Benefits of Locating Textiles in Central America - Research Paper Example

? What are the financial benefits for the US and Central America Dominican Republic of locating textiles in Central America? In the month of August2004, the United States (U.S.) of America signed a free trade agreement i.e. Dominican Republic-Central America United States Free Trade Agreement (CAFTA-DR) with the engagement of countries like El Salvador, Honduras, Nicaragua, , Guatemala and Costa Rica. The Trade agreement is directed towards the elimination of the tariff as well as the non tariff barriers to a two-way trade with the enhancement of the rules and several other standards for the services, intellectual property rights (IPR), investments and other disciplines (Hornbeck, 2012). The agreement holds an underlying mechanism of an economic development perspective. One of the constraints of the economic development of an economy is poverty. Poverty alleviation has been a major political agenda of all the countries since a long time. Infusion of prosperity within an underdeveloped society helps in the eradication of violence, poverty as well as lack of opportunity. In today’s world, the poor section are suffering from the immense lack of resources and opportunities which include basic socioeconomic indicators of development viz, education, mobility in the job market, access of economic power etc (Jasso, 2008, pp. 1-2). Thus it is the primal duty of the government of every country to implement various optimal policies for uplifting the economic standards of the poor and bring economic development in the respective societies. The agreement of CAFTA was regarded as mammoth step towards entering into a larger free trade regime which would be encompassing around 34 economies in the North as well as the South America. The American business sector sought to reap tremendous benefits by the agreement with the access to the Central American market where they will be relocating their factories and utilize to the utmost the lower labor cost in those developing economies. The proponents among whom President George W. Bush was an indispensable figure argued in favor of the agreement that it would accelerate the trade dynamics with the expansion of trade markets and will lead to the reduction of the US trade deficit and will result in the establishment of the stability in the employment market of Central America. In the field of textile industries, the textile workers viewed the agreement as a little more than an outsourcing agreement where the American cloth will be penetrating the textile market of Central America along with the shipping back of the finished products assembled through the very low wages. The proponents argued that the agreement between the US and the Central America will develop a unique platform which will throw heavy competition to the Asian textile markets. The paper aims at investigating the financial benefits of establishing US textile industries in Central America with respect to a macroeconomic model and concentrates on the cost benefit analysis for making the decision of shifting the textile manufacturing base to Central America. Part one: Central America: Trends in Trade, Macroeconomics and Development There has been a pattern of restrictive macroeconomic policies followed in the Latin American countries which have been followed over the last fifteen years and has led to the development of a long period of sluggish economic performance. In the Central American countries there have been low fiscal revenues, falling growth rates with high rates of social inequalities. It is the case that the macroeconomic policies were lacking the capacities in promoting development. The Central American countries did not possess any control over the capital funds which were used in Columbia or in Chile (Nadal, 2001, p.15). There has been a trend in the Central American countries related to the development of the maquila industries. The word maquila has been derived from the Arabic word ‘makila’ which signifies the measurement for the capacity used in the milling for designing the proportional share of grain, lour, oil etc. In the Central America the maquiladora industry basically focuses on the textile sector, clothing, metal working, electronics and footwear industries. Fig. 1 Growth patterns in five Central American countries (Nadal, 2001, p.15) From the above diagram it can be inferred that the growth rates in the Central American regions expanded but slowly after the eighties. The countries which adapted the trajectory of attracting the maquiladora industries showed higher growth rates. Countries like Nicaragua in the latter half received a large amount of investments. The countries suffered from the pattern of concentrating exports mainly in the markets of United States. As a result when the US economy fell into recession in the period of 2000 the exports declined highly and the growth rates also staggered. Again, the predominance of the Chinese market with its attraction on several maquiladora investments set the export sector of the Central America into a great risk (Nadal, 2001, p.15). The International Labor Organisation (ILO) estimated that over 90% of the sales of the Central American maquiladora industry were accounted by the United States of America. The inference states that the countries of Central America are highly dependent on the economy of the United States. Various studies of researchers revealed that there was an existent feeble gap between the maquiladora industries in comparison with the other economic sectors of the nation (Hernandez, n.d.). The balance of payments of these countries also was highly deteriorating. The fiscal policies in Central America are directed towards the transfer of the resources from the real sectors of the economy towards the arena of financial services. The procedure is carried on by cutting expenditures and not enhancing the fiscal revenues. The primary balance basically shows either a surplus (i.e. positive values) but the economic balance shows decline throughout. The public debt service is also an important constituent of the public expenditures along with the interest payments reaching an equivalent of around 12% of the total fiscal revenues (Nadal, 2001, p. 16) . The transfer of the resources from the real sector to the financial sector also includes a cost which is critical for the long term social as well as environmentally sustainable. The following graph will represent the above explanation: Fig. 1 Primary & Economic Balances of the Central American countries * (Nadal, 2001, p.16) *[The primary balances are calculated by the average percentage of GDP from 1995-2003 and the economic balances are calculated with respect to the average total percentage of the fiscal revenues from 1995-2003]. Thus the trade balance shows a deteriorating trend and points towards growing deficits. Although there was the presence of maquiladora sector, the exporting sector has not been performing adequately (Nadal, 2001, p.16). The majority of the maquiladoras sector has been basically economic enclaves of the transnational corporations which have taken advantages of the cheap labor as well as specific raw materials. The inputs here are supplied from the abroad from the parent companies with little room for the local companies in such a way that the maquiladoras are not acting as the economic hubs for the local businesses. Textile industry One of the significant parts of the maquiladora industry in Central American countries is that of the output of the Clothing and apparel industry. Mexico is the prime competitor in this region which has been greatly benefited from the North American Free Trade Agreement (NAFTA). Less than 20% of the apparel products manufactured in the Central American countries are bound to the United States under the custom’s regime of production sharing. The residual production is generally integrated by the Asian clothing maquila. Some implications refer that the maquiladoras generally prefer manufacturing of the goods under a regime which will provide them more incentives as not paying or paying lower levels of taxes to the host country along with the receipt of subsidies (Hernandez, n.d.). Nature of the textile industry The textile industry of Central America is basically concentrated on the labor intensive technologies and is a major provider of employment mainly to the young people from the rural areas who had no previous income or employment and had no income opportunities other than the household works or works in the informal sectors. Among the labor force almost 80% are women and a predominant belief is that the women posses greater levels of nimbleness and that the younger women had better eyesight and the men were more prone in doing jobs like cloth cutting and so on (Hernandez, n.d.). Wage patterns The wages are structured in such a way so that it can uplift the condition of a worker from a level of misery to poverty. The wages are fixed at minimum levels along with a quantity based incentive bonus as for example in Nicaragua the range which can be calculated is around 2000 to 2800 Cordobas per month which is equivalent to an amount of around US$ 120-165. Employee salaries also vary with the change in the style of production. The wages are intentionally kept at a lower level as because there is an excess supply of labor in the market. This can be shown with the help of a diagram as follows: Fig.3. Excess Supply of labor (Jansen, et al, 2007) In the above diagram, DL and SL are the demand curve and supply curve of labor and they are functions of wages. Demand curve is a negative function of wages and so it is negatively sloped and the supply curve is positive function of wage. This means that the as the wages increases the demand for labor decreases and as the wages increases the supply of labor will increase. Now in the market of Central America, at a given wage rate there prevail excess supply of labor as seen in the above diagram at the wage rate of W1. And as a result, the wage is revised downwards. As for example in Nicaragua it is found that around 40 to 50 people line up every Monday outside of the larger maquilas while the smaller assembly firms in search of labor often find the workers by going into the larger tax free zones. The Nicaraguan maquilas report that the typically half eventually secure long term work. Apart from the excess labor supply, another condition in the maquila sector is that of the poor labor conditions. The conditions have been augmented through temporary boycotts of certain apparel brands by the consumers in the U.S. An industry report after rigorous study reveals that the biggest problem is that of the exposure to poor labor conditions (Jansen, et al, 2007, pp. 6-7). Part Two: Macroeconomic model The Mundell-Fleming approach is one of the stylized macroeconomic models which assume that the economy under study is generally a small open economy where free trade takes place between the countries. The economy in this case is subjected to perfect capital mobility which signifies that the economy can borrow or lend as much it can in the world financial market. The economy’s interest rates are determined through with the help of the world interest rates. The model simplifies the concept in the sense that once the interest rate is determined, then the role of exchange rate can be incorporated. The initial assumption of the model is that it holds that the economy is operating a floating exchange rate. The Central bank allows the exchange rate for the adjustments to the changing economic conditions. After this the examination of operation of the economy under a fixed exchange rate can be determined and then the analysis can be made whether the fixed or the floating exchange rate will be better for the economy (Mankiw, 2005, p.312). The Mundell-Fleming model states that an economy’s policy options are limited because it faces the option of choosing only two options among the three policies that are capital mobility, monetary policy autonomy and maintenance of a fixed exchange rate system. As for example it can be said that a state can fix its exchange rate but by the maintenance of the capital controls. The state can also retain an independent monetary policy but with the allowance of floating exchange rates. It can also follow the policy of free capital movement and lead to the stabilization of the currency but at this juncture it will have to face difficulties to face with the inflationary policies and recession. Followed by the end of the Bretton Woods and the Nixon Shock which resulted in the floating exchange rate regime for most of the states and increased the volatility of the exchange rates, and the ease in which the control over the capital could be avoided, the states are left with fewer policy instruments in hand to choose from. With fewer choices in hand, and increased coordination of policies with high income state, a developing country may benefit from the enhanced international confidence occurred due to due to greater domestic policy credibility and now it will be locked up with the high income partners. But the coordination in policies and the requisite loss of autonomy in the monetary policies have some costs attached with it. These attached costs are generally lower when there is perfect synchronization between the states. The costs also become lower when the states or the countries can implement alternative policy instruments like wage and price adjustments as well as labor flexibility for compensating loss of monetary policy autonomy. This is likely the case for the high income states, but this is not likely the case for developing countries. As a result it should be expected that the a little policy co-ordination between the developing countries and the high income country of a Free Trade Agreement (FTA) along with a more coordinated pairs between the industrialized pairs within a Free Trade Agreement (Chang, 2011). The developed country and the developing country would be highly concentrating on the notion of capital mobility for mutual benefit. Macroeconomic volatility can be regarded to impart a negative impact on GDP, output growth as well as consumption growth in the developing countries. As the developing countries are devoid of access with the international financial markets and are exposed to weak internal or domestic markets. Lowering of output coupled with uncertainty prevails in those markets with lower investments which subsequently lead to the declined output rates. So in order to deal with the problems of macroeconomic volatility which the Central American countries have been facing can be solved through the perfect mobility of capital markets. The model states that capital flows in small doses and opening of trade will expose the maquila industry to more organized and wide international financial markets and will help in the stabilization of the macroeconomic condition of those countries ( . In the subsequent section it could be seen that keeping in parity with the discussions of the model how the financial benefits will be spilled over to both the US markets as well as the Central American countries keeping textile industry in the forefront (Chang, 2011). Part-3: Cost – Benefit analysis with respect to CAFTA-DR The past experiences of any free trade agreement are very hard to implement. Studies have revealed that DR-CAFTA is likely to improve the levels of growth for the participating countries in the Central America with positive effects of trade as well as levels of investment. Enhanced trade levels will generate from the virtual elimination of the tariffs and quota barriers for trading among all the parties, consolidating and in some cases expanding the preferential market access which Central American countries have enjoyed in the US markets through the Caribbean Basin Initiative (CBI) program. The agreement is also expected to increase the trade levels among the Central American nations themselves along with the Dominion Republic. It is also expected that the agreement will promote greater levels of foreign and domestic investment with the improvement of the certainty of these countries market access with the US strengthening the broad economic reforms of recent years and developing further efforts of reforms. The investors also respond positively towards the modernization of the primal regulatory areas as trade in services, procurement of the government, Intellectual Property Rights (IPR) and providing greater levels of transparency in the government regulations (DR-CAFTA: Challenges and Opportunities for Central America, 2005, p.1). Now in the subsequent sections the essence of cost benefit analysis can be grasped from the analytical discussion made herein. Potential benefit of manufacturing –Incorporation of non labor cost In the Asian market, the production structure has been mainly concentrated in the country of China with its entry in the World Trade Organization (WTO) in the year 2001, which provided the country with a greater access to the US and European markets. The advantages of China over Central Asia was mainly concentrated on the notion of low labor costs, milieu of technical diversity, university diversifications, clustering and so on. Further there were availability of high quality fabrics with a controlled exchange rate. But recently it could be said that the advantages are not at all absolute. In recent times, the labor costs in some of the manufacturing countries of China have expanded over the past few years. The official minimum wage of manufacturing has also expanded by more than 20% by April 2011.Even the price of the products produced by the Chinese supplier factories also increased by a range of around 15-20% over the first six months of the year 2011. But with the wage gains in the Asian countries did took place but results state that the labor costs in those countries are still lower as compared to the Central America. But close scrutiny in this aspect, one thing can be determined. It is a fact that price is an issue and the cost of labor is only one aspect of the product price. But often the non-labor costs are neglected. In a study in the year 2011 reveals that the comparison of the cost associated with the production of a basic ?ve-pocket denim jean in the Asian countries with Central American countries like Honduras, Nicaragua, Mexico or Haiti. It was found that labor cost was cheaper in Asia. But when the added cost of freight, insurance, duties, agent fees as well as the buyer finance costs were incorporated it was found that the total cost of manufacturing the jean in Central America was less than that of production in the Asian countries (Paredes et al, 2012, pp. 11-12). In the textile and the apparel industry, the DR-CAFTA expands CBI treatment (as reflected in the Caribbean Basin Trade Partnership Act of 2000 known also as “NAFTA Parity) with the inclusion of flexibility in the rules of origin which allowed zero duty entry into the US market for a wider set of products. It can be said that a number of the DR-CAFTA agreement will result in the facilitation of qualification of the goods with duty free conduct. It also includes a large usage of the regional inputs with flexible short supply lists, accumulation of the origin with the regional partners and so on (DR-CAFTA: Challenges and Opportunities for Central America, 2005, p.40). Easy duty free access In the domain of the non-labor costs, one of the prime advantages of Central America can be said to be of the duty free access which are provided under the Dominican Republic-Central America Free Trade Agreement (DR-CAFTA). Apart from that the ability to deliver the finished products duty free to the US along with the execution of different steps in production within the multiple locations can be viewed as a potential advantage of entering the Central American market (Paredes et al, 2012, pp. 15-16). Speed to market The close proximity was also regarded as one of the important competitive advantages of entering into the Central American market. Analysis stated that the time on water to the United States to the Central America was only 3-4 days as compared to that of an average of 20-22 days in Asian penetration. This time advantage becomes in future a huge price advantage with the installation of inventory holding times and financial costs. The notion of the speed to market also impacts the production of different commodities in each of the region. Studies and empirics have revealed that companies utilize countries like Mexico and Central America for the replacement of the large orders on the basic apparel products which could be premade as well as held by the suppliers for the very quick delivery of the goods when they will be sold from the inventories Paredes et al, 2012, p. 18). Recent growth and estimations with the modifications on the CAFTA-DR agreement Estimations reveal that correction on the sewing thread will be generating a potential job creation of a number around one thousand in the US, Central America and the Dominican Republic with the US production located in North Carolina, Florida, South Carolina and Alabama. The changes to the CAFTA-DR free trade agreement received the strong support of the domestic textile industry as well as the US importers and retailers sourcing from the origin. US, Central America bear a long history of arrangements in co-production. The exports of textiles and apparels from US to the CAFTA-DR region were around $3.8 million in the 12 month period ending February, 2012 which increased by 15 percent. The imports of the US imports of textiles as well as apparels from the CAFTA-DR region was around $8.0 billion in March, 2011 through February, 2012 with a 10 percent higher than the previous 12 month period. Around 73 percent of the imports were made from either the United States or from the regional yarns and fabrics (Office of United States Trade Representative, 2012). Conclusion The paper focuses on the discussion of shifting of the textile industries to Central America with the passing of the agreement of CAFTA-DR in 2004. The Central American maquila industry is one of the central pillars of the economy of those countries and they have been highly striving on this particular industry. The textile industry is one of the major areas of maquila industry. But the labor conditions were found to be degenerating with lower wage rates and poor working conditions. The countries have been also trapped in the balance of payment deficit and were suffering from the lack of proper labor market, credit markets as well as exposure towards the global financial markets. The Mundell Fleming model discussed stresses on the development of these economies through perfect capital mobility into the markets of Central America. The cost benefit analysis reveals that for the US market it would be beneficial to shift the textile industry into these countries. These countries will also be open to the wider financial markets with creation of enormous platform of employment, high jolt of investment and opportunity of intersection with the capital market of United States. Thus the CAFTA-DR can act as a fruitful enhancement mechanism for the United States to shift their manufacturing base of textiles to the Central American countries. References Chang, H. (2011), Macroeconomic Synchronization and Policy Coordination After Regional Economic Integration in the Americas, Retrieved on July 23, 2012 from: http://ideas.revues.org/60?lang=es DR-CAFTA: Challenges and Opportunities for Central America, (2005), Retrieved on July 23, 2012 from: http://siteresources.worldbank.org/LACEXT/Resources/258553-1119648763980/DR_CAFTA_Challenges_Opport_Final_en.pdf Hernandez, J. V. (n.d.), CENTRAL AMERICA MAQUILADORAS AND THEIR IMPACT ON ECONOMIC GROWTH AND EMPLOYMENT, Retrieved on July 23, 2012 from: http://www.isini2011.uson.mx/articles/Vargas,%20J.G.%20-%20CENTRAL%20AMERICA%20MAQUILADORAS%20AND%20THEIR%20IMPACT.pdf Hornbeck, J. F. (2012), The Dominican Republic-Central America United States Free Trade Agreement (CAFTADR): Developments in Trade and Investment, Retrieved on 23 July, 2012 from: http://www.fas.org/sgp/crs/row/R42468.pdf Jansen, et al, (2007), THE IMPACT OF THE CENTRAL AMERICA FREE TRADE AGREEMENT ON THE CENTRAL AMERICAN TEXTILE MAQUILA INDUSTRY, Retrieved on July 23, 2012 from: http://unpan1.un.org/intradoc/groups/public/documents/icap/unpan033677.pdf Jasso, S. D. (2008), The Ethic of Capitalism: Peace, Prosperity, and the Good Life through Microfinancing, Journal of International Management Studies Vol. 3, No. 1, Retrieved on July 23, 2012 from: http://www.jimsjournal.org/24%20Sean%20Jasso.pdf Mankiw, N. G. (2005), Macroeconomics, Worth Publishers Nadal, A. (2001), Redesigning the World's Trading System for Sustainable Development, Retrieved on July 23, 2012 from: http://nadal.com.mx/publicaciones/rwts.pdf Office of United States Trade Representative, (2012), Retrieved on July 23, 2012 from: http://www.ustr.gov/about-us/press-office/press-releases/2012/june/kirk-applauds-agreement-to-advance-agoa-caftadr Paredes et al, (2012), A comparative study of the garments export industry in Honduras and Nicaragua, Retrieved on July 23, 2012 from: http://en.maquilasolidarity.org/sites/maquilasolidarity.org/files/Competitiveness-and-Decent-Work-2012_06.pdf?SESS89c5db41a82abcd7da7c9ac60e04ca5f=wxphhhah Read More