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The Central American Customs Union: Potential Economic and Social Impacts

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November 2018 ORIGINAL: SPANISH Economic Commission for Latin America and the Caribbean (ECLAC) The Central American Customs Union: potential economic and social impacts This document, which has not been submitted for editorial review, was developed by the Regional Integration Unit of the International Trade and Integration Division (ITID) of ECLAC. The drafting of the document was prepared by José E. Durán Lima, staff member of the International Trade and Integration Division. Zebulun Kreiter, staff member, and Marcelo Pereira Dolabella, consultant, contributed to the elaboration of the study. Contents I. Background .................................................................................................................................................. 3 II. Literature review on methodologies to assess the impact of trade facilitation programs ............................. 4 A. Gravity models as a tool to estimate administrative costs ........................................................................ 5 B. Computable general equilibrium models and trade facilitation ................................................................ 8 III. Current state of the Central American Customs Union, and evaluation scenarios of ongoing initiatives 11 A. Tariff and non-tariff protection .............................................................................................................. 11 B. Value chains and intraregional trade ...................................................................................................... 13 C. Customs Union and Trade Facilitation ................................................................................................... 16 IV. Expected results of the application of trade facilitation programs at a Central American level............. 21 A. Macroeconomic results........................................................................................................................... 21 B. Effects on tax collection ......................................................................................................................... 25 C. Effects on employment, poverty, and income distribution ..................................................................... 27 V. Conclusions ................................................................................................................................................ 29 Bibliography ....................................................................................................................................................... 32 2 The Central American Customs Union: potential economic and social impacts Abstract The study shows the economic and social effects of the application of trade facilitation programs between the countries of the Central American Customs Union. The base work stems from the efforts of countries in the subregion to deepen the current Customs Union, mainly the three countries of the Northern Triangle (El Salvador, Guatemala and Honduras). I. Background International trade is much more open in the current world than it was at the end of the previous century. Most countries have reduced unilateral rates of tariff protection, and many have also engaged in preferential trade agreements which drastically reduce tariff rates on imports from partners in said agreements. Among Central American countries, the average applied tariff rate for imported goods is low (2%). Nonetheless, there are several additional costs associated with the lack of infrastructure, as well as administrative barriers that hinder the potential offered by such a broad market (customs forms, phytosanitary and zoosanitary certifications, packaging requirements, and inspections in different stages of the exporting process, among others). The concern over the persistence of non-tariff barriers in intraregional commerce has been one of the focal points in the Central American integration agenda in recent years. This has as its main priorities, among others; the implementation of the Customs Union Roadmap 2015-2024, the strengthening of physical regional connectivity, and the start-up of a Central American Strategy of Trade Facilitation. To accompany in this process, ECLAC has been supporting Central American countries by evaluating the cost associated with the non-existence of a Trade Facilitation Program, on the one hand, and on the other, by evaluating the implementation of a program that allows for the reduction of administrative trade barriers. In 2015, at the request of the International Trade Minister of Costa Rica (COMEX in Spanish), the first exercises were carried out to identify the overrun cost caused by diverse administrative barriers to trade. The results served as a valuable input for the technical teams’ discussion, which had been shaping the Central American Strategy of Trade Facilitation. Likewise, they also served to evaluate the cost associated to the lack of such a strategy. The existence of additional average costs for sub regional imports equivalent to a tariff rate of 24% above the unitary value of the traded goods was identified. During 2016, at the request of the Central American Integration Secretariat (SIECA in Spanish), the Ministry of Economy of Guatemala and the Secretariat of Economic Development of Honduras, ECLAC evaluated the cost that would be associated with the removal of the administrative barriers previously calculated. The study considered enacting a trade facilitation plan where exclusive tariff rates were used between both countries. The negotiations concluded by implementing, in June of 2017, bi-national tariff rates in three of the main border crossings between Honduras and Guatemala. Through this, customs territories for both countries were integrated into one unique territory of a little more than 221 thousand kilometers, 52% of the total area of Central America. Customs formalities for 80% of the binational load were reduced from an average of roughly 10 hours, to less than 15 minutes (SIECA, 2018). After implementing the binational 3 Customs Union between both countries, during the second semester of 2017, El Salvador, through its Central Bank and Minister of Finance, solicited support from ECLAC to assist in a new evaluation process. This time, the inclusion of El Salvador in the Customs Union between Guatemala and Honduras was assessed. The present chapter consolidates the main results of the technical support that ECLAC has provided to the governments of Costa Rica, Guatemala, Honduras and El Salvador, as well as to the Secretariat of Central American Integration. For reasons of confidentiality, the results presented are general and referential, intending to illustrate the main themes covered in each case: the macroeconomic, social and tax effects originated from the programs of trade facilitation. The motivation for this chapter is threefold. Firstly, to present ad valorem equivalents (AVE) associated with the administrative barriers to trade in Central America. Secondly, to present the economic and social effects of the reduction of said barriers for countries of the Northern Triangle (El Salvador, Guatemala and Honduras). Lastly, the inclusion of new scenarios extending the Customs Union for the group of Central American countries (incorporating Costa Rica, Nicaragua and Panama). The second section presents a review of the literature on the two main methodologies applied to measure the impacts of trade facilitation: gravity models and computable general equilibrium models. The first model is applied to evaluate the associated cost of the multiple administrative barriers present in intraregional trade. The second is applied to evaluate the effects of the trade facilitation programs. The third section reviews the state of regional integration in the economic scope, quantifying administrative barriers through AVE calculations, and the initiatives undertaken by the countries to strengthen the Customs Union. The fourth section presents results of the main scenarios used to evaluate the effect of implementing trade facilitation programs between Guatemala and Honduras, and between both countries and El Salvador in what would be the Customs Union between the three countries of the Northern Triangle. Likewise, the implications for countries not involved in such programs are presented (Costa Rica, Nicaragua and Panama), as well as the result of the impact of a tariff facilitation program including all Central American countries. The fifth section concludes. II. Literature review on methodologies to assess the impact of trade facilitation programs This section presents a selection of the main work linked to the quantification of trade facilitation measures, focusing on its two main contenders: gravity models and computable general equilibrium models. The objective of this review is twofold. Firstly, to identify background studies that evaluate and estimate the associated cost of non-tariff measures (NTMs) of an administrative nature, specifically through the calculation of ad valorem equivalents (AVEs). Secondly, to define the main analytical methodology that allows for the evaluation of the expected impact of the removal of said barriers on production and trade. Trade facilitation measures are characterized by a variety of activities, such as the reduction of required administrative processing in customs, improvements in transparency, reduction in smuggling, construction of electronic systems for processing cargo, and the development of modern systems that streamline intraregional
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