Chapter 8 Outline

Regional Economic Integration in the Americas

No other attempt at regional economic integration comes close to the EU in its boldness or its potential implications for the world economy, but regional economic integration is on the rise in the Americas. The most significant attempt is the North American Free Trade Agreement. In addition to NAFTA, several other trade blocs are in the offing in the Americas (see Map 8.2), the most significant of which appear to be the Andean Group and MERCOSUR. There are also plans to establish a hemispherewide Free Trade Area of the Americas by 2005.

The North American Free Trade Agreement

The governments of the United States and Canada in 1988 agreed to enter into a free trade agreement, which took effect January 1, 1989. The goal of the agreement was to eliminate all tariffs on bilateral trade between Canada and the United States by 1998. This was followed in 1991 by talks among the United States, Canada, and Mexico aimed at establishing a North American Free Trade Agreement for the three countries. The talks concluded in August 1992 with an agreement in principle.

Map 8.2 see

Economic Integration in the Americas

Both Canada and Mexico committed themselves to NAFTA by the fall of 1993, leaving only the US government to signal its intention to go forward with the agreement. The Clinton administration had already committed itself to NAFTA, and passage by the Senate looked likely, but the agreement faced stiff opposition in the House of Representatives. A last-minute round of lobbying by President Clinton helped the bill pass the House by a comfortable margin on November 17, 1993.

NAFTA's Contents

The agreement became law January 1, 1994.²⁰ The contents of NAFTA include the following:

• Abolition within 10 years of tariffs on 99 percent of the goods traded between Mexico, Canada, and the United States.

• Removal of most barriers on the cross-border flow of services, allowing financial institutions, for example, unrestricted access to the Mexican market by 2000.

• Protection of intellectual property rights.

• Removal of most restrictions on foreign direct investment between the three member countries, although special treatment (protection) will be given to Mexican energy and railway industries, American airline and radio communications industries, and Canadian culture.

• Application of national environmental standards, provided such standards have a scientific basis. Lowering of standards to lure investment is described as being inappropriate.

• Establishment of two commissions with the power to impose fines and remove trade privileges when environmental standards or legislation involving health and safety, minimum wages, or child labor are ignored.

Arguments for NAFTA

Opinions remain divided as to the consequences of NAFTA. Proponents argue that NAFTA should be viewed as an opportunity to create an enlarged and more efficient productive base for the entire region. One likely short-term effect of NAFTA will be that many US and Canadian firms will move some production to Mexico to take advantage of lower labor costs. In 1991, the average hourly labor cost in Mexico was $2.32, compared with $14.31 in the United States and $14.71 in Canada. Movement of production to Mexico is most likely to occur in low-skilled, labor-intensive manufacturing industries where Mexico might have a comparative advantage (e.g., textiles). Many will benefit from such a trend. Mexico benefits because it gets much-needed investment and employment. The United States and Canada should benefit because the increased incomes of the Mexicans will allow them to import more US and Canadian goods, thereby increasing demand and making up for the jobs lost in industries that moved production to Mexico. US and Canadian consumers will benefit from the lower prices of products produced in Mexico. In addition, the international competitiveness of US and Canadian firms that move production to Mexico to take advantage of lower labor costs will be enhanced, enabling them to better compete with Asian and European rivals.

Arguments against NAFTA

Those who opposed NAFTA claimed that ratification would be followed by a mass exodus of jobs from the United States and Canada into Mexico as employers sought to profit from Mexico's lower wages and less strict environmental and labor laws. According to one extreme opponent, Ross Perot, up to 5.9 million US jobs would be lost to Mexico after NAFTA. Most economists, however, dismiss these numbers as being absurd and alarmist. They point out that Mexico would have to run a bilateral trade surplus with the United States of close to $300 billion for job loss on such a scale to occur--and $300 billion is about the size of Mexico's present GDP. In other words, such a scenario is implausible.

More sober estimates of the impact of NAFTA ranged from a net creation of 170,000 jobs in the United States (due to increased Mexican demand for US goods and services) and an increase of $15 billion per year to the US and Mexican GDP, to a net loss of 490,000 US jobs. To put these numbers in perspective, employment in the US economy was predicted to grow by 18 million from 1993 to 2003. As most economists repeatedly stress, NAFTA will have a small impact on both Canada and the United States. It could hardly be any other way, since the Mexican economy is only 5 percent of the size of the US economy. Signing NAFTA required the largest leap of economic faith from Mexico rather than Canada or the United States. Falling trade barriers are exposing Mexican firms to highly efficient US and Canadian competitors that, when compared to the average Mexican firm, have far greater capital resources, access to highly educated and skilled work forces, and much greater technological sophistication. The short-run outcome is bound to be painful economic restructuring and unemployment in Mexico. But if economic theory is any guide, there should be dynamic gains in the long run in the efficiency of Mexican firms as they adjust to the rigors of a more competitive marketplace. To the extent that this happens, an acceleration of Mexico's long run rate of economic growth will follow, and Mexico might yet become a major market for Canadian and US firms.²¹

Environmentalists have also voiced concerns about NAFTA. They point to the sludge in the Rio Grande River and the smog in the air over Mexico City and warn that Mexico could degrade clean air and toxic-waste standards across the continent. Already, they claim, the lower Rio Grande is the most polluted river in the United States, increasing in chemical waste and sewage along its course from El Paso, Texas, to the Gulf of Mexico.

There is also continued opposition in Mexico to NAFTA from those who fear a loss of national sovereignty. Mexican critics argue that their country will be dominated by US firms that will not really contribute to Mexico's economic growth, but instead will use Mexico as a low-cost assembly site, while keeping their high-paying, high-skilled jobs north of the border.

The Early Experience

The first year after NAFTA turned out to be a largely positive experience for all three countries. US trade with Canada and Mexico expanded at about twice the rate of trade with non-NAFTA countries in the first nine months of 1994, compared with the same period in 1993. US exports to Mexico grew by 22 percent, while Mexican exports to the United States grew by 23 percent. Anti-NAFTA campaigners had warned of doom for the US auto industry, but auto exports of autos to Mexico increased by nearly 500 percent in the first nine months of 1993. The US Commerce Department estimated that the surge in exports to Mexico secured about 130,000 US jobs, while only 13,000 people applied for aid under a program designed to help workers displaced by the movement of jobs to Mexico, suggesting that job losses from NAFTA had been small.²²

However, the early euphoria over NAFTA was snuffed out in December 1994 when the Mexican economy was shaken by a financial crisis. Through 1993 and 1994, Mexico's trade deficit with the rest of the world had grown sharply, while Mexico's inflation rate had started to accelerate. This put increasing pressure on the Mexican currency, the peso. Traders in the foreign exchange markets, betting that there would be a large decline in the value of the peso against the dollar, began to sell pesos and buy dollars. As a result, in December 1994, the Mexican government was forced to devalue the peso by about 35 percent against the dollar. This effectively increased the cost of imports from the United States by 35 percent. The devaluation of the peso was followed quickly by a collapse in the value of the Mexican stock market, and the country suddenly and unexpectedly appeared to be in the midst of a major economic crisis. Shortly afterward, the Mexican government introduced an austerity program designed to rebuild confidence in the country's financial institutions and reign in growth and inflation. The program was backed by a $20 billion loan guarantee from the US government.²³

One result of this turmoil has been a sharp decline in Canadian and US exports to Mexico. Many companies have also reduced or put on hold their plans to expand into Mexico. NAFTA critics seized on Mexico's financial crisis to crow that they had been right. But in reality, just as the celebrations of NAFTA's success were premature, so are claims of its sudden demise. Early studies of NAFTA's impact suggest that so far at least, its effects have been at best muted.²⁴ The most comprehensive study to date was undertaken by researchers at the University of California, Los Angeles, and funded by various departments of the US government.²⁵ Their findings are enlightening. First, they conclude that the growth in trade between Mexico and the United States began to change nearly a decade before the implementation of NAFTA when Mexico unilaterally started to liberalize its own trade regime to conform with GATT standards. The period since NAFTA took effect has had little impact on trends already in place. The study found that trade growth in those sectors that underwent tariff liberalization in the first two and a half years of NAFTA was only marginally higher than trade growth in sectors not yet liberalized. For example, between 1993 and 1996, US exports to Mexico in sectors liberalized under NAFTA grew by 5.83 percent annually, while exports in sectors not liberalized under NAFTA grew by 5.35 percent. In short, the authors argue that NAFTA has so far had only a marginal impact on the level of trade between the United States and Mexico.

As for NAFTA's much-debated impact on jobs in the United States, the study concluded that the impact was positive but very small. The study found that while NAFTA created 31,158 new jobs in the United States, 28,168 jobs were also lost due to imports from Mexico, for a net job gain of around 3,000 in the first two years of the NAFTA regime.

However, as the authors of the report point out, trade flows and employment in 1995 and 1996 were significantly affected by the consequences of the peso devaluation and subsequent economic crisis that gripped Mexico in early 1995. Given this, it is probably too early to draw conclusions about the true impact of NAFTA on trade flows and employment. It will be a decade or more before any meaningful conclusions can be stated. The most that can be said at this juncture is that while the optimistic picture of job creation painted by NAFTA's advocates has not yet come to pass, neither has the apocalyptic vision of widespread job losses in the United States and Canada propagated by NAFTA's opponents.

Enlargement

One big issue now confronting NAFTA is that of enlargement. A number of other Latin American countries have indicated their desire to eventually join NAFTA. The governments of both Canada and the United States are adopting a wait-and-see attitude with regard to most countries. Getting NAFTA approved was a bruising political experience, and neither government is eager to repeat the process soon. Nevertheless, the Canadian, Mexican, and US governments began talks in May 1995 regarding Chile's possible entry into NAFTA. So far, however, these talks have yielded little progress, primarily because of political opposition to expanding NAFTA in the US Congress.

The Andean Pact

The Andean Pact was formed in 1969 when Bolivia, Chile, Ecuador, Colombia, and Peru signed the Cartagena Agreement. The Andean Pact was largely based on the EU model, but it has been far less successful at achieving its stated goals. The integration steps begun in 1969 included an internal tariff reduction program, a common external tariff, a transportation policy, a common industrial policy, and special concessions for the smallest members, Bolivia and Ecuador.

By the mid-1980s, the Andean Pact had all but collapsed, and had failed to achieve any of its stated objectives. There was no tariff-free trade between member countries, no common external tariff, and no harmonization of economic policies. The attempt to achieve cooperation between member countries seems to have been hindered by political and economic problems. The countries of the Andean Pact have had to deal with low economic growth, hyperinflation, high unemployment, political unrest, and crushing debt burdens. In addition, the dominant political ideology in many of the Andean countries during this period tended toward the radical/socialist end of the political spectrum. Since such an ideology is hostile to the free market economic principles on which the Andean Pact was based, progress toward closer integration could not be expected.

The tide began to turn in the late 1980s when, after years of economic decline, the governments of Latin America began to adopt free market economic policies. In 1990, the heads of the five current members of the Andean Pact--Bolivia, Ecuador, Peru, Colombia, and Venezuela--met in the Galápagos Islands. The resulting Galápagos Declaration effectively re-launched the Andean Pact. The declaration's objectives included the establishment of a free trade area by 1992, a customs union by 1994, and a common market by 1995.

While this last milestone has not been reached, there are some grounds for cautious optimism. For the first time, the controlling political ideology of the Andean countries is at least consistent with the free market principles underlying a common market. In addition, since the Galápagos Declaration, internal tariff levels have been reduced by all five members, and a customs union with a common external tariff was established in mid-1994, six months behind schedule.

Significant differences between member countries still exist that may make harmonization of policies and close integration difficult. For example, Venezuela's GNP per person is four times that of Bolivia's, and Ecuador's tiny production-line industries can not compete with Colombia's and Venezuela's more advanced industries. Such differences are a recipe for disagreement and suggest that many of the adjustments required to achieve a true common market will be painful, even though the net benefits will probably outweigh the costs.²⁶ To complicate matters even further, in recent years Peru and Ecuador have fought a border war, Venezuela has remained aloof during a banking crisis, and Colombia has suffered from domestic political turmoil and problems related to its drug trade. This has led some to argue that the pact is more "formal than real."²⁷ However, the outlook for the Andean Pact started to change in 1998 when the group entered into negotiations with MERCOSUR to establish a South American free trade area.

MERCOSUR

MERCOSUR originated in 1988 as a free trade pact between Brazil and Argentina. The modest reductions in tariffs and quotas accompanying this pact reportedly helped bring about an 80 percent increase in trade between the two countries in the late 1980s.²⁸ Encouraged by this success, the pact was expanded in March 1990 to include Paraguay and Uruguay. The initial aim was to establish a full free trade area by the end of 1994 and a common market sometime thereafter. The four countries of MERCOSUR have a combined population of 200 million. With a market of this size, MERCOSUR could have a significant impact on the economic growth rate of the four economies.

In December 1995, MERCOSUR's members agreed to a five-year program under which they hoped to perfect their free trade area and move toward a full customs union. Also, the four member states of MERCOSUR have now formally committed themselves to establishing a wider free trade area, the South American Free Trade Area (SAFTA). The goal is to bring other South American countries into the agreement, including the nations of the Andean Pact, and to have internal free trade for not less of 80 percent of goods produced in the region by 2005.²⁹

MERCOSUR seems to be making a positive contribution to the economic growth rates of its member states. Trade between MERCOSUR's four core members grew from $4 billion in 1990 to $16.9 billion in 1996. Moreover, the combined GDP of the four member states grew at an annual average rate of 3.5 percent between 1990 and 1996, a performance that is significantly better than the four attained during the 1980s.³⁰

However, MERCOSUR has its critics, including Alexander Yeats, a senior economist at the World Bank, who wrote a stinging critique of MERCOSUR that was "leaked" to the press in October 1996.³¹ According to Yeats, the trade diversion effects of MERCOSUR outweigh its trade creation effects. Yeats points out that the fastest-growing items in intra-MERCOSUR trade are cars, buses, agricultural equipment, and other capital-intensive goods that are produced relatively inefficiently in the four member countries. In other words, MERCOSUR countries, insulated from outside competition by tariffs that run as high as 70 percent of value on motor vehicles, are investing in factories that build products that are too expensive to sell to anyone but themselves. The result, according to Yeats, is that MERCOSUR countries might not be able to compete globally once the group's external trade barriers come down. In the meantime, capital is being drawn away from more efficient enterprises. In the near term, countries with more efficient manufacturing enterprises lose because MERCOSUR's external trade barriers keep them out of the market.

The leak of Yeats's report caused a storm at the World Bank, which typically does not release reports that are critical of member states (the MERCOSUR countries are members of the World Bank). It also drew strong protests from Brazil, which was one of the primary targets of Yeats's critique. Still, in tacit admission that at least some of Yeats's arguments have merit, a senior MERCOSUR diplomat let it be known that external trade barriers will gradually be reduced, forcing member countries to compete globally. Many external MERCOSUR tariffs, which average 14 percent, are lower than they were before the group's creation, and there are plans for a hemispheric Free Trade Area of the Americas to be established by 2005 (which will combine MERCOSUR, NAFTA, and other American nations). If that occurs, MERCOSUR will have no choice but to reduce its external tariffs further.

Central American Common Market and CARICOM

There are two other trade pacts in the Americas, although neither has made much progress as yet. In the early 1960s, Costa Rica, El Salvador, Guatemala, Honduras, and Nicaragua attempted to set up a Central American common market. It collapsed in 1969 when war broke out between Honduras and El Salvador after a riot at a soccer match between teams from the two countries. Now the five countries are trying to revive their agreement, although no definite progress has been made.

Then there is the customs union that was to have been created in 1991 between the English-speaking Caribbean countries under the auspices of the Caribbean Community. Referred to as CARICOM, it was originally established in 1973. However, it has repeatedly failed to progress toward economic integration. A formal commitment to economic and monetary union was adopted by CARICOM's member states in 1984, but since then little progress has been made. In October 1991, the CARICOM governments failed, for the third consecutive time, to meet a deadline for establishing a common external tariff.

Free Trade Area of the Americas

At a hemispherewide "Summit of the Americas" in December 1994 a proposal was made to establish a Free Trade Area of the Americas (FTAA). It took over three years for talks to be begin, but in April 1998, 34 heads of state traveled to Santiago, Chile, for the second Summit of the Americas where they formally inaugurated talks to establish an FTAA by 2005. The talks will continue for seven years and will address a wide range of economic, political, and environmental issues related to cross-border trade and investment. Although the United States was an early advocate of an FTAA, at this point support from the United States seems to be mixed. Since the United States has by far the largest economy in the region, strong US support is a pre-condition for establishment of an FTAA.

Canada is chairing the crucial first stage of negotiations and will host the next Summit of the Americas, either in 2001 or 2002. If an FTAA is established, it will have major implications for cross-border trade and investment flows within the hemisphere, but at this point it is a long way off.