Trade Effects of the Central American Free Trade Agreement

Proponents of DR-CAFTA argue the RTA will free the U.S. agricultural sector of these disadvantages by leveling the field through the removal of these tariffs and in many cases, create preferences for U.S. exporters over third country suppliers, including those in Canada, Europe, and South America, helping to restore lost U.S. market share and expand overall U.S. exports. In this paper, we develop gravity models to estimate and predict the potential bilateral trade flows between U.S. and CAFTA countries using panel data. In the course of the study, it was expected that if DR-CAFTA were to have an effect, all countries under the agreement should be trade creators. All the six CAFTA countries but one (Costa Rica) are trade creators. The amount trade created ranges from as low as 1% for Guatemala to as high as 13% for Nicaragua, and Costa Rica only diverse 1% of the potential bilateral trade. The study has also revealed the importance and positive effects of differences between resource endowment, relative size of the economies, and exchange rates on trade flows. Distance, though less significant is seen as a factor that can potentially raise trade costs. Given these results, there is no doubt that implementing the DR-CAFTA will lead to an expansion of trade between the United States and the DR-CAFTA countries. As it stands, there appear to be advantages for U.S. producers from the Agreement, given the already low duties on agricultural imports from these countries to the U.S. and the relatively high duties placed on U.S. agricultural exports.