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Testimony

The Free Trade Area of the Americas: US Interests and Objectives

by Jeffrey J. Schott, Peterson Institute for International Economics

Testimony before the Subcommittee on Trade Committee on Ways and Means
United States House of Representatives
Washington, DC
July 22, 1997


At the Summit of the Americas in Miami in December 1994, the United States and 33 other democratic countries in the Western Hemisphere committed to complete negotiations on a Free Trade Area of the Americas (FTAA) by the year 2005, and to make substantial progress toward that goal by 2000. Hemispheric leaders are expected to officially launch the trade talks when they reconvene for a second Summit of the Americas in Santiago, Chile, in April 1998.

To be sure, actual US participation in FTAA negotiations depends on the restoration of fast track authority to implement trade agreements in US law and Congressional approval for the use of such authority for the hemispheric talks. If fast track fails, or is limited to talks with specific countries (e.g., Chile only), the FTAA negotiations will quickly collapse.

In related testimony before this committee and subsequently before the Senate Finance Committee, my colleague C. Fred Bergsten has argued why expeditious passage of fast track authority is critical to the achievement of US policy goals.1 My statement today fully supports those views and recommends that the FTAA talks should be among the important US initiatives covered by that authority.

By way of introduction, I will first discuss the possible scope and coverage of an FTAA, given developments to date since the Miami Summit. I then turn to US interests in an FTAA and the cost of inaction or delay in pursuing those talks. I conclude with a few lessons regarding hemispheric integration based on the experience of NAFTA and other subregional economic initiatives.

 

FTAA: Coverage and Process

Free trade agreements (FTAs) come in all shapes and sizes. The NAFTA represents one of the most comprehensive pacts in terms of coverage of trade and investment in goods and services sectors, and incorporates extensive disciplines on domestic policies that can distort trade and investment flows. Other FTAs are more limited and some simply involve the removal of tariffs on merchandise trade (often with some sectoral exceptions such as agriculture).

The Plan of Action issued at the Miami Summit endorses an FTAA that is “balanced and comprehensive” and proposes an agenda for the FTAA talks that includes virtually all of the subjects covered by the NAFTA.2 While the proposed FTAA agenda is comparable to the broad scope of the NAFTA, it does not follow that the NAFTA will necessarily be the model for hemispheric trade obligations, nor will the FTAA involve accession to NAFTA (although NAFTA expansion to some countries in the hemisphere may be part of the integration process leading up to the FTAA). Rather the process of building the FTAA will likely be an eclectic one, involving concurrent negotiations among bilateral and subregional partners as well as hemisphere-wide talks. However, the experience of NAFTA and the MERCOSUR (Argentina, Brazil, Paraguay, and Uruguay) undoubtedly will help inform the FTAA talks and provide useful precedents for the eventual agreement.3 Trade negotiators “learn by doing”.

To date, trade ministers from the 34 countries have met three times to discuss areas of existing and potential cooperation, and have established 12 working groups to prepare for the FTAA negotiations in three broad areas: market access reforms (including liberalization of trade barriers and the removal of discrimination against foreign suppliers in the application of domestic regulations); rules covering trade and investment in goods and services sectors; and trade facilitation measures (e.g., customs reform; business visas etc.).

All of the issues included in the FTAA negotiations will be considered as a package. Some agreements may be reached early in the process, and could be implemented by 2000 to satisfy the “early harvest” commitment of the Miami Summit declaration. Customs reforms and other trade facilitation measures endorsed by the Americas Business Forum may be achievable in this timeframe; an investment accord comparable to the Multilateral Agreement on Investment being developed in the OECD is also possible.

Interestingly, such an approach would be consistent with Brazil's proposal to emphasize trade facilitation measures at the outset of the FTAA talks. Brazil's argument that market access reforms should be deferred for several years, however, does not make sense and, indeed, is inconsistent with Brazil's own economic policy. Brazilian officials seem to be pushing a “go slow” approach to FTAA trade liberalization to avoid additional adjustment pressures that could upset the noteworthy but fragile progress to date of their Real Plan -- even though continuing trade reform is a critical component of their macroeconomic stabilization policy. I regard the Brazilian proposal as a tactical ploy to assuage their domestic constituencies and not as a roadblock to the launch of substantive FTAA negotiations.

One additional and important point deserves mention. During the past 30 months, the viability of the FTAA commitments has been tested by the Mexican peso crisis, which erupted just 10 days after the Miami Summit and generated a “tequila effect” in a few other Latin American economies, and by a number of political concerns involving inter alia drug trafficking and large income disparities both between and within countries in the region. These problems are difficult and immune to quick fixes via trade or other policy initiatives. Rather they require a long-term commitment to improve education and create viable alternatives to illegal commerce. In that regard, the Miami Summit process, which comprises not only trade but important cooperative efforts in areas such as strengthening democracy, combatting drug trafficking, and promoting sustainable development, should be a constructive part of national responses to these problems.4

 

US Interests in an FTAA

When prospective US-Mexico free trade talks were first broached, few people realized how closely integrated our two economies already were or how closely our interests coincided with the promotion of economic growth and political stability in the region. To a somewhat lesser extent, the same situation holds today with respect to US interests in Latin America and the Caribbean. The United States has an important stake in the economic health and political reform of our southern neighbors.

First, the United States has substantial and growing trade and investment interests in the region. The Latin America and the Caribbean region is becoming an increasingly important market as a result of a decade of economic reform that has produced region-wide GDP growth of 3.5 percent in 1996 and lowered inflation to 22 percent, down from the triple digit levels of just a few years earlier. Forecasts for 1997 look even better, with GDP growth expected to expand by 4.4 percent and inflation to fall to 12 percent.5 This growth does not rival that of the Asian “tigers”, but it is vastly superior to the performance in the region in the debt-laden 1980s. Moreover, if this growth rate can be sustained, the region would comprise a market of about $2.4 trillion (or one-third the size of the current US economy) by the time the FTAA is due to be completed in 2005.

Latin America already is an important market for US companies and has become increasingly attractive for direct investment as their economic reforms have taken root. The region (including Mexico) now accounts for about 18 percent of total US merchandise exports and 16 percent of US imports; and regional sales to the US market represent about half of all merchandise exports by Latin American and Caribbean countries. US-Mexico trade accounts for more than half of those totals, even though Mexico produces only about a quarter of regional output. US exporters have a growing and underdeveloped market for their goods in South America, and have been rapidly expanding their presence in those markets over the past five years. US exports to and imports from the region, excluding Mexico, have increased by about 50 percent since 1993, with the United States running a small trade surplus with the region each year (about $5 billion at an annual rate so far in 1997). During that period, US direct investment in the region increased by 30 percent on a historical-cost basis to a cumulative $92.5 billion in 1995, representing 13 percent of total US foreign direct investment.

Second, the negotiation of an FTAA would not require substantial changes in existing US law or trade practices; indeed, like NAFTA, a prospective FTAA would require much more of US trading partners in terms of trade liberalization and regulatory reform than of the United States. Latin American economies have significantly reduced their trade barriers in recent years down to an average range of 10 to 20 percent through unilateral liberalization and reforms negotiated in their subregional pacts and in the GATT/WTO. These efforts have removed much of the “water” in their protection, but the “muscle” remains intact and will require a broader negotiation to get it removed.

Overall, an FTAA bargain will likely entail substantial new liberalization by Latin American countries in return for guarantees of continued good access to the US market and the removal over a long transition period of a few notable US barriers in textiles and agriculture (comparable to what was done in the NAFTA). Whether some specific barriers will be exempted from the FTAA liberalization commitments and the length of the phaseout periods for remaining trade barriers will undoubtedly be left hanging until the end of the talks.

Why would Latin American countries agree to such asymmetric liberalization? The short answer is that they really have little choice if they want to compete in global and regional markets. The FTAA would provide an insurance policy against new protectionist impulses in the US and other regional markets, as well as “locking in” their domestic reforms through international obligations and thus substantially raising the cost of policy reversals. In so doing, the FTAA would provide strong incentives for both domestic and foreign investors to develop their markets and bring in new technology and management skills.

What was remarkable about the Miami Summit commitments was that the developing countries were in the forefront pressing for trade reforms, even though they maintain much higher trade barriers than the United States and face the daunting challenge of competing openly against the advanced industrial economies of North America. The reason is clear: they regard their FTAA commitments as a complement and integral component of domestic economic policies designed to spur competition in their markets, dampen inflation, promote investment (from both domestic and foreign sources), and generate robust and durable growth. Their focus was not on the prospective change in their bilateral trade balance but rather on the impact free trade could have on promoting economic growth in conjunction with the broad array of domestic economic reforms that they had been implementing for several years.

Third, as evidenced at the Miami Summit, the prospect of improved trade relations can act as a magnet for attracting support among our hemispheric neighbors for other important US political and foreign policy goals, including cooperation on drug interdiction, improving environmental and labor conditions, and reinforcing democratic reforms. An FTAA will thus have important spillover effects on overall US relations with the region. This point is well illustrated by the recent Mexican election, which demonstrates the salutary effect of economic integration on political reform.

Fourth, and perhaps most important, the United States benefits when its neighbors prosper and democratic processes take root. The FTAA process would support the important economic and political reforms that have been achieved throughout Latin America over the past decade. To be sure, the process of economic integration in the hemisphere was already engaged well before the Miami meeting as a result of ongoing domestic economic reforms and the negotiation of subregional trade pacts such as NAFTA and the MERCOSUR. Ongoing and deepening implementation of these policies is a prerequisite for the developing countries in the Western Hemisphere to be able to undertake and sustain the reciprocal obligations of a free trade pact with industrial countries.

 

The Cost of US Inaction

Since the Miami Summit, US trade initiatives in the region have been significantly hampered by the absence of fast-track authority to implement trade agreements in US law. Free trade talks with Chile, advocated by Presidents Bush and Clinton, seized up; negotiations to remedy the potential adverse impact of certain NAFTA provisions on trade and investment in the Caribbean Basin were placed on a back-burner; and US participation in the preparatory meetings for the launch of the FTAA negotiations has been seriously constrained.

To date, the cost of US inaction has been modest. If US negotiators stay on the sidelines much longer without fast track authority, however, the adverse impact on US trading interests in the region could grow significantly. Three related problems bear mention.

First, without fast track authority, our trading partners will understandably question the US commitment to the FTAA talks and our willingness to deepen regional trade relations. The United States accounts for about 75 percent of total economic output in the hemisphere. If the United States backed away from its Miami Summit commitments, or even rode the fence for another year or more pending fast track approval, we would both undermine the credibility of the hemispheric negotiations and encourage a protectionist backlash against the reform policies introduced in Latin America during the past decade -- thus making it more difficult for Latin American countries to maintain and extend the liberalization already implemented. The Venezuelan experience of the early 1990s is instructive in how costly a political backlash against economic reforms can be.

Second, most countries in the hemisphere continue to pursue bilateral and regional free trade pacts without us. In most instances, the new agreements are designed as way stations to an eventual FTAA, but the tariff preferences are accorded only to member countries and thus discriminate against US-based exporters. Both Mexico and Canada have concluded free trade pacts with Chile; Mexico also has agreements with Costa Rica, Colombia, and Venezuela, and is talking with other Central and South American countries about similar deals. In addition, the MERCOSUR is solidifying its customs union and has entered into or is negotiating free trade “association” arrangements with Chile, Bolivia, and countries in the Andean Community.

What this means for US firms is that they often are handicapped in competing for sales in South American markets because they have to pay sizable tariffs and their regional competitors do not. Sometimes US firms can source from foreign plants in countries that receive tariff preferences, but this is costly both for the company and their US workers.6 Besides tariff preferences, these bilateral and subregional trade pacts contain trade rules (e.g., rules of origin; special safeguards) that can impose significant transaction costs for US companies. The proliferation of different customs procedures and content requirements in these arrangements can create a paperwork nightmare for businessmen.

Third, recently concluded regional agreements create precedents involving practices significantly different from those inscribed in US law that member countries may want to extend to the broader FTAA. For example, the Chile-Canada FTA prohibits the use of antidumping laws with respect to bilateral trade as soon as tariffs are removed (i.e., within six years); and several pacts include relatively simple value-based origin rules that do not afford the protection of industry or sector-specific rules such as the triple transformation test for apparel in the NAFTA.

Furthermore, US firms compete in regional markets not only with other hemispheric producers but also with European and other overseas companies. While we have been digesting the NAFTA and Uruguay Round results, many of our southern neighbors have entered into trade talks with the European Union. The European Union has actively pursued discussions with the MERCOSUR countries, Mexico, the Andean Community, and others because of both strong trade and investment linkages with the region and longstanding political and cultural ties with the MERCOSUR in particular. The European Union is the leading trading partner and investor in the MERCOSUR and wants to maintain its lead in that fast-growing market.

To date, EU initiatives in the region have resulted in agreements similar to the “framework” or consultative arrangements that the United States negotiated with virtually all the countries in the region in the 1980s and early 1990s; the promise of future free trade pacts is somewhat suspect, however, since the Europeans refuse to consider farm trade reforms in their negotiations with Latin American countries and thus exclude a large share of MERCOSUR exports to Europe. In the first half of the 1990s, EU exports to the MERCOSUR grew by an annual average of more than 20 percent, while EU imports from that region increased by less than 1 percent annually. EU agricultural restrictions blunted MERCOSUR exports, almost half of which were raw and processed foodstuffs. Nonetheless, bilateral EU-MERCOSUR talks have proceeded apace, despite the substantive trade problems, in hopes of attracting additional EU direct investment in the MERCOSUR region and strengthening political relations.

In sum, regional trade pacts affect US trading interests. When we are not engaged in the talks, we can't influence the outcome and lose an opportunity to build a consensus for US objectives for the FTAA.7 And, of course, restoration of fast track authority is crucial to the achievement of these goals.

 

Lessons from the NAFTA Experience

As the first comprehensive and reciprocal free trade pact between developed and developing countries, the NAFTA has illustrated several important aspects of free trade pacts that should help inform the FTAA process. I conclude with five critical trade policy lessons derived from the NAFTA experience that are relevant for an understanding of the prospective FTAA:

1. Macro matters most. Trade agreements create opportunities; they do not guarantee sales. To promote sustained growth and take full advantage of those opportunities, macroeconomic policy must be prudent -- at home and in the partner countries.

2. Trade pacts provide an insurance policy against new protectionism at home and abroad. They deter abrupt policy reversals and help governments withstand the protectionist demands of their domestic lobbies. Mexico's response to the peso crisis is evidence of this salutary effect.

3. Free trade pacts involve asymmetric obligations which fall heavier on developing than developed country partners. The benefit for developing countries is that the pact locks in the domestic reforms needed to reinforce growth and represents a “good housekeeping” seal of approval for those policies -- thus making them more attractive to foreign investors and promoting the transfer of technology and management skills.

4. Trade pacts are not engines of job creation, but they do support jobs that provide a substantial wage premium over earnings in the non-exporting sector.

5. Integration is an iterative process. Not all issues of importance in bilateral or regional relations are covered ab initio in trade pacts; but as countries become more integrated, new issues which span domestic and international concerns often are added to the common agenda. Indeed, as the Summit of the Americas process has demonstrated, trade talks can serve as a magnet for attracting support on a wide array of initiatives including strengthening democracy, combating drug trade, and promoting better environmental conditions and labor rights.

 

Notes

1. See C. Fred Bergsten, “The Need for New Fast Track Legislation”, Statement before the Senate Finance Committee, 3 June 1997, and “The Imperative and Urgency of New Fast Track Legislation”, Statement before the Subcommittee on Trade, House Committee on Ways and Means, 18 March 1997.

2. Labor issues are not included among the topics for negotiation, but governments committed to “further secure the observance and promotion of worker rights, as defined by appropriate international conventions” (Summit of the Americas Plan of Action, Section II:9(2)).

3. Since the NAFTA region represents more than 85 percent of hemispheric GDP, it is likely that NAFTA provisions will carry great weight in the FTAA talks because companies that want to do business in the predominant market in the hemisphere will tailor their policies and standards to NAFTA norms.

4. For a discussion of the evolution of the Summit of the Americas and its immediate aftermath based on analysis by one of the senior US participants, see Richard Feinberg, Summitry in the Americas, Washington: Institute for International Economics, 1997.

5. Data from Shahid Javed Burki and Guillermo E. Perry, The Long March: A Reform Agenda for Latin America and the Caribbean in the Next Decade, Washington: The World Bank, 1997.

6. Paul Magnusson reports anecdotal evidence of such trade diversion in “Beyond NAFTA: Why Washington Mustn't Stop Now”, Business Week, 21 April 1997, p. 46.

7. These lessons are drawn from my analysis, “NAFTA: An Interim Report”, paper prepared for the World Bank Conference in Montevideo, Uruguay, 29 June - 1 July 1997.