|
APPENDIX 2
ECONOMIC AND TRADE POLICIES IN LATIN AMERICA AND THE CARIBBEAN
Bloated corporate statist economies are now privatized, reformed, more
competitive, and more open ... [G]overnments began to support ... good
banking reforms. Generally, the financial system is in a more resilient
shape today than it was, for example, six years ago. So in a word, Latin
America is more resilient, more able to respond and withstand the shocks
and turbulence of world capital market uncertainties and trade and investment
ups and downs than they have been in the past. [Bob Clark, 25:1555-1600]
Latin America and the Caribbean
Latin America and the Caribbean include 46 countries and territories
(see Exhibit A2.1) with a population of 518.4 million people. Economic
activity in the region is estimated at US $2 trillion as measured by its
constituent countries' combined gross domestic product (GDP). By simply
dividing the latter statistic by the former, Latin American and Caribbean
economic welfare can be considered modest at US $3,917 per individual in
1997.
Trade Developments in Latin America
Latin America has experienced several waves of trade regime reform over
the past half century. From the mid-1950s through to the end of the 1980s,
Latin America had, for the most part, a restrictive trade regime in place,
first relying heavily on import quotas and high tariff rates, followed
by a shift away from quotas towards very high tariffs and other non-tariff
barriers. However, with the collapse of their economies in the 1980s, virtually
all Latin American countries reversed direction, opting instead for the
formation of subregional free trade areas and customs unions, along with
substantial, unilateral tariff reductions with their entry into the World
Trade Organization (WTO).1
While riding the crest of this newest wave has been a trying financial
balancing act - there being the occasional external balance of payments
crisis in the transition period2
- the reversal in trade policy has, in general, been successful.
Perhaps an abbreviated historical summary would shed more light on Latin
America's economic experience and the need for reform of its restrictive
trade regime. Since the mid-1950s, Latin American countries pursued structuralist
economic policies, spear-headed by the import-substitution strategy, which
hold that developing countries are better off industrializing behind high
protective tariffs and restrictive import quotas. Trade strategies premised
on specializing production in commodities and manufactures where there
was a comparative or competitive advantage were discarded in favour of
nurturing home-grown companies and industries that are shielded from international
competition. Export subsidies, even though they by and large achieve the
same trade objective as a tariff, were seldom employed as governments clearly
recognized these privileges as a significant cash drain on their balance
sheet; in contrast to a tariff which would show up on the government's
books as a tax revenue. They were, nevertheless, made available to specific
sectors in regions with strong political lobby groups, such as in Mexico's
maquiladora and Argentina's Tierra del Fuego regions.3
It took a while before Latin American officials realized the full impact
of their restrictive trade policies, possibly because their effects were
intertwined with those of other policies, such as the highly stimulative
macroeconomic stabilization strategies of the 1970-80s, making disentangling
and distinguishing their respective economic impacts difficult. These policies
would include generous government services and programs to the public,
financed by equally easy monetary conditions and heavy foreign borrowings,
thinking that they could buy greater economic prosperity and a lower unemployment
rate at the price of more inflation. This proved correct in the short term,
but this favourable mix of economic outcomes could not be sustained once
everyone adjusted their expectations to the new underlying financial realities
created by these expansionary public expenditure and credit policies. That
is, once labourers, managers and capitalists together demanded and got
inflation protection for their personal efforts and investments, thereby
dissipating the financial stimulus provided by their monetary policies,
economic growth would grind to a halt and the unemployment rate would creep
back up to traditional levels. It would not, therefore, be until the late-1980s
when Latin American trade officials could discern the impact of their restrictive
trade policies and they were unequivocally negative (see Box A2.1).
From a statistical perspective, the 1970s witnessed these stimulative
macroeconomic policies generate tremendous growth for Latin America, in
the order of 5.4% per annum (p.a.), but the economic benefits were short-lived.
Over the longer term, these strategies only served to generate high inflation
rates, high nominal rates of interest and a lower national savings rate.
In fact, hyperinflation in the order of 8,000% p.a. in Bolivia in 1985,
3,080% p.a. in Argentina in 1989, 7,650% p.a. in Peru in 1990, and 2,489%
p.a. in Brazil in 1993 were observed. Even higher nominal interest rates
followed, but to the extent that interest rate ceilings were imposed by
fiat, the savings rates of these economies collapsed (Bolivia, Chile, El
Salvador, Guatemala). The end result of these poor financial conditions
was declining domestic investment, languishing labour productivity, non-competitive
wage rates and unsustainable high domestic currency values. To add insult
to injury, the region's terms of trade declined 47% between 1980 and 1989.
As foreign lenders and other short-term capital providers began to reverse
course, it would not be long before Latin America's economic bubble would
burst. For without unlimited foreign currency reserves or the credit to
obtain them, their pegged currency exchange rate policies were destined
for devaluation, the only question being when and by how much. Even when
these currency regimes were accompanied by a regulatory control framework
on foreign capital, which attempted to manipulate increasingly global financial
markets in ways to dampen the outflow of portfolio and other flight capital
from the region while simultaneously stemming currency speculation, they
too proved wholly unsuccessful.4
By the end of the 1980s, after considerable economic contraction throughout
the region, Latin America's GDP managed an average annual growth rate of
only 1%. Indeed, five of 17 Latin American countries experienced negative
growth throughout the 1980s, one had no growth, and only four countries
recorded more than a 2% annual growth rate in the decade. Latin America
thus suffered its largest and most protracted economic decline since the
Great Depression of the 1930s.5
As it turned out, the region's restrictive trade and expansionary macroeconomic
policies only served to raise the cost of living, as their economic planners
woefully misallocated resources to inefficient economic activities. The
1980s would eventually be coined by regional commentators as Latin America's
"lost decade."
In the end, no less than 18 Latin American countries restructured their
debts with their creditors in the 1980s. Under advice from the International
Monetary Fund and World Bank, these countries also began to exercise more
responsible and sustainable fiscal and monetary policies. Indeed, Latin
America has progressively tidied up its financial problems to more manageable
levels and a new wave of liberal trade policy has taken hold. Three sets
of reforms were put in place: (1) the removal of many protectionist policies,
including unilateral tariff reductions and a general shift from import
quotas to tariffs when protection from foreign competition is granted;
(2) less government intervention into the economy and greater reliance
on liberalized markets with the deregulation and privatization of firms
in many key sectors; and (3) the conduct of more conventional macroeconomic
stabilization policies that are geared to produce stable long-term growth.
By and large, these economic reforms took place or were phased-in in this
chronological order as well.
-- not available; 1995; GDP Deflator
Sources: IMF, Structural Policies in Developing Countries,
1994; World Bank, World Development Indicators, 1998; U.S. Trade Representative,
Foreign Trade Barriers, 1998, ECLAC, Preliminary Overview of the Economies
of Latin America and the Caribbean, 1998.
Latin America's conversion to freer trade is, in part, demonstrated
by the extent of tariff reductions reported in Table A2.1; average country
tariff rates of 20% to 92% in 1985 are now in the order of 9.6% to 13.3%.
Furthermore, all Latin American countries are members of the WTO/GATT;
almost all are, or are in various stages of becoming, compliant with their
WTO trade obligations. State-owned enterprises also play a much smaller
role in the economies of Latin America. Indeed, the privatization of numerous
state-owned enterprises has generated in excess of US $86.3 billion for
Latin American governments between 1990-96.
Finally, the shift in emphasis of their macroeconomic policies towards
stable economic growth and lower inflation has also been successful. For
example, the standard deviation in annual GDP growth for Latin American
countries declined from 10.3 to 7.1 percentage points between 1984-90 and
1991-97, respectively, signalling a more stable economic climate in the
1990s. This economic performance compares to an increase in the standard
deviation of GDP growth from 4.7 to 5.3 percentage points for Canada and
a slight decline from 4.3 to 3.9 percentage points for the United States
over the same periods.6
On the inflationary front, price increases, as measured by their consumer
price indexes, declined significantly for 12 of 18 countries in the latter
decade. There are also no more triple- or quadruple-digit annual rates
of inflation in Latin America anymore; single-digit inflation is not now
uncommon, but double-digit rates are more the norm. Indeed, by 1997, annual
inflation averaged 10.1% throughout Latin America. Not that there is a
lesson to be learned by countries with a poor track record in monetary
policy, but it is interesting to note that the two countries adopting the
U.S. dollar as its domestic currency (or as a part of it), Panama and Argentina,
experienced the lowest price inflation of the region throughout the past
decade.
Interestingly, these prudent macroeconomic policies in combination with
liberalized trade policies have had other - some would claim unexpected
- economic payoffs. When comparing the performances of Latin American GDPs
over the 1980-90s, every country, except Paraguay, experienced a higher
average annual growth rate in the 1990s. Moreover, no national economy
of Latin America contracted throughout the 1990s in contrast to the many
that did in the 1980s. The average annual growth rate of Latin America's
GDP has been 3.7% so far this decade, featuring a range starting from 2.7%
in Nicaragua to 8.0% in Chile. In contrast, Latin America posted an average
annual growth rate in GDP of 1% throughout the 1980s, with a range beginning
with -1.5% in Nicaragua and ending with 3.7% in Colombia. So a period of
stable growth in the 1990s coincided with, or may have been the cause for,
a protracted period of relatively high growth as well.
As a consequence of the policy actions taken, many countries of Latin
America are considered by some as relatively promising markets for trade
and investment. Table A2.2 provides selective financial data for the region,
most notably, Latin America maintained a foreign debt balance of US $540
billion in 1997. The region also demonstrated that, except for a handful
of countries, every country has taken important strides in reducing its
foreign debt exposure relative to GDP. Taken together, the region's foreign
debt-to-GDP level was almost halved, from 56.9% to 32.3%, between 1986
and 1997. The curtailed fiscal policies that has restrained the region's
dependence on foreign debt is also showing up in their ability to service
this debt. Foreign debt service-to-exports levels have substantially declined
from 50.7% to 37.2% between 1986 and 1997. The best performers appear to
be those whose terms of trade improved in the period (i.e., Costa Rica,
El Salvador, Uruguay). Conversely, the poorest performers appear to be
those countries whose terms of trade declined in the period (i.e., Nicaragua,
Honduras, Colombia). In any event, private capital which trickled into
Latin America at the beginning of this decade is now gushing in. Annual
net private capital flows increased more than eightfold since 1990; in
fact, while US $11.2 billion in net private capital flowed into the region
in 1990, the year 1996 saw a US $93.7 billion inflow.7
-- not available
Source: World Bank.
For Latin America, the political focus now turns to the next generation
of reforms that would solidify as well as build upon the economic gains
achieved so far. On the immediate agenda would be the adoption of common
minimum standards of financial regulation and supervision, credible codes
of conduct in implementing fiscal and monetary policies, and sound corporate
governance principles to improve the institutional framework in which financial
markets operate. Over the longer term, the development of autonomous public
institutions, such as independent central banks and judiciaries, and the
encouragement of higher domestic savings rates to be able to invest more
in human and physical capital, such as education and transportation and
communications infrastructure, which tend to yield higher long-term economic
returns, would be advisable. It is further expected that the MERCOSUR might
first shore up its institutional arrangements and broaden its scope to
include the Andean Community in accomplishing some of these tasks and thereby
improve Latin America's readiness for any free trade agreement with North
America.
The Caribbean Challenge
The Caribbean Basin comprises 25 countries and territories as depicted
in Exhibit A2.1, not including Belize, Guyana and Suriname which are members
of the CARICOM, a subregional association of 14 countries devoted to free
trade within, and for some members a common or single market of, the Caribbean.
These island and coastal nations are small economies; their populations
not being sufficient in size to allow firms to exploit extant economies
of scale in the production of manufactures. Like Canada, a small economy
which exports almost 40% of its GDP, the Caribbean countries have had to
become open trading economies in order to obtain and sustain an adequate
standard of living for their residents. Indeed, more than 40% and sometimes
as much as 50% of a Caribbean country's GDP is exported.
The Caribbean countries do, however, differ significantly from the rest
of the Americas in that their small geographic size means that each country,
on its own, is not endowed with a commensurate diversity of natural and
human resources to provide an adequate comfort level of economic security
in the case of an economic or natural disaster (i.e., sharp declines in
the terms of trade in the case of the former; hurricanes, tornados, etc.
in the case of the latter, see Box A2.2). As history would have it, the
region's staple industries evolved to include tourism, financial centres
and agriculture (sugar, bananas, citrus fruits, etc.). For example, in
The Bahamas tourism accounts for as much as two-thirds of its GDP and 80%
of its export earnings; it accounts for 60% of Antigua & Barbuda's
GDP; and 55% of Bermuda's GDP. On the other hand, selective Caribbean countries
have been able to develop other sectors of their economies, most notably,
those endowed with industrial natural resources such as minerals and metals
(bauxite, alumina, aluminum, gold, etc.), forest products, oil, natural
gas and petrochemicals. In addition, some Caribbean countries have reaped
a competitive advantage in the production of simple industrial products,
such as textiles and electronic products and components, based primarily
on cheap labour, carried out in what has become known as the tax-free export
processing zones, and favourable North American trade legislation.
The United States and Canada already extend preferential treatment to Caribbean
export goods in their markets under the Caribbean Basin Initiative (CBI)
and CARIBCAN, respectively.8
These programs provide the Caribbean countries with tariff-free access
on a very broad range of goods, including agricultural products. While
it may at first glance appear that these preferential trade arrangements
are one-sided deals in the Caribbean's favour, North America, in particular
the United States corporations, benefits tremendously from them as well.
This special access to the United States market, along with tax-free operations
in export processing zones, allows North American firms to take advantage
of relatively low wages in the Caribbean Basin while sharing the production
and assembly of labour-intensive products (primarily apparel, footwear
and simple electronics) to improve their ability to compete with imports,
particularly from Asia, in their domestic market.
FDI in the Caribbean Basin has many sectoral destinations, most notably
tourist resorts, petroleum, mining and services, but much of it finds its
way into the establishment of assembly plants, usually in export processing
zones. Indeed, the spike in FDI flows into the Caribbean Basin since the
mid-1980s, following the sharp devaluations of national currencies associated
with the region's debt problems, is closely linked to the expansion of
assembly plants.
More specifically, FDI flows into the Caribbean island and coastal nations
amounted to US $4 billion in 1997, which is more than double the average
annual inflows of US $1.8 billion in the late-1980s. Consulting Table A2.3,
as of 1997, FDI stocks of the Caribbean are in excess of US $47.3 billion;
Bermuda garnering the lion's share with more than 60%. Carrying a foreign
debt charge estimated at US $13.9 billion in 1997, the Caribbean, like
Latin America, is in much better financial shape than a decade ago. Foreign
debt-to-GDP levels of all but four Caribbean countries are down significantly,
with the CARICOM showing an overall decline from 65.9% to 52.6% between
1986 and 1997. The foreign debt service-to-exports level of the CARICOM
has declined slightly from 18.6% to 14.8% in the same period. The Caribbean
remains, therefore, a modestly promising market for trade and investment.
Nevertheless, the challenges presented by a hemispheric free trade agreement
will be formidable because the region has a far more vulnerable economic
profile, quite different from most of their continental counterparts pursuing
an FTAA. These challenges will deserve careful attention in the transition
period. Given these atypical natural and economic circumstances, one might
question why these Caribbean politicians and officials are contemplating
a free trade agreement with the Americas.
-- not available
Source: World Bank.
The answer to this question lies in the recent deterioration in the
relative competitiveness of Caribbean exports entering the American market
subsequent to Mexico's passage of a free trade agreement with the rest
of North America in 1994. The implementation of the NAFTA represented a
major challenge to the assembly operations of the Caribbean Basin, particularly
those in the apparel industry, because Mexican firms benefited from the
equivalent of a six-point tariff advantage, no quotas on many items, and
local inputs counted as having North American content. Should such a deterioration
extend to Central and South America within an FTAA that did not include
the Caribbean, an FTAA would immediately become in their economic interest.
Moreover, it would be economically and, indeed, politically risky for the
Caribbean to increasingly polarize from the rest of the Americas and become
more dependent on foreign aid to maintain their current standard of living,
particularly as this aid has been declining with North American budget
restraints being put into effect and increasing pressures for financial
assistance from the newly formed East European market economies. "Trade
not aid" has become a fashionable slogan in selective political circles
of the CARICOM.
The immediate challenge of an FTAA for the Caribbean will be both a
political one and an economic one, involving: (1) a shift away from tariffs
towards a value-added tax (VAT); and (2) industrial restructuring that
would include rationalizing production on a CARICOM subregional basis.
As was stated above, although put in a different way, what these island
nations produce is not, in general, what they consume. For example, it
is estimated that 70% of market goods in both St. Kitts & Nevis and
the Dominican Republic are imported.9
Under these economic conditions, an ad valorum tariff, apart from
its discriminatory effects, is very much like a consumption tax, such as
a sales tax or VAT which have a similar broad tax base. When one further
factors in the relative ease of administering such a tax at the port of
entry, as well as the little public opposition that a hidden tax such as
a tariff will encounter, it is not surprising that tariffs are a significant
portion of government revenue. In fact, tariffs are the main source of
revenue for most of these countries, accounting for as much as 60% of government
revenues in The Bahamas. Caribbean countries will, therefore, need time
to reform their taxation systems in the advent of any free trade deal.
On that note, several CARICOM countries have been (i.e., Barbados, Belize
and Trinidad & Tobago), or are currently contemplating (i.e., The Bahamas),
replacing the lost revenues associated with lower tariff rates with those
of a VAT. Gasoline, due to its relative price insensitive demand characteristic,
would also be a natural candidate for the imposition of an excise tax as
it has proven in North America.
Finally, the island-nation model of the Caribbean has proved to be too
small an economic unit for the competitive production of many industrial
goods. Rationalizing the number of production facilities throughout the
CARICOM under a more comprehensive subregional trade agreement and further
economic integration, possibly including the adoption of a regionally administered
competition law and a broader and much deeper free trade arrangement between
CARICOM nations, would improve the competitiveness profile and prospects
of local firms. The elimination or centralization of industrial policy
in the CARICOM could also produce social benefits by reducing wasteful
lobbying for protection and privileges, thereby refocusing the region's
limited entrepreneurial acumen on creating value rather than merely redistributing
it. Given the historically and culturally fragmented nature of the Caribbean,
which has led to insular and quite different rigid power structures and
institutions, with the only seemingly common feature or shared experience
being that they are located in the Caribbean Basin, this agenda will clearly
pose a significant challenge to the CARICOM and the Association of Caribbean
States.
1 The
earliest attempts at economic integration took place in the 1960s with
the formation of the Latin American Free Trade Association (LAFTA or ALALC
using its spanish acronym) and signed by Argentina, Bolivia, Brazil, Colombia,
Chile, Ecuador, Mexico, Paraguay, Peru, Uruguay and Venezuela; CACM in
1960; the Caribbean Free Trade Association (CARIFTA) in 1965; and the Pacto
Andino in 1969, which originally included Chile, Colombia, Ecuador,
Peru and later Venezuela with Chile withdrawing. Somewhat paradoxically,
these formative free trade areas, customs unions and common market arrangements
were seen as vehicles to speed up the industrialization process of their
small economies by allowing them to achieve greater economies of scale
in production when complemented by import-substitution policies.
2 Brazil
was a latecomer in this trade and macroeconomic stabilization policies
reversal movement and is still in the throes of this transition.
3 The
Tierra del Fuego free trade zone benefited from an industrial investment
subsidy estimated at US $226 million in 1994 (see Liepziger et al., "MERCOSUR:
Integration and Industrial Policy," World Economy, 1997, p.
69-87).
4 These
regulations, sometimes referred to as capital controls, would include time
reserve requirements on capital inflows and repatriation restrictions on
capital outflows. They can be characterized respectively as entry and exit
barriers to capital mobility that can either forestall or impede foreign
capital entry from the outset or prolong the stay of pre-committed foreign
capital beyond a period which investors might deem compatible with their
risk tolerance. An unintended side-effect of these capital controls is,
therefore, to restrict the country to narrower, more costly investor types,
thereby raising the domestic cost of capital in the longer term.
5 Wrobel,
Paulo S., A Free Trade Area of the Americas in 2005?, International
Affairs, 74(3), 1998, p. 551.
6 International
Monetary Fund, International Financial Statistics Yearbook, various
years.
7 World
Bank, World Investment Report 1998.
8 Under
the CBI and the General System of Preferences, many products produced in
the Caribbean enter the United States duty free provided they meet one
of two requirements: (1) at least 35% of the product's value originated
in the Caribbean; or (2) at least 20% of the product's value originated
in the Caribbean if not less than 15% of its value originated in the U.S.
or Puerto Rico.
9 The
Americas Review 1998.