_Central America and NAFTA_ 20 74. Competition in the Mexican market is rather different. Here the locational advantage of Central America over Asia is very strong, often exceeding a factor of ten to one. The adjacency effect of Guatemala adds a further fillip to these numbers. 75. To make the point about the effect of distance as clear as possible, these distance effects are translated into tariff equivalents reported in Table E.10. Starting with the gravity model T1j = ca Dij I (1 +tQ)<sup>0</sup> we can ask: What is the tariff-equivalent of distance? Take a pair of countries separated by a distance of D(. Trade between them can be reduced either by imposing a tariff or by moving them apart to the new distance D. What level of the tariff yields the same trade as the distance D? The formula for trade over the longer distance is T = c D "' . The trade encumbered by the tariff is T = a D( '(1+t) ". These are equal when c D( (x D( ; (I+t) **'".** Solving this equation yields the tariff equivalent of distance: Tariff equivalent of distance = (D/Do"" - I where: y = distance elasticity; and 0 = tariff elasticity.

76. The tariff equivalents reported in Table E. 10 are remarkably large. The first column uses the elasticity estimates from Linneman et.al. The next six columns use three different values for the distance elasticities and two values for the tariff elasticity. The distance elasticity of' -1.5, -1 and -0.5 range over the set of estimated values from Table E.8. For each of these distance values two tariff elasticities are included: a high tariff elasticity of -3 and a low tariff elasticity of -0.5. The low value for the tariff elasticity yields extraordinarily high values of the tariff equivalent. This elasticity refers to an experiment in which a tariff is imposed against a single country, and substitution among suppliers may make the elasticity rather high. The number -3 seems plausibly high and exceeds the Linneman et al estimate of -2.6.

77. The Chinese distance disadvantage of 3.6 conmpared with Mexico for exporting to the U.S. is equivalent to a tarif'f of approximately 23 percent for even the least elastic distance et'fect and the most elastic tariff effect. Under these same extreme condition, Central America has an advantage over Asia in the Mexican market as if the Asian products had to tace a 37 percent tariff. That ot' course is a substantial tariff, but it is very small compared with most of the other tariff-equivalents in the table.

78. Of course the effect of distance and adjaceny are very complex and cannot be completely captured in simple measures of distance. One reason is that the effects must be greatly influenced by transportation infrastructure. The estimates can also capture cultural influences that are not otherwise controlled for. But regardless of these corrections, it will surely remain the case that Central America has a substantial locational advantage over Asia in both the U.S. market and the Mexican market. In the U.S., however, even without NAFTA, the supplier of choice is Mexico. This leads to one clear conclusion: the future of Central America rests importantly on exports to Mexico, a market which is today pretty much untapped. Investments in transportation