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Free Trade in Latin America
The Free Trade Area of the Americas (FTAA) is proposed to begin operation in January 2005. What is the potential of this agreement? What lessons from NAFTA can be applied? Thunderbird Professors Rob Grosse and Roy Nelson discuss the expected impact.
The broad intent of Free Trade Area of the Americas (FTAA) is to create a regional economy of 34 countries rivaling the European Union, and one that unites the industrial leaders - US and Canada - with emerging markets from Mexico to Argentina. The FTAA is clearly recognized to bring with it major elements to be resolved including the elimination or reduction of non-tariff barriers to trade; similar elimination or reduction of barriers to trade in services; expansion of foreign direct investment; and increased confidence in the economies of Latin America and the Caribbean.
Tariff Barriers
Reduction or elimination of tariffs on specific, highly-restricted goods is a source of great conflict in FTAA negotiations. The United States in particular imposes tariffs on several key Latin American and Caribbean export products, particularly sugar, orange juice, and tobacco. If the United States does not agree to eliminate or reduce the levels of these tariff barriers, then a major source of gains from free trade will be lost.
For example, Brazil would benefit significantly from a reduction of tariffs in the United States in key sectors. Of Brazil’s US$ 60 billion in annual exports, about 25 percent go to the United States1. Brazil is an important producer of orange juice, tobacco, sugar, steel, and soybeans. And the US currently has significant restrictions on trade in all of these sectors. With the advent of the FTAA, the US may agree to eliminate or significantly reduce its barriers to trade in at least some of these areas. One estimate is that if the US were simply to eliminate barriers to trade on just four products – orange juice, steel, meat and soy products - Brazil’s annual exports would increase by US $2 billion2.
Conceptually, dropping ‘artificial’ barriers to international trade will allow for gains from specialization where producers in each member exporting country are more efficient than their competitors in the importing country.
Foreign Direct Investment
An FTAA that includes provisions for national treatment of companies from any country of the region, and for transparent regulation of companies, will very likely have a major impact on FDI.
This impact can be seen in the context of Mexico’s joining the US and Canada in NAFTA in 1994. By formally agreeing to follow rules on business (e.g., incorporation rules, ownership rules, intellectual property rules) – and certainly by pursuing other policies of economic opening – Mexico attracted very large inflows of foreign direct investment after entering NAFTA. The average annual value of FDI flows into Mexico pre-NAFTA during 1990-1993 was $US 4.0 billion, compared to the average annual inflow of FDI during 1995-98 post NAFTA, which was $US 11.5 billion. As an extremely crude indicator, since FDI into the rest of Latin America (without Mexico) averaged $US 69 billion during 1999-2002, then with an FTAA in place the average would leap to $US 198 billion per year during 2006-2009, ceteris paribus.
Credibility
Another major consideration is the credibility that will be attached to a country’s linking itself to the United States. Regardless of the specifics of the agreement, the fact that a country such as Mexico has linked itself legally to the United States in NAFTA has produced a large increase in confidence on the part of investors. That is, investors now believe that the rules of the game in Mexico are more credible and less subject to arbitrary changes that characterized previous times. Because Mexico has trade rules – and other rules on labor, environmental protection, intellectual property protection, etc. – established in a formal agreement with the United States, investors perceive greater likelihood that those rules will be followed and not changed arbitrarily. This expectation of legal stability has contributed very importantly to the large increase in US and other industrial country FDI into Mexico since 1994.
A similar impact can be expected in other Latin American countries that join in a free-trade link with the United States (in FTAA or bilaterally). The impact may be smaller numerically, since other than Brazil, no other Latin American or Caribbean country approaches the economic size of Mexico. Chile may be a good example of this impact, since its recently-agreed free trade pact with the US should produce the kind of impact asserted here. The impact should appear not only in foreign direct investment, but also in portfolio investment (purchase of local financial instruments) from the US, EU, and Japan. These investment effects may ultimately dominate the overall impact of FTAA, just as they do in the case of Mexico in NAFTA.
Overall, we expect that the FTAA will be successfully negotiated by the countries of the hemisphere, and probably on the timetable agreed – namely by the end of 2004.
The above article contains excerpts from a research paper entitled “Expected Impact of FTAA on Latin America” written by Thunderbird Professors Robert Grosse, Ph.D. and Roy Nelson, Ph.D. and published in Loyola University Chicago International Law Review (Volume I, Issue 2, 2004). Thunderbird alumni Monica McIntyre ’03 and Yanfang Lei ’03 and current students Vanya Dimitrova ’05 and Santiago Martello ’05 provided research assistance.
Robert Grosse is currently Thunderbird’s director of research and professor of international business. He earned a Ph.D. from the University of North Carolina, and a B.A. from Princeton University. Grosse has been a Fulbright scholar twice and has authored numerous papers and books. He can be contacted at grosser@t-bird.edu.
Roy Nelson is currently an associate professor of international studies. He earned a Ph.D. and an M.A. from Cornell University, an M.A. from Yale University and a B.A. with Honors from Stanford University. Nelson has authored numerous papers and one book. He can be contacted at nelsonr@t-bird.edu.
Endnotes
[1] EIU, “Country Forecast: Brazil,” August 2003. [2] Roger Burback, “Incoming Brazil President Adept at Checkmating Bush,” ALAI, America Latina en Movimento, December 13, 2002.
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