Speeches and Papers

The Future of Regional Trading Arrangements in the Western Hemisphere

by Gary Clyde Hufbauer, Peterson Institute for International Economics
and Barbara Kotschwar, Peterson Institute for International Economics

Paper for Michigan State University 10th Anniversary Conference
"The US-Canada Free Trade Agreement"
September 11-12, 1998

© Peterson Institute for International Economics

 


© Institute for International Economics

 

Many changes have altered the trade relationships in the Western Hemisphere over the past decade. Latin America has opened up and North America has taken a greater interest in commerce with South America and the Caribbean. The United States has moved away from its previous insistence that multilateral negotiations were the only show in town and Canada has realized that there is life—and even market activity—south of the United States. Countries in the Americas are trading more intensively with one another—of the $1.5 trillion exported in 1997 by the countries of the Western Hemisphere, over 55 percent was sold within the Americas (see Figure 1). Not only is there more trade, there are more trade arrangements. Starting in the late 1980s, existing regional integration arrangements were rejuvenated to fit new economic conditions. Moreover, new arrangements—a variety of customs unions, free trade agreements and hybrids—have been put into place. The culmination of this new regionalism is the Free Trade Area of the Americas (FTAA), proposed at the First Summit of the Americas held in Miami in December 1994. The FTAA has as its objective an agreement by the year 2005, on a schedule for the elimination of barriers to trade in goods and services and restrictions on investment among the thirty four democratic countries of the Americas—the entire Hemisphere minus Cuba. Negotiations were launched in April 1998 at the Second Summit of the Americas, and talks have begun in the negotiating groups.

To predict the future we must examine the past and consider the present. Our aim in this paper is to reflect on the evolution of regionalism in the Americas and to set out a scenario for the next decade of trade relations among the FTAA countries.

 

Latin America: A Clouded Past

Latin America has historically tended towards regionalism. From Simon Bolivar to Raul Prebisch to modern day technocrats such as Fernando Henrique Cardoso, the wisdom has been that unity is better—although not always feasible. While most integration plans did not include the area north of the Rio Grande—in fact, most were construed as means to balance the power of the United States—the idea of Pan-American union has been batted around for ages, even in periods when protectionist policies dominated the daily agenda.

In fact, Latin America's post-war regional integration arrangements were conducted within the framework of import substitution industrialization (ISI). ISI served as an economic development model in the context of declining commodity prices and neglect from the United States (at the time, the United States was concentrated on reconstructing Europe and limiting the spread of communism in Asia). The aim of ISI was to buffer Latin America from worsening terms of trade following the commodity boom sparked by the Second World War. By erecting high walls against manufactured imports, countries would develop their own industries and reduce their dependency on the advanced countries in general and the United States in particular. To overcome scale limitations, ISI was expanded regionally, in theory creating larger markets for regionally produced goods. Regional agreements were often supplemented by production sharing arrangements in which countries would divide the production process among and within industries. To illustrate the theory, using the example of automobile production, one country might produce steel and stamp out auto bodies, another make engines, a third would make transmissions, and a fourth would assemble all the parts into autos.

Regional integration was thus seen as a means to surmount the inherent scale limitations of small domestic markets in Latin America, to allow industries to become competitive on a regional level, and to encourage industrial development within a cooperative framework. Regional markets with high levels of protection vis-à-vis the United States and Europe could be used to shift local firms from solely making consumer goods towards the production of intermediate and capital goods as well.

Early attempts at regional integration date back to the late 1950s when, under the guidance of the United Nations Commission for Latin America (ECLA), a group of South American countries initiated discussions on the means to foster greater regional integration. These proposals were predicated on the need to go beyond the domestic import-substitution strategies, which had been embraced by most Latin American countries. However, the integration agreements that emerged were really anti-trade agreements in that they emphasized the regulation of investment and production and the restriction of imports from the rest of the world.

Early integration agreements

The Latin American Free Trade Agreement (LAFTA/ALALC) was founded in the early 1960s, and the LAFTA eventually embraced all the South American countries plus Mexico. In the LAFTA, high barriers to external trade were maintained despite the Kennedy and Tokyo Rounds—and LAFTA was used to justify their continuance. Incoming investment was licensed and soft attempts were made to divide commercial and governmental functions between members. Within LAFTA, the reduction of tariffs and other barriers were negotiated on the basis of product lists, which limited the extent of cross-sector tradeoffs. Other subjects were likewise addressed on a piecemeal rather than a comprehensive basis; the members sought to regulate economic specialization by agreement rather than the market.

Countries were initially enthusiastic about exchanging preferences within LAFTA, but the game was up once all of the easy items—usually goods that were not produced at home—were liberalized. The process stalled when difficult sectors—e.g., autos, other consumer durables, agriculture, and textiles—came up for discussion. In other words, the theory of industrial rationalization broke down in practice. On the whole, LAFTA served political rather than economic purposes. By 1980, LAFTA had been replaced by the less ambitious Latin American Integration Association (LAIA/ALADI), which was largely structured around bilateral trade preferences.

Andean Pact. Partly due to the limited progress on LAFTA's economic front, and partly to a feeling that Argentina and Brazil were grabbing all the LAFTA gains, in the late 1960s, six of the eleven LAFTA members, established their own new arrangement, the Andean Pact. This new agreement included Bolivia, Colombia, Ecuador, Peru and Chile (which left in 1976) and was later joined by Venezuela (1973). This highly institutionalized structure was modeled after the European Economic Community (EEC), but unlike the EEC, the Pact did little to liberalize trade between members. In fact, severe external barriers were maintained by all members except Colombia. Production-sharing arrangements between the Andean countries were a major focus of negotiation, buttressed by a highly restrictive investment regime (the notorious Decision 24).

Central American Common Market (CACM). Another early regional trade arrangement, made up of the five Central American countries, was the Central American Common Market (CACM). While early liberalization measures produced trade growth among the members, the CACM turned out to be a paper arrangement with little implementation. Efforts at production-sharing led to acrimonious debate among the members. By the 1980s, CACM was totally overshadowed by political and military conflicts within the region.

Caribbean Common Market. In 1968 several Caribbean countries launched their own integration system, the Caribbean Free Trade Area (CARIFTA). In 1973 CARIFTA was replaced by the Caribbean Community and Common Market (Caricom).1 Caricom never came close to a common market, in part because the individual islands relied heavily on tariff revenue; in part because the trade between them was extremely limited.

 

The Move Towards A New Regionalism

In the mid 1980s, as a complement to the disciplined macroeconomic policies adopted in the wake of the international debt crisis, Latin American countries moved away from protectionist policies. They opened their economies, reduced trade barriers and tried export promotion strategies. Unilateral trade liberalization was carried out by simplifying tariff structures and reducing rates from astronomical to merely high levels, and eliminating many nontariff barriers, except on agriculture. Trade policy liberalization was part of a larger outward-oriented development strategy, which replaced the old import substitution approach. Among other features, foreign investment was invited instead of licensed. In the 1980s and 1990s, new agreements were negotiated in the spirit of open regionalism, designed to be complementary with, and a prod to, GATT/WTO negotiations for freer trade on a multilateral basis. This period of hemispheric relations is remarkable not only for the dramatic reorientation of the Latin American approach towards regional integration, but for the heightened participation of North America in Hemispheric trade matters. We now turn to these developments.

Latin America: from import substitution to open regionalism

Ironically, ECLAC, the institution that was founded by and housed Raul Prebisch is now the major exponent of open regionalism, a strategy by which countries simultaneously participate in two or more trade and integration arrangements as long as each participatory step is driven by liberalization both among the member countries and with the rest of the world.2 Domestic policies turned decidedly pro-market, and countries embarked on the new generation of regional agreements. Pro-market translated into lower external tariffs (unilaterally as well as within the Uruguay Round), privatization, disciplined macroeconomic policies (such as small budget deficits and low inflation) coupled with harder currencies, and democratic elections.

While many champion the new attitude of trade agreements in the Hemisphere, there are those who are troubled by the numerous agreements—and have described the Hemisphere as resembling a spaghetti bowl. A kinder term would be network—and the networking continues. In Summer 1998 both the Central American countries and the Caricom signed a Free Trade Agreement with the Dominican Republic. Mexico has signed a free trade agreement with Nicaragua and is negotiating with the other Central American countries. The Mercosur is talking to the Andean Community and the Andeans are considering negotiating with the Central Americans. And so it goes. Chart 1 lists the various plurilateral and bilateral agreements in force today.

Mercosur. The most important new arrangement is the Mercosur, which includes Brazil, the largest South American country, Argentina, Uruguay and Paraguay. Like the original European Common Market, the Mercosur served an important political purpose, namely defusing tensions between Argentina and Brazil.3 Unlike earlier Latin American regional agreements, the Mercosur countries reduced their external barriers, liberalized investment, and tackled difficult sectors. This arrangement proved extremely successful at stimulating trade: as seen in Figure 2, intra-Mercosur exports grew by an average of 30 percent per year in its first five years of existence. Mercosur has not visibly restricted its trade and investment with the rest of the world—both EU and US exports to these countries have grown at respectable rates (Figure 3).

Challenges remain to be tackled within the Mercosur, on the monetary as well as on the trade front. Argentina is highly vulnerable to a possible Brazilian devaluation, and both countries depend on the credibility of the real plan for their economic stability. The Asian financial crisis has drawn speculation—by policymakers as well as bankers—about the staying power of Mercosur. So far Brazil is holding on. Brazil's central response to the crisis has been constructive fiscal austerity, coupled with an IMF package of $42 billion and "voluntary" stretch-outs by the private banks. In addition, Brazil has put into place new trade restraints, consistent with the WTO. This means tighter sanitary and phytosanitary inspections, licensing, more antidumping cases and some manipulation of exceptions to the Common External Tariff (CET). In past crises the Mercosur partnership survived because the partners were willing to forgive each other's policy lapses—as long as these transgressions were not too damaging. This pattern should hold in 1998-99, provided that Brazil keeps its derogations within reasonable limits.

Andean Community. The Andean Community is the Andean Pact in modern packaging. Still highly institutionalized, the Andean Group discarded the more trade-discouraging measures, and replaced the notorious Decision 24 with a more investor-friendly regime. The result is genuine investment liberalization and free trade in some sectors, less bureaucracy, and an approach that is half FTA, half customs union. Trade among the members has grown considerably as the countries have liberalized their trade regimes and has the Andean Community has been reformed (Figure 4). Yet puzzles remain. Trade is free from tariffs and nontariff barriers among only four of the five (Peru apart). Three share a common external tariff—although there are exceptions even among these three. Meanwhile, Bolivia and Peru are outside the common external tariff. Bolivia is now an associate member of Mercosur, and has been allowed to maintain its flat external tariff rate by the Andean Community. Peru's membership came into question in 1992, when the other Andean countries condemned the Fujimorazo—President Fujimori's 1992 closing of Congress and suspension of Constitutional rights. Venezuela broke relations with Peru, and Peru's membership in the Andean Group was suspended. Although Peru has now been reinstated, and in fact houses the Secretariat, Peru's membership remains open to question. Peru also maintains its own bi-level tariff schedule and has bilateral free trade agreements with each of the Andean countries.

Despite all its growing pains, the Andean Community is moving forward with its integration goals, and is expanding trade relations with other countries. The Andean Community members speak with one voice in the FTAA negotiations—and are in the process of negotiating as a unit with a number of other Latin American partners. At this time the Andean Community is negotiating a free trade area with Mercosur—which has already accepted Chile and Bolivia as associate members. If these negotiations succeed—still a far-off proposition, but not an impossible one—a true South American Free Trade Area—or SAFTA—would exist.

CACM and Caricom. There is some new energy in these arrangements, especially among the Central American countries that have resolved their civil wars. Both arrangements, however, lack unity of purpose and strategy. The Central American Common Market is far from a common market. Members have been negotiating together, but signing and implementing separately. The Caribbean countries continue to focus on Lome negotiations with the European Union. For the most part Caribbean countries are waiting for an invitation to join NAFTA, or more US unilateral liberalization, via extension of the Caribbean Basin Initiative (CBI). They place far more value on their dealings with the European Union and the United States than on the creation of a free trade area between the islands.

Chile. In the early 1990s, Chile sought membership in NAFTA; when Washington politics proved too much of a hurdle, Chile negotiated a series of bilateral FTAs with Mexico, Mercosur, and others. Mexico, Canada and Chile have been particularly active in promoting bilateral FTAs within the Western Hemisphere, sometimes one-on-one arrangements (e.g., Chile-Mexico), sometimes one-on-one-plus (e.g., Mexico with Colombia and Venezuela in the Group of Three (G-3) Arrangement). Usually these bilaterals are designed to be NAFTA and/or Mercosur consistent.

Cuba. In addition, there is the sidelines player, Cuba. While the United States continues its embargo, Cuba trades substantially with the countries of the Caribbean as well as with Mexico and Venezuela. Canada and Mexico invest in the Cuban economy, especially in tourism and mining. The Association of Caribbean States (ACS), which includes Cuba in its membership, is considering a proposal for a wider Caribbean Free Trade Area. When Cuba once again joins the inter-American system, the implications will be significant. A large island with rich natural resources and a talented workforce, Cuba will be a frontrunner in the Caribbean. Cuba has potential in mining, pharmaceuticals, sugar, rum and bananas. Added to this is the pent-up desire of many Americans to spend their tourist dollars in Cuba—a factor that will undoubtedly boost Cuba's tourism sector—potentially at the expense of its Caribbean neighbors.

The opening of Cuba could have a major impact on the FTAA. The passing of the Castro government in Cuba may prompt a US rush to bring the new Cuba into NAFTA, and the potential dislocation in the Caribbean and Central America could sweep CACM and Caricom into NAFTA in the same breath. In turn, this could set the stage for a NAFTA-SAFTA bargain that will culminate in the FTAA.

The NAFTA countries. The Canada-US FTA proved to be the forerunner of the North American Free Trade Agreement (NAFTA) and other pacts within the region. The FTA was consciously viewed as a template for the Uruguay Round of GATT negotiations—and was in fact used as a template at least twice, once for the Uruguay Round and again for the NAFTA. NAFTA in turn served as a welcome mat for Mexico into the world trading system, and marked a sharp turn from historical US-Mexican political and commercial antagonism.

In addition, as a consequence of the bilateral agreements negotiated by Canada and Mexico, NAFTA's rules and disciplines have been indirectly "exported" to other Latin American countries. All of Mexico's post-NAFTA agreements are built upon NAFTA disciplines. The G-3 agreement between Mexico, Colombia and Venezuela as well as Mexico's bilateral agreements with Bolivia and Costa Rica, incorporate NAFTA-type rules, and the Canada-Chile free trade agreement even goes beyond the NAFTA in certain areas (notably, it rules out antidumping proceedings between the parties). Mexico and Chile are currently renegotiating their 1992 free trade agreement, in keeping with this trend. Within the Western Hemisphere, in addition to the three NAFTA countries, Bolivia, Chile, Colombia, Costa Rica and Venezuela have also accepted NAFTA-type rules and disciplines in important areas. For example, all these countries will grant investors national treatment and accept international arbitration for the resolution of investment-related disputes. This is a far cry from the old Calvo Clause, which asserted that investor disputes had to be adjudicated by local courts. In the service sector, these countries have agreed to undertake liberalizing measures which exceed those called for in the Uruguay Round, using a "top-down" approach to free trade in all services.4 They have also agreed to national treatment-based rules in government procurement and have updated their intellectual property rights regimes. Finally and importantly, these agreements have adopted NAFTA-type dispute settlement mechanisms to resolve trade disagreements.

Increasing commonality in bilateral and plurilateral agreements bodes well for trade and investment relations within the Americas. Common rules and procedures and a strengthened legal framework will smooth the way in future negotiations. NAFTA may not serve as the path to the FTAA, but it will continue to play a significant role in structuring the framework for trade and investment liberalization in the Americas.

 

The Free Trade Area of the Americas: Choices Ahead

What will happen to existing subregional economic integration arrangements when the FTAA comes into effect? The Declaration of San Jose states that the FTAA, will coexist with arrangements that are already in place. However, since the FTAA is to be WTO-consistent and "balanced and comprehensive in scope", it will in substance supersede many of these arrangements. One can imagine that existing bilateral agreements will be folded into the FTAA in the sense that every commitment in the FTA will be restated in stronger form in the FTAA. In other words, looking to the future, we see the FTAA as a way to unravel some of the spaghetti, while keeping the networking going.

What about the structure of negotiations? Currently, the FTAA talks are being conducted partly by blocs, partly by individual countries. The Mercosur negotiates as one. The Andean Community, the Central American Common Market and the Caricom for the most part speak with one voice per regional arrangement. The NAFTA countries, by contrast, negotiate individually.

The FTAA process has now been underway for three years and much of the preparatory work has been done. Twelve working groups, with the assistance of the Tripartite institutions (the IDB, OAS and ECLAC) have built databases, prepared studies on a range of trade and investment disciplines, and have compared national and regional legislation in the relevant FTAA negotiating areas. The FTAA negotiations were launched in April 1998 at the Santiago Summit, and in September 1998 hundreds of negotiators descended upon the University of Miami conference centre to begin talks. Nine negotiating groups were set up—in market access, agriculture, investment, services, intellectual property rights, competition policy, government procurement, subsidies, antidumping and countervailing duties and dispute settlement. Consultative groups have also been established to study electronic commerce, smaller economies and civil society.

The question now is to what end? It is easy to imagine dead-end scenarios in which nothing comes of the grand design launched at the Miami Summit. The Asian financial crisis gave new arguments to those, especially in the United States and Brazil, who already oppose free trade agreements. Unless the major countries summon the political will, little free trade will result from the FTAA. The next U.S. President—be it Al Gore, George Bush or someone else—will have to work hard to muster support for a Hemispheric trade initiative. Otherwise, the FTAA vision could easily blur into political summits with economic nuggets (a path that APEC seems to be following), and lose its focus on free trade.

We put forth three scenarios for the future FTAA.

  1. The minimalist scenario. Not much happens in the Americas, but the FTAA process stimulates some trade activity in other fora. The EU, eager to preserve its large market in South America, hastens a free trade agreement with Mercosur, with a limited degree of agricultural liberalization. At the same time, a new round of trade talks is launched at the multilateral level. Within the WTO, agricultural talks begin in 1999, and countries start services negotiations in the year 2000. Many, including Sir Leon Brittan, have called for the "Millennium Round", to start in that year. In this scenario, the FTAA acts as a spur to the Millenium Round. Even if the free trade focus is maintained in the FTAA, there may be little substance to distinguish the FTAA from the WTO talks—and thus to make it worthwhile diverting skilled human resources and political capital to the pursuit of freer hemispheric trade. In a minimalist scenario, the first few years of the FTAA negotiations are spent pushing WTO initiatives, and the FTAA eventually folds into the multilateral negotiations.
  2. The middle-of-the road scenario. In a middle-of-the road scenario, the FTAA moves beyond the WTO in certain areas, but it falls short of achieving ambitious goals. A likely area of accomplishment is "civil society". Since the Americas are inevitably linked—by geography, history and culture as well as by commerce, immigration and drugs—as environmental and labor issues (and perhaps a few other civil society questions) are built into the agenda. If the FTAA comes up with a creative way of addressing these contentious issues, than it will have made a significant contribution.
  3. The maximalist scenario. In the maximalist scenario, the FTAA moves well beyond the WTO and eliminates the barriers to trade and investment among the thirty-four participating countries on a much faster schedule than the WTO timetable. Indeed without a surprising great leap forward, the Millennium Round will not produce anything like a world free trade agreement. China and Russia remain to be ushered into the system, and, along with many other countries, they don't seem ready for free trade in the next two decades. Hence, the FTAA can make a contribution above and beyond the multilateral realm through faster liberalization of traditionally protected sectors—notably agriculture, textiles and apparel, autos, and a range of services. Also, the FTAA could move towards deeper integration, addressing sensitive issues such as labor and environmental conditions well before the multilateral level is ready to deal with them.

Supporting this scenario, the FTAA is currently addressing novel issues: government procurement (currently the plurilateral WTO agreement has the participation of only two countries in the Americas), competition policy (not yet the subject of a multilateral framework); and the formation of a mechanism to hear the views of nongovernmetal actors. On this last item, the FTAA countries have formed a Committee on Civil Society to diffuse the sort of tensions that resulted in the burning of cars and spraying of graffiti at the 1998 WTO Ministerial meeting. This committee is designed to serve as a bridge between policymakers and their most vocal constituents.

Especially in the United States, the twin issues of labor and the environment have been linked to the trade agenda—and served as lightning rods for opponents of free trade agreements. One creative solution that could be put into place by FTAA members would be a Hemispheric wide labeling system, along the lines of the ISO 9000 for labor and environmental standards in the manufacture of traded goods and services. Under this approach, business firms would subscribe to labels that attest to the working and environmental conditions under which goods and service are made.5

A companion "market approach" to promoting labor standards is the adoption of codes of conduct, which typically specify minimum labor and environmental standards. The firm that adopts the code would then advise its sub-contractors that if they violate the same code, they lose the contract. Code language is often vague and enforcement can be lax, but steps have been taken to address those problems, starting with the establishment of a universal standard for ethical sourcing.

In our crystal ball, the maximalist scenario describes the future. We think the momentum behind Hemispheric integration will be stronger over the next decade than the push for rapid global integration. Just as a combination of economic and political considerations carried the day in Europe, so too, in our opinion, will they result in a full-blown FTAA.

 

Table 1: Trade and Integration Agreements in the Western Hemisphere


   
Entry into Force

Customs Unions    
  Mercosur
1995
  Andean Community
1969, rev. 1998
  Central American Common Market (CACM)
1961
  Caribbean Community (Caricom)
1973

Free Trade Arrangements    
plurilateral arrangements    
  NAFTA
1994
  Group of Three (G-3)
1995
  Mercosur - Bolivia
1997
  Mercosur - Chile
1996
bilateral FTAs    
  Bolivia-Mexico
1995
  Canada - Chile
1997
  Caricom- Dominican Republic
1998*
  Central-America-Dominican Republic
1998*
  Chile-Colombia
1994
  Chile-Ecuador
1995
  Chile-Mexico
1992
  Chile - Venezuela
1993
  Costa Rica-Mexico
1995
  Mexico- Nicaragua
1998*

Preferential Trade Agreements**    
CARICOM    
  CARICOM-Colombia
1995
  CARICOM-Venezuela
1993

* date of signature
** The trade agreements between Colombia and Venezuela and the Caricom initially offer Caricom preferential access to Colombian and Venezuelan markets, but will be renegotiated to become fully reciprocal.

Source: Miguel Rodríguez Mendoza and Barbara Kotschwar "Latin America: Expanding Trade Opportunities" in SAIS Review, June 1997.

 

Notes

1. Caricom members include Antigua and Barbuda, Bahamas, Barbados, Belize, Dominica, Grenada, Guyana, Jamaica, Montserrat, St. Kitts and Nevis, St. Lucia, St. Vincent and the Grenadines, Suriname, Trinidad and Tobago.

2. CEPAL, El regionalsimo abierto en America Latina y el Caribe. La integracion economica al servicio de la transformacion productiva con equidad, Santiago de Chile, 1994.

3. In the 1970s both countries toyed with nuclear aspirations. Unlike India and Pakistan, they instead pursued a path of cooperation—a path that culminated in the formation of Mercosur.

4. In a "top down" approach, the country agrees to implement the principles of liberalization unless an activity is specifically reserved. This is also called a "negative list" approach.

5. US consumer groups are pushing this approach, and some labels already exist. A famous example is the Rugmark label for carpets which guarantees that the carpet was not made with child labor.



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