FOR DECADES, Paraguay's Ciudad del Este has had a reputation as a smuggler's paradise, loathed by businessmen in neighbouring Brazil and Argentina who view it as the main conduit for much of the contraband that floods into their markets.

A classic opportunist, this city of a quarter of a million residents has developed into the main motor of its country's economy by exploiting its location on the Triple Frontier, where the borders of Paraguay, Brazil and Argentina all meet.

This geography allows it to take advantage of the yawning difference between high Brazilian and Argentinian import tariffs and far lower ones in Paraguay. Businessmen in Ciudad del Este import everything from Scotch to French perfumes to Asian electronics which they then sell on to Brazilians and Argentinians drawn across the border by prices they could never find at home.

Locals argue that the city's reputation is undeserved as this trade only becomes contraband once Brazilian and Argentinian customs fail to collect import duties due. The reality, though is that the city's lifeblood is the army of small-time Brazilian smugglers who carry back cheap goods across the border which they then sell at a profit.

Alongside this contraband economy there has also grown up a thriving industry in pirated goods, both locally produced and imported.

The city also has a reputation as a centre for money laundering, drugs trafficking, arms trading and even terrorist financing.

Now, though, after half a century, time appears to be running out on Ciudad del Este's current business model.

In the wake of the September 11th attacks, US pressure led to a crackdown on money laundering. The target was terrorist financing but the impact was felt across the city's informal economy.

At the same time Brazil has started to toughen up policing of the border.

It still remains impossible to check all of the thousands of people crossing over every day, but the authorities have put pressure on the small-time smugglers known as sacoleiros - bag people, so-called after the large bags stuffed with goods that they haul back to Brazil - to such an extent that there have been angry protests in defence of the right to contraband.

Most ominously for the city, Paraguay will finally enter the customs regime of the regional customs union, Mercosur, in 2012. In theory at least, it will then have to impose the same tariffs on imports from outside the bloc as Brazil and Argentina, wiping out most of its competitive advantage. "There is an economic model in Ciudad del Este which is going to disappear, this model of importing and re-exporting," says Luiz Carlos Salinas, a local business leader involved in developing new industries in the city, "but what we have built up here in Ciudad del Este is excellent business know-how.

"We have a very strong commercial culture with people who have business contacts all over the world. This gives us very important working capital."

This entrepreneurial spirit and the looming changes of 2012 are helping give birth to an emerging - formal - manufacturing sector.

For Salinas, the future of Ciudad del Este is in the hands of men like Walid Sweid.

A refugee from Lebanon's wars, Sweid arrived in the city aged 17 and went into the import/re-export economy.

Now, still just 30 years old, he is the owner of a factory making recordable disks. He employs 220 people working around the clock to fulfil orders for customers in Brazil and Venezuela. Many of the international contacts, crucial to his success as a manufacturer, were first made when he was starting out importing one container of merchandise at a time.

Operating a business in Paraguay presents challenges. Although Sweid pays all his taxes, he gets little in return in terms of new investment in infrastructure. He also has to organise private security to accompany shipments to the Brazilian border, just five kilometres away.

However, there are great opportunities. "I have the cheapest electricity in the world, labour costs are low and there is a very open business environment - and the government will support you as an exporter as much as they can," he says.

The hope of business leaders like Sweid and Salinas is that in the future Ciudad del Este will be viewed by outsiders as the place to invest in Paraguay, rather than treated with suspicion as its contraband capital.

"The media has damaged the city's image with stories about terrorists and smugglers," says Sweid of his adopted home, "but this is a great place to invest and make money."