Statement: Economic Arguments Surrounding CAFTA Remain Misunderstood

As with NAFTA, promises may not hold up on either side of the agreement

For Immediate Release: July 14, 2005

Contact: Lynn Erskine, 202-293-5380 x 115
             Mark Weisbrot, 202-746-7264

As the U.S. House of Representatives moves closer to a vote on the Central American Free Trade Agreement (CAFTA), much of the debate over the economic costs and benefits to all potential signatories remains unclear. In particular:

Wages in the U.S

As compared to job loss, many more workers are affected negatively by trade liberalization through reduced wages. In fact, the overwhelming majority of the U.S. labor force is in that category. Although standard economic theory predicts that increased trade opening can produce a net gain for the country as a whole, it also indicates that there will be winners and losers. In the United States, about three-quarters of the U.S. labor force does not have a college degree, and standard economic theory predicts that they would lose out from increased trade opening. It is almost certain that for them, the reduction in wages due to trade opening in the last 25 or 30 years has outweighed any gains from cheaper consumer goods.¹

In fact, over the last 30 years the median wage in the United States has grown by about 9 percent, while productivity has grown by more than 80 percent. Normally we would expect wage growth to track productivity growth. There is a fair amount of economic research indicating that trade has contributed to this large upward redistribution of income, although how much it has done so is a matter of disagreement. But even if only a small fraction of this income redistribution is due to trade, it would easily outweigh the gains from trade for the vast majority of American employees.

Employment in the U.S.

It is argued that CAFTA will create jobs in the United States. Over the long run, most economists agree that the overall level of employment is determined by the monetary (interest rate) policy of the Federal Reserve. So it is not much influenced by trade.   In the short run, economists agree that trade affects jobs very directly: imports subtract from GDP and therefore employment, and exports add to it. So when the trade deficit increases, it means a net loss of jobs in the short run, if everything else is held constant.²

Economists also agree that trade will change the composition of jobs. The United States  lost about 3 million manufacturing jobs since 2000, and much of that job loss is due to trade. Given that most workers displaced from manufacturing jobs are not re-employed at the same wage level as the jobs that they lost,³ they do lose as a result of increased trade.

It is worth noting that compared to trade agreements such as NAFTA, a bigger cause of our trade deficit is the overvaluation of the dollar. If the dollar is overvalued by 25 percent, that is the same as putting a 25 percent tariff on our exports and, at the same time, subsidizing all imports by 20 percent.  

Economic Growth in Central America/Dominican Republic

It is said that CAFTA will boost growth in Central America and the Dominican Republic. While almost all economists agree that increased trade can contribute to growth, this is not true under all circumstances. Like NAFTA, on which it is modeled, CAFTA contains many provisions that do much more than reduce trade barriers.  
In the ten years since NAFTA went into effect, the annual growth of income per person has been only about 1.2 per cent in Mexico. This is about one-third the growth rate for the period 1960-1979. So there is no evidence that NAFTA was successful in boosting economic growth in Mexico, despite a significant increase in trade and foreign direct investment since the agreement took effect in 1994.

More generally, almost all economists would agree that the growth performance of Latin America over the last 25 years has been a terrible failure. Income per person has increased by about 14 percent, as compared to 80 percent from 1960-1979.⁴

Increased Access to U.S. Markets for Central America/Dominican Republic

This is the main selling point for Central America/DR. However, as the IMF has emphasized, the United States is currently running an unsustainable trade deficit -- about 6 percent of U.S. GDP. This cannot continue indefinitely. The economic implication is that the dollar will have to fall, and the trade deficit will have to narrow -- not disappear, but it must be reduced enough so that the U.S. foreign debt does not continue to grow at an explosive rate. This means that the U.S. import market (measured in non-dollar currencies) will have to shrink over the next decade.⁵ As a result, countries seeking access to the U.S. market will have to displace others that are already here, such as Mexico or China.

This is extremely important, because the Central America/DR countries are making economically costly concessions in areas such as intellectual property and agriculture -- where many thousands of farmers will lose their livelihood due to competition with U.S. agriculture (sometimes with subsidized crops such as corn). The idea is that increased access to U.S. markets will make up for these losses. But when the U.S. import market shrinks over the next decade, these promised gains will not materialize.  

Increased Intellectual Property Protection

CAFTA requires increased protection for pharmaceutical drug patents, beyond even that which is required by the WTO. This could be life-threatening for some of the estimated 275,000 people with HIV/AIDS in Central America/DR, and others who might otherwise have access to essential medicines, in the absence of such an agreement. 

Increased intellectual property protection also has economic costs. In fact, protectionism in the area of intellectual property is much greater than other forms of trade protection, and the resulting economic distortions -- the main thing that free trade is intended to reduce -- are far greater. So CAFTA will increase some barriers to trade while lowering others. 

An example will help clarify this point. Many people are against government spending and consider it wasteful and inefficient, but make an exception for military spending. They have reasons why they think military spending is important, but they would not try to deny that military spending is a form of government spending. 

Similarly, patent monopolies are a form of protectionism, just as much as tariffs on corn or steel. They have their justifications (e.g., to finance research and development) but that does not change their economic effect. The economic analysis of the distortions and economic losses to society as a result of these monopolies is the same as that for tariffs or trade barriers. The failure to understand these costs leads to a mischaracterization of CAFTA as a "free trade" agreement. It also prevents people from looking at the costs and benefits of an agreement such as NAFTA in economic, as opposed to ideological, terms.

This long-term economic failure, the worst performance in modern Latin American history, has led voters to choose candidates who explicitly campaigned against the economic reforms of the last 25 years: in Argentina, Brazil, Venezuela, Uruguay, and Ecuador, with similar elections (Mexico, Bolivia) currently headed in the same direction. These economic results should also lead observers here to question whether the economic reforms embodied in such agreements as NAFTA and CAFTA are best for the region.

Notes

[1] See "Will New Trade Gains Make Us Rich? An Assessment of the Prospective Gains from New Trade Agreements," CEPR, October 2001. 

[2] But all other things are not held constant over the long run; so, for example, if the trade deficit had not increased in the 1990s, the Federal Reserve would almost certainly have raised interest rates rather than allowing unemployment to fall to 3 percent. That is why economists see the overall level of employment, over any long enough period of time, to be determined by the Federal Reserve.

[3] See "Trade-related Job Loss and Wage Insurance: A Synthetic Review," Kletzer 2004.

[4] See "Another Lost Decade? Latin America's Growth Failure Continues Into the 21st Century," CEPR, November 2003.

[5] See "Fool's Gold: Projections of the U.S. Import Market," CEPR, January 2004.