Appendix B -- Honduras

CENTRAL AMERICAN COMMON MARKET

THE CENTRAL AMERICAN COMMON MARKET (CACM) was one of four regional economic integration organizations created during the Latin American export boom of the 1960s. The CACM was established by Guatemala, Honduras, El Salvador, and Nicaragua (and later joined by Costa Rica) with the signing of the General Treaty of Central American Economic Integration (Tratado General de Integración Económica Centroamericana) in Managua on December 15, 1960. The CACM and the three other Latin American trading blocs-- the Latin American Free Trade Area, the Caribbean Free Trade Association (Carifta), and the Andean Group--were generally alike in their initial endorsement of regional integration behind temporary protectionist barriers as a way to continue import- substitution industrialization (ISI--see Glossary).

The basic strategy for development in Latin America was pioneered in the 1950s by Raúl Prebisch and the Economic Commission for Latin America and the Caribbean (ECLAC). The "ECLAC approach" applied a structuralist model of development that emphasized increasing private and public investment in manufacturing and infrastructure in order to overcome dependence on exports of primary commodities. Prebisch argued that continued overreliance on primary commodity exports as a source of foreign exchange would eventually lead to economic stagnation and even economic contraction because as population growth and falling commodity prices would exert downward pressure on per capita gross domestic product (GDP--see Glossary). Concurrently, Prebisch and ECLAC recognized the inherent limitations for single-country domestic markets of ISI based solely on manufacturing. Particularly for the smaller countries of the Western Hemisphere, strictly domestic production of manufactured goods would quickly saturate local demand and would prematurely reduce returns on capital investment.

In order to overcome the limitations of single-country ISI, ECLAC proposed to expand the "local" market by means of common markets among like groups of countries. A common external tariff (CET) would allow nascent industries to develop by protecting local manufacturers from extraregional competition.

The ECLAC approach was advanced and widely accepted throughout the Western Hemisphere as an alternative to both the liberal export-led growth model and the previous single-country ISI approach. In practice, however, elements of all three models coexisted uneasily in most Latin American economies until the mid- 1980s.

Despite their common adherence to the ECLAC model of intraregional free trade within a protectionist framework, the various Latin American trading blocs differed from each other in the size and economic structure of their member states, their intermediate goals, their institutions, their cohesiveness, and their relationships to the global economy. In the case of the CACM, economic disequilibria among member states, incomplete and unbalanced implementation of the ECLAC-inspired integration scheme, and the inherent limitations of a development model based on protection from global competition eventually undermined the CACM as originally conceived by ECLAC. The CACM's effectiveness waned following Honduras's withdrawal in the wake of the 1969 Soccer War with El Salvador. The CACM stagnated throughout the 1970s and virtually collapsed during the prolonged Central American (see Glossary) political and debt crises of the 1980s, revitalizing only after its overhaul and the partial inclusion of Panama in the early 1990s.

INSTITUTIONS

The post-World War II movement toward Central American economic integration began with a wave of bilateral free trade treaties signed among Guatemala, Honduras, El Salvador, Nicaragua, and Costa Rica between 1950 and 1956. By the end of this period of bilateral negotiations, each country had become party to at least one of the treaties, which involved free trade in a limited range of products. The trend toward economic integration was further bolstered by the formation of the Organization of Central American States (Organización de Estados Centroamericanos--Odeca) in 1951. Although primarily a political entity, Odeca represented a significant step toward the creation of other regional multilateral organizations.

Economic cooperation at the multilateral level began to take shape under the auspices of ECLAC, which in August 1952 began sponsoring regular meetings of the Committee of Economic Cooperation, comprising the ministers of economy and commerce of the five Central American republics. It was through the committee that ECLAC advanced the Prebisch model of coordinated industrialization within regional trading blocs. ECLAC's active consultancy efforts facilitated the signing in 1958-59 of three important integration agreements: the Multilateral Treaty on Free Trade and Central American Economic Integration (Tratado Multilateral de Libre Comercio e Integración Económica Centroamericana), the Integration Industries Convention (Régimen de Industrias de Integración--RII), and the Central American Tariff Equalization Convention (Convenio Centroamericano sobre Equiparación de Gravámenes a la Importación).

The Multilateral Treaty on Free Trade and Central American Economic Integration provided for intraregional free trade in 239 groups of Central American products and a ten-year phase-in of intraregional free trade in all Central American goods. The Central American Tariff Equalization Convention was a complementary agreement to the multilateral treaty, establishing a CET on 270 products, including all those listed under the treaty, and proposing a harmonization of tariffs on an additional 200 products within five years. The tariff equalization convention would thereby provide the common barrier to extraregional imports under which Central American producers would conduct a liberalized trade.

The RII was the most controversial component of the ECLAC program and would be the most difficult to implement. As originally conceived, the RII was to direct the flow of capital investment into the region by granting special incentives and privileges to firms given "integration industries" status. In order to prevent costly duplication of capital investment, firms whose products had small consumer markets in the region would be given a virtual monopoly within the CACM. The Central American countries were supposed to distribute integration industry plants among themselves in an equitable and efficient manner.

The integration regime envisioned by the ECLAC-sponsored agreements never entered fully into force, but was instead superseded by the General Treaty of Central American Economic Integration, which became the basis for the CACM. The general treaty represented a compromise between the ECLAC-inspired approach and the policy preferences of the United States. The latter proposed several significant changes to the ECLAC integration scheme, the main difference being the establishment from the outset of intraregional free trade as the norm, rather than as the exception, as provided for in the multilateral treaty. Under the United States plan, all products would be subject to intraregional free trade unless exempted. The United States was also opposed to the granting of monopoly status to integration industries within the region. In exchange for adoption of its plan, the United States would provide funding for the various institutions of the CACM and increase its economic aid to Central America.

In February 1960, Guatemala, El Salvador, and Honduras accepted the United States-sponsored integration scheme and signed the Tripartite Treaty (Tratado Tripartito) in Esquipulas, Guatemala, establishing intraregional free trade as the norm and excluding an RII mechanism. The Tripartite Treaty evoked strong objections from ECLAC, which saw its guiding role in Central American integration undermined by United States involvement in the process. In response to protests from ECLAC and the government of Nicaragua, the United States and the parties to the Tripartite Treaty agreed to negotiate a compromise integration treaty to supersede all prior free-trade agreements. The General Treaty of Central American Economic Integration was signed in Managua, Nicaragua by four of the five republics (Costa Rica delayed signing by two years) on December 13, 1960, with ECLAC conceding on the free trade issue and the United States conceding on the inclusion of the RII. The general treaty went into effect for Guatemala, El Salvador, and Nicaragua in June 1961 and for Honduras and Costa Rica in April and July 1962, respectively.

In addition to the RII, the general treaty established a permanent Secretariat, the Secretariat of the General Treaty on Central American Economic Integration (Secretaría Permanente del Tratado General de Integración Económica Centroamericana--SIECA), and a development bank, the Central American Bank for Economic Integration (Banco Centroamericano de Integración Económica--BCIE). A Central American Clearing House (Cámara Centroamericana de Compensación de Monedas) was established in 1963 to promote the use of local currencies in the settlement of short-term trade deficits between pairs of CACM member states. A Central American Monetary Council (Consejo Monetario Centroamericano) was set up the following year to promote monetary union.

THE CACM EXPERIMENT

During the 1960s and 1970s, the CACM had a significant positive impact on trade flows in Central America. Intraregional exports as a percentage of total exports grew dramatically--from 7 percent of total exports in 1960 to 26 percent in 1970--before declining to 23.4 percent in 1975 and to 14.7 percent in 1985. The total value of trade within the region grew from US$33 million in 1960 to US$1.1 billion in 1980, dropping to US$421 million in 1986. Of all goods traded within the region, 95 percent had attained duty-free status by 1967, and 90 percent of traded goods were covered by the CET. The goods exempted from intraregional free trade were mainly traditional agricultural exports destined for global markets.

Most of the new intraregional trade was in consumer goods, a large share of which consisted of processed foods. By 1970 food processing was the single most prominent industrial activity within the CACM, accounting for approximately 50 percent of gross industrial output. The preference for consumer goods production was built into the CACM tariff structure, which imposed a high CET on extraregional consumer goods but did not impede the import of intermediate or capital goods.

In addition to the protection afforded to consumer goods production by the CET on consumer imports, CACM member states also promoted investment in industry by introducing generous tax incentives and exemptions for new and existing industrial firms. To help promote balanced development, the Convention of Fiscal Incentives for Industrial Development (Convenio Centroamericano de Incentivos Fiscales al Desarollo Industrial) was signed among the then four CACM member states in 1962 to equalize the granting of tax incentives to industrial firms. The convention allowed Honduras and Nicaragua to offer temporarily broader tax breaks to industrial firms than the other two more industrialized republics. Honduras became the main beneficiary of this differentiated treatment, gaining in 1969 an extension of its preferential taxation status.

Another important incentive to industrial development within the CACM was the implementation of regional infrastructure development projects. Several infrastructure development organizations were established during the 1960s to improve intraregional transport and communications: the Technical Commission of Central American Telecommunications (Comisión Técnica de las Telecomunicaciones de Centroamérica--Comtelca), the Central American Corporation of Air Navigation Services (Corporación Centroamericana de Servicios de Navegación Aérea--Cocesna), the Central American Maritime Commission (Comisión Centroamericana de Transporte Marítimo--Cocatram), and the Central American Railways Commission (Comisión Centroamericana de Ferrocarriles--Cocafer). These organizations were financed mainly by the Regional Office for Central America and Panama (ROCAP) of the United States Agency for International Development (AID) as part of the Alliance for Progress initiative. AID/ROCAP also financed a Regional Highway Program to improve highway routes considered vital to intraregional trade.

STAGNATION OF THE CACM

Despite the considerable expansion of intraregional trade and investment in Central America during the 1960s, by the end of the decade, the region had not yet achieved the balanced industrial growth nor the diversification of extraregional exports that was needed to maintain the momentum of the CACM. This failure resulted in part from the inability of Central American governments to implement fiscal modernization or to overcome persistent structural trade deficits by the less developed economies of the region. Moreover, the gradual abandonment by regional economic planners of key components of the ECLAC model, particularly the goal of monetary union and the Integration Industries Convention, reduced the potential for joint action on a broad range of common challenges. Lack of progress on structural reforms of the Central American economies meant that the CACM would exist primarily as a customs union, rather than become an economic community. By the early 1980s, Central America's profound economic problems and political upheavals had undermined most CACM activities and institutions.

During the 1960s, Central American policymakers charged with implementing the ECLAC model were faced with a series of deeply ingrained social and political obstacles to economic modernization. Foremost among these were the structural biases in favor of traditional export agriculture that diverted capital from industrial investment and discouraged export diversification. Among the most pervasive structural biases were the antiquated tax systems that relied primarily on import tariffs as a source of revenue while undertaxing property and personal income. As free trade entered into force within the CACM, governments found themselves forfeiting a large share of their traditional revenues. In all of the republics except Costa Rica, political opposition to fiscal reform from the powerful landowning sector prevented governments from recovering the lost funds through property and income taxes. Pressure for fiscal reform was offset by a surplus of commercial bank credit during the 1970s, which allowed Central American governments to run consecutive fiscal deficits. When the flow of lending to Latin America ended abruptly in 1982, the burden of servicing Central American public and private debts caused a severe regional economic depression. The "lost decade" of the 1980s was characterized by macroeconomic instability, massive capital flight, and severe cutbacks in public services.

Monetary and credit policies were also strongly biased in favor of the traditional export sector, which enjoyed a sharp increase in commercial bank lending throughout the 1960s. In 1970 a large share of domestic credit was still being channeled to traditional export agriculture, which received three times as much credit as did industry. Moreover, interest rates for traditional agriculture were in some cases kept artificially much lower than the rates paid by industry and by nontraditional agriculture.

Despite these inconsistencies in public policy toward industrialization, manufacturing's contribution to GDP grew modestly in all of the region except Honduras during the 1960s. Industrial growth associated with the CACM was generally more capital intensive than manufacturing for domestic markets, where small, labor-intensive firms employing ten to twenty workers were the norm. Rather than producing the desired diversification of extraregional exports, however, Central America's industrial development stagnated at the stage of consumer goods production and became heavily dependent on capital-goods imports paid for with foreign exchange from traditional agricultural exports. The foreign exchange constraint that had existed before formation of the CACM remained essentially unchanged, as competitive export industries oriented toward global markets failed to develop under the CACM's protective CET.

Another major drawback of the CACM was its inability to compensate for disequilibria in capital endowments, in net export volume, and in productivity among more- and less-developed member states. As a result, intraregional trade imbalances became pronounced, and the CACM became polarized between the net creditors, Guatemala and El Salvador, and the net debtors, Honduras and Nicaragua. Costa Rica evolved from a net debtor to a net creditor.

The institutions created by the general treaty to alleviate structural imbalances among member states failed to operate as planned. One of the first CACM institutions to be deactivated was the Integration Industries Convention, which had been negotiated to help allocate capital investment rationally and fairly among member states. The convention had been a source of controversy from the beginning, having been opposed by the United States and excluded from the earlier Tripartite Treaty. When rivalries arose over the proposed location of plants, CACM institutions were unable to mediate the conflicts or to impose solutions. As a result, only two firms ever attained integration industries status, and the convention was effectively scrapped in the mid-1960s when a tire plant was established in Costa Rica to compete with an integration industries plant in Guatemala.

Another CACM institution that abandoned its original purpose was the Central American Clearing House. The clearing house had originally been designed to promote the use of local currencies in the settlement of intraregional trade deficits. The clearing house and the Central American Monetary Council were supposed to represent initial steps toward monetary union. By 1963, however, the CACM member states had allowed the monetary cooperation effort to lapse and were settling their trade deficits in United States dollars twice yearly. Little impetus remained to maintain exchange rate stability or currency convertibility within the CACM.

RUPTURE OF THE CACM

As the 1960s progressed, unbalanced growth and development among CACM member states began to take a serious toll on cooperative efforts in trade, monetary policy, and investment promotion. By the end of the decade, the CACM had reverted to an amorphous grouping of economies at different stages of development pursuing uncoordinated and sometimes antagonistic macroeconomic policies. The most acute conflict arose between Honduras and El Salvador over the issues of unbalanced trade, investment, and migration.

By the mid-1960s, chronic Honduran trade deficits with El Salvador and highly visible Salvadoran investment in Honduras had led to widespread Honduran indignation and a virtual Honduran boycott of Salvadoran products. Meanwhile, 300,000 Salvadoran migrants displaced by the expansion of export agriculture in their country had settled across the border in Honduras. Capitalizing on the widespread sentiment against Salvadoran "encirclement," the government of Honduran President Oswaldo López Arellano (1963-71) attempted to expel Salvadoran squatters under the pretext of land reform. Increasing tensions throughout the summer of 1969 erupted into hostilities on July 14, when Salvadoran air and land units made an incursion into Honduran territory. The ensuing four-day war claimed 2,000 lives and led to the forced repatriation of about 150,000 Salvadorans.

Diplomatic and commercial relations between El Salvador and Honduras were suspended for a decade thereafter, as was air transport between the two countries. In December 1970, Honduras withdrew from the CACM after it failed to persuade the other member states to enact further reforms in its favor. Honduras subsequently conducted trade with CACM countries on a bilateral basis until 1986. Honduras's withdrawal from the CACM, although not significant in terms of lost trade volume, represented a symbolic collapse of the organization as a vehicle for promoting coordinated regional growth. The prospects for integration had already dimmed considerably prior to the Soccer War, as evidenced by the piecemeal abandonment of major components of the original ECLAC integration plan.

REACTIVATION OF INTEGRATION

Despite Honduras's withdrawal from the CACM and its suspension of commercial relations with El Salvador, Central American intraregional trade rose steadily throughout the 1970s, exceeding US$1 billion by 1980, before halving in the mid-1980s as a result of accumulated intraregional debts, the overall debt crisis, and the disruption caused by civil wars in El Salvador and Nicaragua. Most efforts to coordinate industrial and macroeconomic policies had been abandoned, however, well before the general treaty expired in 1982.

A reactivation of Central American economic integration was made possible with the signing of the Central American Peace Agreement (Esquipulas II) in August 1987. Esquipulas II laid the political groundwork for concerted action to renew the integration system following restoration of peace and democracy in the region. Formal action to restart the integration process was taken at the eighth summit of Central American presidents, held in Antigua, Guatemala, in June 1990. The participants at the Antigua summit approved the Economic Action Plan for Central America (Plan de Acción Económico de Centroamérica--Paeca), which foresaw a new conceptual and legal basis for a Central American economic community.

The new integration initiative emphasized insertion of the region's economy into the global economy based on export-led growth. The industrial base established under the CACM was to be retrofitted and modernized to compete in the international marketplace, and nontraditional exports were to be be promoted more vigorously. Concurrently, the maximum CET for the region was to be reduced from 40 percent to 20 percent and was expected to average between 10 percent and 15 percent for most products. With assistance from the European Economic Community (EEC), a new Central American Payments System was established to settle intraregional debts. The main components of this new payments system were a revised Central American Clearing House and a Special Foreign Currencies Fund. The new payments system, backed by an initial 120 million European Currency Unit (ECU--see Glossary) support fund, was designed to manage intraregional creditor-debtor relations multilaterally, rather than bilaterally as under the previous regime, so that trade deficits would be incurred against the system rather than against individual countries. In addition, the Special Foreign Currencies Fund, which was backed by an initial EEC support fund of 30 million ECUs, was to help the less developed countries in the region finance the building and improvement of export-related infrastructure.

Further progress toward integration was made at the tenth Central American presidential summit, held in San Salvador, El Salvador, in July 1991, when the five original participants agreed to include Panama in certain aspects of the new economic community. The eleventh summit, held in Tegucigalpa, Honduras, modified several CACM institutions and incorporated them into the System of Central American Integration (Sistema de Integración Centroamericana--SICA), an umbrella organization encompassing both political and economic integration efforts. Honduras fully rejoined the integration process in February 1992, upon the signing of the Transitional Multilateral Free Trade Agreement with the other Central American republics.

Central American integration was given a further boost with the signing of the North American Free Trade Agreement (NAFTA) among Canada, Mexico, and the United States. In August 1992, a Framework Free Trade Agreement was signed among the five Central American republics and Mexico, establishing the procedures for the formation of a free-trade area projected to enter into force in December 1996. Inclusion of Central America in a free-trade area with Colombia and Venezuela was also foreseen in the Caracas Commitment adopted at a regional summit in February 1993. Guatemala's recognition of Belize in September 1991 made it possible to begin free-trade agreement talks with the Caribbean Community (Caricom), the successor to Carifta. In late 1993, the Central American countries were actively lobbying for incorporation into NAFTA and were expanding ties with the G-3 (Mexico, Colombia, and Venezuela) and Caricom.

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Several detailed studies of the institutional development of the CACM through the 1980s are available; however, no comprehensive treatment of Central American economic integration efforts since Esquipulas II has yet been published. The earlier works include Economic Integration in Central America, an extensive 1978 study edited by William R. Cline and Enrique Delgado; and Victor Bulmer-Thomas's The Political Economy of Central America since 1920, which places the CACM within the context of historical patterns of development in the region. More recent information on economic and political integration efforts in Central America can best be obtained from biannual issues of Revista de la Integración y el Desarollo de Centroamérica, published by the BCIE, and various numbers of Panorama Centroamericano, published by the Instituto Centroamericano de Estudios Políticos. Statistical data on CACM member states are available from various SIECA publications, including Cuadernos de la SIECA, Estadísticas Analíticas del Comercio Intracentroamericano, and Series Estadísticas Seleccionadas de Centroamérica. Current reporting of Central American economic developments is available from Latin American Weekly Report, Latin America Monitor, and the Economist Intelligence Unit's Country Reports and Country Profiles on Central American countries. (For further information and complete citations, see Bibliography.)

Honduras - TABLE OF CONTENTS