By Martn Rama, Chief Economist, Latin America and Caribbean (LAC), The World Bank

This article was originally published in the Winter/February 2020 edition of International Banker

After a period of rapid economic growth associated with high commodity prices, the Latin America and Caribbean region has entered a new phase of lackluster performance. In a recent report, we at the World Bank assessed whether deep South-North trade agreements, such as the United States-Mexico-Canada Agreement (USMCA) and European Union-Mercosur (Mercosur members include Argentina, Brazil, Paraguay and Uruguay) deals signed last year, could be a source of new dynamism. The answer is a resounding yes, but the spatial and environmental impacts of the agreements require attention.

During the golden decade of high commodity prices, the growth rate of Latin America and the Caribbean lay somewhere in between that of advanced economies and the more vigorous results of other emerging markets, especially in Asia. Not anymore: for the last three years, the gross domestic product (GDP) growth rate of the region has been around two percentage points lower than that of the much richer advanced economies, in a clear sign of economic divergence. In 2019, it did not even reach 1 percent.

There is variation within the region, but it is not wide enough to modify the big picture. Overall, countries in the Pacific and the Caribbean subregions have done better than those in the Atlantic subregion. This last group of countries comprises Mercosur members, as well as Venezuela, which has experienced a dramatic economic meltdown. A few individual countries continue to do well, but the largest economies in the region have faced recession, macroeconomic turbulence or growth deceleration. And across the region, a wave of social unrest serves as a reminder that local populations expect much more.

It would be tempting to attribute the sluggish growth of the region to a less conducive external environment or to trade-related tensions. But commodity prices have stabilized in recent years, and the terms of trade have slightly improved for the region. Also, trade diversion from the US-China tension might have benefitted some countries in the regionespecially Mexico and Brazil. The slowdown is in large part related to the problems in local economies, not just to the outside world.

A possible contributor to the sluggish economic growth of the Latin America and Caribbean region is its relatively low integration in international trade and global value chains. Exposure to world markets brings in more choices and fosters competition. Selling abroad requires reaching high-quality standards and meeting tight deadlines. And in the process of trading with more advanced economies, much is learned about technical innovations and management practices.

A standard measure of a countrys external openness is the ratio of its international trade to its overall economic activity. In practice, this ratio is often computed by adding up exports and imports of goods and services and then dividing by the countrys GDP. By this measure, the Latin America and Caribbean area has the lowest external openness among all developing regions

The regions inward orientation is in part the result of economic-policy choices. Some of those choices are related to explicit tariff barriers. Other policy choices are related to logistics and trade facilitation, including limited competition in port and transport services, deficient infrastructure and burdensome customs procedures. And then, there are non-tariff barriers, under the form of licensing procedures or sanitary inspections. Some of them are justified for public health and other defensible reasons. Many may reflect disguised protectionism.

Measuring policy choices related to international trade is challenging. Explicit tariffs are easy to quantify for individual products, but converting a slow port or a burdensome customs administration into an equivalent price surcharge may require multiple assumptions. Aggregating tariff and non-tariff barriers across sectors of activity, or for the entire economy, raises an additional methodological complication.

However, regardless of the metric used, the Latin America and Caribbean region is among the most protectionist developing regions (Figure 1). And not surprisingly, barriers to international trade are highest among countries in the stagnating Atlantic subregion.

Figure 1. The Latin America and Caribbean area has among the highest trade barriers of all regions

Such inward orientation may come as a surprise, given the large number of preferential trade agreements signed by countries in the region over the last few decades. Some of the most significant regional initiatives are the Andean Community agreement (1969), the Caribbean Community or CARICOM (1973), the Latin American Integration Association or ALADI (1980), Mercosur (1991), the Dominican Republic-Central America Free Trade Agreements or CAFTA-DR (2004) and the Pacific Alliance (2012).

By now, the number of agreements per country is the highest among all developing regions. Given that agreements may involve varying numbers of countries on each side, a defensible way to conduct the comparison is to count the number of bilateral trade agreements signed by each country participating in an agreement. For example, when Argentina, Brazil, Paraguay and Uruguay joined Mercosur, each country signed three agreements, so, in total, 12 (4 times 3) bilateral trade agreements were signed. By this way of counting, countries in Latin America and the Caribbean have signed 441 bilateral trade agreements over the last half-century. So, how come they remain so inward-oriented?

The answer is that most of these agreements are South-South rather than South-North. In fact, until the signing of the North American Free Trade Agreement (NAFTA) in 1994, with Mexico as one of its members, these agreements were all intra-regional. Only in recent years have South-North agreements become more common, especially among countries in the Caribbean and the Pacific subregions. The latest examples of South-North agreements are the renegotiation of NAFTA as the United States-Mexico-Canada Agreement (USMCA) and the EU-Mercosur Agreement, both of them signed over the last 12 months.

Figure 2. Most trade agreements in Latin America and the Caribbean are intra-regional

While all preferential trade agreements create export opportunities, some offer much better possibilities because they provide access to bigger and richer markets, and they enable knowledge exchange with more advanced economies once implemented. Thus, the potential for productivity transfers embedded in the exchange of goods and services may vary substantially across trade deals.

To account for market size, each trade agreement can be weighted by the product of the GDP of the two signing parties measured as a share of global GDP. This way of counting obviously increases the importance of those that involve an advanced economy. By this metric, the 110 bilateral trade agreements signed under ALADI become equivalent to the two agreements signed by Mexico under NAFTA.

Further, to account for learning effects, each trade agreement can additionally be weighted by the degree of economic sophistication of the signatories, as measured by their Economic Complexity Index (ECI). The ECI computes the diversity of a countrys exports and their ubiquity, as reflected in the number of countries in the world that produce them. By this more telling metric, it takes the equivalent of two ALADI agreements to reach the same economic potential as NAFTA.

Not surprisingly, it also appears that the share of South-North agreements in the total (weighted) number of trade agreements signed by each country is much higher in the Caribbean and Pacific subregions than on the Atlantic side of the region.

South-North agreements also tend to be deeper than South-South agreements. Many of them reach beyond tariff reductions to cover through legally enforceable provisions new policy areas such as customs procedures, cross-border investments, competition policies, public procurement, state-owned enterprises and intellectual-property rights. By comparison, Mercosur includes very few provisions beyond tariffs, and even those have proved difficult to enforce.

A new analysis was conducted by my team to assess the growth impact of trade agreements of different sorts. The analysis builds on data from 60 economies over the last six decades. The results confirm that a positive relationship exists between trade openness and economic growth. They also show that trade openness carries the risk of heightened macroeconomic instability. However, this second regularity hides quite a lot of heterogeneity. When the 60 countries are split based on their ECIs, it appears that in less-complex economies, greater openness is associated with substantially larger volatility, whereas the opposite is true in more complex economies (Figure 3).

Figure 3. Volatility falls with trade openness in more complex economies

These results imply that trade integration may lead to better economic outcomes if it results in an increase in economic complexity. A comparison between NAFTA and Mercosur is telling in this respect. A simple before-versus-after comparison shows that the volume of trade unambiguously increased in both cases. But while Mexicos ECI was boosted by the agreement, there were almost no changes in the ECIs of Mercosur countries, with the possible exception of Paraguay.

A more rigorous econometric analysis based on the panel with 60 countries over six decades confirms that preferential trade agreements lead to greater trade and that the type of agreement matters. A South-North agreement tends to expand the trade volume of a typical developing country by around 12 percent of GDP over time, 5 percentage points more than a South-South agreement. A South-North agreement also increases the ECI of a typical developing country by 25 points, on a normalized scale from 0 to 100. On the flip side, signing a South-South agreement with other developing countries tends to reduce the ECI score of a typical developing country by as much as five points. Considering the ensuing dynamics, a typical developing country would be around 2 percent richer a dozen years after entering into a South-South agreement but 10 percent richer if a South-North agreement had been signed instead.

Based on these findings, USMCA and EU-Mercosur, the two milestone South-North agreements signed in 2019, could reinvigorate countries with economic growth that has once again stalled. But there could be negative impacts on other fronts.

Trading with countries that have substantially different comparative advantages may entail more economic restructuring than trading with similar countries. Deep agreements also bring in changes affecting the entire economy, such as higher labor standards or greater market competition. And by stimulating the development of sectors with higher carbon emissions, or potentially leading to deforestation, these agreements can also have environmental impacts that need to be assessed as well.

A detailed analysis of the expected impacts of the USMCA and the EU-Mercosur deals, conducted by my office, shows that they will not entail major structural transformation. Agriculture and livestock production will expand in Mercosur countries and skill-intensive manufacturing in Mexico. But except for a few activities, changes in output and employment are not expected to be dramatic. Moreover, there will be both expansion and contraction within aggregated sectors, with the effects roughly offsetting each other, so that the overall structure in terms of agriculture, manufacturing and services will remain almost unchanged.

Income distribution should not change much either. Because the agreements do not lead to major structural restructuring, and they are bound to be implemented gradually, no major losses in sectoral employment are expected. Needless to say, by encouraging soy and livestock production, the EU-Mercosur agreement will boost land rent. But skilled workers will also benefit considerably in Mexico as will unskilled workers in Mercosur countries.

At the same time, these two agreements will have consequences requiring attention. The spatial concentration of economic activity implies that some municipalities, departments and districts will strongly benefit, while others will be adversely affected (Map 1). Similarly, substantial growth impacts will lead to greater carbon-dioxide (CO2) emissions, and the expansion of livestock production in Brazil could result in substantial deforestation (Map 2).

Map 1. A potentially greater spatial polarization in Mexico

Map 2. Livestock production will expand mainly in Brazils Serrado region

In sum, at a time when the multilateral avenue to trade integration does not look promising, deep South-North agreements offer a chance for Latin American and Caribbean countries to export to bigger and more sophisticated markets, to integrate themselves into global value chains, and to learn and increase their productivity along the way. But infrastructure, regulatory and administrative bottlenecks need to be removed for this to happen.

At the same time, it would be unwise to downplay the tradeoffs associated with greater trade integration. As with most major reforms, there will likely be winners and losers. Spatial divergence could be amplified, and specific areas could suffer. Meanwhile, carbon-dioxide emissions would increase and the forest-covered surfaces decrease. These downsides call for place-based policies to redress the imbalances and for environmental policies to offset the damage.

References:

The World Bank, Semiannual Report of the Latin America and Caribbean Region, October 2019

ABOUT THE AUTHOR

Martn Rama is currently the Chief Economist for the Latin America and Caribbean region of The World Bank. From 2013 to 2018, he held the same position for the South Asia region, based in Delhi. Previously he was the Director of the World Development Report 2013 on Jobs. From 2002 to 2010, he was based in Hanoi, where he led the economic program of The World Bank in Vietnam.

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Reinvigorating Economic Growth in Latin America and the Caribbean: Can deep trade agreements help? - International Banker