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What a Difference a CAFTA Makes

IMF logoThe IMF just released a new research paper about the effect of the U.S. economic downturn on 
Central American countries entitled “Spillovers to Central America in Light of the Crisis: What a Difference a Year Makes.”  The main finding of the paper is pretty shocking: Each 1.0 percent decline in U.S. GDP during the most recent economic crisis caused a 0.7 to 1.0 percent decline in Central American GDP.  In total, the link between the Central American and U.S. economies lowered Central American GDP by 4 to 5 percent.

And guess what the culprit is? According to the paper,

Spillovers [from the U.S. economy] have typically been transmitted through both financial and trade links, while remittances were not found to play an important role in transmitting business cycles across borders.

The author of this paper also discusses a paper published in 2005 that “predict[ed] that CAFTA-DR would cause a significant increase in the effects of U.S. shocks on the region.” In other words, the implementation of CAFTA meant that Central American economies are now more sensitive to downturns in the U.S. economy.  So now even the IMF agrees that tearing down trade barriers willy-nilly can expose your country to stronger foreign macroeconomic shocks that have nothing to do with how well your domestic businesses perform.

Coincidentally, the IMF also just released a staff position paper that reversed the IMF’s longstanding opposition to controls on capital inflows that could reduce financial volatility. According to the New York Times,

The other paper, released Friday, said that in the aftermath of the crisis, officials were “reconsidering the view that unfettered capital flows are a fundamentally benign phenomenon.”

“Concerns that foreign investors may be subject to herd behavior, and suffer from excessive optimism, have grown stronger; and even when flows are fundamentally sound, it is recognized that they may contribute to collateral damage, including bubbles and asset booms and busts,” the fund’s deputy director of research, Jonathan D. Ostry, wrote, along with five other authors.

Are these two papers a sign that the IMF wants to turn over a new leaf and pull back from its insistence on excessive economic liberalization for developing countries?  Let’s hope so.

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When the housing bubble popped in California, Arizona, Florida, etc and thereby caused incomes to fall, people purchased fewer cars. Consequently, the midwest suffered. Yet, I don't hear you arguing for limits on inter-regional trade and capital flows in the US. Why then do you think such limits would be good for inter-regional trade in the western hemisphere?

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