Abstract

The authors would like to thank Valerie Cerra for her guidance with this work. This chapter is based on IMF (2017) with the analysis updated and extended to CAPDR.

Introduction

Central America, Panama, and the Dominican Republic (CAPDR) has pursued trade integration as a pillar of its overall growth strategy.1 The region is well integrated into global markets and its countries have continued efforts to promote trade, including through new trade agreements. However, as protectionist sentiment has risen in recent years, particularly in some advanced economies, the finger of blame has been pointed at trade and globalization for widening income inequality and impeding inclusive economic growth. The shift in attitudes about trading raises a question: What potential does CAPDR have to build on its position in global markets? Some stock-taking and exploration of the opportunities for trade integration and an assessment of the relationship between trade and economic growth in the region may go a significant way to providing the answer. This chapter begins by investigating trade flows and their composition in a global context, looking at how the region’s economies are integrated in value chains—in global markets and with countries in the broader region that are at similar levels of development . The export baskets of CAPDR countries are also compared. To shed light on factors that have shaped the region’s integration and may increase potential for further movement in that direction, the determinants of trade and its composition are explored. Consideration is then given to how CAPDR trade policies may be changed to optimize the growth benefits. A policy overview, based on responses to a new survey of country officials, may foster a deeper understanding of trade strategies. That shows opportunities for where trade integration can support the priorities highlighted by empirical work.

Trade Integration in Capdr in the Global Context

CAPDR is well integrated into global markets (Figure 5.1). CAPDR’s trade openness, the most widely used measure of trade integration—and defined as the sum of exports and imports—represented about 74 percent of regional GDP in 2016, broadly consistent with other emerging market economies. Within the region, Honduras, Nicaragua, and Panama are the most integrated economies, while El Salvador and Guatemala are relatively less integrated. CAPDR’s integration has increased over time, particularly as the region liberalized trade in the 1990s, but integration, as measured by trade openness, has either stabilized or declined slightly in many of its countries.

Figure 5.1.
Figure 5.1.

Central America Trade Openness in Global Context

Source: IMF World Economic Outlook.Note: For convenience, references to Central America refer to the IMF subregion Central America, Panama, and the Dominican Republic (CAPDR). The Central American countries in this group are: Costa Rica, El Salvador, Guatemala, Honduras, and Nicaragua.

CAPDR’s integration into global markets can be partially linked to efforts to expand its network of trade agreements (Figure 5.2). The number of trade agreements including emerging market and developing economies has significantly increased since the late 1990s.2 Broadly in line with this trend, CAPDR countries began expanding trade agreements in the early 2000s and have continued with varying intensity. CAPDR countries now account for roughly half of the trade agreements involving countries in Latin America and the Caribbean (LAC) that have been notified at the World Trade Organization. With over 40 percent of the region’s exports destined for the United States, the most notable agreement for the region is the Dominican Republic-Central America Free Trade Agreement (CAFTA-DR) with the United States.3 CAFTA-DR was signed in 2004 and took effect in 2006 as the first free trade agreement between the United States and Central America. It was aimed at expanding trade in goods and services, increasing investment opportunities, and promoting intellectual property rights.4

Figure 5.2.
Figure 5.2.

Central American Trade Agreements

(Number and date of entry)

Sources: World Trade Organization and IMF staff calculations.Note: For convenience, references to Central America refer to the IMF subregion Central America, Panama, and the Dominican Republic (CAPDR). The Central American countries in this group are: Costa Rica, El Salvador, Guatemala, Honduras, and Nicaragua.

Overall, increased policy-based trade integration has expanded CAPDR’s network of trade opportunities significantly and set the basis for deeper cooperation across areas such as investment, public procurement, and services. In parallel, trade liberalization has lowered the cost of trade: average import tariffs have declined markedly since the early 1990s, particularly in the Northern Triangle countries (Figure 5.3).

Figure 5.3.
Figure 5.3.

Weighted Average Tariffs in Central America (In percent)

Sources: World Bank’s WITS database and author calculations.Note: Effectively Applied Weighted Average Tariff (in percent). The average of tariffs’ weights by their corresponding trade value figures. For convenience, references to Central America refer to the IMF subregion Central America, Panama, and the Dominican Republic (CAPDR). The Central American countries in this group are: Costa Rica, El Salvador, Guatemala, Honduras, and Nicaragua.

Despite the move to strengthen integration through trade agreements and the decline in tariffs, the use of nontariff barriers has increased (Figure 5.4). The rise in trade protectionism through nontariff barriers as a global phenomenon is reflected in CAPDR, although by less than in the broader region. Most countries in the region have introduced nontariff measures that may hurt cross-border trade. Trade restrictions introduced by CAPDR countries are concentrated in sanitary and phytosanitary measures, technical barriers to trade, and various safeguards provisions. Costa Rica is the exception, where the use of nontariff barriers has remained relatively constant.

Figure 5.4.
Figure 5.4.

Central America Non-tariff Trade Barriers

(Number)

Sources: World Trade Organization, Integrated Trade Intelligence Portal (I-TIP) and IMF staff estimates.Note: For convenience, references to Central America refer to the IMF subregion Central America, Panama, and the Dominican Republic (CAPDR). The Central American countries in this group are: Costa Rica, El Salvador, Guatemala, Honduras, and Nicaragua.

CAPDR’s trade is dominated by interregional rather than intraregional trade. Over 70 percent of CAPDR’s exports are destined for markets outside the region. This feature of the region’s pattern of trade integration is comparable to other emerging market and developing economies. The United States is by far the most important destination for the region’s exports. El Salvador, Guatemala, and Honduras are the most important intraregional destinations for exports. The Dominican Republic exports notably little to its regional counterparts. While intraregional trade remains low, CAPDR’s trade within Latin America and the Caribbean has clustered around its CAPDR trading partners (Figure 5.5). Other trading clusters in the wider region are shaped by the main subregional trade agreements (Mercosur, Andean Community). Within Latin America and the Caribbean, there is no clear trading hub comparable to China in Asia or Germany in Europe, countries that form the center of their regional value chains, importing from within the region and exporting to global markets (IMF 2015). Instead, the United States is a much more pronounced hub for regional trade than any of the large LAC economies (Figure 5.6).

Figure 5.5.
Figure 5.5.

Regional Trade Clusters in Latin America and the Caribbean

Source: The trade cluster report IMF (2017).Note: ARG = Argentina; BLZ = Belize; BRA = Brazil; BOL = Bolivia; CHL = Chile; COL = Colombia; CRI = Costa Rica; DOM = Dominican Republic; ECU = Ecuador; GTM = Guatemala; GUY = Guyana; HND = Honduras; MEX = Mexico; NIC = Nicaragua; PAN = Panama; PER = Peru; PRY = Paraguay; SLV = El Salvador; SUR = Suriname; URY = Uruguay; VEN = Venezuela.
Figure 5.6.
Figure 5.6.

Central American Trade Integration, 2015

Sources: IMF Direction of Trade Statistics database and author calculations.Note: For convenience, references to Central America refer to the IMF subregion Central America, Panama, and the Dominican Republic (CAPDR). The Central American countries in this group are: Costa Rica, El Salvador, Guatemala, Honduras, and Nicaragua. In panel 3, for each Latin American and Caribbean country, the top three interregional export markets are shown separately. All other interregional export markets are included in other. CAPDR = Central America, Panama, and the Dominican Republic; CAN = Canada; CHN = China; CRI = Costa Rica; DEU = Germany; DOM = Dominican Republic; ESP = Spain; GTM = Guatemala; HND = Honduras; HTI = Haiti; NIC = Nicaragua; NLD = Netherlands; PAN = Panama; SLV = El Salvador; USA = United States.

CAPDR firms have integrated into global value chains (GVCs), but are less integrated into production networks than other emerging markets. Over the past few decades, global production has become increasingly fragmented across countries. This has led to the development of GVCs or networks of the production stages of manufactured goods and services across borders. Insertion into GVCs offers greater opportunity for countries to benefit from learning and technology spillovers and enhance productivity. In particular, the intra-industry trade that characterizes participation in GVCs encourages producers to upgrade product quality, including by building on the foreign technologies to which they are exposed through trade (Baldwin and Yan 2014; de la Torre, Lederman, and Pienknagura 2015). As with the broader region, CAPDR countries have not been as successful at integrating into GVCs as other regions of emerging markets.5

While their overall participation remains weaker than other regions, CAPDR firms do take part in GVCs (Figure 5.7), particularly at the final stages of production. Due in part to their geographical location, CAPDR firms tend to participate in production networks with North American firms. Participation in final production stages is captured by the higher share of foreign value added in their gross exports, which reflects a more downstream role in GVCs as they import intermediate goods to assemble and export final production. By this measure, Panama, El Salvador, and Honduras are the CAPDR countries most integrated into GVCs. The maquilas (subcontractors) of El Salvador and Honduras that specialize in textiles are good examples of CAPDR’s role in this process as is the repacking and reexporting activity in Panama’s Colon Free Zone. CAPDR countries’ participation in the upstream part of production, measured by the value of exported goods that other countries use as imported inputs to produce their exports (indirect value added) is more limited. However, Nicaragua, Costa Rica, and Guatemala have had more success than other countries in the region at integrating in this earlier stage of the production process. A final feature of CAPDR’s integration into GVCs is that they tend to participate in relatively simple production networks, consistent with lower complexity of the goods under production in the region’s GVCs. The simplicity of production networks is captured by the domestic value added in intermediate goods production that is reexported to third countries (Koopman and others 2014).

Figure 5.7.
Figure 5.7.

Central America in Global Value Chains

Sources: Eora multi-region input-output table (MRIO); and author calculations.Note: For convenience, references to Central America refer to the IMF subregion Central America, Panama, and the Dominican Republic (CAPDR). The Central American countries in this group are: Costa Rica, El Salvador, Guatemala, Honduras, and Nicaragua.

Consistent with CAPDR’s participation in GVCs in the downstream part of the production process, the region has specialized in the production and supply of low-skill and labor-intensive manufacturing goods. This is evident in its rising share of global apparel exports over the past 15 years, even as China and other Asian economies continue to dominate this market (Figure 5.8). Most CAPDR countries are ranked in the top 35 percent of apparel exporters globally, well above the wider regional average, despite being small economies. Their central role in the apparel industry reflects the concentration of production activity in the maquilas special economic zones in this sector (see the next section).

Figure 5.8.
Figure 5.8.

Market Share in Apparel Sector

(Share measured as total apparel export over world average, excluding bottom 65 percent of countries and China)

Sources: Comtrade and IMF staff estimates.Note: ARE = United Arab Emirates; AUT = Austria; BEL = Belgium; BGR = Bulgaria; CAN = Canada; CHE = Switzerland; CRI = Costa Rica; CZE = Czech Republic; DEU = Germany; DNK = Denmark; DOM = Dominican Republic; EGY = Egypt; ESP = Spain; FRA = France; GBR = United Kingdom; GRC = Greece; GTM = Guatemala; HKG = Hong Kong SAR; HND = Honduras; HUN = Hungary; IDN = Indonesia; IND = India; ITA = Italy; JOR = Jordan; KHM = Cambodia; KOR = Rep. of Korea; LKA = Sri Lanka; LTU = Lithuania; MAR = Morocco; MEX = Mexico; MUS = Mauritius; MYS = Malaysia; NIC = Nicaragua; NLD = Netherlands; PAK = Pakistan; PAN = Panama; PER = Peru; PHL = Philippines; POL = Poland; PRT = Portugal; ROU = Romania; SGP = Singapore; SLV = El Salvador; SVK = Slovak Republic; SWE = Sweden; THA = Thailand; TUN = Tunisia; TUR = Turkey; USA = United States; VNM = Vietnam.

The Composition of Trade

CAPDR’s export baskets have developed consistently with comparative advantage, as shown by the region’s revealed comparative advantage (RCA). This key indicator of export composition and performance compares the share of a product in a country’s total exports with the share of that product’s world exports in the global exports of all products.6 The region has established RCA in resource-intensive manufacturing products since the 1980s after experiencing a jump in the RCA of low-skill and technology-intensive manufacturing products in the 1980s (Figure 5.9).7 This evolution likely reflects the increased importance of the maquila sector for the region. Export-oriented production commonly located in maquila special economic zones has been concentrated in low-skill and technology-intensive as well as resource-intensive manufacturing products like textiles, footwear, tobacco, and simple components and devices. Since the early 2000s, the region has also seen RCA surge in high-skill and technology-intensive manufactures, likely reflecting the activities of multinationals with production facilities in the region. On the other hand, the region’s high RCA in nonfuel primary commodities fell sharply from the mid-1980s, in line with the decline in the relative importance of these products in the region’s export baskets.

Figure 5.9.
Figure 5.9.

Central America: Revealed Comparative Advantage

Sources: UN COMTRADE and IMF staff calculations.Note: For convenience, references to Central America refer to the IMF subregion Central America, Panama, and the Dominican Republic (CAPDR). The Central American countries in this group are: Costa Rica, El Salvador, Guatemala, Honduras, and Nicaragua. Products grouped according to UNCTAD classification of skill and technology intensity.

In parallel with the RCA gains in new product groups, CAPDR diversified its exports until the early 1990s. The region’s export concentration has remained relatively stable since then (Figure 5.10).8 To some extent, this may reflect the concentration of production activity in the special economic zones (or maquilas) on a limited number of products. While there has been a small push toward more diversification since the early 2000s, the CAPDR’s exports remain relatively more concentrated than those of the largest economies in Latin America. That is surprising given the concentration of these economies’ exports in commodities. CAPDR’s exports are also more concentrated than in other regions besides the Middle East and North Africa and sub-Saharan Africa.

Figure 5.10.
Figure 5.10.

Export Concentration

Sources: UN COMTRADE and IMF staff calculations.Note: AE = advanced economies; LAC = Latin America and the Caribbean; MENA = Middle East and North Africa; SSA = sub-Saharan Africa; CAPDR = Central America, Panama, and the Dominican Republic; LA6 = Latin America 6.

CAPDR’s exports are also less complex than those of the larger Latin American economies. Economic complexity is related to the degree of productive knowledge that is revealed as embedded in a country’s exports, and indicates the productive capabilities of a certain country.9 Highly complex goods (the 5th quintile) account for 5 percent of CAPDR’s export portfolio, compared to about 20 percent for the larger Latin American economies in the LA6 (Brazil, Chile, Colombia, Mexico, Peru, and Uruguay) shown in Figure 5.11. While least complex goods accounted for about 90 percent of the export portfolios in both groups of countries in the 1960s, the LA6 countries have managed to move away from these products much faster, reducing their share to about 25 percent by the late 1990s. However, the commodity price boom in the 2000s reversed these gains to some extent, and the contribution of the least complex products in both country groupings’ exports is similar in the most recent period.

Figure 5.11.
Figure 5.11.

Product Complexities, LA6 versus Central America

Source: Ding and Hadzi-Vaskov.Note: The chart shows the distribution of exports for Latin America and the Caribbean according to the level of product complexity: top area corresponds to the share of export products that belong to the top (fifth) quintile in terms of product complexity, and the bottom area corresponds to the share of products in the bottom quintile of the distribution. For convenience, references to Central America refer to the IMF subregion Central America, Panama, and the Dominican Republic (CAPDR). The Central American countries in this group are: Costa Rica, El Salvador, Guatemala, Honduras, and Nicaragua. LA6 = Latin America 6.

CAPDR countries’ export baskets are indicative of different levels and paths of economic complexity. Within CAPDR, Honduras and Nicaragua have had the lowest levels of economic complexity, whereas Panama and Costa Rica have been at the top consistently (Figure 5.12). While the economic complexity index suggests a stable score for the region, the Dominican Republic has been able to increase its complexity, likely reflecting the move away from agriculture and the addition of more technologically intensive products in free economic zones.

Figure 5.12.
Figure 5.12.

Central America: Economic Complexity Index

Sources: The Observatory of Economic Complexity, and IMF staff estimates.Note: For convenience, references to Central America refer to the IMF subregion Central America, Panama, and the Dominican Republic (CAPDR). The Central American countries in this group are: Costa Rica, El Salvador, Guatemala, Honduras, and Nicaragua

The Determinants of Trade

CAPDR countries appear to be trading in line with their fundamentals. Estimation results from gravity equations that model bilateral exports as a function of economic, historical, and geographic characteristics imply that economic size, common official language, contiguity, and having had a colonial relationship or common colonizer all have positive effects on bilateral trade flows. Conversely, larger geographic distance and being landlocked or trading with a landlocked partner restrict bilateral trade. Results from the gravity models that consider these factors suggest that CAPDR countries trade in line with their fundamentals (IMF 2015).

Structural factors can support trade expansion. Enabling indicators suggest the overall supportive environment for trade in CAPDR is similar to that in Latin America and the Caribbean as a whole and other emerging markets (IMF 2017). These are shown in Figure 5.13. On a country-by-country basis, enabling trade indicators suggest that performance is also broadly comparable across CAPDR countries, with all achieving similar rankings to the wider regional average (Figure 5.14). CAPDR performs a little better than LAC on market access (both domestic and foreign) and slightly worse on the availability and use of information and communication technology. Improvements in the operating environment and quality of infrastructure and transport services, particularly shipping connectivity and port infrastructure, and in the availability and use of information and communication technology, could support the expansion of CAPDR’s trade. Similarly, streamlining customs procedures, which are more burdensome than in other emerging markets, could also help expand trade. Infrastructure quality could be improved to reduce transportation costs and facilitate trade. Despite authorities’ concerted efforts to upgrade logistics and transport infrastructure over the past decade, persistent gaps remain. The exception is Panama, given its extensive port and air transport infrastructure.

Figure 5.13.
Figure 5.13.

Enabling Trade Index, 2016

Sources: World Economic Forum and IMF staff estimates.Note: For convenience, references to Central America refer to the IMF subregion Central America, Panama, and the Dominican Republic (CAPDR). The Central American countries in this group are: Costa Rica, El Salvador, Guatemala, Honduras, and Nicaragua. ICT = information and communication technology; LAC = Latin America and the Caribbean.
Figure 5.14.
Figure 5.14.

Logistics Performance and Subcomponents, 20161 (1–5 worst to best)

Sources: World Bank LPI and IMF staff calculations.Note: For convenience, references to Central America refer to the IMF subregion Central America, Panama, and the Dominican Republic (CAPDR). The Central American countries in this group are: Costa Rica, El Salvador, Guatemala, Honduras, and Nicaragua.1 The logistics performance index (LPI) is the weighted average of the country scores on six key dimensions: efficiency of the clearance process, quality of trade and transport related infrastructure, ease of arranging competitively priced shipments, competence and quality of logistics services, ability to track and trace consignments, timeliness of shipments in reaching destination within the scheduled or expected delivery time.

Product proximity provides insights into the likely direction of change in which CAPDR can take advantage of its current areas of comparative advantage to diversify in related industries. Product proximity suggests that the ability of a country to produce certain products depends on how similar or close it is to the products that are already produced in the country: that is, the current composition of a country’s export basket provides information about the type of goods it is relatively successful at producing.10 It is easier for a country to reuse or reemploy certain skill sets to produce similar goods than to acquire completely new skills and competencies and make revolutionary jumps in its product portfolio. For CAPDR, product proximity has correctly predicted the direction of change in RCA for all broad groups of exports over 1990–2013 (Figure 5.15, panel 1).11 Looking ahead, the proximity between groups of products suggests that the region is likely to lower its RCA in high-skill and technology-intensive products and resource-intensive manufactures (Figure 5.15, panel 2) absent significant policy changes.12 On the other hand, RCA for the region is predicted to increase in medium- and low-skill and technology-intensive products as well as nonfuel primary commodities. This finding is likely related to lack of skills, technology, and adequate infrastructure, which hinders CAPDR countries’ ability to move toward producing more complex products.

Figure 5.15.
Figure 5.15.

Central America: Product Proximity and Comparative Advantage

Source: Ding and Hadzi-Vaskov (2017).Note: For convenience, references to Central America refer to the IMF subregion Central America, Panama, and the Dominican Republic (CAPDR). The Central American countries in this group are: Costa Rica, El Salvador, Guatemala, Honduras, and Nicaragua. Units of measurement are “standardized” RCA that sum up to 1 across the seven product categories.
Figure 5.16.
Figure 5.16.

Global Competitiveness Index

(2017–18, Labor market efficiency, higher = better)

Sources: World Economic Forum, and IMF staff calculations.Note: For convenience, references to Central America refer to the IMF subregion Central America, Panama, and the Dominican Republic (CAPDR). The Central American countries in this group are: Costa Rica, El Salvador, Guatemala, Honduras, and Nicaragua. LAC = Latin America and the Caribbean.

Further diversification of CAPDR’s exports is likely to be gradual, but can be supported by policies to upgrade skills and infrastructure. Episodes of diversification have been characterized by a process where countries move into products similar to those they already produce—as predicted by product proximity. To modify the path implied by predictions and preserve or increase RCA in more high-skill-intensive products, CAPDR countries will likely need to implement substantive policy reforms. For instance, Ding and Hadzi-Vaskov (2017) show that better infrastructure and higher-quality education are associated with more complex and diversified (less concentrated) exports, as well as with higher RCA and shares of high-skill products in total exports (Table 5.1). For CAPDR, upgrading the existing export basket will require advancement not only in infrastructure but also human capital. The region performs relatively poorly compared to other regions on indicators of the quality of education, which can impede workers’ ability to upgrade their skills and participate effectively in the production chain.

Table 5.1.

Determinants of the Composition of Trade

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Source: Ding and Hadzi-Vaskov (2017).Note: Estimation results from panel regressions that include time fixed effects. Infrastructure is measured by the density of the railway network from the WDI, tariffs refer to average applied tariffs retrieved from the WITS database, education refers to secondary school enrollment rate and to share of population with tertiary education in regressions for RCA and share of high-skill products, and income inequality is measured by the net Gini index from the SWIID. pval in parentheses.*** p , 0.01, ** p , 0.05, * p , 0.1.

The Economic Impact of Trade

How is economic growth affected by trade integration and how can CAPDR enhance the growth impact of its integration into global markets? What structural characteristics of trade help explain the relationship between trade and economic growth and how can CAPDR design its trade policy to optimize the growth impact of trade? Estimating medium-term growth equations using data for many countries can shed light on these questions. The equations are estimated in the form of five-year non-overlapping intervals for an unbalanced panel of up to 131 advanced and emerging market and developing economies, including CAPDR countries.13 The estimated equations include a full set of time fixed effects to account for global shocks such as shifts in commodity prices or the global business cycle. To address concerns about reverse causality and dynamic panel bias, the equations are estimated with system generalized method of moments.14 A CAPDR dummy variable is interacted with each trade characteristic to assess whether the structural characteristics of trade have differential growth effects for the CAPDR region.

CAPDR’s integration into global markets is beneficial for economic growth. The results of the benchmark specification (Table 5.2) are broadly comparable to those in the literature: trade openness has a positive and statistically significant impact on average per capita economic growth.15 Evidence also exists of a conditional convergence effect, whereby countries with a lower initial level of real GDP per capita have higher growth rates. The effect of trade on growth also varies with the level of economic development: the growth benefit is stronger for advanced economies than those at earlier stages of economic development.16 This is consistent with other findings that the beneficial effects of trade increase as economies develop and strengthen complementary policies that allow them to reap the benefits of trade (for example, Kim 2011). This includes, among other aspects, strengthening human capital development and physical infrastructure while improving institutional frameworks and putting in place policies that encourage investment.

Table 5.2.

Per Capita Real GDP Growth Equation Estimates

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This table reports the results of regressions of growth in real GDP per capital on various indicators of the characteristics of countries’ exports. All regressions include time fixed effects. Robust standard errors in parentheses. *** p,0.01, ** p,0.05, * p,0.1. See Beaton, Cebortari and Komaromi (2017) for additional details.

The sum of foreign value added as a share of gross exports and indirect value added as a share of gross exports.

Indirect value added is the value of exported goods that are used as imported inputs by other countries to produce their exports.

As measured by the IMF Export Quality Index. Higher values indicate higher export quality. Source: IMF Export Quality Database.

As measured by the IMF Export Diversification Index. Higher values indicate lower (higher) diversification (concentration).

Source: IMF Export Diversification Database.

The characteristics that spur trade integration in CAPDR are also beneficial for economic growth. Participation in GVCs, particularly upstream in production, enhances the effect of trade on economic growth. The region can foster participation in GVCs in support of growth by continuing efforts to reduce trade barriers, build better infrastructure, boost human capital formation, support research and development, and improve institutions.17 CAPDR also reaps growth benefits from the significant portion of its trade with advanced economies (particularly the United States). Results from the growth regressions show that trading with advanced economies is associated with stronger growth outcomes than trading with emerging market and developing economies.18 As with participation in GVCs, this positive growth effect may be attributable to knowledge and technology spillovers. Table 5.2 shows that different trade indicators have similar impacts from participating in GVCs on growth in the CAPDR region as for the global sample, with two exceptions: trade openness contributes less to growth in the region, while the negative effect of export concentration is amplified. Both findings may reflect the importance of maquila exports, which boost gross trade openness and export concentration.

Structural characteristics of trade matter in the trade-growth nexus. Higher quality and more diverse export baskets are associated with higher growth. CAPDR countries perform well in both dimensions. The region’s export quality is considered better than that of the broader region, and the 50th percentile of the world distribution and its export products are less concentrated than in much of Latin America and the Caribbean and the 50th percentile of the world distribution.

Regional View of Trade Policy

A 2015–16 survey of CAPDR trade authorities provides some insight into their priorities for trade policy, their views on regional integration, and the major constraints that exporters experience in these countries.19 The results are summarized below and shown in Figure 5.17. The main objectives of trade policy in the CAPDR region are diversification of products and markets and increasing export sophistication. Respondents, including in countries that have already achieved some sophistication in their export baskets, mentioned increasing the value added of their exports as a goal. Expansion of service exports was mentioned as an objective by Costa Rica, Guatemala, and Panama. Guatemala saw its low labor costs as an advantage, while Panama aimed to become a global service hub. Also mentioned was the goal of integrating small and medium enterprises into trade (Costa Rica, El Salvador, Nicaragua), which would help to create employment and spread gains from trade more widely.

Figure 5.17.
Figure 5.17.

Survey Results on Central American Authorities’ Trade Policy Views

Source: IMF 2017.Note: For convenience, references to Central America refer to the IMF subregion Central America, Panama, and the Dominican Republic (CAPDR). The Central American countries in this group are: Costa Rica, El Salvador, Guatemala, Honduras, and Nicaragua. CAFTA-DR = Dominican Republic-Central America Free Trade Agreement; EU = European Union; LAC = Latin America and the Caribbean; RTAs = Regional Trade Agreements; SME = Small & Medium-Sized Enterprise; WTO = World Trade Organization.

Preferential trade agreements have played a key role in CAPDR’s efforts to expand and diversify trade; notably, bilateral and regional trade agreements were mentioned in the survey. In the survey, Guatemala and Nicaragua noted a focus on seeking new agreements with strategic partners. Costa Rica, Honduras, and Nicaragua saw opportunities for leveraging current agreements by identifying new products or firms in export markets where they already had preferential access, or though seeking more flexibility in rules of origin. Regional agreements and CAFTA-DR were the most frequently mentioned existing trade initiatives, while some responses pointing to the many bilateral trade agreements with other Latin American countries in effect or with negotiations underway. Costa Rica and El Salvador also cited Asia as a key target market. Costa Rica and Panama highlighted their participation in plurilateral negotiations at the World Trade Organization. Nicaragua, on the other hand, expressed concern about the possible fragmentation of the world trading system because of a preference for mega-regional agreements over the WTO and the impact this could have on small developing economies.

Beyond trade agreements, all CAPDR countries mentioned export and investment promotion as a strategy. Trade authorities in the region supported exporting firms through disseminating information, providing training, and sponsoring innovation. Investment promotion activities to attract foreign direct investment (FDI) are also an important component of trade policy, and the link between FDI and trade was mentioned by several countries, including Costa Rica, which attributes its relatively high export sophistication to the positive impact of four decades of FDI. The Dominican Republic highlighted the important role that FDI into free trade zones has played in export diversification, supported by investment provisions in the CAFTA-DR agreement and an improved legal framework to accommodate foreign investors.

Low human capital and infrastructure quality are important constraints for exports in the CAPDR region. Nicaragua and Guatemala noted that low education quality is a constraint on exporting. Costa Rica is encouraging the development of specialized skills to support the expansion of higher-value-added exports, including IT and language skills. Linked to human capital, several countries (Costa Rica, El Salvador, Guatemala, Panama) mentioned low productivity or slowing productivity growth as a constraint. It was recognized that except for Panama, which has a comparative strength in transportation services, transportation infrastructure could be improved to reduce the cost of getting goods to market. Trade facilitation and more efficient logistics operations were also seen as key challenges for the region, and one that almost all respondents saw as essential for increasing trade integration; a strategy to improve these aspects of regional trade was adopted by ministers in 2015.

Nontariff barriers are the most important external constraint to exporting. Given the importance of agricultural products in the region’s export basket, sanitary and phytosanitary measures and agricultural subsidies were mentioned by several countries as significant constraints (Costa Rica, Dominican Republic, El Salvador, Guatemala, Nicaragua). Also, initiatives to harmonize technical barriers to trade across countries would reduce compliance costs (Costa Rica, Dominican Republic, El Salvador). Costa Rica, Honduras, and Nicaragua noted the potential for agreements on rules of origin to boost trade and facilitate regional value chains, including through cumulation of origin mechanisms between trade agreements.

Completing the integration process in Central America is a priority. Movement toward integration began in 1960 and, although progress has been slow, trade barriers have been reduced and intraregional trade expanded. Honduras and Guatemala recently established a customs union, with the hope that neighboring countries will join. Countries in the region tend to produce similar products and there is a history of tax competition in the maquila sector. Nevertheless, closer regional integration has enabled joint trade agreements such as the one finalized between Central America and South Korea in 2018, while trade agreements with the European Union and the United States have also opened opportunities for intraregional trade. Panama recently joined the Central American Common Market, which should provide some growth opportunities for the bloc. Panama sees potential to export services to other Central American countries, but notes that significant barriers to a regional services market are still in place.

CAPDR countries expressed mixed views about integration with the rest of LAC. Asymmetries in the size of economies were highlighted as an obstacle to deeper integration, as some smaller countries are unable to compete and do not benefit as much from regional trade agreements. For Guatemala, the proximity of US and Mexican markets makes integration with South America less of a priority. El Salvador mentioned the idea of linking the various regional blocs in LAC, while noting some obstacles to such an initiative, including a lack of political will. On the other hand, Costa Rica and Panama are the two countries in the region that see the greatest potential in integration with LAC. For example, Panama discussed prospects for an agreement with Mercosur and both Panama and Costa Rica were interested in joining the Pacific Alliance, along with Honduras.

Conclusions and Policy Implications

The analysis in this chapter suggests that CAPDR has penetrated global markets and is well integrated into world trade. However, it also suggests ample scope for tackling structural challenges to preserve the region’s comparative advantages or to diversify into new product groups and promote the growth benefits of trade. Three main messages are offered for the design of CAPDR’s trade policy:

  • Support trade integration with complementary policies. The analysis emphasizes the importance of complementary policies, particularly to strengthen infrastructure and human capital. Continued regional efforts on this front would be useful as part of a broad growth strategy, but they can also enhance trade integration, including by helping countries take part in global value chains, which may offer new opportunities for technology transfer and are critical to diversifying and upgrading the complexity of CAPDR’s exports, which can also enhance the growth benefit of trade integration.

  • Diversify export products and markets. Diversification of export products, particularly toward more complex products, can enhance the growth benefit of trade. For CAPDR, a successful diversification strategy will need to be supported by educational reform to protect comparative advantage and gain further revealed comparative advantage in high-skilled products. With the region’s exports largely concentrated toward a single market, diversification of export markets can also promote external stability, productivity, and economic growth.

  • Exploit opportunities for regional cooperation. While there may be little scope to expand intraregional trade given the similarity of the region’s production structures and export bases, there is scope to enhance regional cooperation on trade. The region should continue its efforts to negotiate joint trade agreements (similar to DR-CAFTA and the recent agreement with South Korea). Cooperation could also be expanded to include regulatory issues, trade facilitation, and improvements in the region’s interconnectivity. Cooperation on such initiatives would provide the region with economies of scale and facilitate broader trade integration by reducing administrative and compliance costs.

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1

For convenience, references to Central America refer to the IMF subregion Central America, Panama, and the Dominican Republic (CAPDR). The Central American countries in this group are: Costa Rica, El Salvador, Guatemala, Honduras, and Nicaragua.

2

Besides stemming from the transition from centrally planned to market economies, this development also reflects a more general change of trade policy orientation toward export-led growth.

3

Members include Costa Rica, El Salvador, Guatemala, Honduras, Nicaragua, and the Dominican Republic.

4

CAFTA-DR entered into force in 2006 for the United States, El Salvador, Honduras, Nicaragua and Guatemala, in 2007 for the Dominican Republic, and in 2009 for Costa Rica.

5

Participation in GVCs is measured as the sum of a country’s foreign value added in gross exports and indirect value added (the value of exported goods that are used as imported inputs by other countries to produce their exports) calculated using the Eora Multi Region Input Output (MRIO Table), as shown in Lensen, Kanemoto, Moran, and Geschke 2012, and Lenzen, Moran, Kanemoto, and Geschke 2013, based on Koopman, Wang, and Wei’s decomposition of gross exports published in 2010.

6

RCA shows the relative advantage or disadvantage that a country (or group of countries) has in exporting a certain good (or group of products). It is measured here with the RCA index by Balassa (1965) that divides the share of a certain good in a country’s total exports by the share of that product’s world exports in total world exports of all goods. Hence, if the RCA index is above one, it indicates a relative advantage for that country in exporting the product (or group of products).

7

See Ding and Hadzi-Vaskov (2017) for a more detailed discussion of the broader region’s RCA in various groups of products and a comparison of RCAs across regions.

8

Export diversification measures differ widely, depending on the definitions and levels of product aggregation used in the analysis. See Ding and Hadzi-Vaskov (2017) for details on these calculations.

10

For detailed discussion about the concept of product proximity see Hausmann and others (2014).

11

For details about the underlying methodology to predict the direction of change in RCA on the basis of proximity between groups of products see Ding and Hadzi-Vaskov (2017).

12

Calculations are based on the methodology of Ding and Hadzi-Vaskov (2017).

13

The equations estimated are as follows: git = β1git-1 + β2Xit + αt + γi + εit where git is average per capita growth over each five-year period t, X is a matrix of country characteristics, αt is a time-specific fixed effect, and γi are country-specific fixed effects. The set of country characteristics is standard and includes human and physical capital and foreign direct investment and the terms of trade in addition to indicators of trade openness. The model is outlined in more detail in Beaton and others (2017).

14

See Arellano and Bover (1995) and Blundell and Bond (1998) for a description of system generalized method of moments. Use of this methodology to understand the trade-growth relationship follows recent contributions from Dollar and Kraay (2004), Loayza and Fajnzylber (2005), Chang and others (2009), and de la Torre and others (2015).

15

A vast literature examines the effect of trade on growth. A seminal contribution by Frankel and Romer (1999) found that trade, instrumented with geography, has a positive effect on countries’ income. There findings were disputed by some (for example, Rodríguez and Rodrik (2001), while more recent papers have found an important role for trade in economic growth. For examples, see Dollar and Kraay (2004), Loayza and Fajnzylber (2005), de la Torre and others (2015).

18

Not reported on Table 2. See Beaton, Cebotari, and Komaromi (2017).

19

Responses were received from Costa Rica, the Dominican Republic, El Salvador, Guatemala, Nicaragua, and Panama between November 2015 and August 2016. The response from Honduras was received in December 2017. See IMF (2017) for further details on the survey.

Contributor Notes

The authors would like to thank Valerie Cerra for her guidance with this work. This chapter is based on IMF (2017) with the analysis updated and extended to CAPDR.