How is it possible that a fertile region less than three hours by airplane from Houston and Miami remains mired in extreme poverty? These International Monetary Fund economists cannot fault Central American macroeconomic policies, which have been relatively strong and stable. Searching further afield, they use statistical "growth accounting" to discover what most every investor in the region intuits: faulty institutions -- weak judiciaries, bureaucratic corruption and red tape, costly customs delays -- are major impediments to faster growth. The most powerful families use their well-oiled connections to work around such obstacles, while mere mortals are entangled in the maze of politicized regulations. Lacking expertise in the political economy behind these institutional obstacles, the economists simply note that it will take broad-based political coalitions to unravel them. Fortunately, the U.S.-Central American Free Trade Agreement (CAFTA) should help to improve the business climate and bolster investment and productivity by catalyzing regional efforts to make rules and regulations more transparent and harmonious and therefore less burdensome. Another potential CAFTA benefit: regionwide standards for corporate taxes and transfer pricing could reverse the proliferation of wasteful tax exemptions, enabling governments to raise the revenues they so badly need to directly address mass poverty.
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