1 Review of Trade Development Strategies

Trade aandnd Development iinn Latin America

Patricio Meller

Universidad de Chile Facultad de Ciencias Fisicas y Matematicas Departamento de Ingenieria Industrial

357 Dr. Patricilo Meller is Professor of Centro de Economia Aplicada, Departamento de Ingenieria Industrial, Universidad de Chile.

358 Table of Contents

Table of Contents ･････････････････････････････････････････････････････････359 List of Tables･････････････････････････････････････････････････････････････360 Abbreviations ････････････････････････････････････････････････････････････361

Executive Summary ･･････････････････････････････････････････････････････362

1 Review of Trade Development Strategy ･･････････････････････････････････365 1.1 Import Substitution Industrialization･････････････････････････････････365 1.1.1 The Economic Effects of the Great Depression ･････････････････････365 1.1.2 Characteristics of ISI ････････････････････････････････････････････366 1.1.3 Theoretical Rationale of ISI ･･････････････････････････････････････368 1.1.4 Results of ISI ･･･････････････････････････････････････････････････371 1.2 Trade Liberalization ････････････････････････････････････････････････374 1.2.1 General Apects ･････････････････････････････････････････････････374 1.2.2 Effects of Trade Reform. Conceptual Aspects･･･････････････････････375 1.2.3 Empirical Effects of Trade Liberalization･･････････････････････････378 1.3 Free Trade Agreements ･････････････････････････････････････････････379 1.3.1 General Aspects･････････････････････････････････････････････････379 1.3.2 Brief Review of Selected Trade Agreements････････････････････････385

2 Pattern of Trade in Latin America ･･････････････････････････････････････390 2.1 General Overview･･･････････････････････････････････････････････････390 2.2 Export Growth ･････････････････････････････････････････････････････392 2.3 Characteristics of Latin American Exports ････････････････････････････394

3 The Curse of Natural Resources ････････････････････････････････････････397 3.1 The Curse Hypothesis･･･････････････････････････････････････････････398 3.2 Lessons from Developed Countries with Abundant Natural Resources ･･･399 3.3 The Second Export Phase････････････････････････････････････････････401

4 Latin America in a Globalized World ････････････････････････････････････404 4.1 Main Issues ････････････････････････････････････････････････････････404 4.2 Natural Resources and Information Technology ･･･････････････････････406 4.3 Some Proposals･････････････････････････････････････････････････････407

References ･･･････････････････････････････････････････････････････････････410

359 List of Tables

Table 1.1 Selected Latin American Countries: Summary of Quantitative Restrictions on Foreign Trade, around 1950 ª･･････････････････････ 368 Table 1.2 Tariff Structure in Selected Latin American Countries 1985-87････371 Table 1.3 Manufacturing Output in Selected Latin American Countries: Annual Average Growth, 1950-1990 ･･･････････････････････････････････････ 373 Table 1.4 Latin America: Share of Manufacturing Sector in GDP, 1950-1990･･ 373 Table 1.5 Tariff Structure in Selected Latin American Countries, 1988 and 1999 ････････････････････････････････････････････････････ 378 Table 1.6 Selected Trade Openness Measures, 1990-1999････････････････････ 379 Table 1.7 Tariff Structure in the Western Hemisphere, 1994 ････････････････ 380 Table 1.8 Institutional Characteristics of the Main Trade Agreements in the Americas･･････････････････････････････････････････････････････････ 387 Table 1.9 Latin America: Total and Intraregional Exports, 1990-1999 ･･･････ 389 Table 2.1 Exports and Imports in Selected Latin American Countries, 1999 ･ 390 Table 2.2 Share of Exports in GDP in Selected Latin American Countries, 1960-99 ･･･････････････････････････････････････････････････････････ 391 Table 2.3 Regional Shares of Worldwide Exports, 1953-1999･････････････････ 392 Table 2.4 Behavior of the Real Exchange Rate in Selected Latin American Countries ･････････････････････････････････････････････････････････ 393 Table 2.5 Rate of Export Growth: Selected Latin American Countries ･･･････ 393 Table 2.6 Export Growth by Regions ････････････････････････････････････････ 394 Table 2.7 Composition of Latin American Exports: 1965-1990 ･･･････････････ 394 Table 2.8 Latin America: Main Export Categories, 1990 and 1999 ･･･････････ 395 Table 2.9 Annual Growth of Manufactured Exports, 1990-99 ････････････････ 396 Table 2.10 Concentration of Export Basket ･･･････････････････････････････････ 397 Table 4.1 Economic Growth (Total and per-Capita GDP) for Different Regions and Different Periods ･････････････････････････････････････････････ 405

360 Abbreviations

CACM Central American Common Market CARICOM Caribbean Community and Common Market CET Common External Tariff ECLAC Economic Commission for Latin America and the Caribbean FTA Free Trade Agreements GSP General System of Preferences ICT Information and Communication Technology ISI Import Substitution Industrialization LAC Latin America and the Caribbean MERCOSUR Mercado Comun del Sur MITI (Japan) Ministry of International Trade and Industry (the former Ministry of Economy, Trade and Industry) NAFTA North American Free Trade Agreement ROW the Rest of the World SMEs Small and Medium-size Enterprises UTR Unilateral Tariff Reduction

361 Trade and Development in Latin America

Executive Summary

This article provides an overview of Latin American development strategies and the role played by trade. The first part examines the import substitution industrialization strategy (ISI) which prevailed up to the 80s. Then, most Latin American countries liberalized their trade regime; the 90s is characterized by many Free Trade Agreements.

Development strategies in the region pursued two objectives: economic independence from world markets and a reduction in external vulnerability; ISI was the easiest way to achieve these two objectives. In fact, prior to the 1960s, it was thought to be the only mechanism leading to industrialization; infant industries had to be protected. After all, this had been the way the industrialized countries had developed in the 19th century. Industrialization came to be synonymous with development; if a Latin American country wanted to raise its per-capita income to developed country level, it had to industrialize.

The main tools used to promote the strategy were high tariffs, special incentives for manufacturing industry involving cheap credit and special access to foreign currency, and public investment in infrastructure aimed at complementing industrial production.

Manufacturing industry was promoted indiscriminately; there was no attempt to direct incentives towards industries with potential comparative advantages. Any domestic production that replaced imports was deemed to increase national welfare. Such a framework produces ISI at any cost; the benefits would come later.

Latin America’s industrial sector was inefficient in its use of economic resources, and was blamed for the failure to transform Latin America into a developed economy. It generated relatively few jobs and did not produce enough basic goods (at low prices) to satisfy the needs of the majority of Latin American people. Following a long period of preferential incentives under ISI, industry still required a high level of protection in the early 1980s. It is hard to find reasons to explain why, after 40 years of ISI, the ever-incipient Latin American industry never reached maturity. As a result of this failure, local consumers had to pay

362 higher prices for lower quality manufactured goods. In addition, the industrial sector was also excessively diversified, with inefficient and underutilized industrial plants kept financially afloat through subsidized inputs, particularly credit, and a system of monopoly pricing made possible by import restrictions.

The evolution of trade restrictions is a clear example of the burgeoning bureaucracy of Latin American economies, which led to a complex network of regulations, extreme instability in government decisions, arbitrary action and incentives for corruption. The system of policies applied to promote ISI was inflexible in the face of changing conditions; once protection was granted, it was very difficult to remove. This led to the development of a society motivated by the idea of making easy profits, where success depended more on having the right connection than on developing productive entrepreneurship.

There were two sequential features in the trend of Latin American trade systems during the 1990s. Firstly, most Latin American countries have implemented a process of unilateral trade liberalization, making the region more open and export-oriented than it was before. The share of exports in GDP has risen sharply in most Latin American countries, in several cases by more than 50%. Nonetheless, the level of exports measured in terms of dollars per capita is still relatively low compared to Asian exporting countries.

Latin America has comparative advantages in natural resources (NR). Whilst the anti-export bias prevailed before 1990, most Latin American exports were raw materials. In 1965, these accounted for 79.1% of total Latin American foreign sales; but this proportion had fallen to 53.2% in 1980 and 46.4% by 1990. Manufactured goods accounted for just 3.6% of the region’s exports in 1965, but had risen to 29.5% by 1990

During the 1990s, Latin America as a whole managed to reduce the relative importance of NR in its total exports — this category accounted for less than 25% of the export basket in. Yet this result depends crucially on whether or not Mexico is included in the total. With Mexico excluded, NR still represented 38% of the Latin American export basket in 1999. The relative importance of technology-

363 intensive goods in Latin American exports rises from 12.1% in 1990 to 36.1% in 1999; but once again this major change depends largely on Mexico. When Mexico is excluded, the share of technology-intensive products expands from 8.1% in 1990 to just 13.9% by 1999. Other Latin American countries that export significant amounts of technology-intensive goods are Brazil and Costa Rica.

In Latin America a new debate over the development strategy has emerged. Information and communication technologies (ICT) are seen as crucial to a country’s growth in the twenty-first century. So, how can Latin American countries incorporate such technologies into their economies.

Is it possible to make the leap from producing NR to producing ICT? This question implicitly suggests a dichotomy between producing natural resources and producing information technology.

However, NR are really an asset for Latin America, and the region has been fortunate to have them in abundance. Moreover, abundant NR should not be an obstacle to incorporating ICT. In reality, the historical and empirical evidence from a variety of countries shows that there is a two-way link between NR and ICT (including information and knowledge). ICT makes it possible to expand the availability of NR in a country; and greater production of NR makes it possible to import more ICT. In addition, the application of ICT leads to more efficient NR production, and generates a learning process that can be applied in other economic sectors. In summary, as the World Bank states, for a Latin American or any other country to be competitive internationally, it does not matter what is produced but how it is produced.

364 Trade and Development in Latin America

1 Review of Trade Development Strategies

1.1 Import SSubstitutionubstitution IIndustrializationndustrialization ((ISI)ISI)

1.11.1...11 The EEconomicconomic Effects of the Great Depression

In the early years of the twentieth century, Latin American countries were relatively open to foreign trade; they were also mostly exporters of natural resources (in some cases exporting single products).

The Great Depression of the 1930s hit Latin America very hard. Gross domestic product (GDP) fell by between 15% and 35% in individual countries; exports shrank by between 40% and 80%; and per-capita GDP dropped to nearly 30% of its pre-1929 level.

The severity of the Great Depression stemmed from the intensity of the external shocks involved, but national policies magnified the domestic effects. Dogmatic economic policy-thinking in some countries maintained the gold standard and full convertibility even after they had been abandoned in the United Kingdom. Díaz-Alejandro (1982) argues that the Latin American countries which rapidly implemented heterodox policies suffered less than those that clung to orthodox policies to the end. But even economies with a dogmatic orthodox tradition were forced to violate basic principles. It was absurd to maintain full convertibility and the gold standard when central bank reserves were running out and the flow of external credit had dried up. It was also absurd to balance the fiscal budget with the external sector contracting sharply, which was the main source of tax revenue at that time (Díaz-Alejandro, 1982).

The Great Depression led to a sudden abandonment of the natural resource exporting strategy and laissez-faire policies. This was not ideologically motivated, but was imposed by the nature and seriousness of the economic problems generated by the slump. It was no longer possible to rely on raw materials exports as the main sector keeping the national economy afloat. The damaging effect of the external shocks revealed how vulnerable Latin American economies were. Consequently, given the international climate of the time, development priorities had to be shifted in favor of sectors producing for the domestic market.

365 While developed countries emerged from the Great Depression with the aim of preventing mass unemployment, Latin American countries decided to reduce their dependence on the external sector. One of the consequences of this process was a gradual change in the macroeconomic role of governments — from liberalism to restriction, and from restriction to intervention. In addition, the public sector became a major productive actor in the context of long-term growth.

1.1.2 Characteristics of ISI

Let us now briefly review the ISI strategy. Some Latin American countries were already pursuing this approach to development in the 1930s, before the corresponding conceptual framework and policy recommendations were formulated by ECLAC in the 1950s.1 The seeds of ISI came from abroad. The First World War, the Great Depression and the World War II created an acute scarcity of imported products, whose relative prices rose; this increased the return on investment in ISI. During the Great Depression in particular, an massive import contraction created a vacuum which remained even in the face of reduced local demand; ISI filled that vacuum. This initial stage was generated by market incentives: prices and differential returns were the mechanisms that channeled resources towards manufacturing.

Latin American governments played a more active role in the second stage of ISI. Development strategies in the region pursued two objectives: economic independence from world markets and a reduction in external vulnerability; ISI was the easiest way to achieve these two objectives. In fact, prior to the 1960s, it was thought to be the only mechanism leading to industrialization; infant industries had to be protected. After all, this had been the way the industrialized countries had developed in the 19th century. Industrialization came to be synonymous with development; if a Latin American country wanted to raise its per-capita income to developed country level, it had to industrialize.

The rationale of ISI sees it as a self-sustaining process — ISI automatically generates more ISI. The process starts with the production of goods for final use

1 See Prebisch (1950).

366 (the easy stage); then it draws in machinery and capital-goods production through backward linkages (the difficult phase of ISI).

In 1930-1980, all kinds of restrictive mechanisms were used in Latin America. Exchange controls were introduced during the Great Depression, and these were kept on until 1990, although at times they were made more flexible. Multiple exchange rates, high and widely dispersed tariffs, many different taxes and surcharges on imports, permits, quotas and prior deposits, lists of permitted and prohibited imports, implicit and explicit subsidies, special regimes and exceptions, direct taxes on exports and tax drawback schemes, special regulations for foreign investment and related capital movements ... all these measures were included in the battery of instruments used to implement ISI (see Table 1.1).

The political economy of the ISI strategy in several Latin American countries could be characterized as follows. The strategy was implemented and promoted in the late 1930s through a tripartite urban alliance linking government, industrialist entrepreneurs and urban manufacturing workers. The mechanisms for implementing ISI had a clear anti-export bias (i.e. against foreign firms which mostly controlled export sectors) and anti-agriculture (i.e. against the latifundio oligarchy), supported by price controls on basic food products. Higher tariffs benefited the industrial sector, favoring employers and workers alike; in addition a large proportion of fiscal revenue came from tariffs and special taxes on imports.

367 Table 1.1 Selected Latin American Countries: Summary of Quantitative Restrictions on Foreign Trade, around 1950 ª Country Multiple Currency Quantitative Prior Deposits Exchange Rates Controls Restrictions B

Argentina Yes Yes Yes No Bolivia Yes Yes Yes No Brazil Yes Yes Yes No Colombia Yes Yes Yes Yes Costa Rica Yes Yes Yes Yes Cuba No No No No Chile Yes Yes Yes No Ecuador Yes Yes Yes Yes El Salvador No No No - Guatemala No No No - Haiti No No No - Mexico No Yes Yes - Nicaragua Yes Yes Yes Yes Panama No No No - Paraguay Yes Yes Yes Yes Peru No Yes Yes Yes Uruguay Yes Yes Yes No Venezuela Yes Yes Yes No Note: a Approximately 1948-1950. b Import prohibition and/or prior import permits. Sources: ECLAC, on the basis of official information; International Monetary Fund. Taken from Richard L. Ground, “La genesis de la substitution de importations en America Latina”, Revista CEPAL 36, December 1988.

1.1.3 Theoretical RRationaleationale of ISI

The theoretical rationale for raising protectionist barriers to implement ISI is founded on three pillars (Ffrench-Davis, 1985; Caves, et al., 1990): (i) Infant industry: relatively low import prices prevent local firms emerging that are able to compete; so raising domestic prices through tariffs (or non-tariff barriers) would allow new local firms to set up and begin the learning curve; these would need some time to become efficient enough to compete with foreign firms. (ii) The existence of externalities, generated by industry, require this sector to be specifically compensated. (iii) The existence of market failures in the industrial sector; e.g. manufacturing firms cannot internalize the human capital training they carry out, because of inter-sectoral labor migration.

There is a theoretical counter-argument to this latter point (Corden, 1974). It is possible to establish a ranking of different economic policies to achieve a given objective; e.g. a direct subsidy would be better than a tariff to stimulate local production; a (direct) tax on consumption would be more efficient than a tariff to discourage the consumption of a specific good (e.g. cigarettes); a (direct) subsidy on the use of labor would be more effective than a tariff to create jobs. In short, more

368 precisely targeted policies, i.e. closer to the externality or market failure, are relatively more welfare-efficient, whereas more distant policies cause distortions and consequent welfare losses. Thus, in most cases trade policy would not be the most appropriate tool to deal with externalities or market failures. This being the case, why has the Latin America historically been more inclined to use tariffs and non-tariff barriers?

There are two plausible explanations for this (Krueger, 1990; Meier, 1991). From the government point of view, there is a clear asymmetry between tariffs and subsidies — a tariff generates resources while a subsidy uses them. A subsidy involves budgetary cost, is highly visible and is subject to annual debate; on the other hand, the tariff structure established in an earlier period t0 is considered an exogenous fact, i.e. it is not very visible nor are the amounts transferred to the protected sector called into question every year. Generally speaking, policies whose costs are more visible in the short run are more difficult to implement, and vice-versa (Krueger, 1990). In addition, in the case of protection for the manufacturing sector, the welfare gains generated in that sector tend to be perceived as greater than the costs borne by consumers. While it is understood that tariffs provide visible gains to a concentrated minority, the perception of costs is minimized because they are diffuse and dispersed among many agents. This has led Blinder (1987 p.121) to argue that, in the political calculus, what is important are visible and concentrated costs; diffuse and hidden costs do not move voters and consequently fail to arouse political passions.

Although the economists that supported the ISI strategy had the best of intentions, the resulting foreign-trade regime did not reflect economic criteria systematically applied, but was the outcome of ad hoc reactions by the economic authorities to successive external crises, compounded by relentless pressure exerted by lobby groups that generated a monopoly industrial structure. The entire 1940-1980 period was dominated by higher tariffs and non-tariff barriers without any deliberate scheme, and in which the cumulative effect was not the result of a decision taken at the outset. Clearly there were periods of exception to this general rule (see Ffrench-Davis, 1973). The resulting foreign-trade regime (see Table 1.2) had extremely high tariff levels that could not be justified in welfare or infant-industry protection terms; its chaotic structure is largely explained by pressure from interest groups. Moreover, once protection is granted (i.e. tariff, subsidy, price bands), it is hard to eliminate.

It has been argued that the implicit rationale of the tariff structure prevailing throughout the ISI period was to give greater protection to the

369 production of final consumption goods, lower levels to intermediate goods and near zero levels to capital goods; this would facilitate the development of the initial stage of ISI. An alternative explanation, however, suggests that the existing structure really reflected pressure from the lobbyists that benefited from the resulting effective protection structure (i.e. protection for the value-added of a specific sector). Indeed, the users of intermediate goods and machinery pushed for lower tariffs on these goods, while nobody argued in favor of lowering tariffs on final consumption goods (Meier, 1991).

Trade policy was one of the key mechanisms used to implement ISI in Latin America; other components of this industrial policy included credit rationing at low (including negative) real interest rates, preferential access to foreign currency for input and machinery imports, and low public-utility rates.

A parallel can be drawn between the Latin American industrial policy and that of Asia (Sachs, 1987). In the period 1950-1973, Japan maintained one of the highest average annual rates of economic growth in the world. The package of economic policies implemented by Japan during that period was as follows: (i) Exchange-rate policy:policy the government had full control over foreign currency; exporters handed over all foreign currency earnings to the government; there were no specific rules for making foreign exchange available, with allocations being made between the different sectors and firms by civil servants; between 1950 and 1964 there was no official foreign currency available for tourism. (ii) Capital accountaccount: the government was the only economic agent that could contract foreign debt; there was tight control over foreign investment, and the entry of majority foreign- controlled multinational firms was not allowed. (iii) Interest rate:rate the real interest rate was low and bounded above; credit was allocated on a discretionary basis. (iv) Incentives for exporters:exporters export promotion was not achieved by liberalizing imports, but through specific fiscal incentives (subsidies and tax breaks) for exporters; this type of incentive was also provided for exports that had natural comparative advantages. In brief, according to Sachs (1987), the Japanese export experience was based neither on free trade, nor on the free workings of the market mechanism; nor was it free from government intervention.

370 Table 1.2 Tariff Structure in Selected Latin American Countries. 1985-87 (Percentages) Country Tariff Protection Coverage of Maximum Import (Tariffs plus Non-Tariff Barriers Tariffs Para-Tariffs, Simple (Simple Averages) Averages)A Argentina 28 32 55 Bolivia 20 25 20 Brazil 80 35 105 Chile 36 10 20 Colombia 83 73 200 Costa Rica 92 1 100 Ecuador 50 59 290 Guatemala 50 7 100 Mexico 34 13 100 Nicaragua 54 28 100 Paraguay 72 10 44 Peru 64 53 120 Uruguay 32 14 45 Venezuela 30 44 135 Sources: World Bank, UNCTAD, and Edwards (1994 ). a Figures correspond to 1985.

The following points can also be made regarding the successful non-Japanese Asian export strategy (Sachs, 1987): (i) Export promotion was the powerhouse of economic growth. (ii) Export promotion was not equivalent to import liberalization, however, nor was import liberalization a pre-requisite for export promotion. (iii) Something similar can be said about the pure role of the market and the role of government. In Korea, the government encouraged the formation of large trading companies to distribute export products; there was no equivalent to the Japanese MITI (famous for its guidelines on future export products), but the Korean government lobbied and interacted directly with large exporting firms and played an important proactive role in implementing the export promotion strategy.

In short, there were apparent similarities between the industrial policy used by Latin American countries in implementing ISI, and Asian industrial policy. But there was also one crucial difference: Asian industrial policy had the goal of promoting industrial exports; in the Latin American case there was no equivalent objective, either explicit or implicit.

1.1.4 Results of ISI

During the 1960s, the ISI strategy started to come under fire. There were widespread signs of inefficiency in Latin American manufacturing industry; and ISI had failed to make the domestic economy independent of the external sector — at best the degree of dependence was unchanged. They were two reasons for the

371 persistent vulnerability of the domestic economy to events in the external sector following the long ISI period. The share of exports in GDP was reduced, but given the anti-export bias inherent in ISI policies, the low level of export diversification remained unchanged. Natural resources continued to account for a high percentage of total exports. The proportion of imports in the economy was lower than before the Great Depression, but there was also a major change in their structure, as they came to be dominated by intermediate imports needed to keep production going, together with capital goods imports which were crucial for growth. Accordingly, balance of payments crises caused a contraction in imports and hence reductions in present levels of production and future rates of growth.

After nearly 40 years of ISI, the growth of the Latin American economy still depended on exports, which were now needed to break the bottleneck caused by a shortage of foreign currency. In addition, every balance of payments crisis gave rise to new protectionist regulations. External problems were resolved by unilaterally raising barriers, which only provided a partial solution; the whole picture revealed a progressively chaotic situation.

Distortions in prices and market signals generated a productive structure characterized by uncompetitive oligopolistic industry, protected by high tariffs and para-tariff barriers, in which the opportunity cost of the (marginal) unit of foreign currency saved by ISI activities was two to four times higher than the official exchange rate.

372 never reached maturity. As a result of this failure, local consumers had to pay higher prices for lower quality manufactured goods. In addition, the industrial sector was also excessively diversified, with inefficient and underutilized industrial plants kept financially afloat through subsidized inputs, particularly credit, and a system of monopoly pricing made possible by import restrictions.2

It seems paradoxical that the sector that benefited most from these economic incentives ended up least efficient in the early 1980s.

Table 1.3 Manufacturing Output in Selected Latin American Countries: Annual Average Growth, 1950-1990 (Percentages) 1950-1981 1981-1990 Argentina 3.1 -1.1 Brazil 7.6 1.1 Chile 3.7 2.5 Colombia 5.9 3.5 Mexico 7.4 1.3 Peru 5.5 -2.3 Venezuela 5.9 2.1 Central America a 6.1 0.8

LATIN AMERICA 6.1 0.3 Oil exporters 6.9 1.1 Oil importers 5.8 0.1 Note: a Figures refer to the five countries of the Central American Common Market (CACM). Source: Based on ECLAC, Statistical Yearbook for Latin America and the Caribbean, 1991, and figures from the ECLAC Statistical Division .

Table 1.4 Latin America: Share of Manufacturing Sector in GDP, 1950-1990 (Percentages) 1950 1980 1990 Argentina 21.4 25.0 21.6 Brazil 23.2 33.1 27.9 Chile 20.6 21.4 21.7 Colombia 17.2 23.3 22.1 Mexico 17.3 22.1 22.8 Peru 15.7 20.2 18.4 Venezuela 10.2 18.8 20.3 Central America a 11.5 16.5 16.2

LATIN AMERICA 18.4 25.4 23.4 Note: a Includes the five countries of the Central American Common Market (CACM). Source: ECLAC, Statistical Yearbook for Latin America and the Caribbean, 1991 and data from the ECLAC Statistical Division. Figures for 1950 are expressed in 1970 prices; those for 1980 and 1990, in 1980 prices.

2 See World Bank (1969).

373 1.2 Trade LLiberalizationiberalization

1.2.1 General AApectspects

We now consider the elements involved in the unilateral trade liberalization process implemented by Latin American countries in the 1980s and 1990s.

Firstly, the traditional ISI strategy imposed in the 1930s was replaced by opening up the economy to imports. An open economy achieves a higher level of welfare than a closed one for two distinct reasons: (i) production specializes in line with comparative advantages, given the existing resource endowment; this results in greater efficiency linked to better use of factors of production. (ii) There is a broader range of goods available to consumers; society is faced with a larger quantity and greater variety of goods of relatively better quality and lower cost. In short, trade openness directs resources to where the local economy is more efficient, and enables people to consume goods more cheaply.

This is particularly true when comparing the extreme cases of a closed economy (autarchy) and an open economy. Despite questions raised by the theory of second-best and pro-ISI arguments, until recently there has been broad consensus that free trade raises global welfare.

This conceptual argument goes even further; any individual country will benefit from unilateral trade liberalization even if its trading partners do not reciprocate. This is because of the increase in welfare generated by goods imported at lower cost to replace inefficient local production. In other words, even if there are tariffs in the rest of the world, a country can increase its own welfare by cutting tariffs unilaterally without the need for reciprocity. This proposition is (theoretically) valid when the tariffs of the country in question are very high and those of the rest of the world are low.

Economic openness makes international relative prices the key to domestic resource allocation; in other words, international relative prices act as an external anchor determining domestic relative prices. Until 1980, several Latin American economies had made use of price controls; but a system of free markets and an open economy ties domestic prices to external ones and makes it impossible to reinstate such controls.

Trade liberalization means applying the neutrality principle with respect to economic incentives; trade policy is not used to create privileged or discriminated

374 sectors. The economic authorities refrain from signaling which sectors should be promoted in accordance with priorities established in an overall long-term development plan. In other words, there is no specific development strategy defined by the public sector; it is defined exclusively by the private sector.

In short, the rationale of trade liberalization and its modality coincides with the more global objective of reducing the public sector’s role in the economy. Aside from efficiency considerations, the use of international relative prices as an external anchor, and implementation of a lower tariff structure, limits the range of instruments available and prevents potential discretionary behavior by the private sector.

1.2.2 Effects of TTraderade RReform.eform. Conceptual AAspectsspects

Trade liberalization generates fierce resistance in a democratic regime. The sectors harmed by tariff reduction, entrepreneurs and workers alike, will react immediately by lobbying against it through the political system; in contrast, the potential beneficiaries will remain silent. Public opinion is likely to side with workers made redundant, for, while protectionism generates a basis of political support, there is no perception of likely future benefits. In other words, there is no physical counterpart to the worker made redundant today as a result of decreased tariff protection. Redundant workers may obtain jobs in the future, but they do not know this in the present, so they do not actively support trade reform (Krueger, 1990; Rodrik, 1992).

To summarize, there are different perceptions of trade reform and its impact on employment. From the traditional economic point of view, trade reform generates a change in domestic relative prices, leading to a reallocation of resources; workers are shifted from low- to high-productivity jobs, and this eventually generates higher living standards among the population as a whole. Nonetheless, from the standpoint of union leaders, trade reform is seen to make employed workers redundant, and these are not reabsorbed quickly by the new jobs that get created. In addition, the new jobs are likely to appear in geographically different places, and in other types of occupation requiring different skills (Blinder, 1987).

375 In other words, trade reform generates major social costs; the effect on manufacturing employment may be non-trivial.3 But on the other hand, preserving jobs in activities of relatively low productivity also entails opportunity costs for society. When one considers that labor costs absorb between 1/3 and 1/2 of the price of the final good, the cost of propping up inefficient sectors is equivalent to between two and three times the total payroll. It would be better to channel these funds into specific programs aimed at re-skilling or re-training, and relocate workers made redundant by the consequences of trade liberalization.

Traditionally, much has been made of the fact that trade reform generates an efficient reallocation of resources, leading to higher social welfare. Yet the (static) measurement of these welfare gains is generally modest at between 1% and 2% of GDP. In reality, the key political problem of trade reform stems from the large volume of resources that are redistributed between different sectors of the population; the net welfare gains are likely to be relatively small in relation to the global redistribution of resources generated by trade liberalization. As Rodrik (1992) points out, the key question is how many dollars of income are redistributed from one group to another, compared to the extra dollars generated by the net efficiency gain.

Adjustment of domestic relative prices is the mechanism whereby trade reform induces a reallocates resources and redistributes income. To examine these phenomena, it is helpful to distinguish two different relative prices; (i) PM/PX (the price of import-competing goods/(domestic) price of exporTable goods); if there is a * * tariff t (and no export subsidies) we have: PM/PX = eP M (1 + t) / eP X, which reduces * * to: PM/PX = TI (1 + t), where TI = P M/P X is the terms of trade faced by the country on international markets. (ii) PT/PM (price of tradable goods/price of non- tradables); PT = F(PX,PM), and PT/PM is the relative price that is changed by movements in the real exchange rate.

The relative price PM/PX allows us to examine intra-sectoral reallocation and redistribution within the tradable goods producing sector (exportable and import- competing goods). Trade liberalization (i.e. a reduction in the tariff level t) implies a fall in PM/PX, which leads to a reduction in the economy’s anti-export bias (when high tariffs prevail); this adjustment in relative prices leads to a transfer of resources and incomes from the import-competing sector to the export sector.

3 In the Chilean case, trade reform in the 1970s is thought to have resulted in the loss of around 10% of all manufacturing jobs (Meller, 1984 and 1992a).

376 Changes in the exchange rate do not affect the relative price PM/PX; this is altered by changes in TI.

The relative price PT/PM allows us to examine inter-sectoral reallocation and redistribution between the tradable and non-tradable sectors. In this case, the behavior of the (real) exchange rate is crucial to variations in this relative price. A real devaluation raises PT/PM and therefore generates greater relative incentives for the production of tradable goods (both exportable and import-competing).

Trade liberalization accompanied by a real devaluation encourages an expansion of exports through two different mechanisms: a reduction in PM/PX and a rise in PT/PM. In addition, the impact on local producers of import-substituting (or competing) goods will depend on the net effect of the reduction in tariffs t, and the rise in the real exchange rate. In cases where trade reform coincides with currency appreciation, both relative prices, PM/PX and PT/PM, fall, which is doubly negative for the local import-competing sector, whereas the effect on the export sector is ambiguous (it will depend on which relative price changes more).

Trade reform that simplifies the tariff structure is very attractive, and the extreme case of a flat tariff has several special qualities. Firstly, it is easy to operate and control; secondly, it removes incentives for corruption at the individual level — a customs agent has no incentive to be (monetarily) persuaded that an private car (with high tariffs) is really a truck or a tractor (with zero tariffs). A flat tariff structure also provides the government with a powerful tool for resisting pressures from specific interest groups (Rodrik, 1990). Any departure from the flat tariff rule is highly visible, and it is not easy to explain satisfactorily why extra protection has been given to sector j and not to sector k. The above reasoning can also be extended to the case where two or three clearly specified tariff categories are used. It would merely remain to resolve the problem of supervision to avoid confusion among individual civil servants.

Let us now re-examine the following question: why was the pro-ISI consensus of the 1960s replaced by the pro-export consensus of the 1990s?

There are several different aspects to this. Firstly, the success of the Asian export model proved that using exports as the engine of growth is a very powerful mechanism for raising per-capita income. Moreover, small Asian countries have shown that it is possible to export manufactured goods to developed countries. Secondly, there have been profound changes in the international environment: nowadays there is a high and increasing degree of global economic

377 interdependence; there is a positive attitude to greater integration in world markets (i.e. the benefits of integrating are perceived as outweighing the adjustment costs incurred to achieve such integration). Technological innovation has accelerated tremendously; a ten-year gap between a developed and developing country in the 1990s is equivalent to a 30-year gap in the 1950s. In visual terms, the growth patterns of countries in the 1950s were like a sort of carriage race, whereas what we see today is more like Formula One. Thirdly, opinions on the costs and benefits of foreign investment have changed; the 1960s debate on expropriation and nationalization has been replaced in the 1990s by discussion on how to generate a favorable climate and establish regulations to attract the largest possible foreign investment inflow.

1.2.3 Empirical EEffectsffects of TTraderade LLiberalizationiberalization

As noted above, trade reform brings domestic relative prices into line with international ones. This eventually leads to a reallocation of resources in accordance with the static comparative advantage of the country concerned. Consequently, the sector that enjoyed the greatest relative protection in the pre- trade reform period, will undergo the most far-reaching restructuring and adjustment; this is precisely what is happening with the industrial sector.

Table 1.5 Tariff Structure in Selected Latin American Countries, 1988 and 1999 (Percentages) Country Maximum Tariff Average Tariff 1988 1999 1988 1999 Argentina 83 33 29.9 13.5 Bolivia 17 10 16.7 9.7 Brazil 85 35 41.4 14.3 Chile 23 10 15.1 9.8 Colombia 218 35 44.2 11.6 Ecuador 325 99 39.7 11.5 Mexico 20 260 10.4 16.2 Paraguay 70 30 19.3 11.4 Peru 109 68 69.0 13.7 Uruguay 45 10 27.0 4.1 Venezuela 160 35 41.7 12.0 Sources: Inter-American Development Bank, LAIA Secretariat.

378 Table 1.6 Selected Trade Openness Measures, 1990-1999 (Percentages) 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 Exports/GDP Latin America and the Caribbean 12.3 9.9 11.3 11.2 11.6 13.2 13.8 14.0 13.4 17.9 Latin America and the Caribbean 11.3 8.8 10.8 10.5 10.5 10.2 10.4 10.6 9.5 13.3 excl. Mexico Mercosur 7.5 5.7 7.8 7.8 7.5 7.1 7.0 7.3 7.3 8.9 Andean Community 23.0 18.9 17.1 16.9 17.1 15.8 18.8 17.2 13.5 15.7 Caricom 30.5 28.0 27.4 21.9 32.6 32.0 27.9 28.5 16.9 n.a. CACM 15.9 16.1 15.5 14.7 15.0 16.5 17.7 17.0 19.8 20.9 Source: IDB Integration and Regional Programs Department.

1.1.33 Free TTraderade AAgreementsgreements

1.3.1 General AAspectsspects

379 Table 1.7 Tariff Structure in the Western Hemisphere, 1994 Regional Agreements Number of Average Tariff Maximum Tariff Modal Tariff Tariff Lines % % % NAFTA United States 7 503 6.36 48.00 0.00 Canada 7 104 8.66 30.00 0.00 Mexico 11 092 11.58 25.00 10.00

ANDEAN GROUP Bolivia 6 269 9.80 10.00 10.00 Colombia 7 212 11.57 40.00 5.00 Ecuador 6 262 11.91 40.00 5.00 Peru 6 482 16.32 25.00 15.00 Venezuela 6 898 11.80 25.00 5.00 CET 7 212 13.44 20.00 10.00

MERCOSUR Argentina 8 815 15.82 30.00 25.00 Brazil 7 983 10.69 35.00 10.00 Paraguay 5 578 8.03 32.00 10.00 Uruguay 9 591 14.74 20.00 20.00 CET 8 743 11.14 20.00 14.00

Chile 5 812 10.96 11.00 11.00 Note: Figures for national tariffs applied to third parties and common external tariffs (Cats) are simple averages. For the United States and Canada, tariff figures correspond to 1993, excluding specific duties. The CETs applied by CACM and CARICOM correspond to the rates effectively applied to that part of the tariff universe not exempted at national level. The CETs applied by Mercosur correspond to those agreed for the entire tariff universe, including items on the lists of exceptions. National tariffs applied by Mercosur member countries correspond to those in force in December 1994, prior to implementation of the CET. In Costa Rica, Honduras and Nicaragua, the calculations have taken into account tariff surcharges currently in force. Source: Garay, L. J. and A. Estevadeordal (1995), Protection, degradation preferential y norms de origin en lass Americas, IDB, June.

The second feature relates to the surprising proliferation of (bilateral) free trade agreements (FTAs) during the 1990s, of which no less than 26 were signed between 1990 and 1994. The decade also witnessed the creation of major subregional preferential trading areas, such as NAFTA and Mercosur. Consequently, the 1990s could well be called the “FTA decade” in Latin America. All countries make use of trade barriers or other forms of protection. A preferential trade agreement established between a subset of countries implies preferential tariff reduction between the parties. An FTA is a complex entity from the conceptual point of view. On the one hand, the lowering of trade barriers generates greater efficiency and social welfare. But on the other hand, it causes distortions by discriminating between goods from different countries.

380 In short, an FTA is discriminatory, because it involves tariff preferences for member countries; but it also involves a movement towards free trade between its members.

The traditional welfare analysis of a country joining an FTA distinguishes between trade creation and trade diversion. As an example, consider an initial situation in which the tariffs set by Chile and Mercosur are uniform for all trading partners of both countries. An FTA is established between Chile and Mercosur, granting reciprocal tariff preferences. Suppose Chile now starts to import footwear from Mercosur, which is a change from the pre-FTA situation. Will welfare in Chile increase or decrease? The answer depends on what was happening before (Krugman, 1993). (i) If Chile previously produced shoes but its cost of production are higher than those of Mercosur, then the FTA will lead to substitution of high cost Chilean footwear by the lower cost product from Mercosur. This is an example of trade creation that generates a welfare increase for the FTA and member countries. (ii) Alternatively, if Chile previously imported footwear from China, and now, as a result of the FTA, it imports shoes from Mercosur, this means substituting a lower-cost external producer (China, which was the country whose footwear was locally cheapest under uniform tariffs), by the relatively higher-cost Mercosur alternative. In this case, the FTA is diverting trade, and welfare in Chile may deteriorate.

In case (i), trade creation is accompanied by no change in Chile’s trade with the rest of the world (ROW). On the other hand, in case (ii), trade diversion entails an increase in trade within the FTA, matched by a reduction in Chile’s trade with ROW.4

As mentioned above, when a country liberalizes its external sector, there is an increase in total social welfare. Nonetheless, some groups and sectors are negatively affected, and these will try to block the liberalization process.

There is another factor that inhibits greater openness. More openness in a small economy means less local (or national) control over that economy: the

4 Consequently, trade diversion generates an inferior allocation of resources at the global level and a reduction in the level of welfare.

381 country loses degrees of freedom and elements of control over its national sovereignty.

The question then arises, what type of FTA should a country enter into? It might prefer to enter an agreement with other relatively similar countries; this would make it possible to set up regulation schemes and harmonization policies that are similar to those prevailing locally. On the other hand, there is a reason for the existence of countries, so it would be easier to extend borders towards neighboring countries than towards more distant ones. A military logic would suggest the opposite, however: better to have an FTA with more distant countries than with one’s neighbors.

The pattern of trade, measured in terms of countries’ trading partners, varies between continents, which suggests that geography affects a country’s choice of trading partners Krugman, 1991). An FTA between countries located in different continents or regions will be different; trade with closer neighbors is relatively greater.5

What are the advantages of geographic proximity? Firstly, transport and communication costs are relatively lower. Secondly, there tends to be greater affinity between the personal characteristics of trading partners; there is greater mutual understanding, so it is easier to do business (i.e. transaction costs are lower). FTAs with distant partners from other continents require major investments in knowledge and communications. Latin America has the great advantage of a common language, but there is still much to do to reduce interconnection costs between countries in terms of better infrastructure (roads, etc.), and harmonization of trade practices. In short, the ideal interconnection between two countries should be similar to the links between two regions of the same country. European Union countries have made great strides in this direction.

The FTAs established in practice are generally between countries that already have significant and long-standing trading relations. Geography and proximity are important features of the FTAs that have been set up, so trade creation ought to dominate trade diversion effects. This is particularly true when intra-sectoral is more important than inter-sectoral trade. Among developed countries, intra-sectoral trade is more frequent, whereas inter-sectoral trade is more common between developing countries.

5 In making this statement, one is implicitly assuming the different countries are homogeneous in size and per-capita income.

382 In reality, the topic of FTAs and regionalism is more complex than the traditional but limited trade-creation/diversion approach would suggest. Given the existence of FTAs and trade blocs, we need to take into account interaction between different blocs and possible strategic behavior between countries. There are both static and dynamic effects; effects on investment and also interaction between investment and trade.

The option of joining an FTA should also be weighed against the decision to stay outside one. For example, the possibility of Chile joining Mercosur is seen in the short run as giving preferential access to a large market. But, if Chile had not established an FTA with Mercosur, it would have risked incurring greater costs from its exclusion from an important regional market in the short and long run. Once a trade bloc such as Mercosur has been established, the need to expand commercial exchange outside the bloc is potentially less. Vested interests generated inside the bloc can cause protectionist pressures in the future; interest groups may come to feel that the Mercosur market belongs to them and resist further liberalization towards countries outside the bloc. A European Union Minister has argued, for example, that they were not creating a common market to be exploited by foreigners.

In short, for a country outside a commercial bloc it is advantageous to enter the bloc, especially if the latter maintains high external barriers. But it also needs to minimize trade diversion, so establishing an FTA with the bloc allows many more degrees of freedom than full membership of a customs union.

There has been a tendency to present FTAs and unilateral tariff reduction (UTR) as contradictory trade strategies, yet they can be complementary. Let us firstly consider the arguments for an FTA - UTR dichotomy. Corden (1993) makes the following points regarding FTAs between developing countries: (i) It is much better for a small country to liberalize unilaterally and in non-discriminatory fashion. In other words, a Latin American country should export to the world market rather than focus on and discriminate in favor of Mercosur. The world market is much larger than Mercosur. (ii) It is true that economies of scale generated by being able to export at preferential rates to Mercosur would cause trade to expand. But the gains from trade here would likely be small. (iii) On the other hand, provided there was no increase in tariffs with respect to ROW, the trade diversion problem would not be great.

383 Nonetheless, signing a regional FTA is not a substitute for UTR and keeping open the option of exports to ROW.

In other words, the problem is not trade diversion as such — but diversion of priorities. Mercosur should not be considered a panacea for trade and export growth in the future. The goal of increasing trade with the whole world must be kept alive. (iv) FTAs must be prevented from generating a new wave of protectionism, this time at the regional (FTA) level; i.e. barriers should not be raised to imports from ROW.

Clearly there is no inherent reason why an FTA should become a protectionist bloc. This could be avoided by turning the FTA into a club with rules, open to new members. Any country wishing to enter the club can do so, provided it obeys the rules, but no country is obliged to do so; entry is voluntary. A member of the club has rights and obligations, which is a basic principle of any club.

Another approach to the debate between FTAs and UTR argues as follows (Melo, et al, 1993): (i) It is said that for a small country UTR is always preferable to an FTA from the welfare standpoint. But if economic blocs already exist, a country will achieve larger welfare gains by entering a bloc than applying UTR, even if this means maintaining tariffs with ROW (i.e. no unilateral tariff reduction). (ii) Economies of scale and product differentiation are not decisive for the superiority of FTAs or UTR. (iii) Countries with high tariffs will benefit most from UTR. Only if the world is divided into economic blocs is an FTA generally superior to UTR in creating welfare.

Where does a small underdeveloped country have the best chance of increasing its exports — to the rest of the world or to a bloc that gives it preferential access? In some cases (countries and products) there are protectionist restrictions in ROW that the multilateral system has not yet managed to eliminate.

On the other hand, UTR applied by all countries — i.e. a multilateral FTA, moving towards worldwide free trade — would be preferable to individual UTR. Accordingly, it could be argued that a partial (non-global) FTA could be a second- best alternative compared to a global FTA.

384 To summarize, for a small country an FTA could be a more efficient mechanism than multilateralism to guarantee access to external markets in the future.

Trade debate generally tends to focus on lowering tariffs — either through UTR or FTAs. Yet, tariff rates have already been lowered substantially, so tariff reduction is not really such a crucial problem in today’s world as it used to be.

Current trade negotiations are concerned with harmonizing policies and institutions in order to eliminate other elements that cause market segmentation. It is now recognized that trade integration involves far more than trade in goods and services. Trade integration means adopting common rules of conduct between countries, together with certain agreements on policies.

Lastly, political objectives are sometimes more important than economic ones in forming an FTA or a trade bloc. A clear example of this is Europe, where the creators of the European common market believed that making member countries more economically interdependent would reduce the chances of future military conflict, as well as strengthening democratic institutions, the market mechanism and competition (Baldwin, 1993). Political economy issues have been a driving force in the evolution of the European Community, and are crucial in explaining the success and continued trade expansion that has been achieved there. Political considerations dominated economic arguments when Spain was admitted in the 1980s, and also in the case of East Germany in the 1990s.

It has been suggested that Latin American trade integration efforts in the 1960s and 1970s failed because of their entirely economic focus, to the exclusion of political objectives (Baldwin, 1993).

The gains from political stability and reduced potential for military conflict between neighboring countries are probably far greater than the gains from trade generated by an FTA. This is what has been seen in the European case; Germany and France were often fighting each other during the 19th and first half of the 20th centuries, but now they are close allies and it is impossible to conceive of a war between them today.

1.3.2 Brief RRevieweview of SSelectedelected TTraderade Agreements

The existence of a variety of FTAs with different rules, especially NAFTA (an FTA) and Mercosur (a customs union), raises complex problems for the general

385 consistency of the Latin American trading system. Table 1.8 summarizes the characteristics of the region’s main trade agreements.

NAFTA is an FTA in which the timetable for lowering tariff rates to zero is divided into four categories: immediate, five years, 10 years and 15 years. The base date is 1 January 1994 in each case. Calculation of tariff reductions for Canada and the United States is based on the general system of preferences (GSP), while effective tariffs are used in the case of Mexico, establishing a maximum value of 20%. All quantitative restrictions on imports have to be abolished, along with export restrictions, such as taxes.

The comparative number of products included in the four NAFTA tariff reduction categories is as follows:6 (i) the immediate reduction category includes around 80% of Mexican non-oil exports to the United States and Canada (6,800 tariff lines) and about 42% of non-oil exports from the United States and Canada (5,900 tariff lines). (ii) the five-year reduction category includes 1,200 products from the United States and Canada representing 8% of Mexican non-oil exports to those countries; Mexico will eliminate tariffs on 2,500 products (equivalent to 19% of imports from the USA and Canada). (iii) the ten-year tariff reduction category covers 3,300 products accounting for 38% of Mexican imports from the other member countries: the US will reduce tariffs on 700 products (7% of Mexican exports), and Canada 1,600 (12% of Mexican exports); and (iv) the 15-year category represents around 1% of the imports of each of the three member countries.

Accordingly, about 60% of trade within NAFTA had a zero tariff by 1999, and 99% will have a zero tariff by 2004. There are several sectors that receive special treatment, however, including the automotive sector, agriculture, energy, textiles and apparel, and petrochemicals.

By December 1994 Mercosur had already completed a reciprocal tariff- reduction program, establishing a zero tariff for reciprocal trade within the bloc. Mercosur is an imperfect customs union, in which the main trade policy instrument is intended to be the common external tariff (CET) which has been in force since January 1995. The agreed CET contains 11 tariff levels with a minimum of 0% and a maximum of 20%. About 85% of all tariff lines had their CETs operating by January 1995. The Mercosur customs union is described as

6 Celedón and Sáez (1995); the original source is Centro de Estudios Estratégicos (1994).

386 imperfect, because barriers to trade and differentiated external tariffs persist for 15% of all tariff lines.

Table 1.8 Institutional Characteristics of the Main Trade Agreements in the Americas Regional Tariff List of Common Rules of Safeguards Dispute Trade Reduction Exceptions External Origin Settlement Agreements Timetable Tariff Mechanisms NAFTA: Zero tariff: Automotive None Change in tariff Bilateral Consultations 1 January four groups industry classification safeguards Trade 1994 Immediate Agriculture and value- (with Commission 5 years Energy added rule compensatio Arbitration 10 years Textiles and (50% or 60% n) and panel 15 years apparel regional global Petrochemicals content) safeguards Mercosur: 1 Zero tariff Capital goods 0 - 20% Value-added Temporary Direct January granted to all Informatics rule (60% safeguards negotiations 1995 members industry regional (200 days) Common since Telecom content, and and global Market Group December products up to 80% for safeguards Arbitration 1994 Chemicals capital goods) (4 years, Court Petrochemicals extendable Automotive for up to 4 industry further Wines years) Cheeses G-3: Zero tariff: 3 Agriculture and None Change in tariff Bilateral Consultations 13 June groups hunting classification safeguards and mediation 1994 Immediate Food and and value- (with Arbitration 5 years beverages added rule compensatio panel 10 years Tobacco (similar to n 1 year, 2 13 years Textile industry NAFTA) maximum) (automotive global industry) safeguards Andean Pact: Zero tariff Ecuador Basic LAIA rule Global Direct (1969) granted to all receives structure: Change in tariff safeguards negotiations members preferential 5% classification; (imports may Andean Court except Peru treatment on agricultural 50% value not fall to of Justice about 1,000 products; added in FOB less than the product lines 10% value average Peru and processed value of Bolivia maintain raw previous their national materials; three years); tariff structure 15% semi- and manufactur exchange- ed goods; rate 20% safeguards maximum final products; 40% automotive products Source: Celedón and Sáez (1995).

387 The CET is designed with rates that increase stepwise according to the level of processing of the products concerned (ECLAC, 1995). Raw materials have low or zero tariffs; capital goods face a rate of 14%; informatics and telecom goods have a tariff of 16%; consumer durables pay between 16% and 18%, and automobiles 20%. Each country has specified a certain number of products exempted from the CET; these include capital goods, and informatics and telecom products that will maintain their national tariff rates in dealings with third countries, while automatically converging by 2001 (capital goods) and 2006 (telecom and information technology products). Apart from capital goods, and informatics and telecom products to three member countries (Argentina, Brazil and Uruguay), exceptions to the CET were allowed on up to 300 tariff lines (400 in the case of Paraguay).

Among the goods that each member country temporarily exempted from the zero tariff in reciprocal trade (see Bouzas, 1995; Celedón and Sáez, 1995), Argentina listed mainly steel products, textiles, paper and footwear. Brazil included woolen fabrics, canned peaches, cork products and wines. Textiles and agricultural goods account for 67% of the products Paraguay put on its list of exceptions. Uruguay’s list mostly consisted of textiles, chemical and pharmaceutical products, together with steel, electrical appliances and machinery, transport equipment, plastic and food products. Tariffs on these goods were lowered gradually to reach zero by 1999 in the case of Argentina and Brazil, and in 2000 in the cases of Paraguay and Uruguay. Automobiles and auto-parts, along with sugar, were also exempted from the reciprocal zero tariff.

In brief, for trade between Mercosur countries, nearly all goods faced a free trade situation with zero tariffs by 2000; in addition, Mercosur will have a CET on nearly all goods by 2001.

388 Table 1.9 Latin America: Total and Intraregional Exports, 1990-1999 (Millions of US dollars and percentages) 1990 1999 Latin America and the Caribbean (LAC) a b Total Exports 136 177 281 745 % growth 8.4 Extra-LAC Exports 119 260 238 204 % growth 8.0 Intra-LAC Exports 16 917 43 541 % growth 11.1 Intra/Total 12.4 15.5

Andean Community Total Exports 31 751 43 207 % growth 3.5 Extra-Andean Exports 30 427 39 268 % growth 2.9 Intra-Andean Exports 1 324 3 939 % growth 12.9 Intra/Total 4.2 9.1

CACM Total Exports 4 046 11 175 % growth 11.9 Extra-CACM Exports 3 388 8 886 % growth 11.3 Intra-CACM Exports 658 2 289 % growth 14.9 Intra/Total 16.3 20.5

Mercosur Total Exports 46 402 74 320 % growth 5.4 Extra-Mercosur Exports 42 275 59 158 % growth 3.8 Intra-Mercosur Exports 4 127 15 163 % growth 15.6 Intra/Total 8.9 20.4

1990 1999 NAFTA Total Exports 537 226 1 071 355 % growth 8.0 Extra-NAFTA Exports 307 297 486 296 % growth 5.2 Intra-NAFTA Exports 229 930 585 059 % growth 10.9 Intra/Total 42.8 54.6 Source: IDB Statistics and Quantitative Analysis Unit, based on official country data. a Latin America and the Caribbean consists of Argentina, Bolivia, Brazil, Chile, Colombia, Costa Rica, Dominican Republic, Ecuador, El Salvador, Guatemala, Honduras, Mexico, Nicaragua, Panama, Paraguay, Peru, Uruguay, Venezuela and CARICOM. Totals exclude the Dominican Republic for 1990-91 and 1998-1999, and Panama for 1994, owing to the unavailability of data. b CARICOM figures refer to Bahamas, Barbados, Belize, Dominica, Grenada, Jamaica, Saint Kitts and Nevis, Saint Lucia, Saint Vincent and the Grenadines, Suriname and Trinidad and Tobago, owing to the unavailability of data for the remaining CARICOM member states. Totals exclude Bahamas (1990, 1992-96), Belize (1991), Dominica (1992), Grenada (1993), Saint Kitts and Nevis (1990-92, 1996), Saint Vincent and the Grenadines (1990-92) and Suriname (1993).

389 2 Pattern ooff Trade iinn Latin America

2.1 General OOverviewverview

In 1999, the trade account of Latin America’s balance of payments showed total goods and services exports of US$ 348 billion and imports of US$ 368 billion (Table 2.1). Whether or not Mexico is included has a major effect on the overall Latin American figures, since that country’s exports and imports account for about 43% of the total. If Mexico is excluded, Latin American exports and imports in 1999 shrink to US$ 199 billion and US$ 212 billion respectively.

Table 2.1 shows the seven Latin American countries with the highest levels of exports and imports. Exports from these seven countries were as follows: Mexico, US$ 149 billion; Brazil, US$ 56 billion; Argentina, US$ 27 billion; Venezuela, US$ 22 billion; Chile, US$ 20 billion; Colombia, US$ 14 billion; and Peru US$ 8 billion. It is notable that Mexico’s exports alone surpass total exports from the next six Latin American countries.

During the ISI period, exports played a small role in Latin American economies, as can be seen in the share of exports in GDP. In the 1960s-1980s period, exports averaged less than 8% of GDP throughout Latin America7 (see Table 2.2), barely reaching 5% of GDP in some countries, such as Argentina and Brazil.

Table 2.1 Exports and Imports in Selected Latin American Countries, 1999 (Billions of US dollars) Exports Imports Goods Services Total Goods Services Total

Latin America (incl. Mexico) 304 44 348 309 59 368 Latin America (excl. Mexico) 167 32 199 167 45 212

Argentina 23 4 27 24 8 32 Brazil 48 8 56 49 14 63 Chile 16 4 20 14 4 18 Colombia 12 2 14 10 3 13 Mexico 137 12 149 142 14 162 Peru 6 2 8 7 2 9 Venezuela 21 1 22 12 4 16 Source: ECLAC (2001).

7 This excludes the special case of Venezuela.

390 By the start of the 1990s a significant change was already visible in the relative importance of Latin American exports, which rose to 11.9% of GDP in 1990-1991. In most Latin American countries, the share of exports in GDP increased by over 50% during the 1990s, and exports clearly became a major source of GDP growth in the region during that decade. By 1997-1999, exports on average accounted for 18.3% of Latin American GDP8 (Table 2.2), and for many countries the ratio of exports/ GDP by the end of the twentieth century was twice its pre-1990 level.

In the middle of the 20th century, exports from Latin America accounted for more than 10% of world exports, after which the region gradually lost share, slumping from 10.5% in 1953 to 4.3% in 1993, just 40 years later. Only in the 1990s did Latin America manage to reverse this declining trend, climbing back to 5.2% of total world exports by 1999 (Table 2.3).

There is a stark contrast between Asian and Latin American export trends. In 1953, exports from Asia accounted for 13.2% of the world total, slightly above Latin America’s 10.5% share at that time. By 1999, Asia’s share of world exports had grown to 27.5%, which was roughly five times Latin America’s share in that year (Table 2.3).

Table 2.2 Share of Exports in GDPa in Selected Latin American Countries, 1960-99 (Percentages) 1960-61 1980-81 1990-91 1997-99 Latin America (incl. Venezuela) 11.3 8.7 12.5 18.9 Latin America (excl. Venezuela) 7.8 7.1 11.9 18.3

Argentina 4.8 5.0 9.0 11.8 Brazil 4.3 5.0 7.6 9.0 Chile 10.9 16.6 27.0 34.8 Colombia 10.7 8.7 13.1 16.7 Mexico 9.1 9.0 15.1 31.1 Peru 14.6 10.8 10.5 13.8 Venezuela 55.7 19.9 26.1 32.5 Source: ECLAC (2001). a Value of exports as a percentage of GDP, measured in 1995 dollars.

8 Excluding Venezuela.

391 Table 2.3 Regional Shares of Worldwide Exports, 1953-1999 (Percentages) 1953 1963 1983 1993 1999 Latin America 10.5 7.0 5.8 4.3 5.2 USA and Canada 24.6 19.4 15.4 16.8 16.6 Europe 34.9 41.0 39.0 44.0 43.9 Asia 13.2 12.6 19.1 28.4 27.5

World a 100.0 100.0 100.0 100.0 100.0 Source: ECLAC (2001). a Includes rest of the world.

2.2 Expansion of exports

As discussed above, the protectionist policies of the ISI strategy generated an anti-export bias, but trade liberalization reduced this considerably. Prior to 1990, an import tariff below 20% was considered very low in Latin America; but since then this perception has changed significantly, and tariffs above 20% are now considered very high.

The lowering of protectionist barriers alone should stimulate the export sector, but the behavior of the real exchange rate has also boosted export performance to a considerable degree.

As a result of the external debt shock in Latin America in the early 1980s, Latin American countries were forced into drastic devaluations in the middle of that decade. By 1985 real exchange rates in the region’s countries were between 20% and 100% higher than in 1980 (Table 2.4), and this massive real devaluation gave a powerful stimulus to the expansion of exports in the 1990s.

During that decade, however, there were massive capital inflows into Latin America; and in addition, many countries used the exchange rate as a nominal anchor to combat inflation. These two phenomena combined to cause a fall in the real exchange rate — a process that began in some Latin American countries in the early 1990s. The real exchange rate in 1991 was below its 1985 level in several countries, and in 1999 it was generally not very different from its level in 1980 (Table 2.4). This suggests that the Latin American export boom of the 1990s is unlikely to be repeated in the first decade of the twenty-first century.

392 Table 2.4 Behavior of the Real Exchange Rate in Selected Latin American Countries (Indices: 1985 = 100) 1980 1991 1999 Argentina 36 44 34 Brazil 71 51 69 Chile 55 83 72 Colombia 79 126 98 Costa Rica 66 97 96 Mexico 83 77 73 Venezuela 84 132 69 Source: Edwards (1994)

Let us now examine the figures for Latin American export growth. Out of 16 selected countries, eight saw their exports grow by less than 5% per year in the 1970s and 1980s, while only four countries displayed annual export growth above 7%. In contrast, during the 1990s, 11 of the same 16 countries posted export growth above 7% (in six cases over 9% per year), and the figure was below 5% (but above 4%) in just two countries (Table 2.5).

Compared to other regions of the world, the annual rate of export growth in Latin America was 50% of that achieved by Asian countries in the 1970s and 1980s. During those decades, Latin American exports grew by 4.6% and 4.8% respectively, below the corresponding world rates of 6.4% and 5.0%. In the 1990- 1995 period, the region’s exports expanded at an annual rate of 8%, compared to global export growth of 6.9% per year, while Asian exports grew at 13.2% (Table 2.6).

Table 2.5 Rate of Export Growth: Selected Latin American Countries (Annual average %) 1970-80 1980-90 1990-95 Argentina 4.5 4.0 9.0 Bolivia -1.3 1.3 7.0 Brazil 9.6 8.4 4.6 Colombia 5.3 6.0 8.1 Chile 9.5 6.9 9.6 Costa Rica 6.7 5.5 9.3 Dominican Republic 8.7 5.5 9.1 Ecuador 13.2 4.5 8.0 El Salvador 2.9 -4.8 12.8 Guatemala 5.7 -1.4 6.0 Mexico 7.0 7.6 11.9 Nicaragua -1.7 -4.7 8.2 Paraguay 6.8 5.5 11.9 Peru 2.6 -2.6 4.3 Uruguay 6.8 4.6 6.7 Venezuela n.a. 0.6 6.5 Source: World Bank (2000)

393 Table 2.6 Export Growth by Regions (Annual average; %) 1970-80 1980-90 1990-95 East Asia & Pacific 9.6 9.3 13.2 OECD 6.6 4.6 6.1 Latin America and the Caribbean 4.6 4.8 8.0 World 6.4 5.0 6.9 Source: World Bank (2000)

In short, the 1990s saw a break with the past in relation to the role of exports, which are now a driving force in Latin American economies. Nonetheless, apart from Mexico, the region still lags far behind the performance of Asian exporting economies.

2.3 Characteristics of Latin American EExportsxports

Latin America has comparative advantages in natural resources. Whilst the anti-export bias prevailed before 1990, most Latin American exports were raw materials. In 1965, these accounted for 79.1% of total Latin American foreign sales; but this proportion had fallen to 53.2% in 1980 and 46.4% by 1990. Manufactured goods accounted for just 3.6% of the region’s exports in 1965, but had risen to 29.5% by 1990 (Table 2.7).

Table 2.7 Composition of Latin American Exports: 1965-1990 (Percentages) 1965 1980 1990 Natural Resources 79.1 53.2 46.4 Semi-Manufactured Products 17.0 25.7 23.1 Manufactured Products 3.6 20.5 29.5 Source: O. Muñoz (2001).

During the 1990s, Latin America as a whole managed to reduce the relative importance of natural resources in its total exports — this category accounted for less than 25% of the export basket in 1999 (Table 2.8). Yet this result depends crucially on whether or not Mexico is included in the total. With Mexico excluded, natural resources still represented 38% of the Latin American export basket in 1999.

Statistics on the region’s exports only began to provide a breakdown between the different types of industrial goods during the 1990s, which resulted in technology-intensive goods and manufactures involving major economies of scale being specifically stated for the first time. The relative importance of technology- intensive goods in Latin American exports rises from 12.1% in 1990 to 36.1% in

394 1999; but once again this major change depends largely on Mexico (Table 2.8). When Mexico is excluded, the share of technology-intensive products expands from 8.1% in 1990 to just 13.9% by 1999. Other Latin American countries that export significant amounts of technology-intensive goods are Brazil and Costa Rica.

Table 2.8 Latin America: Main Export Categories, 1990 and 1999 (Percentages of total) Countries and Primary Traditional Manufactures Technology- Total Subregions/Categories Products Manufactures Involving Intensive Major Manufactures Economies of Scale 1990 1999 1990 1999 1990 1999 1990 1999 1990 1999 Mercosur 24.0 24.6 29.3 29.0 33.6 27.8 13.1 18.6 100.0 100.0 Argentina 28.9 31.6 33.2 27.9 31.3 24.9 4.8 6.8 100.0 100.0 Brazil 19.7 18.3 28.7 29.7 30.8 24.7 12.8 17.2 100.0 100.0 Paraguay 68.1 55.1 29.4 35.7 2.3 7.8 0.2 1.4 100.0 100.0 Uruguay 18.0 16.5 68.9 66.4 10.5 8.5 2.6 8.7 100.0 100.0

Chile 27.5 31.7 16.2 19.8 53.5 41.3 0.9 2.1 100.0 100.0

Andean Community 73.2 68.9 10.6 12.9 14.5 15.1 1.6 3.1 100.0 100.0 Bolivia 67.3 31.7 15.9 28.2 16.6 12.4 0.0 26.5 100.0 100.0 Colombia 63.8 59.6 21.1 18.1 13.5 17.4 1.6 4.9 100.0 100.0 Ecuador 86.7 75.5 7.0 16.2 6.0 6.2 0.3 1.4 100.0 100.0 Peru 28.8 30.3 30.3 34.9 39.8 32.6 1.1 2.1 100.0 100.0 Venezuela 83.2 83.4 3.4 2.9 11.4 11.9 2.0 1.8 100.0 100.0

Mexico 47.0 10.4 8.6 19.3 17.3 6.9 13.8 38.9 100.0 100.0

CACM 58.7 33.2 27.5 26.8 8.6 8.8 5.2 31.2 100.0 100.0 Costa Rica 53.6 24.2 23.2 20.3 8.6 5.5 5.7 48.4 100.0 100.0 El Salvador 50.8 26.4 29.8 43.1 12.2 20.7 6.2 8.9 100.0 100.0 Guatemala 55.2 47.9 30.7 31.6 7.2 13.0 6.7 6.9 100.0 100.0 Honduras 75.3 52.4 16.9 36.6 7.5 7.6 0.2 3.0 100.0 100.0 Nicaragua 52.6 62.4 40.1 32.3 7.0 3.6 0.2 1.0 100.0 100.0

Panama 54.2 62.0 36.3 20.7 3.7 12.9 5.8 4.4 100.0 100.0

Total Latin America 42.8 24.8 19.3 22.1 25.8 17.0 12.1 36.1 100.0 100.0 (incl. Mexico) Total Latin America 41.7 37.9 22.2 23.7 28.1 24.6 8.1 13.9 100.0 100.0 (excl. Mexico) Source: ECLAC, International Trade and Development Finance Division, based on figures from the International Commodity Trade Database (COMTRADE).

Table 2.9 shows annual growth rates of Latin American manufactured exports to different trade blocs for 1990-1999. Mexico and Central America clearly stand out with annual growth of 19% and 20.6% respectively. When Mexico is

395 excluded, manufactured exports from Latin America grew at a rate of 5.6% per year (Table 2.9).

Table 2.9 Annual Growth of Manufactured Exports, 1990-99 (Percentages) Latin America Latin America Mercosur Andean Central Mexico (incl. Mexico) (excl. Mexico) Pact America

12.5 5.6 5.2 6.4 20.6 19.0 Source: IDB (2001).

Which markets receive Latin American manufactured exports? In 1999, 68% of the region’s manufactured exports were sent to the United States and 15% went to other Latin American countries; but here again the inclusion of Mexico is crucial, because 90% of Mexican manufactured exports go to the United States market (1990). According to ECLAC (2001), the United States market absorbs over 40% of total manufactured exports from Mexico, Honduras and Costa Rica, while the Latin American market absorbs over 40% of manufactured exports from Argentina, Paraguay, Uruguay, Chile, Bolivia, Colombia, Ecuador, Venezuela, El Salvador, Guatemala and Nicaragua.

Thus, the region itself provides the most important market for manufactured exports from most Latin American countries.

In contrast, the share of Latin American manufactured exports worldwide (global exports of manufactured goods) is very small — 2.2% in 1990, rising to 3.4% in 1998. If Mexico is excluded, however, Latin American exports only accounted for 1.1% of worldwide manufactured exports in 1998 (IDB, 2001).

We now consider the degree of concentration of total Latin American exports, i.e. the relative importance of the main export products. Taking the region as a whole, the share of the five leading products (at ISIC three-digit level) in total Latin American exports was 27.8% in 1999, up from 22.2% in 1998. Generally speaking, both in trade blocs and in individual countries, the share of a larger number of export products seems to have risen during the 1990s 9 (Table 2.10).

This indicator of relative export diversification displays a pattern approximately opposite to that of the Asian exporting economies during the 1990s. The share of the five leading export products increased from 22.1% in 1990 to

9 According to the available statistical information, Argentina would seem to be an exception to this general pattern.

396 37.3% in 1998 among the four Asian “tiger” economies (Korea, Hong Kong, Singapore and Taiwan), and from 30.9% to 35.3% among four other Asian countries (Indonesia, Malaysia, Philippines and Thailand).

Export baskets in the largest Latin American economies were less concentrated than in Asian countries in 1998. Mexico, Brazil and Argentina have export concentrations (share of the five leading products) of 29.4%, 25.2% and 34.5%, respectively, compared to 36% for the eight Asian exporting economies mentioned above (see Table 2.10). The situation is the reverse for the smaller Latin American countries, whose export baskets tend to be more concentrated. Chile, Colombia and the five Central American countries reported concentrations of 59.5%, 59.8% and 51.7% respectively in 1998 (Table 2.10).

Table 2.10 Concentration of Export Basket (Share of five leading export productsa in total exports) Country / Group 1990 1998 Latin America 27.8 22.2 Mercosur 24.2 21.9 Andean Community 63.3 55.8 Central America 53.3 51.7

Argentina 30.1 34.5 Brazil 29.1 25.2 Chile 65.3 59.5 Colombia 63.9 59.8 Costa Rica 61.6 52.0 Mexico 37.0 29.4 Dominican Republic 44.7 49.8

Asian Tigersb 22.1 37.3 Other Asiac 30.9 35.3 Source: IDB (2001). a Level of disaggregation: ISIC 3-digits. b Asian Tigers: Hong Kong, Korea, Singapore, Taiwan. c Other Asia: Indonesia, Malaysia, Philippines, Thailand.

3 The Curse ooff Natural Resources

Has the abundance of natural resources been a blessing or curse for Latin America? 10

10 For a more complete discussion of this issue, see Meller (1996) and World Bank (2001).

397 The role of natural resources has been viewed in very different ways at different times during the history of economic thought. In the early nineteenth century, the classical economists believed that natural resources, particularly land, were in fixed supply. Consequently, they acted as a constraint that would eventually limit the growth of per-capita income.11 Twentieth-century economists have generally been more optimistic, thanks to rapid technological progress and the continuous discovery of new mineral reserves.

In 1972, the Club of Rome revived the threat of natural resource scarcity for future economic growth: given the speed at which consumption was expanding, it estimated that mankind was rapidly depleting the total stock of natural resources existing on planet earth.

The neo-classical counter-argument is that capital accumulation and technological change, through the substitution mechanism, enable per-capita income to continue growing indefinitely, despite the existence of a fixed stock of natural resources. Moreover, the predictions made by the Club of Rome of zero growth and stagnation for the world economy by 2000, as natural resources ran out, have not come to pass.

The optimistic view seems to have reasserted itself; but a new variant of pessimism has also emerged, this time associated with the pattern of growth in developing countries.

3.1 The CCurseurse HHypothesisypothesis

A number of empirical studies have suggested that natural-resource- abundant countries tend to grow more slowly than those that are less well endowed, and countries that display high growth rates are generally natural- resource-poor. An econometric relation has even been found between rates of economic growth and the ratio of natural resource exports to GDP for a set of 80 developing countries (Sachs and Warner, 1995). All these studies cover the 1970s, 1980s and early 1990s (Auty and Mikesell, 1998).

The empirical evidence also shows clearly that more developed countries with higher per-capita incomes do not specialize in natural resource-based production. On the contrary, their manufacturing sectors have a greater weight, and they display considerable productive diversification. The question that arises

11 For that reason, economics has been dubbed the “dismal science”.

398 then is to what extent the existence of natural resources hinders the productive diversification usually seen in countries with higher per-capita incomes and sustained economic growth (Larraín et al., 1999).

A variety of explanations have been used to justify belief in the curse (Meller, 1996b; Auty and Mikesell, 1998): a) The Prebisch hypothesis of worsening commodity terms of trade. There is little empirical evidence in favor of this. Suffice it to mention that the price of computers has fallen in real terms by more than 10% per year for 30 consecutive years: in other words, a ton of copper today buys many more computers than it did in 1970. b) The high degree of volatility in international commodity prices generates macroeconomic imbalances that are likely to affect the pace of economic growth. The empirical evidence shows that the terms of trade facing commodity exporting countries are more volatile than for other countries. Nonetheless, the postulated growth-rate effect is by no means obvious, because productive linkages from the natural-resource- exporting sector to the rest of the economy are generally weak. c) “Dutch disease” would be another explanation. A natural resource export boom would generate a major inflow of foreign-currency leading to exchange-rate appreciation. This would harm the other tradable goods producing sectors. Given the cyclical behavior of international commodity prices, Dutch disease ought to have more short-term consequences than long-term ones. d) Lastly, it has been claimed that, given its high relative productivity, the natural resource producing sector attracts human capital, business skills and so forth, away from the other economic sectors, thereby affecting their growth potential. Given the low labor-intensity of mining activity, this would not seem to be a relevant argument for the Chilean economy.

In short, there are no really persuasive and solid arguments why a natural resource-abundant country should be condemned to low growth rates.

3.2 Lessons from DDevelopedeveloped CCountriesountries with AAbundantbundant Natural RResourcesesources12

The United States experience is interesting, because in the late nineteenth and early twentieth centuries, the US economy was relatively natural resource-

12 This section draws on the excellent paper by Wright (2001).

399 intensive. This case shows that for a country to develop on the basis of its natural resources, what matters is not the type of natural resources it possesses, but the learning process generated by exploiting them.

The US economy was not seen as natural resource-abundant in the eighteenth century — a fact that decisively refutes the classical economists’ argument that natural resources were a fixed factor. New mines were continually being discovered, and existing ones were increasingly worked to their full potential. Academic centers prepared detailed maps showing the location of all mineral outcrops, which was very useful for firms and for scientific research. Research and development in specific technologies enabled the country’s natural resource endowment to be steadily expanded, effectively creating new natural resource wealth; copper is a successful North American example.

Three elements have been identified that could have favored the expansion of the United States’ natural resource endowment (Wright, 2001): (i) A relaxed and quite liberal legal environment in the nineteenth century; open access to exploration, exclusive property rights to exploit a discovered outcrop, and the requirement to demonstrate productive activity in the mine in order not to forfeit exploitation rights. (ii) Although rapid exploitation and even exhaustion of natural resource outcrops occurred in the United States, the key to this process was essentially continuous learning, investment, technological progress and cost reduction; this generated, not exhaustion, but major expansion of the country’s natural resource endowment (ibid, p. 7). (iii) The third element was mining education. The United States became the world leader in mining and metallurgyl engineering. Mining and oil development formed the basis of a technological knowledge industry. United States geologists were being hired as oil and mineral prospecting consultants throughout the world by the end of the nineteenth century. The truth is, it is not geology (or financial capital), but investment in geological knowledge that explains the North American dominance of world oil production (ibid, 2001, p. 16).

To refute the argument that cites the large population of the USA, suffice it to mention that Norway developed major engineering potential with a population of just 2 million people at the start of the twentieth century; the combination of

400 engineering services and shipbuilding created one of the leading shipbuilding industries in the world (Larraín et al., 1999).13

3.3 The SSecondecond EExportxport PPhasehase

The first Latin American export stage was easy — exports of oil and natural resources. But it is not sufficient to export more; we must export better quality products. Accordingly, Latin America needs to upgrade to a more advanced second stage, which can be characterized as adding ‘intelligence’ to the rocks (minerals) being exported, for example. This would be in keeping with the idea of the twenty- first century as the knowledge century.

The information technology revolution means that knowledge and information will play a larger part in the prices of final goods to be consumed in the future, thus also suggesting a decreasing share for natural resources; a strategy based on exporting natural resources is therefore doomed to failure in the long run.

One of the solutions proposed for this is to incorporate additional value- added into natural resource exports, thereby achieving the age-old objective of linking natural resources to local economic activity. The enclave status of copper would thus be reduced or abolished.

The production of copper manufactures for the export market fulfils the main objective of the ISI strategy — moving from natural resource activities towards manufactured goods production. Moreover, this natural resource (copper) processing strategy resolves one of the main criticisms of ISI and other industrial policies, namely the problem of choosing which industries to promote, i.e. picking winners.

There are numerous obstacles to producing manufactured natural resource- based goods for export: (i) the stepped tariff structure in developed country markets; and (ii) the extremely costly requirement to possess mass distribution channels located in foreign markets.

There is also a conceptual issue that needs to be discussed. The strategy of processing natural resources implicitly assumes that a country with comparative advantages in natural resources will automatically have comparative advantages

13 For the cases of Ericsson (Sweden) and Nokia (Finland) see Blomström & Kokko(2001).

401 in processing them. Yet what guarantees that processing one’s own natural resources will have positive effects on economic development? If natural-resource processing yields similar positive returns, why do most developing countries export raw materials instead of manufacturing goods from them? Are rising tariff rates imposed by developed countries really the main obstacle, or is the heart of the matter the comparative advantages that a developing country has in producing processed natural resource-based goods. In any event the rising tariff structure is a bottleneck that needs to be removed.

There are three factors that could persuade a developing country to process its own natural resources:14 (i) Technology: when processing natural resources near their original location has cost advantages — for example, fishmeal factories are located near the areas where fish are caught. (ii) Ecology: where smelting and refinery processes cause extensive pollution, these activities should be carried out at isolated sites. (iii) Lower transport costs for manufactured goods compared to the cost of transporting natural resources may generate comparative cost advantages.

In short, there is no general rule indicating whether or not a country should process its own natural resources.

The strategy of exporting manufactured goods based on natural resources implicitly involves the same bias as ISI. Manufactured exports are considered better than natural resource exports; industrial production is deemed better for the Latin American economy. But why is this so? US$ 100 million earned from natural resource exports are the same as US$ 100 million earned from manufactured exports (processed natural resources). Where is the difference? The answer would seem to be that what is really important is industry. Why? Because industrial production is believed to generate externalities stemming from the incorporation and dissemination of modern technology.

The strategy of adding value to natural resources is based on forward linkages; but there is an alternative approach to natural resource exports that emphasizes backward linkages (Ramos, 1998).15 To illustrate this we will again consider the case of Chilean copper.

14 For a more in-depth discussion see Meller (1996b). 15 See also Meller (1996b), and Waisbluth and Délano (1993).

402 Internationally competitive copper production in Chile requires the use of highly sophisticated machinery and technological equipment. The people working in mines (especially large ones) are technically highly skilled at all levels — workers, managers and professionals. In short, exporting 4.6 million metric tons per year of copper requires a lot of human knowledge and modern technology; backward linkages to natural resource production (copper) make heavy demands on machinery and modern technology.

Copper production is an activity of long tradition in Chile. Over time, many different firms have been formed to produce inputs and provide services for the copper sector. A specific study of the demand for goods by Chile’s copper industry identified two types of product (Duhart, 1993): intermediate inputs and services, and capital goods. During the 1950s, less than 40% of total intermediate inputs used by copper mining were provided by the local market. In the 1970s, less than 10% of professional engineering services were provided by Chilean professionals. These figures both increased sharply during the 1980s and 1990s, and now 80% of intermediate inputs required by copper mining are provided by local firms, and 90% of engineering services are provided by Chilean consulting firms. In the case of machinery and capital goods, the share of Chilean producers has also increased but remains more modest at under 20% of total expenditure on capital goods in the 1980s. In summary, during the 1950s, less than 25% of copper mining backward linkages were provided by local suppliers. Forty years later, Chilean firms accounted for 60% of these (Ramos, 1998).

The recent sharp increase in copper production must have had knock-on effects on local providers of intermediate inputs and engineering services. Large mining companies require high-quality inputs and services, so local supplier firms will be acquiring experience and know-how that will be competitive on the international market, enabling them to become exporters themselves. Indeed such firms posted export earnings of US$ 26 million in 1992 (Waisbluth and Délano, 1993).

In other words, today’s large-scale copper production (and mining) sector is a major domestic market which could form the basis for developing a sector that exports inputs and engineering services needed for mining activities elsewhere. The focus of the strategy in the second export stage would emphasize backward linkages in natural resource exporting activities.

403 4 Latin America iinn a Globalized World

4.1 Main IIssuesssues

Most Latin American countries implemented far-reaching structural reforms in the 1980s, based on the triad of free markets, free trade and privatization. In short, the inward-looking ISI approach to development was replaced by an outward-looking strategy, as Latin America decided to integrate into the global economy. This economic reform program was initially stimulated and promoted by the International Monetary Fund (IMF) and the World Bank, for which reason it has been dubbed the Washington Consensus (Williamson, 1990). This new development strategy held out the promise of generating a high and sustained rate of economic growth that would eventually solve Latin America’s social and distributive problems.

The economic results achieved in the 1990s were disappointing, and current economic prospects (in 2001) and projections for the near future (2002) are also bad, with economic growth rates forecast to be zero or negative. Given that Latin America is a region of very unequal income distribution, sluggish growth provokes social instability and produces an environment that nurtures populist leaders.

Historically, Latin America has paid a high economic price for populist policies. These involve stimulating domestic aggregate demand (via a major expansion of public spending and wage hikes way above productivity), which generates high economic growth in the short run. These initial results are seen as an indicator of the success of the populist model, and lead to calls for more of the same. Gradually this generates major and growing macroeconomic imbalances, and bringing the process under control requires adjustment policies. The final outcome is several years of low growth, high unemployment and low levels of investment. It is therefore essential to avoid populism. But the bad economic results seen recently have generated a perception in the region that structural reform (the Washington consensus) and globalization have failed Latin America. Is this true? If so, what economic policies should be applied now?

During the 1990s, Latin America achieved average growth of 3.2% per year, compared to 1.4% in the 1980s (Table 4.1). Unlike the lost decade of the 1980s when per-capita income fell in Latin America, the region performed better in the 1990s; nonetheless, growth was still well below expectations. In fact, during the ISI period (1950-1980), Latin America achieved average annual growth rates of

404 around 5%. If the structural reforms of the Washington Consensus were intended to replace a development strategy plagued by distortions and inefficiency such as ISI, then why is the growth rate lower now?

In general, growth rates in Latin America compare very unfavorably with those achieved in Asia. In the 1990s, Asia’s average annual growth rate was twice that of Latin America — 6.5% compared to 3.2%; moreover, when measured in per-capita terms, it was four times as big — Asian per-capita income in the 1990s grew by 5.4% per year while in Latin America it only grew by 1.3%. This is because the population of Latin America is growing twice as fast as Asia’s, while its economy is expanding half as fast. This makes it easy to understand the reasons for the widening per-capita income gap between Asian and Latin American countries. There are also major differences between the two regions in terms of income distribution. The persistent situation of poverty and inequality in Latin America is highlighted by the fact that, in the late 1990s, 44% of all households representing more than 200 million people were living below the poverty line. The economic reforms of the Washington Consensus have so far done little to resolve this problem.

Table 4.1 Economic Growth (total and per-capita GDP) for Different Regions and Different Periods (Annual Average, %) Periods World Latin America Developed Developing Asia Countries Countries (Total GDP Growth) 1950-1960 4.4 4.9 4.1 5.1 5.7

1960-1973 5.1 5.5 5.0 5.5 5.2

1973-1980 3.4 5.1 3.0 5.3 6.2

1980-1990 3.1 1.4 3.1 3.7 6.8

1990-1999 2.4 3.2 2.2 4.7 6.5

(Per-capita GDP Growth) 1950-1960 2.8 2.2 2.8 2.8 3.6

1960-1973 3.1 3.3 4.1 3.0 2.9

1973-1980 1.6 2.3 2.3 3.0 4.2

1980-1990 1.4 -0.1 2.0 1.6 4.9

1990-1999 0.8 1.3 1.8 2.6 5.4

Source:: ECLAC (2000)

405 4.2 Natural RResourcesesources and IInformationnformation TTechnologyechnology

Is it possible to make the leap from producing natural resources to producing ICT? This question implicitly suggests a dichotomy between producing natural resources and producing information technology; and, as discussed in the previous section, it has been argued that Latin America needs to overcome the curse of natural resources — the future destiny of Latin America should not be to continue producing raw materials.

The previous section refuted this argument. Natural resources are really an asset for Latin America, and the region has been fortunate to have them in abundance. Moreover, abundant natural resources should not be an obstacle to incorporating ICT. In reality, the historical and empirical evidence from a variety of countries shows that there is a two-way link between natural resources and ICT (including information and knowledge). ICT makes it possible to expand the availability of natural resources in a country; and greater production of natural resources makes it possible to import more ICT. In addition, the application of ICT leads to more efficient natural resource production, and generates a learning process that can be applied in other economic sectors. In summary, as the World Bank (2001) states, for a Latin American or any other country to be competitive internationally, it does not matter what is produced but how it is produced.

Scandinavian countries have succeeded in developing specific know-how linked to their natural resources, and have gone on to become world-class producers of machinery, technology and consulting services related to the different stages of natural resource production. To achieve this, they have cultivated links between the private sector, universities and public bodies to create knowledge clusters (World Bank, 2001). It would be good if Latin American countries could develop a similar interactive network, although there are certainly many difficulties involved in doing so. Firstly, it will be necessary to overcome the mutual distrust that exists between the private sector and Latin American universities, and between the private sector and public bodies. In addition, appropriate incentives would have to be coordinated, financed and provided in order to set up such knowledge clusters.

406 Another completely different alternative for acquiring ICT is through foreign investment. The case of INTEL in Costa Rica (1996) has become an emblematic example in the region. Why did INTEL choose that country? Which other Latin American countries could replicate the INTEL experience? Other technology firms, encouraged by the behavior of INTEL, have also recently set up facilities in Costa Rica.

Mexico’s electronics industry is another interesting example of a Latin American country replicating the evolutionary export pattern of Asian countries. Membership of NAFTA clearly plays a fundamental role in this case, but this also shows how important it is for other Latin American countries to intensify trade relations both within the region and with the large North American market.

4.3 Some PProposalsroposals

Latin America must stay integrated into the world market, and even strengthen its links with it. But to maximize the benefits of globalization, it also needs to significantly increase productivity and become more competitive internationally. But the development strategy also needs components aimed at reducing social inequalities. Below we examine three areas of weakness in the Latin American region: small and medium-size enterprises (SMEs), export diversification and technology transfer.

SMEs account for over 80% of all firms in Latin America and generate a similar percentage of all jobs. It is therefore essential for them to raise their productivity and international competitiveness in order to generate long-term sustainable employment. Latin American SMEs tend to exist as islands, with restricted access to credit and modern technology, and run by owner- entrepreneurs who take all management, production and long-term strategy decisions themselves (most of the time not having the qualifications for doing so).

Measures are needed to facilitate SME access to the credit market; a long- term capital market is also needed for this type of firm. This means overcoming the problem of the guarantees that small businesses have to put up to back their loan applications; a revolving fund scheme with matching finance from the public sector and/or special grants might resolve the guarantee problem. Additionally, however, a system of private consultants is needed to analyze the viability and long-term profitability of SME investment projects.

407 Latin American SMEs tend to use old and sometimes obsolete technologies, and this reduces their competitiveness. Efficient mechanisms are needed for disseminating existing technological knowledge, adapting it to local conditions and promoting its use among SMEs. A specific example would be the development of programs aimed at achieving mass use of computers and Internet, based on associative networks to provide specialized SME support; this could include websites classified on a sectoral production basis that would provide full information on credit, technology and markets. A positive externality arising from this would be the creation of an SME entrepreneur network (at the sectoral or regional level) for input purchase and to provide productive benchmarking. The public sector would provide telecenters for access to this information at the local level (ECLAC, 2000).

Public-policy mechanisms can help SMEs generate appropriate channels to help market the range of goods they supply. These could be aimed in two different directions: (i) An SME internationalization strategy, to connect them with large marketing firms and distributors abroad. This might mean having to comply with technical and environmental regulations and quality standards. (ii) Strategy of producing inputs for large domestic firms. This would involve raising SME bargaining power to the level of large firms.

In today’s globalized world, it is essential for Latin American countries to increase their exports. This requires action on several different fronts: (i) Diversification of the export basket; it would be useful to have risk capital for firms or new economic activities that contribute to export diversification. (ii) Mechanisms giving access to financing sources for export insurance. (iii) Stimulation and promotion of associations of exporters, based either on product type or destination market, to exploit economies of scale and externalities arising from their collective presence on international markets. (iv) Analysis of linkages between export activities and local production mechanisms.

Technological innovation, R&D (research and development) and technology transfer are activities traditionally accorded a low priority in Latin America. Average R&D expenditure in the region amounts to just 0.5% of GDP, whereas the equivalent figure is between four and five times higher in developed nations and in Asia. Traditional mechanisms to increase technological innovation include the following: (i) Subsidies for technology projects that have a counterpart in productive enterprises. (ii) Tax incentives for investments in R&D. (iii) Attracting foreign direct investment into modern technology-intensive activities. (iv) Seed

408 capital to promote the creation of new technology-based firms, a specific example being university technology incubators.

Apart from the above, it is essential for all productive firms to incorporate modern technology (including ICT). An innovative mechanism to achieve this would be to promote new firms specializing in these services. In other words, the public sector, through the public tender mechanism, would create a market for technical and professional services aimed at inducing modern technology transfer (including ICT) in all types of firms, and particularly SMEs. These technical- professional services would be financed jointly by the public sector and the firms making use of them.

Incorporating ICT into all productive activities is a basic requirement. If a Latin American firm is to compete in the current globalized world, it must use ICT throughout all stages of production. Latin Americans need to acquire know- how to be able to operate in the knowledge and information society. This means rethinking the educational system in general, while also creating a training and re-skilling scheme for adults, and designing systems for ongoing learning throughout an individual’s working life.

Finally, the creation of knowledge clusters should be promoted for a number of reasons. Firstly, this would enable Latin America to exploit technological innovation and progress more rapidly. Secondly, the interaction this would generate between the private sector, academia (universities) and the public sector, would help ease tensions and overcome the mistrust that exists between the three sectors. In this respect, Latin America can learn a lot from the Asian experience; a component of development assistance programs could be oriented to facilitate this type of experience and knowledge. In a global world, all economic agents need to pull together and optimize their interaction to maximize national welfare.

409 References

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