contribute to genuine
development gains for Central Americans
and avoid harsh economic and political
shocks to the region:

the terms of agricultural trade
liberalization;

the need for adjustment assistance to
help those who will lose from the
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trade pact adapt to new economic
circumstances;
AGRICULTURE

the reform of the region’s inadequate
labor laws;

and the need for credible, external
monitoring during the start-up phase
of the agreement.
The terms on which agricultural trade is
liberalized under CAFTA will likely
determine whether four of the five Central
American countries are net winners or
losers from the agreement for the
foreseeable future. It will certainly
determine whether poverty increases or
decreases in those countries for many
years to come, because agriculture employs
the largest share of the population in
Honduras, Nicaragua, Guatemala, and El
Salvador: 42 percent on average for the
four countries.5 The impact on rural
households that depend on agricultural
income will critically affect whether the
countries adjust to free trade with only
tolerable disruptions and adjustment costs
or, instead, face a wrenching dislocation
that worsens poverty, swamps urban labor
markets, and increases migration to the
United States.
Each of these four areas affects the
incomes of average (meaning poor)
Central Americans, as the issues are
interrelated through the functioning of
labor markets. What happens to small
farmers as a result of the agricultural terms
of the trade agreement will determine how
much labor is released from the
agricultural sector, and at what pace. If
U.S. grain exports are allowed to displace
too many campesinos too rapidly, the large
redundant labor force will then migrate to
the cities, producing an unwanted supply
shock to labor markets already saturated
with underemployed workers scraping out
a living in the informal sector as well as a
young population coming of age. Wages in
maquila assembly plants will decline
because of the imbalance in the labor
market—and, in most cases, those wages
are currently below the poverty line. The
resulting imbalance in the already
asymmetrical power relationship between
employers and employees in factories
there will be further skewed, reinforcing
inequities in income and rights. And in
Central America, the distribution of
incomes and rights between the small
wealthy class and the rest of the
population stand among the most unequal
in the world.
Each of these areas can be managed,
however, through effective negotiating
approaches. The following sections define
the four critical issues and what the United
States must do differently, if it wants a
successful CAFTA.
Central American governments are hoping
CAFTA will result in more manufacturing
firms that will employ the labor released
from the agricultural sector. But in all
those countries except Costa Rica, the
only currently viable manufacturing export
industry is textile and apparel. Even if it
grows at double-digit rates, this industry
alone will not have the capacity to absorb
large numbers of displaced rural workers.
For example, in El Salvador, about a
million people are employed in agriculture,
while the textile and apparel sector
employs only about 200,000.6
Agricultural production in the region
includes staple crops, such as corn and
beans, for household consumption, similar
production for local markets, and cash
crops, such as coffee and sugar, for export.
Changes in tariffs and other trade rules
will affect each of these crops differently.
The optimal combination of trade terms
for Central American rural development
would be to phase out the tariffs on staple
crops very slowly and gradually, so that
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subsistence farmers have time to adapt,
while increasing access to the U.S. market
for the region’s traditional cash crops such
as sugar and other agricultural products
that exploit the comparative advantages of
the region. As already noted, however, the
current market access proposal of the
United States does exactly the opposite,
demanding immediate access for U.S.
corn, beans, rice, beef, and chicken, while
delaying improved access for sugar to an
unspecified date in the distant future. If
adopted, this proposal would lead to an
almost immediate displacement in Central
American markets of staples produced by
local subsistence farmers. These crops
would be replaced with U.S. corn, beans,
and other products that are produced
more efficiently and also benefit from U.S.
government subsidies that allow them to
be sold below their cost of production.
Meanwhile, production of sugar and other
export products that could absorb some of
the labor displaced from staple crops
would be denied greater access to U.S.
markets for many years and thus constrain
any labor-absorbing growth.
This is hardly a picture of free trade, and
more importantly, it would not be a happy
outcome for Central America. While
households there would face cheaper
prices for some food products, the great
bulk of rural households would lose all
possibility of selling their crops, and thus
lose the cash income needed to buy U.S.
agricultural products. Moreover, such an
outcome would take place at the same
time that one of the major agricultural
exports of the region—coffee—is facing
historically low prices, which is leading to
abandonment of many coffee plantations
and destruction of existing wage labor jobs
for rural workers.7 Faced with hunger,
poor rural families would drift to the cities
to join the ranks of the underemployed or
migrate to the United States as illegal
immigrants.
What will it take to change the U.S.
bargaining posture and avoid these
perverse outcomes? The U.S. government
will have to take on agricultural lobbies
that seek to influence the terms of the
agreement and be firm in its design of
policies that benefit broader U.S. interests.
While the power of those lobbies is
formidable, the actual impact on the
United States of a more pro-Central
American, pro-poor proposal would be
negligible. The entire agricultural sector in
the United States employs less than 1
percent of the U.S. workforce.8 Profits of
farm owners and agribusiness firms would
be barely affected, since the Central
American market is relatively small and
very poor. One can only assume that the
reason for the inappropriate U.S. proposal
is a concern about precedent for other
trade negotiations. However, no trade
agreement need form a precedent for
others, and the risk of a major negative
shock to Central American farmers and
economies cannot justify basing policy on
any such distant, tactical concern.
The U.S. proposal should provide long
transitions, of twelve years or more, for
staple food crops produced by subsistence
farmers in Central America. It would be
worth exploring the possibility of a gradual
phase out of tariffs and other market
restrictions on these crops to
incrementally change the incentives and
prices for producers and households. On
the import side, U.S. liberalization of
access for Central American export crops,
including sugar, should occur early in the
agreement to allow for absorption of labor
from subsistence agriculture.
TRADE ADJUSTMENT ASSISTANCE
A second area that will require attention,
even if the United States offers a more
appropriate agricultural proposal that
allows for a gradual transition of Central
American economies away from
subsistence agriculture, is the need to help
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those countries, and specifically, their poor
rural households, make the transition. It is
important to remember four key points:
(1) underemployment is already high; (2)
the labor force will continue to grow
rapidly over the medium term due to
earlier high population growth rates; (3)
education levels are low; and (4) illiteracy
is high. Those who lose their incomes due
to CAFTA-induced changes will be poorly
equipped to find other employment. None
of the Central American countries
currently provide social safety nets such as
unemployment insurance for workers who
lose their jobs. Assistance to help farmers
and workers displaced by CAFTA will be
essential if the net impact of the
agreement is to be positive and poverty is
to be reduced, not increased.
The countries involved will need help,
both to construct and finance the
programs needed. Technical assistance to
design the programs is available from
international agencies such as the
International Labor Organization (ILO) or
the UN’s Economic Commission on Latin
America and the Caribbean (ECLAC).
Financial resources will have to be pieced
together from a variety of sources, and the
U.S. government should be among them.
The United States will benefit from a
stable, developing Central America in
myriad ways that include reduced
migration flows, less drug production and
transit, and a reduction in the instability
and criminality that flow from the drug
trade. The benefits of freer trade with the
region, though modest, will redound to
U.S. firms. Therefore, the U.S.
government—for the first time—should
accept the responsibility to contribute to
needed transitional adjustment programs,
just as the wealthy countries of Europe
assisted Portugal and Greece with their
transition from agricultural to modern
economies and as they will do again with
the Eastern European countries that
accede to the European Union in 2004.
Free trade imposes adjustment costs, and
those costs should be distributed
throughout the free trade area with some
acknowledgement of ability to pay. The
multilateral financial institutions, including
the World Bank and the Inter-American
Development Bank (IDB), should also
assist through grants and loans. However,
loans cannot constitute the major source
of finance—debt burdens that are already
difficult would become unsustainable.
New funds are needed, and some of the
resources must come from the United
States.
LEGAL FRAMEWORK FOR LABOR
MARKETS
A third area that requires attention—and
new thinking by the United States—is the
need for better labor laws in Central
America. The region suffers from the
most egregious income inequalities in the
world, and this is both reflected in and
partly explained by the highly unequal
distribution of rights and protections in
the laws of those societies. In most of the
countries of Central America, small ruling
classes (referred to locally as the oligarchs
or families) have dominated both the
economies and the polities for centuries.
In every Central American country except
Costa Rica, this domination led to
numerous civil wars, including those of
the 1980s and 1990s. The societies are still
deeply polarized. Laws are inadequate to
balance the rights of the weak (workers
and the poor) with the de facto power of
the oligarchs and employers. Enforcement
is irregular, and impunity for the powerful
is the norm.9 Collusion of government
labor inspectors with employers is not
uncommon. When workers attempt to
organize to improve their bargaining
power with private sector employers, they
are routinely fired. The employers often
circulate their names to other firms and
the workers may be blacklisted and denied
employment elsewhere. Thus, the existing
unequal economic and power relationships
in society are preserved and perpetuated in
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the workplace. Some of the worst abuses
of the right to organize occur in export
sectors, including apparel and export
agriculture.10
These problems are widely documented
and well-known to the U.S. government.
The U.S. Department of State,
Department of Labor, and the Office of
the United States Trade Representative
have engaged the Central American
governments in recent years to seek
reforms of weak laws and enforcement
capacities.11 Technical assistance has also
been provided, but little has changed. U.S.
negotiators risk perpetuating this
unsatisfactory status quo under CAFTA
unless they make it a condition of the
agreement that the Central American
governments finally make the changes to
law and practice needed to protect the
most basic human rights of workers.
Necessary legal changes in each country
have been identified by the ILO, which
has been designated by all CAFTA
countries as the international standardsetter and interpreter of fundamental labor
rights. Most of the Central American
countries have made previous
commitments to improve their labor laws,
whether as part of peace agreements to
end civil wars or to qualify for preferential
trade benefits under programs that the
United States extends unilaterally to the
region. However, these commitments have
not been fulfilled. The Central American
governments clearly have not had
sufficient interest or political will to do so.
Their desire to conclude a free trade
agreement with the United States should
be used as leverage to secure the reforms
they have long promised to their own
citizens and to the United States.
Given the history of failure to abide by
previous commitments, the labor law
changes must be agreed to in writing, with
specific time frames for completion. At
the end of the day, the benefits of CAFTA
must be at risk should the signatory
countries fail to comply with their pledges.
This requirement of labor law reform
would be new for the United States in a
regional free trade agreement, but there
are precedents. The United States
routinely requires trading partners to
amend their intellectual property laws as a
condition of free trade and will
undoubtedly do so in the CAFTA.
Workers, whose labor is often their only
economic asset, should enjoy labor rights
protections at least as strong as those for
property rights. It is only when the legal
regimes of Central America are brought
into line with modern norms that the
political and economic imbalances in the
region will begin to be rebalanced.
MONITORING OF
IMPLEMENTATION
A final area that requires attention and
innovation in the CAFTA is oversight of
the implementation of labor rights
commitments. Because of the deep
polarization of these societies and the
weak enforcement capacity of the region’s
governments, compliance with the terms
of the agreement and with domestic labor
laws will require neutral, credible outside
oversight for a significant transition
period. This is a necessary part of the
effort to rebalance the highly unequal
distribution of rights and power between
employers and employees.
It is also necessary to address concerns of
firms that might invest in Central America
or use the region as an important sourcing
location, thus creating new jobs. Firms
that have invested in their brands and
reputations will locate only where their
reputations are not put at unacceptable
levels of risk. It is widely recognized that
most manufacturing growth in Central
America in the medium term will be in the
apparel sector, because some
infrastructure and skills already exist.
Apparel trade currently takes place under a
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global quota system due to be phased out
at the end of 2004. Then production will
no longer be distributed globally under the
quota system, and the prospect of tarifffree access to the U.S. market will be an
incentive for firms to produce and source
in Central America. The proximity to the
United States will be an additional factor
in favor of investment in the region.
However, the region’s labor costs, while
low, are not nearly as low as in China and
other Asian countries. Therefore, in the
complex equation that drives investment
and sourcing decisions, the question of
whether a country poses acceptable risk to
a firm’s brand reputations will loom large.
Most apparel firms have invested heavily
in their brand identity and reputation—a
primary determinant of pricing power.
Apparel is also a sector of considerable
activism by consumer and
nongovernmental organizations. Thus, a
monitoring system that can provide firms
with reasonable certainly about conditions
in factories and compliance with laws
could provide the tipping factor in favor
of investment and sourcing in the region.
The logical organization to provide such
monitoring is the ILO. The agency is
recognized by all of the parties to CAFTA
as having the right to assess compliance
with internationally recognized labor
standards. Moreover, the ILO has recently
gained experience and expertise in factory
monitoring in Cambodia under an
innovative agreement between the U.S.
and Cambodian governments. The ILO
proved there that it could conduct costeffective, neutral and credible monitoring
that won the trust—indeed, praise—of all
parties. The primary benefit provided by
the ILO was transparency: all interested
parties, including the two governments,
factory owners, workers, buyers, and
consumers, had access to information
about what actually went on in the
factories. Thus, efficient decisions could
be made by brands regarding whether
potential sourcing factories complied with
labor laws. International consumers,
media, and NGO activists learned that
they could rely on ILO information as
accurate. The result was that compliant
factories gained increased orders, while
noncompliant factories did not. This is
precisely the kind of mechanism that sends
appropriate market signals to all actors.
In Central America, unlike Cambodia at
the beginning of the ILO monitoring
project, a number of independent
monitoring groups already exist, although
they are very small in scale. It is easy to
envision a rapid start-up of monitoring led
by the ILO, which could then engage
these existing groups, provided they met
ILO-determined standards and
procedures.
Who would pay for such a project? There
are a number of possibilities. In the case of
Cambodia, the cost was split between the
U.S. government (70 percent of the total),
Cambodian government (15 percent), and
Cambodian apparel manufacturers (15
percent). It would be fair to require the
multinational firms that buy from the
factories and export farms to contribute as
well, since they gain such apparent value
from the arrangement. An alternative to
government contributions might come
from multilateral development finance
organizations such as the IDB and the
World Bank. Both entities have facilities to
make grants to projects that enhance
development, and this approach would
certainly qualify.
It would be optimal to begin designing
such a monitoring effort now, while
negotiations for CAFTA are still
underway. That would minimize any delay
in launching the operation once CAFTA is
completed and thus provide an early
incentive for firms to decide to produce
and source in the region.
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CONCLUSION
The CAFTA negotiations represent a
potential turning point for Central
America. The region is economically
fragile and politically precarious. A wellconstructed CAFTA could reinforce weak
institutions and government capacities and
thus allow positive market forces to take
hold, creating jobs and gradually allowing
the region to grow out of poverty. But the
large size of the agricultural sector, the
severe constraints on workers and
households, the lack of public funds for
adjustment, as well as the deficient laws
and weak enforcement systems all demand
that CAFTA be constructed with
extraordinary care. Otherwise, the positive
opportunity could instead produce a major
development setback. To achieve progress
and avoid peril, the United States will have
to make proposals and take steps it has
never undertaken. U.S. negotiators have
long recognized that a cookie-cutter
approach to trade pacts does not produce
good results. CAFTA will be the most
demanding test of their ability to break
new ground.
1
The Central American countries involved are Costa Rica, El Salvador, Guatemala, Honduras, and Nicaragua.
2
World Bank, World Development Indicators Database. Data for 1993.
3
Ibid. Data for 2001.
United Nations Economic Commission for Latin America and the Caribbean (ECLAC), Social Panorama of
Latin America, 2001–2002. Data for 1999.
4
Based on a compilation of data from the International Labor Organization, World Bank, and ECLAC by Jose M.
Salazar-Xirinachs and Jaime Granados in “The United States–Central America Free Trade Agreement:
Opportunities and Challenges,” paper prepared for the Institute of International Economics conference on “Free
Trade Agreements and U.S. Trade Policy,” May 7–8, 2003, Washington D.C. Paper on file with the author.
5
6 U.S. Department of State, Country Reports on Human Rights Practices for 2002—El Salvador. Available at
<www.state.gov>.
7 Some analysts promote the idea that horticultural products, fish, and other nontraditional primary sector
exports can take up the slack. However these are the very products that are also being promoted in Mexico, the
Andes, and other parts of the developing world. The risk of overproduction in these products—and a resulting
collapse of prices, as with coffee—is very real and reinforces the case for a gradual transition away from
subsistence crops.
U.S. Bureau of Labor Statistics, Occupational Employment and Wages, 2001. Available at <www.bls.gov>;
U.S. Department of Agriculture, National Agricultural Statistics Service, “Farm Labor,” November 2002.
Available at <http://jan.mannlib.cornell.edu/reports/nass>.
8
9Authoritative information on the deficiencies in labor law and enforcement can be found in the U.S.
Department of State’s Country Reports on Human Rights Practices. Available at <www.state.gov>.
10
Ibid, reports for 2000, 2001, and 2002.
11 In addition to the extensive documentation of ongoing problems found in the U.S. Department of State’s
Country Reports on Human Rights Practices, the Office of the United States Trade Representative issued the “Fourth
Report to Congress on the Operation of the Caribbean Basin Economic Recovery Act” December 31, 2001.
The report notes similar problems and includes the observation that prior commitments have not been kept, for
example, in Honduras (pp. 43–44).
CARNEGIE ENDOWMENT FOR
INTERNATIONAL PEACE
1779 Massachusetts Avenue, NW
Washington, DC 20036
Phone 202-483-7600
Fax 202-483-1840
www.ceip.org
Copyright 2003 Carnegie Endowment for International Peace
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