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Monday, April 30, 2012
Perspectives

The Hemisphere's Spaghetti Bowl of Free-Trade Agreements

The increasingly complicated web of FTAs raises concerns about overlap, duplication and conflicts of rules and technical standards, the author argues.

 

The hemisphere's free-trade agreements—and how to untangle them.

BY JOSE RAUL PERALES
Americas Quarterly

Twenty years after the launch of market reforms, Latin American countries are among the most active players in the international trading system, thanks to their participation in free-trade agreements (FTAs) and preferential market access accords.

As the network of Latin American and Caribbean free-trade agreements matures—with more than 20 intraregional FTAs signed—this is the time  to work toward a convergence of the region’s many agreements and market access rules. Greater coordination would not only strengthen individual economies but foster the region’s global competitive position.

The flurry of regional FTAs began with the 1994 North American Free Trade Agreement (NAFTA) involving Mexico, Canada and the United States. Over the next decade, Mexico went on to sign trade agreements with Costa Rica (1995),  Chile (1999) and the European Union (2000), to name just a few. Those were followed in 2006 by a framework agreement between Mexico and the Common Market of the South (Mercosur)—setting the pace for a veritable wave of Latin American commercial diplomacy.

The passage of FTAs has helped Mexico and Chile become two of the world’s most globalized countries. Chile alone now has 21 agreements with 58 countries, covering 92.5 percent of all merchandise exports and giving its products preferential access to 4.2 billion potential customers.

TRADE BLOC-ING

Overall, the regional trend is to strike FTAs with advanced industrial countries in traditional markets (like North America and Europe), to seek nontraditional partners (especially in East and South Asia), and to conclude intraregional deals within the framework of existing regional integration schemes (like the Latin American Integration Association). Another important area of trade diplomacy is the development of new regional initiatives such as the Arco del Pacífico—a space created in 2007 for regular meetings among ministers of the 11 Latin American countries with Pacific Ocean coasts.

While the trend toward free trade has been generally positive, there have been some recent signs of backlash. For example, policymakers in Argentina added to their list of import restrictions in February 2012 the requirement that a Sworn Affidavit of Intention to Import be completed before importing any merchandise. Last December, Brazil slapped an additional 30 percentage-point tax on selected imported cars.

At the same time, Latin America’s active trade agenda, and the signing of second-generation FTAs, has created an increasingly sophisticated cadre of trade diplomats and bureaucrats in government trade ministries. Newer agreements include clauses not included in earlier trade negotiations, covering areas such as competition policy, services and intellectual property. As a result, FTAs are supporting new spheres of policymaking or the development of new mechanisms that have, in turn, assisted the modernization process in many states.

Peru, for example, created a ministry of environment in 2008 as part of the implementation of its free-trade agreement with the United States. That agreement, which went into effect in 2009, led to significant policy changes that incorporated protection of the environment into Peru’s increasingly complex economy.

Latin America’s higher profile in global commerce was transformative in other ways as well. Trade has become entrenched as an independent policy agenda, apart from demands of foreign policy or strategic interests. One result of this has been a new flexibility in dealing with foreign investment and business-friendly regulatory standards.

Trade’s emergence as a source of policy expertise in its own right has been especially noticeable in countries that have concluded the most FTAs: Mexico, Chile, Costa Rica, and Peru. In 1996, Costa Rica created a ministry of foreign trade to establish the technical and administrative framework for its ambitious trade policy. Like other countries at the time, Costa Rica realized that foreign trade was the clearest route to sustainable economic growth.

The network of free-trade agreements in the hemisphere—58 negotiated and implemented so far—has boosted the total regional share of foreign trade as a percentage of GDP from 31.7 percent in 1988 to 44.7 percent in 2010. Intraregional trade as a proportion of foreign trade also has climbed from an average of 16 percent in 1981 to almost 20 percent in 2007, particularly in Mercosur and in Central America.

With more FTAs in the pipeline, the prospects for an economically integrated continent look bright. Supply chains are increasingly linked, and regional investment poles, like retail and financial services in Central America, are being established.

THE UNHOLY KNOT OF RULES OF ORIGIN

But the growing number of free-trade agreements has also posed management challenges and transaction costs that can potentially affect the gains from free trade.

The increasingly complicated web of FTAs raises concerns about overlap, duplication and conflicts of rules and technical standards. For example, standards vary from agreement to agreement on issues such as the acceptable levels of pesticides for certain agricultural exports and in-country content requirements for machinery equipment exports.

Even when free-trade agreements exist among countries participating in a commodity chain, differences in rules of origin may impose additional costs by forcing producers to change their supply chains to source from an FTA-partner country or from one where the rules of origin involve more favorable terms. This is a salient feature of Mercosur’s automotive regime, which was conceived to promote investments by a key group of transnational companies that sought to boost production linkages and build supply chains with local providers, particularly small- and medium-size businesses.

The Mercosur example illustrates how rules are often tailored in response to sectoral pressures as producers adapt to foreign competition. Rules of origin also may serve a political and economic function: they facilitate an adjustment process to foreign competition that results from greater commercial openness. This is particularly the case in key or sensitive sectors like textiles, autos and agricultural products like poultry or beef.

As countries adapt to freer trade and lower trade barriers, they should, in theory, have greater incentives to standardize the FTAs’ rules of origin. In Latin America, about 89 percent of foreign trade is covered by a preferential or free-trade agreement, while the average external tariff for the remaining items hovers near 10 percent—down from over 40 percent in the early 1980s.  In addition, negotiating an FTA with a powerful trading partner like the U.S. ought to provide another strong incentive to converge rules of origin.

But this has not happened. In more than half of the FTAs concluded by Mexico, Chile and Peru (all signatories to FTAs with the U.S.), the same rules of origin apply for only slightly more than 40 percent of traded products. Regionally, FTAs include a complex web of rules of origin involving nearly 40 annexes of rules per product and 24 regulatory chapters.

Complicated or restrictive rules of origin hinder the development of “cumulation processes” in which producers in one FTA country use inputs from another FTA country to make goods without affecting the preferential status of the finished product. This runs contrary to one of the basic premises of free-trade agreements: countries are likely to be more attractive to foreign investors because preferential market access and the possibility of cumulation allows companies to build lean cross-country supply chains and lower costs of production. Successful examples of cross-border production include textiles in Central America and automobile production in the Mercosur countries.

POLICY RESPONSES

Beyond just getting a trade agreement in place, governments also have to ensure its proper functioning and to develop complementary agendas in areas, such as trade facilitation and customs efficiency, competitiveness policies, and even workforce development. Governments sometimes use the policy space created by FTA implementation to pursue policies associated with, but not strictly belonging to, the concluded trade agreement.

This was the case in Peru. In the wake of negotiating the FTA with the U.S., President Alan García’s government submitted 99 legislative decrees on a wide range of issues, including the creation of a civil service, supposedly to comply with the U.S.–Peru Trade Promotion Agreement.

For countries like Mexico and Chile, implementation of FTAs has created an opportunity to make necessary reforms both in the way trade policy is formulated and in the overall policymaking environment, especially on issues of transparency and the business environment.

These reforms, including competition policy, investment rules and regulatory framework changes, supported the ambitious array of trade negotiations both countries launched in the 1990s.

But doing so requires a commitment of resources, both financial and human, that may lie beyond the means of many government budgets and the capacity of technocrats.  Concerns over these resources and commitments to full FTA implementation have underpinned recent efforts in support of trade facilitation, particularly in the Dominican Republic–Central America–United States Free Trade Agreement (DR-CAFTA) region.

In the same vein, the idea of linking or harmonizing the various Latin American free-trade agreements is gathering strength. Doing so would also reduce the hub-and-spoke behavior of regional FTAs, where multiple countries possess an FTA with a given country (the “hub”), but there is no connection among the different partners (the “spokes”).

In cases where there are similar FTAs—both in terms of scope and actors involved—a convergence of all or portions of these FTAs, especially rules of origin, would dramatically reduce the burdens of administration and enforcement. That would apply, for instance, to the FTAs concluded by Mexico and Chile with Central American countries, or to the partial-scope agreements concluded under the rubric of the Latin American Integration Association.

Convergence would also reduce the private sector’s burden of complying with competing or overlapping rules and regulations, and thereby allow businesses to improve productivity. It would expand the universe of cumulation sources, thus reducing the transaction costs of sourcing and eliminating possible disincentives arising from competing rules applied to the same product.

Consequently, the private sector has expressed interest in convergence. But actual convergence would require a negotiation exercise that may be politically difficult because of the enormous effort required to secure ratification of the FTA in the first place. In some cases, however, specific FTAs have language that allows for the possibility of extended cumulation with other countries that share FTAs, thus avoiding separate approval processes. This is the case in Canada’s FTA with Peru (2009), allowing it to negotiate extension to the other countries with which it shares FTAs (like Chile and the U.S.).

Furthermore, since a substantial percentage of Latin America’s trade already takes place through some type of preferential program, convergence of FTAs can lead to increased gains from trade that extend beyond the actual network of free-trade agreements.  This is different from the now-abandoned dream of creating a Free Trade Area of the Americas.

The countries tied up in individual FTAs have already worked on the elimination of tariff and nontariff barriers for trade in goods and services. Many are now searching for ways to streamline rules and create a more dynamic and efficient way of engaging in free trade. Such is the case for Mexico and the Central American countries, which in November 2011 concluded the process of consolidating their various FTAs into a regionwide trade regime for goods and services.

Considering its central role in the spaghetti bowl of free-trade agreements in Latin America, the U.S. should play a pivotal role in FTA convergence. This could start with harmonizing the rules of origin for textiles in the various FTAs negotiated by the U.S. with Latin America and the Caribbean. Since textiles involve some of the most politically sensitive aspects of trade negotiations, both in the U.S. and in Latin America, an agreement on a single rule of origin for textiles would pave the way for convergence in other realms.

Of course, any move in this direction would require a serious investment of political capital that is currently not evident in Washington.

Yet the current negotiations of the Trans-Pacific Partnership (TPP) between the U.S. and six countries in the Pacific Rim offer a renewed possibility of FTA convergence. Three of the countries engaged in TPP negotiations already have FTAs with the U.S. (Singapore, Chile and Peru) and two others have applied for admission into the negotiations (Mexico and Canada). Their accession raises the chance that, given the convergence of possibilities already being negotiated among these countries, the process might eventually be expanded to all Latin American countries in the Pacific Rim that have an FTA with the United States.

Given that it remains the central axis for most trade agreements in the region, the U.S. is uniquely positioned to start the process. Political support for trade expansion is difficult, but already the movement toward harmonization is starting to pick up strong backing from the U.S. and regional business communities.

This should surprise no one. If Latin America is to fully realize the potential unlocked by trade liberalization, it must move in the direction of greater convergence.

The foundation has already been laid. The region already has a robust set of trade rules and preferential pacts that have woven together markets that once operated at cross-currents to one another.

Arguably, the task of harmonization will be no easier to accomplish. Existing free-trade agreements must be fully implemented, and the clutter of overlapping rules and regulations that continue to stand in the way of full harmonization must be eliminated—with the ultimate goal of developing a set of clear and transparent rules for doing business anywhere in the Americas.

But by keeping that goal firmly in mind, the governments of the Americas can free up the resources and  recently developed expertise currently devoted to FTA management to craft policies that can truly bolster the region’s competitive position—and at the same time improve the lives and living conditions of their people.

José Raúl Perales is executive director of the Association of American Chambers of Commerce in Latin America (AACCLA) and a lecturer at the Elliott School of International Affairs at The George Washington University. The expressions and opinions contained in the text are the author’s alone and do not represent the official position of AACCLA or the U.S. Chamber of Commerce.

A previous version of this article appeared in Spring 2012 Americas Quarterly (www.americasquarterly.org)

 

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