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Economic Integration in Central America

Author(s):
International Monetary Fund. External Relations Dept.
Published Date:
March 1966
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John W. Crow

WHILE THE MOVEMENT toward Central American unification that has taken place over the last few years constitutes a new departure, it has deep historical roots in what has been termed “the Central American tradition.” This is the conviction shared by many Central Americans for more than a century that there exists among their countries a community of interest which transcends political and economic divisions and rivalries.

Although the five Central American nations (Costa Rica, El Salvador, Guatemala, Honduras, and Nicaragua) were included as provinces in a single administrative unit for most of the Spanish colonial era, the individual communities scattered down the length of the mountainous isthmus enjoyed a good deal of independence. Therefore, in the early 1820’s, when Spanish rule crumbled, its substitution by a united Central American nation was only one of a number of possibilities. In the next two decades attempts were made to establish a federal form of government for the whole region, the United Provinces of Central America, but local rivalries and separatist tendencies proved too strong and by 1840 the five nations had emerged as independent entities.

The collapse of the attempts at federation did not, however, mean that the aspiration toward Central American political union was discarded; in later years, many attempts were made to achieve this goal. All were signally unsuccessful. Although the ideal of a Central American community rising above local divisions was widespread, it was never a to prevail over the short-term demands of practical politics. In the first place, the smaller nations were profoundly suspicious of the ambitions of their larger neighbors. Secondly, agreements between nations often broke down through lack of a consensus at home. It became increasingly clear that immediate political union was not a practical aim. A new approach was needed.

CENTRAL AMERICA

By the beginning of this century many supporters of union had come to realize that the key lay in a gradual approach stressing regional cooperation in specific fields of common interest rather than in general political agreements. Only after World War II, however, when economic development and integration became matters of world-wide concern and investigation, did a blueprint for cooperation become available which could, on its own merits, attract and sustain the interest of individual governments. This interest soon led to the formulation of the Central American Economic Integration Program.

THE PREPARATORY STAGE

At the Fourth Session of the United Nations Economic Commission for Latin America (ECLA) in June 1951, the Central American representatives introduced an important resolution. In this resolution they

expressed the interest of their governments in the development of agricultural and industrial production and of transportation systems in their respective countries so as to promote the integration of their economies and the expansion of markets by the exchange of their products, the coordination of their development programs and the establishment of enterprises in which all or some of these countries have an interest.

This was a fresh start which made it clear that the Central Americans aimed at nothing less than the achievement of full economic integration—but also, for the present, at nothing more. This declaration of policy was followed a few months later by the signing of the Charter establishing the Organization of Central American States, a body designed to serve as a political forum for sovereign nations whose principal instrument was to be periodic meetings of the Ministers of Foreign Affairs. The preamble to its Charter reveals the new gradual approach: “the procedures tried in the independent life of the Central American Republics for restoration of their former unity have proven ineffective and … modern international law offers adequate formulas for this end through the institution of regional associations.” Finally, in August 1952, the five Ministers of Economy met to establish the Central American Economic Cooperation Committee, to which was entrusted the task of directing the future programs of the economic integration movement.

The Committee was faced by a most challenging situation. In spite of their historic sense of unity, the Central American states, in the middle of the twentieth century, traded little within the area—their trade with one another was only 5 per cent of their total trade. Yet from the very outset the Economic Cooperation Committee, whose Secretariat was provided by ECLA, saw its task to be the creation of a multilateral free trade area complemented by a program to stimulate industrialization throughout the region. It was considered that through the achievement of a common market in Central American goods, the way would be opened for the establishment of industries which could function efficiently only on a regional scale. These industries, supplying a market of some 10 million people rather than small national markets (the largest of which at that time had fewer than 3 million), would, it was hoped, prove an important element in stimulating development and trade within the area. The pattern of industrial growth was to be based upon what has been termed the principle of reciprocity, that is to say the integration industries would have to be distributed evenly among the five nations.

The activities of the Economic Cooperation Committee over the first few years were devoted to carrying out studies in a large number of fields. These investigations, undertaken by specialized subcommittees, ECLA itself, and technical assistance missions from outside the area, were designed to provide information which would serve as a basis for adapting the integration formula to Central American circumstances. Among the subjects studied were potential integration industries; agricultural development; road and maritime transportation; electric power; weights and measures; statistical coordination; technological research; public administration; the effect of free trade on fiscal revenues; and the problems of development financing.

First Results

The first concrete results of these activities were the establishment of two Central American institutions, the Advanced School of Public Administration (1954) and the Institute for Industrial Research and Technology (1956), and the adoption by each country of the Central American Uniform Customs Nomenclature. These were advances but they were only preparatory to the task of drafting a series of agreements through which the basic structure of the integration program, the free trade area, the system of integration industries, and the common external tariff could be brought into existence.

This work was begun in earnest in 1956 when the Economic Cooperation Committee made a formal request that ECLA and groups of country representatives prepare draft agreements relating to multilateral free trade and integration industries. In June 1958, representatives of all five nations met to sign the final versions, the Multilateral Treaty on Free Trade and Economic Integration and the Agreement on a System of Central American Integration Industries. Work on an agreement establishing a unified external tariff had been held back until these two basic agreements were signed.

The Instruments of Integration

In accordance with the gradual spirit of the Integration Program, the Multilateral Treaty provided for the creation of a free trade area within ten years of its entry into force and the establishment of a customs union “as soon as conditions are appropriate.” As a first step in this direction, the Multilateral Treaty included a list of some 200 commodities on which all import and export duties and other similar charges would be eliminated immediately. The economic impact of this measure was, however, much smaller than might be thought. The free trade provisions were restricted by the Multilateral Treaty to natural products and manufactures of the contracting parties, but not many of the items included in the list were actually produced within the area at that time. In addition to the agreement on free trade in commodities, the Multilateral Treaty provided for national treatment in each country of the persons and investments of the other four.

The declared purpose of the Agreement on Integration Industries, signed on the same day as the Multilateral Treaty, was “to promote the establishment of new industries and the specialization and expansion of existing industries within the framework of Central American integration”; it was also to ensure that this would be done “on a reciprocal and equitable basis in order that each and every Central American state may progressively derive economic advantages.” A Central American Industrial Integration Commission was set up to carry out the Agreement. The output of the designated industries would receive free entry into all five markets, while the same products of plants located in Central America but falling outside the system would gain free entry only after a ten-year transition period during which the protective duty would be progressively reduced. The Agreement confined itself to the enunciation of general principles and left the details to the separate protocol required for each industry. Such a protocol would not only specify the type of industry and its country location but would also stipulate capacity, quality standards, the degree of participation of Central American capital, and the uniform tariff protecting the industry’s products. Equitable distribution was obviously important, and among other measures to achieve this it was agreed that no country could acquire a second integration industry until each of the five had been assigned one.

With the successful conclusion of negotiations in the fields of free trade and industrial policy, the Economic Cooperation Committee turned to the third key requirement of the integration program, the creation of a common external tariff. This was achieved in September 1959, when representatives of all five nations concluded the Central American Agreement on the Equalization of Import Charges. Tariff equalization was to be based on two commodity schedules, one to have immediate effect and one to take effect progressively over a period of two to five years.

Thus, in the space of just over one year, the three basic aims of the integration program as originally conceived were translated into treaty commitments. However, even as this was occurring, doubts arose within Central America not only about the direction the integration movement was taking but also about the desirability of economic integration in any form. While the two agreements concerning free trade and industrial policy concluded in June 1958 had been signed by representatives of all five nations, not all the signatories, even by the end of 1959, had deposited the instrument of ratification. Only three ratifications were needed for the Multilateral Treaty to enter into force and these were on deposit by the middle of 1959, but for the more controversial integration industries agreement all five ratifications were required to make it effective. Only three had been obtained by the end of 1959, and it was becoming increasingly clear that there would, at the very least, be some considerable delay before all five ratifications were deposited. Important bodies of opinion in one of the countries were becoming more and more skeptical as to the benefits it might obtain from participation in the integration program. After seven years of progress following the fresh start in 1951, the prospects for Central American integration were once more clouding over.

REORGANIZATION AND REORIENTATION

Instead of allowing the entire program to founder, three of the participants—El Salvador, Guatemala, and Honduras—began intensive negotiations aimed at preserving as much as possible of the integration movement and even at giving it new impetus. The result of these deliberations was the signing in February 1960 of the Treaty of Economic Association.

This tripartite Treaty, the first to be concluded without the sponsorship of the Economic Cooperation Committee, went much more directly about the business of creating a common market in Central American products. The method adopted in the Multilateral Treaty was exactly reversed, inasmuch as the new Treaty granted immediate free trade status to all but a few specified natural and manufactured products of the member countries. Furthermore, trade in most of these remaining commodities was to be freed within five years. As in the September 1959 Agreement on the Equalization of Import Charges, the unification of external tariffs was to be achieved over a period of five years, but the new Treaty also foresaw the establishment of a common customs administration when all tariff rates had been standardized. The most radical innovations, however, were in the field of industrial policy. In the new integration system the regional industry concept was abandoned and its place taken by a Development and Assistance Fund to promote economic integration and development by “facilitating public and private investment for production purposes.”

This burst of activity on the part of three of the five members stimulated a new approach. In April 1960 the Economic Cooperation Committee held a special meeting, at which all five countries were represented, to consider how the older agreements and the new tripartite Treaty of Economic Association could be reconciled. As a result of this meeting, the Economic Cooperation Committee voted (with one abstention) to instruct its Secretariat to prepare a new draft treaty “for the accelerated integration of the five countries.” Although the instructions did not make any explicit reference to the tripartite Treaty, the burden of these directives was that the draft should follow the general lines of that Treaty but should also include the integration industries program.

The 1960 Agreements

These developments led directly to the signing, in December 1960, of the General Treaty for Central American Economic Integration and two related agreements, the Agreement to Establish the Central American Bank for Economic Integration and the Second Protocol to the Agreement on the Equalization of Import Charges. From that time up to the present, this General Treaty has served as the basic instrument of the integration movement. Only four nations signed these agreements, but both the General Treaty and the Bank Agreement made explicit provision for the eventual accession of the fifth.

The General Treaty, following the timetable and procedures set out in the tripartite Treaty, called for the establishment of a common market not later than five years after its entry into force. To this end, the signatories agreed to conclude subsidiary agreements for the adoption of a uniform customs code and the necessary transport regulations. In addition to determining the trade system, the General Treaty provided for significant advances in the much debated area of industrial policy. The integration industries agreement, signed in 1958 and still not in effect, was incorporated into the new Treaty, now with the additional provision that the first plants were to be chosen within six months. It was also agreed to harmonize fiscal incentives to industry.

To “direct the integration of the Central American economies and to coordinate policy,” the Treaty created the Central American Economic Council, to be composed of the Ministers of Economy of the contracting states, an Executive Council, and a Permanent Secretariat. The Economic Council, composed of the same members as the Central American Economic Cooperation Committee, was called upon to “facilitate the execution” of the latter’s resolutions. Thus the task of guiding the evolution of the integration program became to a much greater degree than before the responsibility of purely Central American institutions.

The agreement on the Central American Bank for Economic Integration was signed the same day as the General Treaty. The Bank’s title was meaningful; not only was it barred from making investments in industries of a purely local character but it was specifically charged with seeking a “balanced economic development” of the member countries, implying a special effort to channel resources into the economically weaker members. The initial capital resources of the Bank were fixed at the equivalent of US$16 million, payable in local currency.

Subsequent Developments

Since the end of 1960 the integration program has progressed along two distinct but complementary ways. The first way has been by giving effect to the provisions of the 1960 agreements, the second by pursuing new initiatives to carry Central America beyond these agreements toward full economic union. An important development was the return of Costa Rica to the program in 1962, so that when the long-range aspirations were set out in the Declaration of Central America, issued by the Central American heads of state on the occasion of President Kennedy’s visit in March 1963, all five countries were once again involved.

The Implementation of the General Treaty

The General Treaty entered into effect in June 1961, thus setting June 1966 as the date by which the free trade area and the common external tariff are to be achieved. Subsidiary agreements on external tariff equalization were duly signed in July 1962, January 1963, and August 1964. Over 98 per cent of the total number of items included in the uniform customs nomenclature are now covered, although the few items still pending, notably automotive vehicles, petroleum products, radios and television sets, and wheat and wheat flour, account for about 20 per cent of the region’s imports. Furthermore, equalization of duties on these items could strongly affect import duty receipts, which yield approximately 40 per cent of the combined tax revenues of Central America.

The two agreements provided for by the General Treaty in the field of industrial policy, the Agreement on Fiscal Incentives for Industrial Development and the Protocol to the Agreement on a System of Central American Integration Industries, were signed in July 1962 and January 1963, respectively. The Agreement on Fiscal Incentives aimed at introducing a greater degree of uniformity into the kinds of benefits—mainly in the form of tax relief—the various countries grant to industrial enterprises. The industries to receive benefits were divided into three groups according to priority.

The Protocol to the integration industries agreement created the first two such enterprises, a rubber tire and tube industry in Guatemala and a caustic soda and chlorinated insecticides industry in Nicaragua. In addition, it provided a new basis for regional industrial development, the Special System for the Promotion of Productive Activities. Industries which are established under this System receive the benefits of free trade and uniform tariff protection from the time production begins, provided that they have capacity to satisfy at least 50 per cent of regional demand. In sharp contrast to the integration industry regime, no provision is made for an even geographic distribution of the industries which might be set up under its terms.

While both these agreements were signed within about six months after the General Treaty’s entry into effect, there has been considerable delay in ratifying them. The Fiscal Incentives Agreement calls for five ratifications, but only four have been deposited at the time of writing. For the Integration Industries Protocol, which required only three deposits, the third was not obtained until February 1965—more than two years after the Agreement had been signed. This lag in ratifying the agreements on industrial policy is indicative of the concern of some countries that they may not receive an adequate share of new regional industry. It does not mean that any of the countries now have misgivings about economic integration as a goal.

Toward Economic Union

The most striking indication of the progress made by the integration movement is the dynamic rate of growth of intra-Central American trade. From 1951 to 1961 this commerce grew on average by 14 per cent a year, while over the period from 1961 to 1964 the annual increase jumped to over 40 per cent. Furthermore, this upsurge has been accompanied by an even greater increase in trade in industrial products, so that by 1964 such items accounted for almost 60 per cent of the value. Against such a background it is easy to understand the interest that has been shown in moving toward an even greater degree of unification than that provided for in the General Treaty.

Important steps in this direction were taken toward the end of 1961, when the Central American Bank for Economic Integration and an associated institution, the Central American Clearing House, began operations, which since then have expanded rapidly. CABEI, as the Bank is usually known, acting as a funnel for official development capital from both within and without the area, has to date granted loans totaling over $30 million. Most of this sum has gone to private industry, but there are indications that in the future the Bank will play an increasingly important role in financing public sector investment, especially of a regional character. Future operations will be financed largely from the recently created Central American Integration Fund, which is to be administered by CABEI. The initial subscription to this Fund, a joint venture of the United States and Central America, was $42 million. In 1964 payments made through the Clearing House, established with the aim of promoting the use of Central American currencies in transactions among member countries, were the equivalent of almost 75 per cent of intra-regional trade.

The task of coordinating national development planning efforts began in 1962, with the establishment of the Joint Programing Mission under the auspices of the Inter-American Development Bank, the Organization of American States, and ECLA. This body, in cooperation with the various national planning agencies, has produced a development plan for the period 1965-69 for each nation.

The successful operation of the Clearing House has inspired the various central banks to begin work on the establishment of the monetary union foreseen in the joint declaration of March 1963. In 1964 they concluded an agreement which provided for the eventual establishment of a monetary union through the gradual expansion of monetary and fiscal cooperation and coordination within the area. While the achievement of the final goal will undoubtedly take à considerable time, the fact that all five countries have liberal payments systems and stable exchange rates makes the task much easier than it might otherwise be.

These parallel strands of development began to be brought together in April 1965, when, for the first time, a joint meeting of the Ministers of Economy and the Ministers of Finance was held. This meeting was also attended by the presidents of the central banks and the directors of the national planning offices. After a discussion covering many aspects of both development and financial policy, namely, economic planning activities and public investment policy, balance of payments and foreign trade policies, agricultural and industrial policy, and fiscal policy, a series of resolutions was adopted calling for further studies on a Central American level in some fields and the preparation of draft agreements by the Permanent Secretariat of the General Treaty in others. This meeting could mark the beginning of a new phase in Central American relations, one in which a distinction between economic and political decisions is no longer appropriate.

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