Trade beyond tariffs revisiting the 2012 EU-CA Association Agreement

• Lewin Schmitt (Germany) and José Noguera (Nicaragua)
• 22. August 2020

Looking at the impact of trade liberalisation following the 2012 EU-Central American Association Agreement, we find positive trends in overall trade. However, when disaggregating CA exports, a more complex picture appears. We discuss the development of the exports’ sectoral composition (primary products vs. manufactures), where for most countries we find a slight shift towards manufactures. In the future, CA agricultural exports might come under pressure through various trade liberalisation processes, which is why we underline the importance of upgrading the region’s value chain.

The European Union (EU) and the Central American region (CA)^[1] concluded an Association Agreement (AA) in June 2012, consisting of three pillars: political dialogue, cooperation, and trade.^[2] While the first two are important, it was undoubtedly the trade imperative that drove the negotiations, with tariffs and trade barriers gradually being removed since 2013.

Advocates of the agreement referred to the positive impetus it would bring to bi-regional trade and thus to CA’s economic development.^[3] However, little research on the trade pillar’s impact has been conducted in the follow-up of the agreement, surprisingly.

To fill this gap, we present an overview on the development of bi-regional trade for the period of 2008-2017, covering the five years before and after the trade pillar took effect. We focus our analysis on the CA side, having noted that the entirety of the EU’s exports to Central America have been rather stable since the Agreement. For CA, our findings show that overall exports to the EU have indeed increased, but with differing impacts on the composition of exports.

Of course, it is difficult to substantiate a direct causal link between changes in export patterns and the AA, as trade is influenced by many domestic and international factors. Externalities should not be underestimated. Notably, the decline of international commodity prices, the droughts caused by “El Niño” in 2014 and 2015, and the rust disease – that reduced coffee output by up to 70% from 2010 until 2014 – all had an impact on the region’s trade results.^[4]

Nevertheless, as our findings indicate, the story of overall positive economic development for both sides is more ambivalent than promoters of free trade often assert. While further research is needed to thoroughly assess the situation, we want to present some first results and discuss a few possible explanations below.

Different trends in bi-regional trade

Figure 1: CA exports to EU in million US-$, stacked.

Source: Trademap. Note: 2017 data was unavailable for Panama, so we used the 2016 values.

Analysing the development of CA exports to the EU for the period of 2008-2017 (fig. 1) shows stagnation in overall exports for the first two years after the trade pillar entered provisionally into force. This might in part be caused by the externalities mentioned above, which affected the region’s output of primary goods. Exports to the EU picked up growth again since 2016.

Figure 2: Exports to the EU as a share of total CA exports (lines) and the non-weighted average (bars).

Source: Trademap.

The non-weighted average share of exports to the EU relative to total CA exports (fig. 2, grey bars) went down just before the Agreement entered into force, but has again increased in recent years, suggesting a positive impact of trade liberalisation. In 2017, that share was at an all-time high (12%), surpassing even the 2011 peak (11%). That year, Costa Rica and Honduras sent respectively 17% and 29% of their exports to the EU.

This development has not been shared by all countries. Instead, the EU has lost relative importance as an export destiny for Nicaragua and El Salvador (table 1). Since 2014, however, the share of exports to the EU is on an upward trend for all countries.

Table 1: Five-year-average share of exports to the EU relative to total exports before (2008-2012) and after (2013-2017) the trade pillar entered into force.

Source: Trademap.

Changes in sectoral composition

According to measures by the European Commission, the share of manufactures in CA’s overall export composition dropped by more than half from 44% to just over 20% over the last three years.[5] This can be explained by the closing of an international chip manufacturer’s assembly plant in Costa Rica.^[6] Accordingly, when we exclude Costa Rica, the reduction of manufactures in the sectoral export composition is less drastic, shrinking from 17% to 13% over the past three years. This reduction in the share would suggest that the increase in CA exports to the EU has been predominantly driven by a higher share of primary products.

Disaggregating these numbers and looking again at the five-year intervals before and after the trade pillar entered into force (table 2), we can see that the share of manufactures in a country’s exports to the EU have increased for all but Costa Rica. Noting that the strong decline of Costa Rican exports in 2015 (-30%) is also the main reason for the stagnation of overall CA exports observed in 2015, this shows how singular events, in this case completely unrelated to the AA, can have a distortionary large effect on the overall picture.

Table 2: Five-year-average share of manufacturing exports to EU relative to total exports to EU before (2008-2012) and after (2013-2017) the trade pillar entered into force.

Source: Trademap.

While the trend of manufacturing seems to be slightly positive in the long run, it is far from the sort of industrialisation and structural changes that the “Asian Tigers Economies” experienced in the 1960’s.^[7] The European Commission numbers underline the fragility of CA manufactures competing in global value chains. With this in mind, the next section will briefly discuss the implications of the AA on CA economies.

The quest for upgrading the value chain

Observers have long noted that the CA region is slow in upgrading its value chain.^[8] This is also supported by our findings, which show overall robust increases of primary commodity exports to the EU, while the trend in manufacturing is more ambiguous. This can be easily explained: agricultural exports are not subject to strong EU competition, as most of the concerning crops naturally grow better in the CA ecosystem. This presents a clear competitive edge for exports, which accordingly increased after the removal of tariffs.

However, this advantage is threatened by the liberalisation process of DR-CAFTA (Dominican Republic-Central America Free Trade Agreement) in key primary sectors. Since 2015, import tariffs on agricultural goods from the US have been gradually lifted. These crops are often subsidized in the US and thus are expected to crowd out CA domestic producers. For instance, this is the most likely scenario for Nicaraguan rice, where local farmers might not be able to compete with US producers. Furthermore, considering the forthcoming trade agreement between EU and MERCOSUR, CA will encounter competition in some other agricultural products, where it may possibly lose market share.

Manufacturing and industry, however, are sectors in which many other factors define the competitiveness of a product. Besides resource inputs, labour costs are important, perhaps the only field in which CA can clearly outperform the EU through lower wages. Although productivity, R&D, skilled labour, et cetera are also decisive, and it is easy to see that in these fields, the EU has the competitive edge.

Since the AA subjected CA producers to more competition from the EU, emerging industries had new obstacles to face. Access to a big consumer market tends to benefit established players, which are rare within the region. Therefore, for certain sectors, trade liberalisation might undermine efforts of consolidating and fostering nascent producers.

Discussing trade beyond tariffs

The AA strengthened bilateral trade flows between CA and the EU. CA exports did get a significant boost in primary commodities, but less so in the manufacturing sector. Our discussion of possible root causes for this mixed picture indicates that CA economies continue to struggle to include more steps of the value chain and to diversify their production.

Hence, it seems that the AA at present has had a limited impact in reducing existing imbalances and improving the business environment for CA. At the same time, EU businesses, built around an economic structure conducive to exports and international competition, were better equipped to enjoy the benefits of the agreement.

Our discussion shows that tariffs (or their elimination) are clearly not the only determinants of exports. It might therefore be beneficial to shift the discussion of fair and sustainable trade to focus more on trade barriers and structural disadvantages such as legacy imbalances, infrastructure deficiencies, logistic costs, time consuming procedures, et cetera. There is evidence suggesting that remaining barriers in CA have limited the potential gains from Free Trade Agreements[9] and tariffs removal alone have small effects on the number of new exporters as well as on the behaviour of incumbent firms.[10]

This leads us to argue that if economic development of CA and other less developed regions is to be taken seriously, trade liberalisation alone is insufficient. CA industries require more skills, resources and experience to properly use the trade opportunities made available through trade liberalisation.

For CA to benefit from increased trade openness, they need to focus on upgrading their value chains rather than merely boosting exports in particular sectors.^[11] A comprehensive industrial policy and ambitious, focused commitments to fostering domestic industries will be decisive in achieving sustainable economic development. It is under such circumstances that the AA’s trade pillar will prove the most beneficial for both sides.

References

^[1] Comprising Costa Rica, El Salvador, Guatemala, Honduras, Nicaragua and Panama.

^[2] The full text of the agreement: http://trade.ec.europa.eu/doclib/press/index.cfm?id=689, accessed June 2, 2018.

^[3] European Commission (2012) EU-Central America: Trade relations under the Association Agreement, http://trade.ec.europa.eu/doclib/docs/2012/november/tradoc_150029.pdf and Coulombe, G. (2010). Central America seals association deal with EU. FOCAL, https://www.focal.ca/es/publications/focalpoint/271-july-august-2010-gabriel-coulombe-en (both accessed July 28, 2018).

^[4] FEWSNET (2016) El impacto de la roya de café en el sector cafetalero de América Central.http://fews.net/sites/default/files/documents/reports/AMERICA%20CENTRAL%20Informe%20Especial%20-%20sector%20cafetalero%20-%202016.pdf accessed May 17, 2018.

[5] European Commission, Directorate-General for Trade. (2018) Trade in Goods with Central America 6, http://trade.ec.europa.eu/doclib/docs/2013/november/tradoc_151894.pdf, accessed on May 2, 2018.

^[6] Randewich, N. (2014) Intel closes Costa Rica operation, cuts 1,500 jobs. https://www.reuters.com/article/us-intel-costa-rica/intel-closes-costa-rica-operation-cuts-1500-jobs-idUSBREA371TJ20140409, accessed June 15, 2018.

^[7] Hong Kong, Singapore, South Korea and Taiwan.

^[8] Oddone, N. and Padilla, R. (2014) Upgrading Value Chains Through Professional and Supporting Services: Lessons from three Agro-Industry Chains in El Salvador and Guatemala. Mexico: CEPAL

[9] Cunha, B. & Jaramillo, C. (2013) Trade and Logistics in Central America: A Survey of Recent Analytical Work Sponsored by The World Bank. Washington, DC: The World Bank.

[10] Molina, A., Bussolo, M., and Iacovone, L. (2011) The DR-CAFTA and the Extensive Margin: A Firm-Level Analysis. Washington, DC: The World Bank.

^[11] Gereffi, G. et al. (2013): Costa Rica in Global Value Chains: An Upgrading Analysis. Duke Center on Globalization, Governance & Competitiveness.