Adjustment Problems in Developing Countries and the U.S.-Central America-Dominican Republic Free Trade Agreement

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1 The International Trade Journal ISSN: (Print) (Online) Journal homepage: Adjustment Problems in Developing Countries and the U.S.-Central America-Dominican Republic Free Trade Agreement Don P. Clark To cite this article: Don P. Clark (2009) Adjustment Problems in Developing Countries and the U.S.-Central America-Dominican Republic Free Trade Agreement, The International Trade Journal, 23:1, 31-53, DOI: / To link to this article: Published online: 10 Jan Submit your article to this journal Article views: 274 View related articles Citing articles: 6 View citing articles Full Terms & Conditions of access and use can be found at Download by: [ ] Date: 21 December 2017, At: 19:08

2 ADJUSTMENT PROBLEMS IN DEVELOPING COUNTRIES AND THE U.S.-CENTRAL AMERICA-DOMINICAN REPUBLIC FREE TRADE AGREEMENT Don P. Clark This article examines changes in intraindustry specialization indicators over the period to assess the potential for factor adjustment problems that may arise in Central American countries and the Dominican Republic (CA/DR) with trade growth resulting from the U.S.-Central America-Dominican Republic Free Trade Agreement (CAFTA-DR). Results show there is considerable scope for intraindustry specialization between CA/DR countries and their most important trading partner. Few CA/DR industries are likely to encounter adjustment problems. When adjustment problems are indicated, extended phase-out periods for tariffs, tariff-rate quotas, and import safeguards are used to ease factor adjustment pressures in import-sensitive industries. * * * * * Don P. Clark is the Beaman Professor of Business at the University of Tennessee, Knoxville, Tennessee, USA. THE INTERNATIONAL TRADE JOURNAL, Volume XXIII, No. 1, January--March ISSN: print/ online. DOI: /

3 32 THE INTERNATIONAL TRADE JOURNAL I. INTRODUCTION The U.S.-Central America Free Trade Agreement was signed by the United States, and Guatemala, Honduras, El Salvador, Nicaragua, Costa Rica, and the Dominican Republic (CA/DR) on August 5, Implementing legislation passed the U.S. Senate in June 2005 and the House of Representatives in July The president signed the CAFTA-DR agreement in August All members have ratified this agreement. CAFTA-DR is designed to enhance political stability, growth, and economic integration in the region by fostering trade and investment. 1 Negotiations to establish CAFTA-DR followed a long process of unilateral and regional trade policy reforms undertaken by CA/DR countries since the late 1980s. 2 Early reforms were intended to stimulate economic activity in the region by pursuing outward-oriented development strategies. CA/DR countries began to reduce tariffs unilaterally in the late 1980s and eliminated most nontariff barriers. For these members, average tariffs fell from 45 percent in 1985 to 14 percent in 1990, and to seven percent by Other reforms included the removal of exchange controls, using export processing zones (EPZs) to promote exports, opening up to foreign direct investment, and increased participation in bilateral, regional, and global agreements. CA/DR countries also actively pursued bilateral or subregional FTA negotiations with other Western Hemisphere countries to stimulate trade and investment. Examples include Costa Rica s FTA with Mexico in 1995, with Chile, the Dominican Republic, andthecaribbeancommunity(caricom)in2000,andwith 1 Key CAFTA-DR provisions are presented in Jaramillo and Lederman (2006), a U.S. International Trade Commission (2004) publication, and are available from the Organization of American States website ( 2 Trade policy reforms are discussed in Jaramillo and Lederman (2006). According to Schipke (2005, p. 32), CA/DR exports to the U.S. started to grow rapidly nine years before the CAFTA-DR agreement was implemented. Schott (2006) discusses U.S. objectives in pursuing bilateral FTAs in the Western Hemisphere.

4 Clark: Adjustment Problems Canada in Members of the Central American Common Market (CACM), which include Guatemala, El Salvador, Honduras, Nicaragua, and Costa Rica, jointly negotiated FTAs with the Dominican Republic in 1998, Chile in 2001, and Panama in El Salvador, Guatemala, and Honduras established an FTA with Mexico in These agreements encouraged trade among members and enhanced their ability to participate in regional negotiations such as CAFTA-DR and global negotiations. At the regional level, CA/DR countries revived the CACM in the 1990s. Progress was made toward reducing trade barriers among members and in harmonizing and lowering common external tariffs. Trade-related initiatives designed to deepen regional integration among members include macroeconomic, political, social, and environmental agreements. Central American countries also participated in negotiations for the Free Trade Area of the Americas (FTAA), and at the global level, participated in the Uruguay Round. CA/DR countries have long enjoyed preferential access to the U.S. market. Prior to the CAFTA-DR agreement, nearly eighty percent of their exports to the U.S. entered duty-free at most favored nation duty rates or under various trade preference programs such as the Generalized System of Preferences (GSP), the Caribbean Basin Economic Recovery Act (CBERA), the Caribbean Basin Trade Preference Act (CBTPA), and offshore assembly provisions under the U.S. tariff code. In 2000, the U.S. Trade and Development Act extended trade concessions to CBERA beneficiaries that were similar to those enjoyed by Mexico under the North American Free Trade Agreement(NAFTA)forapparel.Tariffswerereducedforother products that were previously excluded from the CBERA. Trade policy reforms and preferential access to the U.S. market stimulated trade, investment, and growth in the CA/DR countries. Unfortunately, the growth rate was not large enough to transform these economies and drastically reduce poverty rates. The CAFTA-DR agreement represents a landmark for the CA/DR

5 34 THE INTERNATIONAL TRADE JOURNAL countries. An FTA with the U.S. will be more beneficial to CA/DR members than the unilateral removal of trade barriers and trade preference schemes because it will guarantee long-term market access to their major trading partner. When combined with policies to address key constraints, such as infrastructure, education, governance, and macroeconomic stability, CAFTA-DR holds the potential for promoting growth and increasing welfare in the region. Approximately 80 percent of U.S. exports of consumer and industrial goods to other CAFTA-DR members entered duty-free upon implementation of the agreement. Extended tariff phase-out periods ranged up to 10 years for other manufactured goods. 3 Average tariffs on these products in CA/DR countries ranged from 4.1 percent to 7.8 percent. Tariffs on some products of export interest to the U.S. exporters were as high as 25 percent. Trade in nearly all textile and apparel products that meet rules-of-origin requirements immediately received duty-free treatment. The CAFTA/DR agreement extended immediate duty free access to more than half of all U.S. agricultural exports. Average tariffs applied by CA/DR countries to imports of agricultural products from the United States exceed 11 percent and on certain import sensitive products, can be more than 150 percent. Tariffs on the most sensitive agricultural products will be phased out over periods ranging from five to 20 years. Liberalization will be undertaken using tariff-rate quotas. White corn (El Salvador, Guatemala, Honduras, and Nicaragua) and onions and potatoes (Costa Rica) will retain over-quota tariffs. Long tariff phase-outs, tariff-rate quotas, and import safeguards are used to ease factor adjustment pressures in the most import-sensitive sectors. 4 3 Manufactured products with long tariff phaseout periods include certain products from the following categories: footwear, leather and leather goods, medical equipment, steel products, chemicals, and transport equipment. 4 Examples of agricultural commodities with long tariff phaseouts include milk, beans, poultry, beef meat, pork, apples, wheat, rice, potatoes, and onions.

6 Clark: Adjustment Problems Tariffs on U.S. imports from CA/DR countries are much lower than tariffs on U.S. imports from the region. 5 Prior to the agreement, nearly 80 percent of U.S. imports from CAFTA/DR countries entered duty-free at most-favored nation duty rates or under various tariff preference programs such as the GSP, CBERA, and the CBTPA. Duties on 1,710 tariff-line products that had an average tariff rate of 2.6 percent were eliminated upon implementation of the agreement. Highest pre-agreement tariff rates applied to agricultural and textile and apparel products. Seven products with an average tariff rate of 7.0 percent will have duty cuts staged over 10 years. Included here are rubber footwear, cushions, pillows, bedding and tuna. The 26.4 percent tariff on bovine meat will be phased out over a 15-year period. Ten dairy products with an average tariff rate of 41 percent will have tariffs phased out over 20 years. Included here are milk, cream, cheese, and dairy preparations. Sugar and sugar-containing products will not face tariff cuts, but tariff-rate quotas will be gradually increased over a 15-year period. Imports of products with tariffs phased out over ten or more years will be regulated by tariff-rate quotas that are expanded over time. Free Trade Agreements are intended to increase both production and trade among member countries. Resulting trade flows can be divided into two components: interindustry and intraindustry trade. Interindustry trade is the exchange between countries of totally different products, such as trading apparel for transport equipment. Specialization entails shifting resources from one industry to another within each country. Opponents of economic integration among developed and developing countries argue it will entail a considerable amount of economic adjustment in each country by encouraging specialization across rather than within 5 Tariff rates on U.S. imports from CA/DR countries and on CA/DR country imports from the U.S. are identified in a U.S. International Trade Commission (2004, p. 69) publication.

7 36 THE INTERNATIONAL TRADE JOURNAL industries. Adjustment costs are expected to be high because productive factors displaced from contracting industries are not well suited for employment in the expanding ones. Economic integration is more valuable when it enables countries to achieve greater specialization within the same industry. According to Weintraub (1997), the most direct test of the effectiveness of a free trade agreement involves determining the extent to which two-way trade has increased. Intraindustry trade (IIT) is two-way trade in products falling under the same industry classification. Here, productive factors shift with minimal internal disruption between segments of the same industry. This pattern of specialization will enable producers to realize efficient scale operations. Consumers enjoy lower prices and greater varieties of products through imports. Trade growth stimulated by free trade agreements is expected to facilitate both IIT and inter-industry trade. It is commonly believed that free trade agreements between industrial nations and developing countries will generate more interindustry trade than intraindustry trade. This article provides a detailed examination of trends in intraindustry specialization over the period to assess the potential for factor adjustment problems that may arise in CA/DR countries with growth in trade resulting from the CAFTA-DR agreement. 6 Economic integration studies are often preoccupied with adjustment problems that occur in industrial nations in response to increased imports of unskilled labor intensive products from developing countries. Regional economic integration may also entail a considerable amount of economic adjustment in developing countries as the pattern of production, 6 Economic integration studies typically estimate trade creation, trade diversion, and terms-of-trade effects. See Viner (1950) and Meade (1955). The period captures effects of unilateral and regional trade initiatives undertaken by CA/DR countries, U.S. trade preference programs, and Uruguay Round multilateral trade liberalization. The CAFTA-DR agreement can be expected to accelerate the pattern of intraindustry specialization, production, and employment that had been taking place over this period.

8 Clark: Adjustment Problems employment, exports, and imports respond to the removal of trade restrictions. CAFTA-DR will provide increased market access to CA/DR countries most important trading partner and will open their markets to exports from the world s second largest exporter. The agreement is expected to accelerate the pattern of intraindustry specialization, production, and employment that had been taking place prior to the agreement. II. INTRAINDUSTRY TRADE The most commonly used index of intraindustry trade is the Grubel-Lloyd (1975) index. This index measures the share of intraindustry trade in total trade, and is expressed as ð1þ j GL i ¼ 1 X i M i j ðx i þ M i Þ where X i is exports of industry i, M i is imports of industry i, jx i -- M i j is net trade, (X i þ M i ) is total trade, i ¼ 1,2,...,n, and 0 GL i 1. An index value of 0 indicates complete interindustry trade. Here, either the value of exports or imports is zero. Higher index values are associated with increases in the share of intraindustry trade in total trade. An index value of 1 indicates complete IIT or the equality between exports and imports. The Grubel-Lloyd (GL) index is used to describe an industry s trade pattern at a point in time. Indices of IIT in total trade between CAFTA-DR members in Central America and the United States are shown in Table I. 7 Overall, nearly thirty-two percent of 2006 trade consisted of two-way trade within the same industry classification. Many industries are found to exhibit significant amounts of IIT relative to total trade. The trade weighted 7 Export and import figures at the two-digit Standard International Trade Classification (SITC) level of product aggregation are from U.S. Bureau of the Census (1993, 2007) publications.

9 38 THE INTERNATIONAL TRADE JOURNAL Table I Grubel-Lloyd (GL) Indexes for Trade Between CAFTA-DR Members and the United States SITC Industry Live Animals Meat and Meat Preparations Dairy Products and Birds Eggs Fish (Except Marine Mammal) Cereals and Cereal Preparations Vegetables and Fruit Sugars, Sugar Preparations Coffee, Tea, Cocoa Feeding Stuff for Animals Miscellaneous Edibles Beverages Tobacco and Tobacco Products Hides, Skins and Furskins Oil Seeds and Oleaginous Fruits Crude Rubber Cork and Wood Pulp and Waste Paper Textile Fibers Crude Fertilizers Metalliferous Ores Crude Animal and Vegetable Mat Coal, Coke and Briquettes Petroleum, Petroleum Products Gas, Natural and Manufactured Animal Oils and Fats Fixed Veg. Fats and Oils Animal/Vegetable Fats/Oils Organic Chemicals Inorganic Chemicals Dyeing, Tanning and Coloring Mat Medicinal and Pharmaceutical Prod Essential Oils Fertilizers Plastics in Primary Form Plastics in Nonprimary Form Chemical Materials Leather, Leather Mfr Rubber Manufactures Cork and Wood Manufactures (Continued )

10 Clark: Adjustment Problems Table I (Continued ) SITC Industry Paper, Paperboard Textile Yarn, Fabrics Nonmetallic Mineral Manufactures Iron and Steel Nonferrous Metals Manufactures of Metals Power Generating Machinery Machinery Specialized Metalworking Machinery General Industrial Machinery Office Machines and ADP Equipment Telecommunications Equipment Electrical Machinery, Appliances Motor Vehicles Transport Equipment Prefab Buildings Furniture and Bedding Travel Goods, Handbags Articles of Apparel and Clothing Footwear Professional Scientific Instruments Photo Appt, Equipment, Optical Goods Miscellaneous Manufactured Articles Simple average Trade weighted average average GL index value is thirty-four percent. The simple average of the GL index rose over the period, while the trade weighted average GL index fell. Changes in overall average GL index values are not large because IIT rose relative to total trade in forty-five industries and fell in fourteen industries. The Grubel- Lloyd index remained unchanged for three industries. The largest increases in the GL index value are in Office machines and ADP Equipment (SITC 75), Meat and Meat Preparations (SITC 01), Nonmetallic Mineral Manufactures (SITC 66), and Plastics in Primary Form (SITC 58). Metalliferous Ores

11 40 THE INTERNATIONAL TRADE JOURNAL (SITC 28), Tobacco and Tobacco Products (SITC 12), Photo Apparatus, Equipment and Optical Goods (SITC 88), and Hides, Skins, and Furskins (SITC 21) registered the largest declines in GL index values. Adjustment implications associated with changes in intraindustry trade are explored in the next two sections of the article. III. INDUSTRY TRADE BOX Adjustment implications of dynamic changes in the share of IIT in total trade are evaluated using the industry trade box shown in Figure 1 Dimensions of this box measure maximum attainable levels of exports and imports. Each point in the box represents a trade point, or combination of exports and imports. The GL index (IIT/TT), total trade (TT), net trade (NT), and intra-industry trade (IIT) can be compared for changes in trade points. The trade box is bisected by a 45 degree line representing combinations of perfectly matched two-way trade (X ¼ M). GL index values equal unity along this line. Consider point A where X. M. The line of equi-tt running through point A, perpendicular to the X ¼ M line, shows combinations of trade points with equal total trade levels. Equi-GL lines indicate combinations of trade for which the share of IIT in TT and the ratio of exports to imports remain constant. Net trade, jx i -- M i j, is constant along equi-nt lines. The equi-iit line shows trade points that give equal absolute IIT values, where IIT ¼ (X i þ M i ) jx i -- M i j. It is well known that an intertemporal comparison of GL index values may fail to signal potential adjustment problems. 8 For example, if points A and B are symmetrical, the same GL value is obtained at either point as well as at any point along either equi-gl 8 See Shelburne (1993), Azhar et al. (1998), Clark et al. (2001), and Clark (2002).

12 Clark: Adjustment Problems Figure 1 Industry Trade Box Xmax Equi-IIT Line Equi-GL Ray Equi-NT Line (X > M) (X > M) (X > M) X = M Line ΔIIT < 0 Δ(IIT/TT) < 0 ΔNT > 0 ΔIIT > 0 Δ(IIT/TT) < 0 ΔNT > 0 I II III A B ΔIIT > 0 Δ(IIT/TT) > 0 ΔNT > 0 ΔIIT > 0 Δ(IIT/TT) < 0 ΔNT < 0 ΔIIT > 0 Δ(IIT/TT) < 0 ΔNT > 0 ΔIIT > 0 Δ(IIT/TT) < 0 ΔNT > 0 ΔIIT > 0 Δ(IIT/TT) < 0 ΔNT > 0 ΔIIT < 0 Δ(IIT/TT) < 0 ΔNT > 0 0 Equi-TT line Mmax IV ray shown in Figure 1. A movement from point A to B entails a shift in the industry trade balance from a net exporter to a net importer. The decline in exports and increase in imports is likely to be associated with a fall in production and employment. Such a movement suggests potential adjustment pressures not signaled by a change in the GL index. Care must be exercised when attempting to draw inferences regarding potential adjustment pressures from an intertemporal comparison of GL index values. Additional information will often be required to identify potential adjustment problems. V VI VII VIII Equi-NT Line (M > X) Equi-GL Ray (M > X) Equi-IIT Line (M > X)

13 42 THE INTERNATIONAL TRADE JOURNAL Changes in TT, NT, IIT, the GL index, and the trade ratio (r) can identify potential adjustment problems associated with greater trade. Each point in the industry trade box has a trade ratio, r ¼ X/M. IIT relative to TT is constant along a ray from the origin because all trade points on an equi-gl ray share a common trade ratio. Changes in the GL index can be analyzed by observing changes in r. For example, with an increase in TT, moving from either point A or B to a point closer to the diagonal in Figure 1 will increase both IIT and the GL index. Analyzing a shift in the direction of the trade balance from a net exporter to a net importer can be facilitated by defining r ¼ r x ¼ X/M in the net exporter plane, and r ¼ r m ¼ M/X in the net importer plane. When TT increases, changes in the value of the GL-ray, or Dr, may not provide sufficient information to assess potential adjustment problems. Knowledge of trade points and other indicators of intraindustry specialization may also be needed. Using changes in r in conjunction with changes in other indicators of adjustment pressures will avoid some of the pitfalls associated with intertemporal comparisons of GL index values alone. Adjustment pressure implications of changes in trade points can be analyzed using Figure 1. Start at point A. Construct equitrade component lines. An increase in TT can move the economy into any of the eight regions in the figure. Consider a movement from point A to a point in each of these regions. Region I is associated with an increase in NT. IIT declines absolutely along with the GL index. Exports have increased and imports fallen. This is traditional interindustry trade characteristic of a comparative advantage activity. Adjustment problems are not expected. A movement to Region II increases IIT and NT, but reduces the GL index. Export growth exceeds import growth. Adjustment problems will not arise. When the economy moves from point A to a point in Region III, r x is falling but the industry remains in the net exporter plane. IIT increases absolutely along with the GL

14 Clark: Adjustment Problems index. NT also rises. Adjustment problems will not be associated with a movement into Region II. Trade points in Region IV are also in the net exporter plane. Points in this region are associated with an increase in both IIT and the GL index. NT falls. Although r x falls, a large increase in TT will result in higher export and import levels. A modest increase in TT can be associated with a decline in exports and increase in imports, but these changes will be relatively small. Adjustment problems are not expected. The remaining regions lie in the net importer plane. Regions V and VI are associated with increases in both IIT and the GL index. NT falls in Region V and rises in Region VI. A movement from point A to a point in either of these regions can give rise to adjustment problems because the country has switched from a net exporter to a net importer. However, adjustment concerns can be lessened by a large increase in TT that results from an increase in exports as well as imports. Export growth will provide some scope for factor reallocation. 9 When TT increases, changes in the value of the GL-ray may not provide sufficient information to assess potential adjustment problems. Knowledge of changes in IIT, NT, and r are often required. Movements from point A to a point in Region VII may be associated with potential adjustment problems. Although IIT rises, the GL index declines. A large increase in r m suggests imports grew faster than exports or exports may have fallen in absolute terms. Growth in NT can exceed growth in IIT. Adjustment problems are likely when NT growth exceeds that of IIT. However, a very large increase in TT can lead to IIT rising more than NT. The decline in the GL index could be small with a rise in r m. These changes provide scope for factor reallocation. Here, 9 Not all imports result in job displacement. Some imports serve as inputs for expanding activities.

15 44 THE INTERNATIONAL TRADE JOURNAL factor adjustment problems are likely only if NT growth greatly exceeds IIT growth. Shifting from point A to a point in Region VIII suggests potential adjustment pressures. Large increases in r m are associated with declines in both IIT and the GL index, and increases in NT. Here, exports fall and imports rise. Industries that move into Region VIII have a pronounced comparative disadvantage. IV. ADJUSTMENT PRESSURES Table II shows changes in U.S. trade ratios and various indicators of intraindustry specialization for two-digit SITC industries over the period. Figures represent trade between CAFTA-DR members in Central America and the United States. Industries are grouped in accordance with the regions identified in Figure 1. Outcomes are associated with changes in TT, NT, IIT, the GL index, and r. Changes in these indicators over a lengthy period of time are used to assess the potential for adjustment problems that may arise in CA/DR countries with growth in trade resulting from the CAFTA-DR agreement. One industry falls into Region I of the net exporter plane. The Articles of Apparel and Clothing (SITC 84) sector was in the net exporter plane during the entire period and experienced a large increase in r x due to rapid export growth. IIT and the GL index both fell with the increase in r x. This favorable trend is expected to continue over the CAFTA-DR implementation period because the agreement expanded and made permanent the reciprocal trade preferences established under the CBTPA. It provided for the elimination of duties on products that meet rules-of-origin established in the agreement A partial equilibrium simulation discussed in Jaramillo and Lederman (2006) found most of the trade gains for Central American members would be in the apparel sector.

16 Table II Indexes of Intraindustry Specialization for Trade Between CAFTA-DR Members and the United States SITC Industry rx rm rx rm DTT DNT DIIT DGL DTT. 0 Region I 84 Articles of Apparel and Clothing , , Region II 12 Tobacco and Tobacco Products Metalliferous Ores Crude Animal and Vegetable Mat Iron and Steel Professional Scientific Instruments , Region III 03 Fish (Except Marine Mammal) Vegetables and Fruit Sugars, Sugar Preparations Coffee, Tea, Cocoa Beverages Organic Chemicals Rubber Manufactures Cork and Wood Manufactures Region IV 81 Prefab Buildings Furniture and Bedding Region V 01 Meat and Meat Preparations (Continued ) 45

17 Table II (Continued ) SITC Industry rx rm rx rm DTT DNT DIIT DGL Region VI 02 Dairy Products and Birds Eggs Cereals and Cereal Preparations Feeding Stuff for Animals Miscellaneous Edibles Crude Rubber Cork and Wood Pulp and Waste Paper Textile Fibers 1, Crude Fertilizers Petroleum, Petroleum Products , , Gas, Natural and Manufactured Fixed Veg. Fats and Oils Inorganic Chemicals Dyeing, Tanning and Coloring Mat Medicinal and Pharmaceutical Prod Essential Oils Plastics in Primary Form Plastics in Nonprimary form Chemical Materials Leather, Leather Mfr Paper, Paperboard Nonmetallic Mineral Manufactures

18 69 Manufactures of Metals Power Generating Machinery Machinery Specialized Metalworking Machinery General Industrial Machinery Office Machines and ADP Equipment Telecommunications Equipment Motor Vehicles Miscellaneous Manufactured Articles , Region VII 00 Live Animals Textile Yarn, Fabrics , , Electrical Machinery, Appliances , , Region VIII 21 Hides, Skins and Furskins Oil Seeds and Oleaginous Fruits Animal Oils and Fats Animal/Vegetable Fats/Oils Fertilizers 6, Nonferrous Metals Photo Appt, Equipment, Optical Goods DTT, 0 32 Coal, Coke and Briquettes Transport Equipment Travel Goods, Handbags Footwear Note: Trade figures are in millions of U.S. dollars. rx ¼ X/M and rm ¼ M/X. When M ¼ 0 in the net exporter plane, or X ¼ 0 in the net importer plane, r will be undefined. These cases are denoted with a (--). 47

19 48 THE INTERNATIONAL TRADE JOURNAL The textile and apparel quota regime administered under the WTO s Agreement on Textiles and Clothing (ATC) ended on January 1, 2001, after a ten year phaseout period. There has been a shift in recent years in U.S. apparel imports from CA/DR countries toward China and other Southeast Asian countries. Despite this trend, there are reasons to believe that CA/DR exports of apparel to the U.S. will continue to grow. CA/DR countries enjoy preferential access to the U.S. market while Chinese exporters continue to face tariffs. On January 1, 2006, in response to import surges, the U.S. reimposed quotas on apparel imports from China. The adoption of lean retailing that involves low inventories and frequent restocking of time-sensitive apparel products favors CA/DR countries that are in close proximity to the United States. 11 Five industries fall into Region II of the net exporter plane. Four of these activities were net exporters over the period. Included here are Tobacco and Tobacco Products (SITC 12), Metalliferous Ores (SITC 28), Crude Animal and Vegetable Materials (SITC 29), and Iron and Steel (SITC 87). Professional Scientific Instruments (SITC 87) switched from the net importer to the net exporter plane. All of these industries experienced rapid growth in exports relative to imports. TT, NT, and IIT rose. NT grew more than IIT. The GL index fell. These industries occupy the net exporter plane so they are not expected to face adjustment pressures. Region III has eight industries. Imports grew faster than exports in five cases, but these industries remained in the net exporter plane. Three industries switched from the net importer plane to the net exporter plane, with export growth exceeding import growth. TT, NT, IIT, and the GL index rose in all eight cases. NT grew more than IIT in three of thirteen industries. CA/DR countries enjoy a comparative advantage in products produced by these industries. 11 See Evans and Harrigan (2005) and Jaramillo and Lederman (2006, p. 88).

20 Clark: Adjustment Problems Adjustment problems are not expected in these net exporting activities. Two industries are in Region IV. Prefab Buildings (SITC 81) switched from the net importer plane to the net exporter plane, with export growth exceeding import growth. Furniture and Bedding (SITC 82) remained in the net exporter plane with imports growing faster than exports. TT, IIT, and the GL index rose, while NT fell. These industries in the net exporter plane will not experience adjustment pressures. Region V in the net importer plane has one industry. Meat and Meat Preparations (SITC 01) switched from the net exporter plane to the net importer plane. Imports grew rapidly, and exports fell. Adjustment pressures are not expected because NT fell with increases in TT, IIT and IIT/TT. Thirty-one industries are in Region VI. All but one of these industries remained in the net importer plane during the period. Miscellaneous Manufactured Articles (SITC 89) switched from the net exporter to the net importer plane because imports grew faster than exports. Twenty-seven industries experienced declines in r m because exports grew relative to imports. Three industries did not export in the base period but imports grew relative to exports over the period under study. NT growth exceeded IIT growth in twenty-three cases, but TT, IIT and the GL index rose. These trends do not suggest the free trade agreement will cause adjustment pressures in the Central American countries. Region VII in the net importer plane has three industries. The increase in r m indicates imports grew faster than exports. TT, NT, and IIT grew in all three cases, while the GL index fell. Electrical Machinery and Appliances (SITC 77) is not expected to face adjustment pressures because IIT grew faster than NT. The remaining two industries had NT growth exceeding IIT growth.whengrowthinntexceedsiitgrowthbyanarrow

21 50 THE INTERNATIONAL TRADE JOURNAL margin, an increase in exports might be enough to provide some scope for factor reallocation. Live Animals (SITC 00) and Textile Yarn, Fabrics (SITC 65) may be candidates for adjustment pressures because NT growth exceeded IIT growth by a wide margin. 12 These two industries account for 13.4 percent of Central American CAFTA-DR members imports from the United States. Seven industries fall into Region VIII. All of these industries remained in the net importer plane. Large increases in r m indicate imports grew relative to exports. Two industries did not export in Relatively large increases in NT were recorded for all of these industries. IIT remained unchanged in two cases. The remaining industries experienced declines in IIT in absolute terms, and relative to TT. These industries are most likely to experience factor adjustment pressures based on past trends in intraindustry specialization indicators. The seven industries in Region VIII account for 2 percent of CA/DR countries imports from the United States. Over the period, four industries experienced declines in TT. Travel Goods and Handbags (SITC 83) and Footwear (SITC 85) will not be candidates for factor adjustment pressures because they fall into the net exporter plane. The other industries remained in the net importer plane. Transport Equipment (SITC 79) experienced a decline in r m because exports grew relative to imports. NT fell and IIT rose. Adjustment pressures are not expected in this case. Coal, Coke, and Briquettes (SITC 32) did not export over the period under study. TT and NT declines are the result of falling import levels. IIT rose. This activity will not experience adjustment pressures. 12 CAFTA-DR uses a yarn-forward rule of origin that encourages the importation of U.S.-made textiles to Central American countries. To receive duty-free treatment, U.S. yarn and fabrics must be used in apparel products exported to the U.S. market.

22 Clark: Adjustment Problems V. CONCLUSIONS This article examines changes in intraindustry specialization indicators over the period to assess the potential for adjustment pressures that may arise in CA/DR countries with growth in trade resulting from the CAFTA-DR agreement. Previous economic integration studies focus on adjustment problems that occur in industrial nations in response to increased imports of unskilled labor intensive products from developing countries. Results show there is considerable scope for intraindustry specialization between other CAFTA-DR members and the United States. Central America s most important trading partner is the United States. CA/DR member countries collectively rank as the 12th largest market for U.S. exports. Few industries in CA/DR countries should face adjustment problems. Changes in intra-industry specialization indicators suggest only nine of the sixty-two 2-digit SITC industries are candidates for adjustment pressures. These industries account for approximately 15 percent of CA/DR countries imports from the United States. When adjustment problems are indicated, extended phase-out periods for tariffs and import safeguards are used to ease factor adjustment pressures in import-sensitive industries. Given the small number of industries in CA/DR countries that face potential adjustment pressures, and the fact that the U.S. is their most important trading partner, all seven CAFTA- DR members should have used either much shorter phase-out periods or liberalized all trade immediately. Compensation could have been provided to producers of import sensitive products to help them adjust to changing economic circumstances rather than using long phaseout periods and statutory exclusions. 13 Consumers would benefit immediately from lower prices rather than waiting five to twenty years. Products in longer tariff 13 Compensation issues are discussed in Jaramillo and Lederman (2006).

23 52 THE INTERNATIONAL TRADE JOURNAL phaseout categories are of considerable export interest to trading partners. The failure to launch multilateral trade negotiations has made FTAs an important means by which developing countries and industrial nations can foster trade, investment, and growth. ACKNOWLEDGMENTS The author wishes to thank two reviewers for providing many helpful comments. REFERENCES Azhar, A. K. M., Elliott, R. J. R., and Milner, C. R Static and Dynamic Measurement of Intra-Industry Trade and Adjustment: A Geometric Reappraisal. Weltwirtschaftliches Archiv 134(4): Clark, D. P Intra-Industry Specialization and the North American Free Trade Agreement. The International Trade Journal 16(4): Clark, D. P., Fullerton, T. M. Jr., and Burdorf, D Intra-Industry Trade Between the United States and Mexico: Estudios Economicos 16(2): Evans, C. L., and Harrigan, J Distance, Trade, and Specialization: Lean Retailing in General Equilibrium. American Economic Review 95(1): Grubel, H. G., and Lloyd, P. J Intra-Industry Trade: The Theory and Measurement of International Trade in Differentiated Products. London: Macmillan. Jaramillo, C. F., and Lederman, D Challenges of CAFTA: Maximizing the Benefits for Central America. Washington, D.C.: The World Bank. Meade, J The Theory of Customs Unions. Amsterdam: North Holland.

24 Clark: Adjustment Problems Schipke, A Building on CAFTA: How the Free Trade Pact Can Help Foster Central American Economic Integration. Finance and Development 42(4): Schott, J. J Free Trade Agreements and U.S. Trade Policy: A Comparative Analysis of U.S. Initiatives in Latin America, the Asian-Pacific Region, and the Middle East and North Africa. The International Trade Journal 20(2): Shelburne, R. C Changing Trade Patterns and the Intra- Industry Trade Index: A Note. Weltwirtschaftliches Archiv 129(4): U.S. Bureau of the Census U.S. Exports and Imports of Merchandise on CD-ROM. Washington, D.C.: The Bureau. U.S. Bureau of the Census U.S. Exports and Imports of Merchandise on CD-ROM. Washington, D.C.: The Bureau. U.S. International Trade Commission U.S.-Central America-Dominican Republic Free Trade Agreement: Potential Economywide and Selected Sectoral Effects. USITC Publication Washington, D.C.: USITC. U.S. Trade Representative CAFTA-DR Final Text. Available at Bilateral/CAFTA/CAFTA-DR_Final_Texts. Viner, J The Customs Union Issue. New York: Carnegie Endowment for International Peace. Weintraub, S NAFTA at Three: A Progress Report. Washington, D.C.: Center for Strategic and International Studies.