Latin America: crisis of regionalism vs advancement of economic integration
Recent trade discord highlights the need for creation of a free-trade area
Many regional organizations in Latin America are currently in crisis or confronted with the risk of dissolution. This is the case for the Union of South American States (UNASUR), where half of its members suspended their participation and stopped their financial contributions. The Government of Colombia even announced that it will exit the organization. However, crises may also create opportunities.
While the perspectives of high-flying political cooperation projects have been overrated, the advances of Latin American economic regionalism have been underrated. Latin American governments should capitalize more on these progresses in times of crisis. Moreover, according to Intal-Latinbarometro survey data from 2017, four of five Latin Americans support both economic integration and free trade with other countries in the region.
At present there are no less than 33 preferential trade agreements between Latin American and Caribbean (LAC) countries and as much as 90% of regional trade value is already under preference. Most sub-regional preferential trade agreements will have reached their full-liberalization potential by 2020. Thus, most of the adjustment costs after intraregional trade liberalization have already been paid. Moreover, since 2016 the Pacific Alliance and Mercosur have been negotiating a closer cooperation.
Based on these advances, international organizations such as the Inter-American Development Bank, the International Monetary Fund or the World Bank Group make a strong case for the creation of a LAC free trade area, which would constitute a market of scale for local industries with approximately 7% of global gross domestic product (GDP).
However, such a free trade area should advance beyond liberalizing trade tariffs. It should remove non-tariff barriers, especially sanitary and phytosanitary standards and technical barriers, to trade without watering down the standards of protection for consumers and the environment.
A successful policy of integration has to combine political and economic cooperation. Regional integration should be more then trade. Still, one can also argue that regional integration projects that do not take into account the commercial dimension are incomplete. Moreover, they have lower exit costs, as the UNASUR case demonstrates. A comprehensive regional integration project must include trade as the basis for major economic regionalization which will be also beneficial for the integration into the global economy.
Until now a major challenge for the LAC region is the relatively low share of intraregional trade compared to other world regions. Exports are very much concentrated in the commodity sector. While the percentage of intraregional trade increased in 2017 and 2018, it is still below the 2010 level. In most sub-regional integration schemes it is still well below 20% – the only exception being Central America. For Latin America there exists no trade hub comparable to China in Asia; the United States of America is a more important trade partner than larger Latin American countries. As a result trade is concentrated outside the region, with the United States, China and Europe representing the region’s largest markets.
Given the structure of Latin American economies and prevailing trade patterns, one might ask whether it makes sense to invest in regional integration instead of focusing on integration into the global economy. However, geographic forces and the economic strength of a region condition the success of a country’s global integration strategies. As a result the economic performance of a country in the long run (but also in the short run) is closely correlated with that of its neighbors.
Compared to extra-regional exports, LAC intraregional exports comprise a larger percentage of manufactured products. Exports are of higher quality and have more technological content. Also, a greater variety of products are traded intra-regionally with a higher participation of small and medium-sized enterprises (SMEs). Thus trade connections with regional partners might produce larger growth effects than interregional trade connections.
The question then is how to increase intraregional trade. The so-called Balkanization of regional integration agreements and a multiplicity of rules hinder LAC from reaping the full potential of existing trade agreements. Moreover, the two largest Latin American economies – Brazil and Mexico – are not linked by a preferential trade agreement.
This might change in the case of a free trade agreement between Mercosur and the Pacific Alliance. The rules of origin determine what products can benefit from bilateral or multilateral tariff preferences. There are currently 47 different rules of origin included in the 33 preferential trade agreements in Latin America. Harmonizing the trade rules between existing sub-regional trading blocs would generate prospects for increased intra-industry trade and the formation of regional value chains. It would contribute to strengthening the region’s capacity to compete in both the regional market and the global economy.
However, Latin America also lags behind other regions in terms of adequate roads and railways as well as in port and airport efficiency. The lowering of transport costs by improving the infrastructure and the interoperability of national customs systems is another prerequisite and tool to increase intraregional trade.
In the current crisis of Latin American regionalism, a strategy based on pragmatic progress seems to be most promising. Future regionalism projects there should be grounded in more regionalization in the economic realm. The existing network of preferential trade agreements provides a very useful platform for expansion and the implementation of a regional free trade area. This can be done step by step and country by country. While not all countries will (or must) participate, countries have to live up to their political and economic status and take on a leadership role. Looking ahead, processes of economic regionalization might induce new regional projects, not the other way around.