The Heritage Foundation

Backgrounder #1430 on Latin America

April 12, 2001

April 12, 2001 | Backgrounder on Latin America

Advancing Free Trade in Latin America at the Quebec Summit of theAmericas

[In Spanish]

On April 22, when President George Bush addresses the third Summit of the Americas in Quebec, he will have a unique opportunity to launch a new U.S. trade policy for Latin America. This new strategy should encourage America's neighbors in the region to continue the tide of economic liberalization they began in the 1980s in order to strengthen their markets, democratic institutions, and political environments and to reap the benefits of free trade for their citizens.

Although the Bush Administration supports a Free Trade Area of the Americas (FTAA), at the Quebec Summit, the President should avoid the temptation to re-launch the initiative as it was designed during the first Summit of the Americas in 1994. At that time, the Clinton Administration sought to tie hemispheric free trade to the date of 2005. Rather than encourage Latin governments to open their markets further, this misguided approach induced them to stop their liberalization efforts. The governments saw reforms as bargaining chips for future trade negotiations that would be wasted if they liberalized their economies before that date.

The concept of a free trade area for the hemisphere, which was originally put forth by the earlier Bush Administration, remains a worthwhile goal, but the strategy of tying it to a specific date has undermined the process. President Bush should eliminate this disincentive by offering to sign a free trade agreement in the immediate future with any country that already has liberalized its economy. He should also encourage the rest of Latin America to accelerate their liberalization efforts. That would make these countries more attractive partners for a trade agreement.

THE GOAL OF LIBERALIZING HEMISPHERIC TRADE

At his confirmation hearing, newly appointed U.S. Trade Representative (USTR) Robert Zoellick made it clear that the Administration's goal is to promote economic liberalization through free trade agreements. "[T]he US will use its leverage as the world's largest and most attractive market," Zoellick said, "to press other trading partners to move rapidly on liberalization."1 This goal, however, may prove more difficult to achieve than it appears. For one thing, most Latin American leaders have not made a principled commitment to economic freedom. Liberalization has come as the result of random patches of incomplete privatization, fiscal tightening, and inflation controls--usually in response to some kind of crisis. These random patches demonstrate the overwhelming protectionism to which politically vested interests in Latin states cling at the expense of sound economic policies. Such protectionist habits will not be easy to break.

Chile is a conspicuous exception to this trend. Its strong markets, fostered with more than 20 years of consistent liberalization policy, are responsible for its impressive economic performance today, as well as its level of poverty alleviation, political stability, and strengthening of democratic institutions. Signing a free trade agreement with Chile should be an essential first step in implementing the new U.S. trade strategy for Latin America; it would certainly signal Washington's commitment to its stated goal.

Few can argue against the evidence that free trade has a positive effect on economic growth. However, merely offering the promise of free trade by a date certain can have harmful effects. Mary O'Grady, editor of the "Americas" column in The Wall Street Journal, has noted that, for many Latin countries, "the preferred course is to haggle over `reciprocal' trade agreements with the rich countries, particularly with the United States."2 She suggests that the promise of an FTAA by 2005 made in the Clinton years has functioned as a "reciprocity trap" that slowed economic reforms rather than encouraged them. Argentina, for instance, stopped reforming in 1995 and instead increased government expenditures and debt. So did Peru, which also failed to strengthen the rule of law, resulting in a corruption scandal that involved its president and a top military officer. If the tide of market opening during the 1990s in Latin America was indeed the result of a conviction about liberalization, no country would have fallen into the "reciprocity trap."

The United States should continue to work with its neighbors to bring transformation and results to this important region. The upcoming Summit of the Americas in Quebec offers President Bush an opportunity to exercise such leadership.

WHAT THE PRESIDENT SHOULD DO AT THE SUMMIT

President Bush should use his speech before the participants of the Summit of the Americas on April 22 to:

  • Highlight the benefits of free trade. Free trade is one of the most important economic policies a country can adopt to alleviate poverty and to develop economically. According to Heritage trade analyst Denise Froning, there are four reasons that higher living standards accompany free trade:3

  • Free trade promotes competition and innovation. A free flow of goods and services gives consumers and producers access to the world's best products at the lowest prices. This, in turn, motivates local businesses to innovate in order to remain competitive in the global market.

  • Free trade generates economic growth. A broader range of business opportunities creates incentives for more investment. Higher investment leads to more and higher-paying jobs both at home and abroad. The economy finds new channels in which to expand, consumption increases, and additional economic growth follows.

  • Free trade strengthens the rule of law. Companies doing business in another country rely on the host country's enforcement of their property rights in contractual disputes. Individuals rely on property rights as their living standards rise. Free trade increases prosperity, which indirectly strengthens of the rule of law, since without it neither investment nor higher living standards would endure.

  • Free trade fosters economic freedom. As Froning explains, "With a sound infrastructure based on economic freedom, assured property rights, a fair and independent judiciary, the free flow of capital, and a fair system of low taxation, poor countries can create an environment that is friendly to trade and inviting to foreign investors."4 But these benefits of free trade can only last in a fully liberalized economy.

  • Propose a new global trade strategy to begin in the Hemisphere. The basis for a new trade policy is proposed in the Heritage Foundation/Wall Street Journal 2001 Index of Economic Freedom. The Index outlines a rules-based global free trade association (GFTA) whose members must meet four qualifications:

  • An open trade policy,

  • Transparent and open foreign investment policies,

  • The fewest possible regulations on opening new businesses, and

  • Secure property rights.

The specific reforms that some Latin American countries would need to implement in order to qualify for accession to such a GFTA are listed in the sidebar.

The GFTA members would benefit by gaining immediate access to a group of open-market, wealthy countries, including the United States. They also would benefit from an increase in capital investment, which typically follows free trade. For the qualifying countries, such an association would offer a significant opportunity to increase economic growth, which would lead to a rise in living standards and further their economic development.

The GFTA format differs from the FTAA in that its members need to have an open market before they can enter the club. Such a strategy rewards a nation's commitment to economic freedom. Likewise, it punishes protectionism; every decision that protects political interests at the expense of economic freedom would push the countries further away from trade agreements with the strongest markets in the world. The United States could take the lead in driving this strategy forward at the Summit of the Americas by inviting qualifying countries to join a GFTA.

  • Congratulate Chile. For more than 20 years, Chile has been a model of economic reform for the region. It made free trade the leading policy of its economic reforms, and implemented a set of complementary policies to help its citizens reap the benefits of economic liberalization. For example, Chile implemented a uniform import tariff that will decrease by 6 percent by 2003. This uniform tariff has helped reduce the opportunities for corruption, facilitated trade flows, and weakened special-interest lobbying. It also undermined the dominant entrenched interests in other Latin American countries. In addition, Chile diversified its export markets by signing free trade agreements with Asia, Canada, Europe, and many Latin countries.

Chile also has had strong protection for property rights, which reduces business risk and attracts investment. Through the privatization of state-owned enterprises and the pension system, it has created a wide range of investment opportunities. Two decades of commitment to reform have made democracy in Chile stronger than ever, reduced poverty by over 30 percent,5 and raised the overall living standards of the Chilean people.

  • Applaud El Salvador and Uruguay for their significant reform efforts and encourage them to continue. Not long ago, El Salvador was embroiled in a deep internal war; effective economic policy reforms were not possible. Since the 1992 peace accords, the government has opened markets, privatized state-owned enterprises, and cut regulatory and fiscal burdens on businesses. The most important task today is for the government to strengthen the rule of law.

Uruguay, too, has made substantial progress from its social welfare and import substitution policies of the 1960s. In general, it made progress in liberalizing the foreign investment code and banking system, opening trade to its neighbors, and strengthening the rule of law. With further deregulation, the country could be among the most liberal in the region.

  • Emphasize the crucial importance of property rights. A transparent judiciary, immune to the influence of political interests, is a key factor in economic growth. No long-term investment will occur in a country where the ability to sue and the right for that lawsuit to be justly and promptly executed are nonexistent. Ultimately, no economic reform has a chance to reap its benefits if private property is unprotected.

In most of Latin America, citizens do not trust their judicial systems. News of corruption at different levels of government is common. No Argentine is surprised by the bribery scandal in the Senate regarding labor reform laws. No Peruvian is astonished by the current political crisis. Almost no Venezuelan thinks of criticizing last year's crisis when the country's president practically coerced changes to the national constitution. Lack of trust in the rule of law creates a culture that prompts citizens to consume and invest less, and reinforces a downward economic spiral that impedes the ability of most citizens to reap the benefits of economic liberalization.

WHAT PRESIDENT BUSH SHOULD NOT DO

In addition to these positive steps, there are important things to avoid. At the Summit in Quebec later this month, President Bush should:

  • Not forgo liberalization in the region simply to get a trade deal. The United States, the wealthiest and largest economy in the world, will not get significantly richer by signing a free trade agreement with most of its Latin neighbors. But, as USTR Robert Zoellick noted in a speech at the Chilean-American Chamber of Commerce in Santiago on April 4, 2001, the reason to pursue such agreements is to bring economic freedom, stability, and growth opportunities to Latin countries.

Latin America has gone through numerous economic reforms since the early 1980s. In most Latin countries, however, political influence still matters. With the exception of Chile, the countries have not liberalized enough so that ordinary Latin people can benefit from capitalism. This point is well argued by economist Hernando de Soto in The Mystery of Capital.6 De Soto suggests that burdensome regulations to register property leave people--mostly the poorest people--with no option but to operate in the black market. In this extra-legal realm, the cost of doing business is very high and the benefits significantly lower than they are in the legal system.

Reform efforts have been incomplete in Latin American states. Privatization has turned public monopolies into private ones; lack of judicial transparency has scared away long-term investment, despite the incentives that deregulation offers. As the sidebar shows, liberalization in the region has a long way to go.

  • Not tie trade deals to a specific date. Tying free trade agreements to specific dates rather than policy reforms has undermined liberalization in the Americas. When the FTAA was launched in 1994, President Clinton wanted the agreement to foster a more open and transparent region by a specific date of 2005. But this strategy only thwarted his goal of liberalization, as countries saw reforms as bargaining chips for future trade negotiations. Specifying future dates also signals a lack of commitment to an agreement, since the proponent might not be in office when that date arrives.

President Bush should emphasize that the United States is ready to sign free trade agreements immediately with countries whose economic openness is similar to that of the United States. He should invite the other countries to complete certain economic reforms so that they can engage in free trade talks with the United States.7

CONCLUSION

Despite the economic renaissance in Latin America that began in the early 1980s, the Latin countries --with the exception of Chile--have not shown a true commitment to economic liberalization. Moreover, entrenched interests that are opposed to free trade remain strong. Only by opening markets will the Latin people find the resources they need to prosper and the flexibility their economies need to adjust to the fluctuations that are typical of today's global economy.

Supporting free trade strategies based on values, rather than specific dates or geography, would reinforce the incentives countries have to carry out the reforms that are necessary to liberalize their economies. President Bush, at the Summit of the Americas in Quebec, will have a unique opportunity to promote economic liberalization throughout the hemisphere by presenting the opportunity for countries that have already liberalized their economies to sign a free trade agreement with the United States, beginning with Chile.

Ana I. Eiras is an Economic Policy Analyst for Latin America in the Center for International Trade and Economics at The Heritage Foundation.

Endnotes

1. The Financial Times, "Zoellick Warns on World Trade Talks," January 31, 2001.

2. 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 and Company, 2001).

3. Denise H. Froning, "The Benefits of Free Trade: A Guide for Policymakers," Heritage Foundation Backgrounder No. 1391, August 25, 2000.

4. Ibid.

5. Economist Intelligence Unit, EIU 2000-2001 Country Profile, p. 27.

6. Hernando de Soto, The Mystery of Capital (New York: Basic Books, 2000).

7. For the criteria that should be used to determine a country's ideal minimum openness to trade, see John C. Hulsman, Gerald P. O'Driscoll, Jr., and Denise H. Froning, "The Free Trade Association: A Trade Agenda for the New Global Economy," in O'Driscoll et al., 2001 Index of Economic Freedom.

About the Author

Ana I. Eiras Senior Policy Analyst on International Economics
Center for Trade and Economics (CTE)

Related Issues: Latin America