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Trade’s Trade Offs

Trade’s Trade Offs


Adam Smith and David Ricardo’s theories regarding the potential positive effects of free international trade are today widely leaned upon by economists and policymakers. But even Adam Smith came to qualify his claims, noting, among other things, the need for free trade to be introduced slowly so that domestic industry and labor could adjust to increased international competition.1 Now, with the Doha Round of World Trade Organization (WTO) negotiations at an impasse and a proliferation of separate free trade agreements (FTAs) in the Americas and around the world, it is advantageous to reconsider, in light of new evidence, the ideal state-market relationship concerning trade liberalization and development in Latin America.

This essay presents two interrelated cases: first, that the neoliberal Washington Consensus development model, adopted throughout Latin America since the late 1980s, domestically has produced rather poor results; second, that US-involved FTAs unduly constrain the ‘space’ within which Latin American countries might pursue a different generation of development strategies, which have exhibited some success on their application throughout East Asia. Both arguments are constructed and presented under the premise that Latin American countries should not effectively be restrained from pursuing state-directed development strategies; not unlike what the majority of now developed or rapidly developing countries have done in the recent past, or continue to do.2

The U.S. and FTAs in the Americas: Some Preliminary Facts

Since implementing the North American Free Trade Agreement (NAFTA) with Canada and Mexico in 1994, “the United States has concluded agreements (or, at least, has either begun negotiations or undertaken preliminary discussions on such agreements) with more than half the countries of Latin America and the Caribbean.”3 Free trade agreements in the Americas differ significantly amongst themselves in breadth (ranging from bilateral deals to multilateral regional and hemispheric arrangements), as well as in depth, with some incorporating more carefully delineated policies than others. FTAs involving the United States are normally characterized by asymmetrical, often highly unequal negotiating positions, and by requirements which severely constrain the policy options available to signatory countries. Talks regarding a US-led Free Trade Area of the Americas (FTAA) involving all thirty-four countries in the region (sans Cuba), essentially have ground to a halt, mostly directly due to differences between the US and Brazil. On this point, two Brazilian officials, one a former co-chair of FTAA negotiations from 2003-2006, the other a diplomat with the Ministry of Foreign Relations, write:

    “[w]e faced a dilemma: the United States refused to make any more significant concessions in the areas in which we had the greatest interest, such as agricultural trade and antidumping regulations, and exerted pressure seeking advances in areas in which we had a so-called ‘defensive interest,’ such as services, investments, government procurement and intellectual property.”4

What is new about recent U.S.-involved FTAs in the Americas is their North-South aspect, bringing together national economies that are highly disparate, with the US demanding concessions even on non-trade matters like intellectual property rights (IP) and investment management.5 Thus, FTAs between Latin American countries and the U.S. can be described as “a bargain of market access in exchange for regulatory harmonization,”6 with the former gaining access to the U.S. import market upon acceptance of mostly US-designed regulatory regimes. Latin American FTA signatories seek foreign direct investment (FDI) from transnational corporations (TNCs), hoping that the operation of foreign-owned firms in their country will create positive ‘spillover’ effects, such as technology and knowledge transfers, and the integration of local businesses into global supply and distribution networks, which creates jobs.

But some scholars are concerned that the trade-offs involved in FTAs with the US are simply not worth the price which regional developing nations must pay. As the editors of a recent scholarly book examining the political economy of hemispheric integration emphasize, “[t]he prevailing concern…is that [bilateral FTAs with the US], which dramatically restrict countries’ opportunities for policy innovation, may lock in strategies of economic development that have thus-far failed to spur economic development.”7 Hence, with virtually all Latin American countries already constrained in their menu of developmental policy options by virtue of their membership in the WTO, FTAs with the US increasingly appear to be a poor strategic choice.

This argument is, of course, controversial. Some scholars argue the exact opposite, especially in the sense that ‘policy space’ and development strategies, such as industrial subsidies, can result in more problems than solutions. Critics of ‘policy space’ (or, similarly, ‘policy innovation’ and special and differentiated treatment clauses) for development strategies argue that the anarchy of the market creates the surest and soundest economic growth, through competition, whittling away weak enterprises while producing globally competitive businesses. Likewise, it is asserted that governments are notoriously inept when it comes to ‘picking winners’: choosing which sectors to support, and determining how long that support should continue. Conservative scholars also can point to the problem of corruption, tending to agree with the assertion that, “everyone ‘knows’ that trade ministers representing poor countries cannot be asked to dismantle their protective barriers because…well, because they like to use muddled infant industry arguments to confer favors on well-connected constituents.”8 These objections regarding the political economy of the proactive state will later receive a closer look, and potential effective countermeasures will also be introduced.

Why the Push for Policy Space?: Latin America’s Recent Sub-Par Economic Performance

    “During the last two decades, Latin American countries have pursued an agenda of widespread market liberalization, commonly referred to as the Washington Consensus. These policies have left Latin American economies—with few exceptions—with an old/new comparative advantage in natural resources, a shrinking manufacturing sector, a growing informal sector, low investment ratios, slow economic growth, more unequal income distribution and rising poverty rates.”

Thus, the broad argument of those advocating the need for policy space in FTAs (including in the WTO), and particularly candidates scheduled to be involved in US-involved bilateral agreements, is that the current formula essentially has failed. This conclusion is further substantiated when the lackluster performance of neoliberalized Latin America throughout the 1990s is contrasted with the explosive growth of China and other more managed Asian economies during the same period.10 Between 1990 and 2004, the average annual rate of growth of GDP per capita in Latin America and the Caribbean was a paltry 1.3 percent, compared with 6.7 percent in East Asia, 3.5 percent in South Asia, and 8.6 percent in China.11 While diverse social, economic and political aspects apply to both regions, it is apparent that the development model espoused by Korea, Taiwan and other relatively recent Asian industrializers is based on an entirely different premise. More specifically, the East Asian method, characterized by,

    “adopt[ing] managed and pragmatic strategies of economic integration…combin[ing] liberalization and privatization with the maintenance of an active role for the state to correct market failures [and] to build productive capacities in strategic sectors…[with gradual liberalization] executed with the twin goals of expanding domestic markets and reducing social costs,”12

has proven to be a more effective formula for development than the orthodox Washington Consensus program of systematically privatizing while de-emphasizing (and probably somewhat delegitimizing) the state. Experts note that East Asian growth was aided by certain general policies, including: a targeted industrial policy; loose intellectual property rules; and investment in human capital and public infrastructure.13 Still, conservative scholars assert that “the underlying problem is less a matter of failure than of containing rising expectations.”14 But Latin America’s post-liberalization economic performance is disappointing in other respects as well. Take, for instance, the much-maligned decades of import-substitution industrialization.15 During the 1960s, average GDP per capita growth rates in Latin America and the Caribbean were 5.3 percent, higher than any other developing region in the world. At 6.6 percent, per capita economic growth was even higher during the 1970s.16

Yet, “[e]ven more significant for the discussion of responses to globalization and trade policy choices has been Latin America’s mixed record of in terms of exports.”17 Although Latin American liberalization has concentrated on a strategy of export-oriented industrialization, achieving an average annual export growth rate of 7.2 percent from 1990 to 2004, East Asian countries’ exports grew by an annual average of 12.6 percent during the same time span, thus significantly outperforming their Latin American counterparts.18 Moreover, Latin America has largely failed to diversify its exports. Even in Chile, South America’s supposed success story, 91 percent of the country’s exports were still primary based in 2004, and, excluding Mexico, over two-thirds of Latin America’s total exports remained primary goods or resource-based manufactures.19 (It is also important to note that Chile did not succeed in establishing a more advanced production structure during the 1990s.)20

Considering that many economists judge productivity to be the most significant indicator of an economy’s performance and competitiveness, it is telling that labor productivity in Latin America grew at an annual rate of only 0.7 percent during the 1990s, barely higher than in Africa, and a third less than in Asia.21 And, although the presence of TNCs and FDI in Latin America already is firmly established and situated to deepen further,22 the hands-off Washington Consensus approach generally adopted throughout the region has not encouraged much in the way of positive ‘spillovers’ from foreign firms into local economies.23

Why the Push for Policy Space? (continued)

Furthermore, “China’s size and dynamism profoundly questions the feasibility of Latin America’s—and Mexico’s—EOI [export oriented industrialization].”24 Chinese exports already have generated “massive displacements” of Mexican exports in the U.S. import market, while beginning to crowd out Mexican producers in their domestic market as well.25 Most analyses of China-Latin America trade dynamics emphasize that fact that, while Mexico has lost significant market shares and runs a trade deficit with China, South America (especially Mercosur) has “won” by exporting raw materials to China and building a trade surplus.26 However, a more recent (albeit preliminary) analysis contends that this picture is short-sighted and misleading.27 First, South America has benefited from recent high commodity prices, so countries like Brazil and Argentina are dependent on the perpetual growth in both the price and quantity of a small number of goods. Second, Latin America only received 3 percent of China’s exports in 2005, so the potential for increased Chinese exports to the region is huge. Third, the difference in trade balance between South and Mexico-Central America vis China are probably transitory, as China is expected to increase its light manufactured exports to all of Latin America, likely smothering light manufacturers throughout the region in the process. Besides, asks one scholar: “Is the exporting of raw materials,” to be “the new Latin American Model?”28

In light of the fact that, after two decades of reforms congruent with the neoliberal Washington Consensus, most South American economies have fallen back on comparative advantages involving the export of primary products in agriculture and mining, while most Central American economies rely on assembling labor-intensive products, a new development agenda for Latin America is necessary to address the region’s social problems and to increase the region’s competitiveness in the global economy.29 This appraisal of Latin America’s recent unsatisfactory economic performance and the need for concomitant policy changes challenges the theoretical ‘wisdom’ that free markets alone can provide a solid base for development in Latin American markets that are “riddled with failures and imperfections.”30 Increased policy space will allow Latin American countries to formulate and implement policies that could help them not only to weather heightened competition from China, India and Central European countries in foreign and domestic markets, but could also help position Latin America to take advantage of the developing world’s growing purchasing power, as over 40 percent of developing countries’ exports are imported by other developing countries, and the share of global consumption by developing countries continues to rise.31

Finally, not only Latin America’s economic indicators, but also its social and technological indicators, evidence the need for redress. Latin America must improve its public education, which a survey of the region’s citizens has ranked the poorest in world. The region’s total enrollment rate in 2000 was 72 percent, well below the 91 percent of East Asia’s school-age population, and 95 percent in Eastern Europe.32 Also, both the average Latin American firm’s technological capacities, as well as its access to information and communication technology, are deficient, especially when compared to Asia.33 With an average Gini coefficient of .52, Latin America is, along with Sub-Saharan Africa, one of the two most unequal regions in the world in terms of income. Latin America is the single most unequal place on the planet regarding land holdings. Even beyond relevant ethical and moral considerations, there is ample evidence of such inequality’s adverse impact on economic development.34

Putting Policy Space to Good Use: Bringing the State Back in to Latin American Development

In the hypercompetitive era of globalization, a strong argument can be made that a proactive state is necessary, throughout Latin America, in order to successfully and sustainably integrate this relatively underdeveloped region into the global economy. Improving Latin America’s productivity growth and global competitiveness requires, among other things, investing in human capital, “[a]n expansion of domestic technological capabilities, macroeconomic stability…requisite infrastructure improvements as well as institutions conducive to fostering these elements.”35 The ultimate strategy is a ‘capability-centered’ or ‘knowledge-based assets’ approach, aimed at creating new comparative advantages in higher value-added manufacturing and service sectors, beyond primary products and unskilled labor intensive goods, which will require activist government policies in industry, public finance, macroeconomics, and poverty alleviation. Everything should be conceived and implemented in an environmentally conscious manner.36 While this is a tall order (especially regarding the environment), it has successfully been done before37 (albeit often minus environmental consciousness). Latin American policymakers also have the benefit of learning from the deficiencies of past import-substituting policies, particularly the lack of effective ‘reciprocal control mechanisms’ and ‘embedded diagnostics’38 for industrial policies, and the naïve belief in government infallibility.39

Successes in East Asia show that reciprocal control mechanisms and embedded diagnostics are particularly valuable tools for minimizing corruption and state inefficiency when governments assume a more proactive role in economic development. The former mechanism works to ensure that public-private partnerships are characterized by discipline and accountability. Political economists have shown that effective policies have involved subsidy recipients being “subjected to monitorable performance standards that [are] redistributive in nature and result-oriented…[thereby]…transform[ing] the inefficiency and venality associated with government intervention into a common good.”40 Similarly, ‘embedded diagnostics’ refers to state agencies being entrenched in private enterprises as relatively autonomous interlocutors; aiding information flows between public and private so that both market failures and opportunities are more accurately acted upon.41 To be sure, the extent to which the two aforementioned measures are implementable, amidst widespread corruption and institutional weakness in Latin America, is uncertain. What is more certain, however, is that the neoliberal model essentially has proven itself insufficient, and that “no country can climb the ladder of development without a development strategy in place.”42

While countries must formulate development-oriented policies that are unique to their own distinct exigencies, certain broad policy tools can be distinguished and somewhat delineated. Industrial policies meant to address market failures, realize positive externalities, and protect infant industries, might include subsidies with performance requirements, government procurement policies, coordination policies to encourage cluster and linkage formation, technology transfer mechanisms, and information and finance provisions. Public finance policies to fund improvements in education, infrastructure, technological learning, as well as support for the private sector, could rely on progressive taxation, tapping natural resource rents, borrowing domestically or internationally, foreign debt restructuring or forgiveness, public investment and public-private partnerships.43 Macroeconomic policies aimed designed to increase macroeconomic stability and to perhaps set basic prices conducive for development in prime areas of the public economy, can be pursued via short-term capital controls, interest rate adjustments and exchange rate management. Finally, pro-poor policies to supplement market outcomes could take the form of various targeted interventions.44 Land redistribution policies are likely to be necessary throughout the region in order to, among other things, combat land speculation and undo past wrongs.

Other policy tools which countries traditionally have utilized to develop their economies, and which are especially pertinent to the discussion, are domestic tax export incentives, and, for foreign investors, the upholding of duty of establishment requirements, local labor and technology transfer standards, and intellectual property regulations pertaining to early-working permission and high disclosure and local production regulations.

Conclusion: FTAs with the US are Probably Not Worth the Trade-Offs

While the six previously mentioned policy tools are not comprehensively disallowed even under the strictures of the WTO (abiding by the two principals of non-discrimination and national treatment, of course) nor commonly in FTAs with the EU, trade agreements drafted with the US generally lack flexibility in these areas, and they thereby significantly delimit the policy space within which Latin American signatories can design and legally implement development policies.45 A very recent scholarly article examined the four trade-related areas of goods, services, and investment and intellectual property rights in thirteen trade agreements contracted around the world, concluding that FTAs with the US are indeed the most constraining.46 The study analyzed several agreements germane to Latin Americanists, including three US FTAs with Latin American countries (NAFTA, DR-CAFTA and US-Chile), four EU FTAs (including EU-Mexico and EU-Chile), and four South-South FTAs (including Mercosur, the Andean Community and the China-Chile agreement).

The authors of the aforementioned study also note that US FTA provisions regarding the domestic regulation of service providers and the treatment of foreign investment are remarkably intrusive and binding.47 Other analysts observe that, “the proliferation of [investment provisions in US FTAs] has created a de facto international investment regime by which TNCs can use [compulsory] international arbitration…to challenge public policies.”48 Furthermore, Latin America has been subject to more investor claims than any other capital-importing region in the world.49 Also, regarding this critical issue, legal scholars point out that, [p]erhaps the most troubling aspect of the current system [of investment treaty arbitration] is that the power to determine the legality of sovereign acts has been delegated to private arbitrators who lack…key hallmarks of judicial independence and accountability in public law.”50 Finally, the investment and intellectual property rights stipulations entailed in US FTAs also are being demonstrated to have adverse effects on the provision of public health in signatory countries. Organizations such as the World Health Organization and Oxfam have documented how US FTAs “have strong negative impacts” on the production and commercialization of generic medicines.51

Because they significantly delimit the policy space available to developing Latin American countries (which is, of course, already considerably circumscribed by existing WTO regulations) and because Washington’s liberalization-heavy development program has heretofore produced rather lackluster (and perhaps unsustainable) results in the region, US FTAs in their current form are probably not in the best short-, mid-, or long-term interests of Latin American countries. Some final observations on this matter must include the fact that, although individual Latin American countries seeking FDI and export opportunities have been known to solicit, if not initiate FTAs with the US, the competitive nature of this further liberalization—of which the US shrewdly takes systematic advantage—places great stress on the efforts of Latin American countries to further integrate on different levels, whether amongst themselves or even in collective multilateral bargaining, as at the WTO.52 Latin American countries looking for a quick advantage over their neighbors may be acting both against their own, and their neighbor’s enduring interests.

A Final Remark

To be sure, any development agenda will require political support to come to fruition; new political parties and alliances with, at the very least, a modicum of support from Latin American elites, would be deemed essential. But this essay aims only to present a case for the perceived need for a different development agenda, as well as evidence for the potential effectiveness of a proactive state in this endeavor. Lastly, a word on the ubiquitous obstacle of corruption, which, those who are understandably skeptical might argue, could render such tools as ‘embedded diagnostics’ and ‘reciprocal control mechanisms’ worthless in the region, as the role of corruption is vastly different in Latin America than in East Asia, and the former region is perhaps less suited to pursue similar development strategies. Scholars of political economy emphasize the fact that, “we do know from the history of the geographical spread of capitalism…that the difficulty of building supporting institutions in apparently ‘culturally’ hostile or inappropriate environments should not be exaggerated, and that orientations can be modified if not entirely changed by institution-building.”53 Latin America is not incapable of learning from and mirroring the notable successes of other development models elsewhere, but FTAs with the US may make this less likely, and even illegal.

1 Crane and Amawi, “The Theoretical Evolution of International Political Economy: A Reader ,” eds., 2nd ed. (New York: Oxford University Press, 1997).

2 See, for example, Chang, “Bad Samaritans: The Myth of Free Trade and the Secret History of Capitalism,” (New York: Bloomsbury, 2008).

3 Sanchez-Ancochea and Shadlen, pg. 1.

4 Bahadian and Carvalho Lyrio in Sanchez-Ancochea and Shadlen, pg. 206.

5 Ibid.

6 Ibid.

7 Ibid, pg.2.

8 Hufbauer in McKinney and Gardener, pg. 220.

9 Abugattas and Paus in Sanchez-Ancochea and Shadlen, pg. 113.

10 Sanchez-Ancochea and Shadlen, pg. 4.

11 Ibid, pg. 9.

12 Ibid, pg. 8.

13 Gallagher and Thrasher, “21st Century Trade Agreements: Implications for Long-Run Development Policies,” Boston University, The Frederick S. Pardee Center for the Study of the Long-Term Future, The Pardee Papers, No. 2 (September 2008), pg. 10.

14 Hart in McKinney and Gardener, pg. 15.

15 Sanchez-Ancochea and Shadlen, pg. 9.

16 Ibid, pp. 9-10.

17 Ibid.

18 Ibid.

19 Ibid, pg. 20.

20 Abugattas and Paus in Sanchez-Ancochea and Shadlen, pg. 114.

21 Ibid, pg. 116.

22 Mortimore in Sanchez-Ancochea and Shadlen, pg. 32.

23 Abugattas and Paus in Sanchez-Ancochea and Shadlen, pg. 119.

24 Dussel Peters in Sanchez-Ancochea and Shadlen, pg. 77.

25 Ibid.

26 Ibid.

27 Ibid.

28 Ibid.

29 Abugattas and Paus in Sanchez-Ancochea and Shadlen, pg. 114-115.

30 Ibid.

Also see Stiglitz, “More Instruments and Broader Goals: Moving Towards the Post-Washington Consensus,” United Nations University. World Institute for Economic Research (1998).

31 Ibid, pg. 115.

32 Ibid, pg. 118.

33 Ibid, pp. 118-119.

34 See, for instance, Lopez and Perry, “Inequality in Latin America: Determinants and Consequences,” Policy Research Working Paper 4504. The World Bank Latin America and the Caribbean Region Office of the Regional Chief Economist (February 2008).

35 Ibid, pg. 116.

36 Ibid, pp. 119-120.

37 Again, see Chang (2008).

38 Gallagher and Thrasher, pg. 12.

39 Abugattas and Paus in Sanchez-Ancochea and Shadlen, pg. 115.

40 Amsden quoted In Gallagher and Thrasher, pg. 13.

41 Ibid, pg. 12.

42 Weiss, statement at the State of the World Conference, Princeton Institute for International and Regional Studies (February 2004).

43 Abugattas and Paus in Sanchez-Ancochea and Shadlen, pg. 120.

44 Ibid, pg. 121.

45 Gallagher and Thrasher, pg. 14.

46 Ibid, pp. 47-8.

47 Ibid, pp. 31-3

48 Sanchez-Ancochea and Shadlen, pg. 11 (referring to a chapter by Van Harten)

49 Van Harten in Sanchez-Ancochea and Shadlen, pg. 84.

50 Ibid, pg. 102.

51 Bahadian and Carvalho Lyrio in Sanchez-Ancochea and Shadlen, pg. 212.

52 Tussie in Sanchez-Ancochea and Shadlen, pg. 246.

53 Weiss, “The Myth of the Powerless State,” (New York: Cornell University Press, 1998), pg. 24.


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