June 5, 2002 | Lecture on Latin America
I have a longstanding interest in Latin America, and it has become an increasingly important focus of our work at The Heritage Foundation. Together with The Wall Street Journal , we now publish our annual Index of Economic Freedom in Spanish as well as English. Many of our policy papers are also translated into Spanish. We are partners with a network of think tanks in Latin America through which we market our output and ideas. My colleague Ana Eiras drives much of this activity.
The Heritage Foundation is committed to promoting global free trade. Anyone involved with the fight for securing trade promotion authority for President Bush knows of the leadership role played by Heritage. We were at the front lines of the policy battle for TPA. It is our position that free trade is not only good economic policy but good foreign policy.
Trade strengthens our allies and engages potential adversaries, and its absence punishes our enemies. Countries with strong trade links never go to war. As Ambassador Robert Zoellick, the U.S. Trade Representative, put it:
Earlier enemies learned that America is the arsenal of democracy; today's enemies will learn that America is the economic engine for freedom, opportunity and development. To that end, U.S. leadership in promoting the international economic and trading system is vital. Trade is more than about economic efficiency. It promotes the values at the heart of this protracted struggle.2
In the post-Cold War era, trade must be the leading edge of U.S. foreign policy. In Latin America, we must follow the vision of the senior President Bush that trade must be the lens through which we view our Latin neighbors. That vision was enshrined in the North American Free Trade Agreement (NAFTA), but it also animated his broad goals of linking all of the Americas through trade in the Enterprise of the Americas Initiative.
Implementation of a Free Trade Area of the Americas (FTAA) would be a giant step toward implementing this vision. As I argue, however, waiting for FTAA would be a huge mistake. It would lock Latin America into four more years of little growth and stalled reforms. FTAA can be an element in revitalized trade in the Americas, but it is not by itself the solution.
It is a commonplace to decry the absence of U.S. leadership on trade after the passage of NAFTA. Along with many others, we at Heritage criticized the Clinton Administration for lacking a trade policy, particularly in Latin America.
After the disastrous meeting of the World Trade Organization in Seattle in 1999, we published a paper entitled "An Absence of Leadership."3 Seattle was a terrible failure of U.S. leadership. It does not compare, however, to the policy failure of Latin American governments in opening their own economies unilaterally.
Mary O'Grady of The Wall Street Journal has identified the systemic failure of successive Latin governments as that of falling into the "reciprocity trap." That trap arises when governments believe that it is to their advantage to put off unilateral trade liberalization in order to hold back something for trade negotiations.4
That policy ignores the most basic fact of trade: The benefits of open markets for a country's citizens come from imports, not exports. Exports are the cost to society of obtaining imports. Lower-priced imports are the source of improved standards of living, which are surely the object of trade.
President Clinton inadvertently helped set the reciprocity trap by proposing the FTAA.5 Up until 1994, trade liberalization had proceeded apace in Latin America through largely unilateral openings. With the announcement of FTAA, unilateral tariff reductions "screeched to a halt" in O'Grady's words.6
Not surprisingly, other economic reforms ground to a halt as well. Table 1 shows the changes in trade policy, regulations, property rights protection, and black market activity for FTAA-qualifying countries from 1995 to 2002. According to the table, improvements in deregulation and trade opening have been minimal. Black market activity and protection of property rights actually worsened. The stop in the liberalization process has now put democracy itself at risk in some countries.
Trade helps drive other reforms. Open markets quickly uncover domestic economic policy failures. Firms open to global competition cannot bear the burdens of high tax rates, burdensome regulations, and general government interference in the economy. Official corruption is a tax on economic activity and a depressant on growth.7 As a result, the government implements reforms that bring prosperity. As shown in Chart 1, countries most opened to trade also have higher levels of per capita income.
Firms in emerging markets with a weak rule of law, a corrupt and inefficient judiciary, and ineffective enforcement of property rights will quickly discover that foreign counterparts are unwilling to subject themselves to these problems. The investment flows that typically accompany increased trade flows--and which are often the ultimate object of trade agreements--will come in trickles, not torrents.8 (See Chart 2.)
The unintended consequences of trade opening on a political system were dramatically revealed in Mexico. "In a very real sense, it was NAFTA that brought Vicente Fox to power because it weakened the grip of the PRI."9 The unintended consequences of keeping markets closed is being revealed in Argentina: zero economic growth and political crisis.
Just as Mexico exemplifies the positive dynamic of opening markets, Argentina is the paradigmatic case of a closed economy, stalled economic reforms, and political paralysis. Argentina has fallen from being the tenth wealthiest country in the world in 1913 to the 36th wealthiest in 1998. Argentina is the only wealthy country to experience such a reversal in modern times.10
Argentina and Australia were, for much of their history, two Southern Hemisphere countries similar in resource endowment and climate. They tracked each other economically through the 1930s. Institutional differences began to tell over time, however. Particularly in the past 20 years, successive Australian governments have remained committed to economic reform, one hallmark of which has been aggressive tariff liberalization and market openings.11
Argentina's protectionist policies also close it off to innovation in business practice, production, and ideas. It made a disastrous political and economic miscalculation by adopting the dollar as its currency but MERCOSUR, the Southern Cone Common Market, as its trading partner. Joining MERCOSUR diverted trade patterns, making Argentina overly dependent on trade with Brazil. Backed by the International Monetary Fund and the Washington public policy consensus, Brazil in turn pursued an aggressive policy of beggar-thy-neighbor devaluation to gain competitive advantage over Argentine producers. The IMF's policies in both countries have impoverished Argentina, gradually destroying the Argentine middle class.12
Institutional differences between Australia and Argentina explain the different course income per capita in each country followed throughout the last century. Although Australia had higher per capita income than Argentina throughout the 20th century, the gap between both countries, as shown in Chart 3, does not vary much until the late 1930s. After the 1930s, Australia's growth in real GDP per capita becomes increasingly higher, and after the 1970s, the difference between both countries increases at a much faster pace.
The difference in wealth between the countries is due to the different public policies each country has chosen to implement. Capital undoubtedly flies to the safest, most predictable economies. Australia, in this sense, has been rewarded for implementing sound economic policy. Argentina, by contrast, will continue to suffer until it decides to throw open its markets and strengthen the protection of property.
Chile defied all the conventional policy wisdom by continuing to pursue fairly aggressive unilateral trade liberalization. It basically has a flat tariff rate that will be gradually reduced to 6 percent in 2003. It has pursued bilateral trading arrangements forcefully. In short, Chile followed both good trade policy--unilateral liberalization--and good politics by not waiting for the United States to act. The paradox for the rest of Latin America, which remains caught in the reciprocity trap, is that Chile is currently the only Latin American country negotiating a trade agreement with the United States.
Good principles produce good policy, and no good policy comes from bad principles. Pursuit of the realpolitik agenda has led the rest of Latin America into a policy dead-end. The question is whether FTAA is the way out.
In its origin, the FTAA unwittingly slowed the progress of trade in Latin America. Will it in the long run unite the Americas in the one giant economic enterprise envisioned by the senior Bush? Will its sheer breadth make the effort that must be expended on it worth the price? Certainly, that is the hope of its proponents. The possibility of such a huge payoff surely makes the effort worth pursuing.
My guess, however, is that it will be passed up by more aggressive trade agreements before it is ever negotiated. By its nature, it will be held down by the lowest common denominator. It is hard to believe that Brazil will not play spoiler throughout the negotiations, as much for its own geopolitical reasons as any economic advantage. I would frankly be disappointed if the U.S.-Chile bilateral trade agreement, now likely to be completed in late spring 2002, did not advance trade in the Americas further than anything the negotiators for FTAA can yet hope to negotiate.
A U.S.-Chile agreement will likely become a model for other, similar bilateral agreements. Uruguay leaps to mind as another likely partner. If Uruguay joins, could Argentina fail to fall into line? Now encircled, how will Brazil react? By accepting liberalization, or by throwing a monkey wrench into the FTAA process in the hope of obstructing the progress of trade? I don't pretend to understand Brazil enough to answer those questions, but the answers will largely determine the outcome of FTAA.
The one thing trade advocates must avoid at all costs is allowing the European Union to become a model for the FTAA: free internal trade with substantial barriers to external trade. Most of all, FTAA must not be permitted, a la MERCOSUR, to commit its members to undoing more liberal trade agreements. What I advocate is "trade a la carte," with trade leaders moving ahead as fast as they want and FTAA providing a free trade floor to economic relationships in the Americas.
At Heritage, we have advocated a specific plan for multi-speed pursuit of trade liberalization: the Global Free Trade Association (GFTA). Membership in this association would be voluntary, inclusive, and based solely on a country's demonstrated commitment to a liberal trading order. This means that its members share similar beliefs and market institutions.
In order to qualify for membership, a country would need to meet certain criteria. (See Table 2.) Doing so would indicate that the country is open to trade and investment, and that it maintains a secure rule of law with low levels of regulation. The criteria include liberal policies in the following areas:
Under these criteria, the countries that currently qualify for membership include Australia, Chile, Denmark, Estonia, Finland, Hong Kong, Iceland, Ireland, Luxembourg, New Zealand, Singapore, the United Kingdom, and the United States.
The advantage of the GFTA over current mechanisms for promoting free trade is that qualifying countries would secure the benefits of increased trade and investment among the members without having to undergo any new major policy reforms.13
The FTAA represents the fulfillment of the great vision of the elder President Bush for relations throughout the Americas. It would be fitting for the current Bush Administration to implement that vision.
There are ample opportunities, however to pursue even more aggressive trade strategies through free trade agreements and, even better, comprehensively through the GFTA. The Administration should aggressively pursue all trade opportunities in the region. Especially in the light of recent events in Argentina, the Administration should encourage all countries in the Hemisphere to open their economies to trade and the prosperity that follows.
Gerald P. O'Driscoll, Jr., Ph.D., is Director of the Center for International Trade and Economics (CITE) at The Heritage Foundation.
1. The author would like to thank Ana I. Eiras, Sara Fitzgerald, and Anthony Kim for their contributions to this lecture, which was presented at the U.S. State Department Conference on the Free Trade Area of the Americas (FTAA) on December 14, 2001.
4. Mary Anastasia O'Grady, "First, Open Markets," in Gerald P. O'Driscoll, Jr., Kim R. Holmes, and Melanie Kirkpatrick, 2001 Index of Economic Freedom (Washington, D.C.: The Heritage Foundation and Dow Jones & Company, Inc., 2001), p. 27.
5. "The Leadership Council concluded that Summits have successfully focused leaders' attention on policy initiation, but governments have paid insufficient attention to policy implementation. Especially in the larger countries where protectionist interests are strong, leaders must repeatedly make the case for the benefits that trade can bring to economic development." Richard Feinberg, "Advancing Toward Quebec City and Beyond," Policy Report III , Leadership Council for Inter-America Summitry, March 2001.
7. Alejandro A. Chafuen and Eugenio Guzmán, "Economic Freedom and Corruption," in Gerald P. O'Driscoll, Jr., Kim R. Holmes, and Melanie Kirkpatrick, 2000 Index of Economic Freedom (Washington, D.C.: The Heritage Foundation and Dow Jones & Company, Inc., 2000), pp. 51-63.
8. On the empirical importance of secure property rights in explaining foreign direct investment, see Philip C. English II and William T. Moore, "Property Rights Ambiguity and the Effect of Foreign Investment Decisions on Firm Value," in Gerald P. O'Driscoll, Jr., Kim R. Holmes, and Mary Anastasia O'Grady, 2002 Index of Economic Freedom (Washington, D.C.: The Heritage Foundation and Dow Jones & Company, Inc., 2002), pp. 49-57.
10. Ana I. Eiras and Brett D. Schaefer, "Argentina's Economic Crisis: An `Absence of Capitalism,'" Heritage Foundation Backgrounder No. 1432, April 19, 2001, p. 1. See also Martin Wolf, "Argentina's Riches to Rags Tale," The Financial Times , March 21, 2001.