BP-452E

TABLE OF CONTENTS

SUMMARY

INTRODUCTION

LATIN AMERICAN ECONOMIC REFORMS

REGIONAL ECONOMIC INTEGRATION: A GLOBAL PHENOMENON

SUBREGIONAL TRADING ARRANGEMENTS IN THE WESTERN HEMISPHERE

   A. Origins of Subregional Trade Agreements

   B. Subregional Economic Integration Trends

   C. Typology of Economic Integration

   D. Customs Unions

      1. Mercosur

      2. The Andean Group

      3. Central American Common Market

      4. Caribbean Community and Common Market (Caricom)

   E. Free Trade Agreements

      1. North American Free Trade Agreement (NAFTA)

      2. The Canada-Chile Free Trade Agreement

      3. Other Completed Free Trade Agreements

      4. Prospective Free Trade Agreements

   F. Preferential Agreements

      1. Caribbean Basin Initiative

      2. Caribcan

      3. Andean Trade Preference Act (ATPA)

      4. Caricom-Venezuela

      5. Caricom-Colombia

   G. Sectoral Agreements

      1. Latin American Integration Association

PROGRESS TOWARDS FTAA NEGOTIATIONS

   A. The Summit of the Americas

   B. The First Trade Ministerial (Denver)

   C. The Second Trade Ministerial (Cartagena)

   D. The Third Trade Ministerial (Belo Horizonte)

   E. Next Steps

CONCLUSION

THE HEMISPHERIC FREE TRADE PROCESS*

Between 9-11 December 1994, 34 leaders representing every country except Cuba in North America, Latin America and the Caribbean (LAC) gathered in Miami at a Summit of the Americas and agreed to complete negotiations by the year 2005 on a Free Trade Area of the Americas (FTAA). If successful, these negotiations will create the world’s largest trading bloc with 750 million people and a combined economy of almost US$10 trillion. Since the Summit of the Americas was held in 1994, trade officials in the hemisphere have been laying the groundwork for formal negotiations, slated for launch in March 1998 at a second Summit of the Americas in Santiago, Chile.

The first part of this four-part paper briefly describes the dramatic economic reforms that have swept LAC countries over the past 10 years. The changes are significant because they put these countries back on a realistic development course and improve the countries’ ability to accept the kind of trade obligations likely to be required as part of a hemispheric free trade agreement. For some time now, world trade has been coalescing into regional trading groups; the paper’s second section illustrates this global trend by discussing the growing share of trade that is intra-regional in nature. It also shows that two regions -- LAC and East Asia -- are becoming more important markets for other regions’ exports.

The paper’s third part examines economic integration within the Western Hemisphere. The rejuvenation of existing trade agreements and the creation of new accords are knitting together the Hemisphere economically while creating an increasingly complex web of trading rules. Fourth, the paper summarizes the preparations for negotiation of a hemisphere-wide free trade agreement, known as the Free Trade Area of the Americas (FTAA). So far, Western Hemisphere Trade Ministers have held three meetings and 12 Working Groups are gathering and compiling information on the status of hemispheric trading relations.

The final section assesses the economic integration processes at work in the hemisphere. Unless the U.S. President is granted "fast track" trade negotiating authority,** there is little chance that substantive FTAA negotiations will proceed. Regardless of whether or not FTAA negotiations are successful, however, hemispheric economic integration is likely to increase as subregional trade agreements deepen and proliferate. However, a single hemisphere-wide agreement, such as the FTAA, would provide a simpler, more transparent trading environment than the complex web of rules resulting from the rising number of such subregional agreements.

Between 9-11 December 1994, 34 leaders representing every country (except Cuba) in North America, Latin America and the Caribbean (LAC) gathered in Miami at a Summit of the Americas and agreed to complete negotiations by the year 2005 on a Free Trade Area of the Americas (FTAA). If successful, these negotiations will create the world’s largest trading bloc with 750 million people and a combined economy of almost US$10 trillion. Since the Summit of the Americas was held in 1994, trade officials in the hemisphere have been laying the groundwork for formal negotiations, slated to be launched in March 1998 at a second Summit of the Americas, this time in Santiago, Chile.

The proposal to extend free trade from Alaska to Argentina was first put forward in 1990 by former U.S. President George Bush, as part of the Enterprise for the Americas Initiative. Free trade with the United States offered Latin American exporters improved access to the huge U.S. market. It also provided a way to lock in economic reforms, reassuring foreign investors that the new pro-market policies would not be reversed. Mexico’s eagerness to sign the North American Free Trade Agreement (NAFTA) was based in part on improving that country’s ability to attract foreign investment.

The decision by Latin American leaders to embrace free trade with the United States represented a startling change of heart. Even ten years earlier, the creation of closer economic links with the United States would not have been possible, given Latin America’s historic fear of U.S. domination. Latin America’s acceptance of the idea of free trade with the United States was part of a general move by these countries towards market-oriented policies and away from reliance on the state to allocate resources.

Over the last 20 years remarkable changes have taken place in Latin America. Two decades ago, almost every country in South and Central America was a dictatorship. Today, every country in the hemisphere except Cuba enjoys some form of democracy. Latin America’s economic transformation has also been remarkable. During the 1980s, the "lost decade" of Latin American growth, regional economic output per capita declined by an average of 1.3% annually and by a total of 12% over the period.(1) Inflation rates soared during the 1980s as Latin American central banks printed money in order to finance huge government deficits. Inflation was a major source of instability and uncertainty throughout most of the region, reaching more than 3,000% in Argentina in 1989 and in excess of 8,000% per annum in Bolivia in 1985.

Latin America’s poor economic growth during the 1980s can be explained by two main factors: (1) the huge increase in the foreign debt of the region, combined with the higher carrying costs from rising international interest rates; and (2) a decline in the ability of most Latin American countries to service international debts as the region’s terms of trade -- the price of exports relative to imports -- declined by 21% between 1980 and 1989.(2)

Latin America’s economic situation worsened in the 1980s as individuals and businesses shifted their assets out of the region into more secure foreign bank deposits, securities, and real estate. According to the World Bank, the outflow of flight capital from Latin America between 1976 and 1984 roughly offset dollar for dollar the inflow of new loans. Capital flight, combined with low domestic savings rates and increasingly scarce foreign financing, caused investment in the region to decline.

The international debt crisis was precipitated in 1982 when the Mexican government notified the country’s creditors that it was unable to meet its debt-servicing commitments. Other Latin American countries, including Brazil, the developing world’s largest debtor, also defaulted. Between 1980 and 1991, a total of 18 LAC countries negotiated debt restructuring agreements with their creditors. The debt crisis marked a watershed for Latin American countries. It revealed the inflexibility and inefficiency of Latin American economies, particularly when compared with those of the Asian tigers -- South Korea, Taiwan, Singapore, and Hong Kong -- which weathered the debt crisis relatively easily, suffering only a brief pause in economic growth.

With the International Monetary Fund and World Bank providing advice, Latin American countries have restructured their economies. The macroeconomic environment has been stabilized reducing the size of public sector deficits significantly and controlling inflation. Throughout Latin America, government-owned enterprises have been privatized on a large scale. Banks, airlines, telecommunications companies, utilities, and other state-owned companies have been placed on the auction block, raising over US$68 billion for Latin American and Caribbean treasuries between 1988 and 1995.

Latin America has also taken a liberal approach to international trade. Previously, most Latin American governments pursued inward-looking economic policies behind high tariff walls. Since the mid-1980s, Latin American trade has been liberalized unilaterally, plurilaterally within regional trading groups, and multilaterally under the auspices of the GATT/WTO (Table 1). All LAC countries, apart from Panama and the Bahamas, are now WTO members.(3)

Source:  IMF, Structural Policies in Developing Countries, 1994.

The economic reforms undertaken by LAC countries vastly improved the region’s attractiveness to foreign investment. In the early 1990s, private foreign investment, including returning "flight capital," started flowing into the region on a large scale. Net private capital flows into LAC almost quintupled from US$12.5 billion in 1990 to US$59.8 billion in 1993.

In December 1994, a balance of payments crisis erupted in Mexico after investors, concerned about the Mexican government’s ability to meet redemptions of its dollar-denominated bonds, called tesobonos, sold large amounts of these securities. The Mexican peso began melting down and it seemed likely that Mexico would default on its debt payments. The situation prompted the United States, Canada, and other countries to mobilize a US$50 billion financial rescue plan. In an effort to re-establish balance of payments equilibrium, the Mexican government imposed fiscal austerity measures, which helped to cause the nation’s real GDP to drop by 6.2% in 1995. The Mexican peso crisis damaged investor confidence, not only in Mexico, but also in much of Latin America. Net private capital flows to LAC slipped to US$53.6 billion in 1994 and US$54.3 billion in 1995.

Since the latter part of 1995, the Mexican economy has stabilized, growing by 5.1% in 1996. As a result, Mexico has been able to repay the international financial rescue package ahead of schedule. There are signs that foreign investors have begun to regard Mexico and the LAC favourably again. Preliminary data reveal that Mexico attracted more private investment inflows in 1996 than prior to the peso crisis. Overall, the LAC region attracted US$74.3 billion in net private capital inflows in 1996, a 37% increase over 1995.

Over the last several decades, there has been a tendency for trade to coalesce around regional growth poles in Europe, North America, and East Asia. This tendency has been accentuated by the proliferation and deepening of regional trade agreements throughout the world. Some economists believe that regional trade agreements have negative economic consequences; it is thought they may divert trade from lower cost sources outside a trading bloc to higher cost sources within the bloc. This was one of the conclusions reached by a recent World Bank study on the South American trading bloc, Mercosur.(4) Such agreements may also have negative economic consequences if they divert attention away from the achievement of multilateral free trade, which most economists agree is the optimum trade policy.

On the other hand, if multilateral free trade is not attainable in the short to medium term, regional free trade may provide a second best alternative. Regional free trade may provide important dynamic economic gains. Such gains are realized when member countries’ economic efficiency is enhanced through achievement of economies of scale, increased competition, and by improved flows of foreign investment and technology. The resulting higher incomes within the trading bloc, may draw in more imports, benefiting countries both inside and outside the trading bloc.

The negotiation of regional trade agreements may also help to push forward the agenda at multilateral trade talks. The Canada-U.S. Free Trade Agreement, and subsequently the North American Free Trade Agreement, probably helped achieve progress in certain areas of the Uruguay Round discussions. Furthermore, regional trade agreements may bring pressure to bear on countries that are hesitant to liberalize multilaterally. The U.S. used the APEC agenda (involving the creation of free and open trade and investment in the Asia Pacific region) to push the European Union (EU) to complete the Uruguay Round.

It is beyond the scope of this paper to assess the economic welfare effects of the various regional and subregional trade agreements out some conclusions can be drawn about the directions of trade. Table 2 divides the globe into four main trading regions: (1) the North American Free Trade Agreement (NAFTA); (2) the European Union (EU-15); (3) East Asia; and (4) Latin America and the Caribbean (LAC).

* EU-15 includes the 15 current members of the European Union.

** East Asia includes: Australia, Brunei Darussalam, Cambodia, China, Hong Kong, Indonesia, Japan, South Korea, Laos, Macao, Malaysia, Myanmar, New Zealand, Papua New Guinea, Philippines, Singapore, Taiwan, Thailand, Vietnam.

*** LAC (Latin America and the Caribbean): excludes Mexico but includes Cuba.

Source:  Calculations based on: Direction of Trade Statistics Yearbook 1996, (IMF).

The following points are relevant with respect to Table 2:

• With the exception of the EU, intra-regional trade is increasing in all major regions of the world. Nevertheless, the EU remains the world’s most integrated trading bloc;

• The extent of LAC intra-regional trade has increased in the past few years but the region remains only about one-half as regionally integrated as NAFTA or East Asia;

• East Asia and LAC have become relatively more important markets for inter-regional exports from NAFTA and the EU, as well as from each other. For NAFTA exports, however, the East Asian market is almost four times as important as that of LAC;

• The EU and NAFTA have decreased in relative importance as markets for inter-regional exports;

• LAC exports have become relatively less dependent on NAFTA and EU markets and have grown more dependent on intra-regional trade and on the East Asian market;

• Overall, LAC’s most important export market is NAFTA but, as will be shown later, certain LAC countries are more dependent on other markets, especially the EU market.

Subregional trade agreements have been part of the region’s economic architecture since the 1960s. They were promoted by the UN Economic Commission for Latin America and the Caribbean (ECLAC) during the 1950s and 1960s as a way of nurturing regional industries. ECLAC recommended that developing countries liberalize intra-regional trade while maintaining barriers against extra-regional imports. The intention was to provide regional industries with larger, protected markets to enable them to achieve economies of scale before eventually being exposed to global competition. After some initial success, regional integration plans languished in the 1970s and LAC countries retreated behind high trade barriers and interventionist policies.

In recent years, existing regional trade agreements have been revitalized and new agreements have proliferated, with more than 30 agreements signed since 1990. In December 1992, Mexico joined the North American Free Trade Agreement, the Western Hemisphere’s largest trading bloc. A year earlier, Brazil, Argentina, Uruguay, and Paraguay signed the Treaty of Asuncion establishing Mercosur - the Southern Cone Common Market -- Latin America’s largest trading bloc. In contrast to previous arrangements, the new web of trade agreements in the Western Hemisphere tend to be outward-looking, employing lower external trade barriers and encouraging foreign investment inflows.

* The Bahamas are not a member of the common market, only of the Caribbean Community.

The British Virgin Islands and the Turks and Caicos Islands were granted associate membership in 1991.

Table 4 shows the pattern for intra-subregional exports. Clearly, the global trend to greater intra-regional trade shown earlier also holds at the subregional level of the Western Hemisphere.

Sources:  (1) Direction of Trade Statistics Yearbook, 1996 (IMF); (2) Caricom Secretariat.

The following points are noteworthy here.

(1) There has been an increase in intra-subregional trade in the Western Hemisphere. This trend can be attributed to Latin American and Caribbean economic reforms, particularly trade liberalizations undertaken unilaterally, multilaterally, and at the subregional level.

(2) Between subregional trading blocs, the degree and trend of intra-regional integration varies.

• The share of intra-subregional trade in NAFTA (46.2%) is far greater than that of other subregional trading groups and the share has been has been growing;

• While the Andean Group and Mercosur are becoming more integrated, they are still very dependent on outside markets;

• Caricom’s integration level has increased slightly in recent years while CACM has not shown a discernable trend.

(3) As the next section will show, there are great differences in the degree to which individual countries within subregional trading blocs rely on intra-regional trade.

Economic integration agreements can be classified according to the degree to which they require member countries to harmonize their policies. The following list is a typology of the major economic integration classifications.

• economic union -- in which member countries integrate all of their economic policies.

• common market -- in which a customs union is supplemented by removal of all barriers to labour and capital movements between member countries.

• customs union -- in which a free trade agreement is supplemented by the establishment of a common external tariff (CET) on goods from non-member countries.

• free trade agreement -- in which member countries eliminate substantially all tariffs and non-tariff barriers among themselves but maintain their individual external tariffs. Rules of origin ensure that goods from outside countries are not able to circumvent a member’s high tariff by being transported through the territory of a low tariff member.

• preferential agreements -- in which a country provides access to another country’s market without requiring reciprocal access.

• sectoral agreements -- in which reduced-duty or duty-free access is provided among members on a limited range of products.

Many economic integration agreements contain elements of more than one classification. For example, the world’s most integrated region, the European Union, is a common market that aims to become an economic union with a common currency and monetary policy and common rules governing the size of government deficits and debt.(5) The North American Free Trade Agreement primarily involves the removal of mutual tariff and non-tariff barriers but it contains provisions to facilitate investment flows and to improve access by business people and professionals, albeit on a temporary basis. Other subregional trade agreements described below may aspire to achieve common market status but are still at the customs union stage of integration.

The major trade agreements in the Western Hemisphere fall into two main categories: (1) customs union or (2) free trade agreement. The difference between the two types of economic integration is important because of the implications for the hemisphere’s economic architecture. A customs union, such as Mercosur, has a common external trade policy. Therefore, it must negotiate as a bloc any trade agreements with outside countries. Similarly, outside countries that join a customs union must harmonize their external trade policy with that of the union. For this reason, full membership in a customs union is less attractive to countries, such as Chile, which have already signed other trade agreements. On the other hand, free trade agreements permit members to exercise independent trade policies vis à vis outside countries. For example, Chile has been able to negotiate free trade agreements with Mercosur, Canada, Mexico, Venezuela, and others. As a result, FTAs are proliferating in the hemisphere, knitting together the various existing trading arrangements.

The Treaty of Asuncion, signed by Argentina, Brazil, Paraguay and Uruguay in 1991, created the Mercado Comun del Sur (Mercosur) or Southern Cone Common Market.(6) This has three main elements: (i) a four-year transition period ending 31 December 1994 during which internal trade barriers were phased out ; (ii) the establishment of a common external tariff on 1 January 1995; and (iii) the creation of a common market -- in other words, the removal of internal impediments to the free flow of labour and capital as well as trade.

In contrast to some earlier ad hoc sub-regional efforts, the Mercosur tariff reductions are linear and automatic. At January 1995, internal tariffs had been eliminated on 80% of all goods traded, amounting to about 8,000 categories. Tariff barriers remain until 1 January 1999 on sensitive items, including textiles, steel, automobiles, and petrochemicals.

* average annual increase in GNP deflator; ** increase in consumer prices; *** Brazilian real GDP growth for 1996 is based on IMF estimate.

Sources:  The World Bank and the IMF.

On 1 January 1995, Mercosur’s customs union was launched with the erection of the common external tariff. In fact, the common external tariff comprises 11 individual tariff levels varying from 0% to 20%, applying to 85% of all items. On the other 15% of items, including capital goods, telecommunications equipment, and computer equipment, national tariff rates continue to apply. In 1995, fiscal problems in Argentina and balance of payments difficulties in Brazil forced the two countries temporarily to alter the external tariff, mostly on goods from outside countries.

Although Mercosur has yet to achieve the status of a true free trade area, it has the lofty goal of becoming a common market. Part of the program involves the coordination of the member countries’ economic, legislative, environmental, infrastructure, and technology policies. Member countries will be required to harmonize standards and surrender some authority to a supranational bureaucracy.

Note:  Top row represents source of exports; left hand column represents destination of exports.

Source:  Calculations based on IMF, Direction of Trade Statistics, Yearbook 1996.

Trade within the Mercosur group is growing rapidly. The share of intra-Mercosur exports as a share of total exports increased from 8.9% in 1990 (US$4.1 billion) to 18.5% in 1995 (US$12.7 billion) (Table 4). As Table 6 indicates, Mercosur’s largest single export market is the European Union. Taken together, Mercosur’s internal market (18.5%) and that of the EU (26.4%) account for 44.9% of all Mercosur’s exports, which approximates the value of the entire western hemisphere’s market for Mercosur exports (45.8%). This explains Mercosur’s eagerness to obtain a free trade agreement with the EU.(7)

It is also interesting that, although the share of intra-subregional trade in Mercosur is increasing, Brazil remains heavily dependent on outside markets, especially the EU and NAFTA. This fact suggests that Latin America’s largest country has a significant stake in trade liberalization with countries outside Latin America. On the other hand, given their heavy reliance on Mercosur’s internal market, Paraguay and Uruguay may be more concerned with defending their preferred access to that market.

In 1969, Bolivia, Chile, Colombia, Ecuador and Peru signed the Cartagena Agreement which launched the Andean Pact or Andean Group. In 1973, Venezuela joined the Group and in 1976 Chile withdrew in order to pursue trade liberalization with outside countries. A major reason for the Group’s formation was dissatisfaction with the LAFTA arrangement whereby, according to the Andean countries, most of the benefits had been delivered to the largest member countries (Brazil, Mexico, Argentina).

The Andean Group had only modest success in increasing the share of intra-regional trade for several reasons including: the small size of the Andean Group’s internal market; inadequate intra-regional transportation links; the large number of duty reduction exemptions; delays in implementing the common external tariff; and failure to implement the regional industrial strategy.

* average annual increase in GNP deflator; ** annual increase in consumer prices; *** Bolivian data for 1996 are IMF estimates.

Sources:  The World Bank and the IMF.

The Quito Modifying Protocol of 1987 liberalized investment policies, moved the Andean Group away from the import-substitution model of economic development, and placed less emphasis on the common industrial policies envisaged by the Cartagena Agreement.(8) In 1989, the Heads of State of the Andean Group countries assumed direct leadership in the process, announcing plans to establish a free trade zone by 1995, to be followed by a common market by 1997.

In December 1991, the Andean Group of Ministers signed the Act of Barahona, which was to establish a internal free trade zone and introduce a common external tariff scheme with four different levels (5%, 10%, 15% and 20%). Bolivia was to maintain external tariff levels of 5% and 10%. Changes were also made to end discrimination against foreign investment and protect intellectual property. On 1 February 1995, Colombia, Venezuela, and Ecuador introduced the common external tariff in conjunction with a price band system for agricultural imports.

In April 1997, Peru announced that it intended to withdraw from the Andean Group. The decision stemmed from a disagreement over the speed with which Peru would be required to phase out its tariffs in order to bring these under the duty-free parameters of other Andean Group countries. In June 1997, Peru changed its plans and decided to stay in the Andean Group after it was allowed to keep tariffs on sensitive agricultural imports in place until 2006.

Note:  Top row represents source of exports; left hand column represents destination of exports.

Source:  Calculations based on IMF, Direction of Trade Statistics, Yearbook 1996.

As Table 8 indicates, Andean Group exports tend to rely heavily on Western Hemisphere markets, especially that of the United States. Intra-subregional trade within the Andean Group has been increasing in the last few years but remains below that of other major trading blocs in the hemisphere (Table 4). With the exception of Bolivian exports, Mercosur does not represent a large market for Andean Group exports relative to NAFTA or EU markets. This fact suggests that a free trade agreement involving NAFTA should be more attractive to Andean Group countries than some form of South American Free Trade Area. Nevertheless, the Andean Group is currently negotiating a free trade agreement with Mercosur. Bolivia is not part of this effort since it has already reached a free trade agreement with Mercosur.

The five countries of Central America began the process of economic integration in the 1950s with a number of bilateral commercial accords. In 1960, the countries of Guatemala, El Salvador, Honduras and Nicaragua created the Central American Common Market (CACM) through the General Treaty for Central American Integration, which provided for immediate free trade on 95% of all merchandise trade. Costa Rica joined the CACM in 1963.

* average annual increase in GNP deflator; ** increase in consumer prices; *** El Salvador GDP growth for 1996 is IMF estimate.

Sources:  The World Bank and the IMF.

Primary responsibility for administering the CACM agreements resides with the Permanent Secretariat for Economic Integration (SIECA) and the Central American Bank for Economic Integration (BCIE). SIECA supervises the implementation of CACM agreements, carries out relevant studies, and arranges meetings between member states. BCIE promotes integration and economic development by financing public and private development projects.

After some initial success in increasing Central American trade, the share of intra-regional trade declined in the 1970s and 1980s due to economic difficulties, such as overvalued exchange rates and low commodity prices. Political unrest and conflicts between member countries also damaged regional integration plans.

In recent years, the CACM has been revitalized. In July 1990, Honduras was re-admitted to the CACM and formed the Northern Triangle with El Salvador and Guatemala. In 1993, Nicaragua joined with these three countries to create the Group of Four, which agreed to establish a customs union with common external tariffs at 5%, 10%, 15%, and 20%. In October 1993, the four countries signed the Guatemala Protocol, the primary aim of which is to establish an economic union. In the same year, Panama, which had never been a member of the CACM, also agreed to join the pact.

Note:  Top row represents source of exports; left hand column represents destination of exports.

Source:  Calculations based on IMF, Direction of Trade Statistics, Yearbook 1996.

As Table 10 indicates, CACM country exports rely heavily on the North American market, especially the United States. The largest single export to the U.S. from these countries is textile and clothing products. This explains why Central American countries are so eager to obtain access to the U.S. market for these products on a parity with that achieved by Mexico under NAFTA. Clearly, a regional free trade without the inclusion of the United States would be of limited value to Central American countries.

The Caribbean Community originated in 1965 with the Caribbean Free trade Association, which was formed by Antigua, Barbados and Guyana. These three members were joined in 1968 by eight other Caribbean countries (Jamaica, Trinidad and Tobago, Grenada, Dominica, St. Lucia, St. Vincent, Montserrat and St. Kitts-Nevis-Anguilla). The 1967 Treaty of Chaguarmas launched Caricom, a more comprehensive type of regional integration which proposed not only erecting a CET but harmonizing economic policies, establishing a common market, and cooperating in certain fields such as education, health, transportation, research and trade relations with outside countries.

The leaders of Caricom countries agreed in June 1991 to create a true single market by removing all barriers to intra-regional trade, allowing free movement of skilled workers and professionals, developing a common currency and establishing a regional investment fund. Caricom intends to introduce common external tariffs ranging between 5 and 20% by 1998.

Concerns about trade diversion arising from NAFTA motivated the Caricom countries to begin discussions with Central American leaders about integrating the Caribbean and Central American regions. In August 1995, the Association of Caribbean States (ACS) was formed joining all the countries of the Caribbean basin (including Central America, Caribbean islands, and Mexico.) Initially, activity will focus on cooperation in the tourism and transportation industries.

Table 12 reveals that, overall, NAFTA countries together represent Caricom’s largest export market. However, because of old colonial ties with the United Kingdom, a number of individual Caricom countries, such as the Bahamas, Belize, and St. Lucia, maintain stronger trade links with the EU than with NAFTA. With the exception of Antigua, Caricom countries do not export significantly to other subregional markets.

* average annual increase in GNP deflator; ** increase in consumer prices; *** some data for 1996 are IMF estimates.

Sources:  The World Bank and the IMF.

Note:  Top row represents source of exports; left hand column represents destination of exports.

* intra-regional exports include domestic exports only (i.e., excluding re-exports) and do not include the Bahamas. Data showing Caricom’s exports to other subregional groups were unavailable. Instead, the subregional groups’ imports from Caricom were used as proxy for Caricom’s exports.

** includes also Dominica, Grenada, Montserrat, St. Kitts and Nevis, St. Vincent and the Grenadines, and Surname.

Source:  Caricom Secretariat; and calculations based on IMF, Direction of Trade Statistics, Yearbook 1996.

NAFTA was signed by Canada, the United States, and Mexico on 17 December 1992. The agreement, which went into effect on 1 January 1994, will phase-out most tariffs over a ten-year period, although a small number of tariffs will take 15 years to eliminate.

* average annual increase in GNP deflator; ** increase in consumer prices.

Sources:  The World Bank and the IMF.

NAFTA covers trade in goods and services, provides protection for investment and intellectual property, liberalizes trade in enhanced telecommunications services, opens up government procurement markets to competition, provides dispute settlement mechanisms in trade and investment, facilitates the movement of business persons, and provides for the development, adoption and enforcement of sanitary and phytosanitary standards. Two supplementary side agreements -- one on labour standards and other on the environmental standards -- were added to NAFTA in 1993.

Note:  Top row represents source of exports; left hand column represents destination of exports.

Source:  Calculations based on IMF, Direction of Trade Statistics, Yearbook 1996.

Table 14 shows the extent to which Canada and Mexico rely on NAFTA markets, mainly that of the United States. Indeed, Canada and Mexico have become more dependent on the U.S. market since NAFTA was introduced in 1994. The United States trade, on the other hand, is much more diversified, with less than 30% of exports shipped to the other two NAFTA countries and other markets, especially East Asia and the EU, also being important for U.S. exports. Overall, the Western Hemisphere accounted for less than 40% of U.S. exports in 1995; on the other hand, LAC countries are among the fastest growing markets for exports from that country.

In December 1995, Canada and Chile committed themselves to negotiating an interim agreement as a bridge to Chile’s accession to NAFTA. This step was taken when it appeared that U.S. President Clinton would not obtain the necessary fast-track negotiating authority from Congress to begin Chile’s NAFTA accession discussions. In November 1996, Canada and Chile signed a free trade agreement which will eliminate both countries’ tariffs over a five-year period, provide protection for each country’s investors in the other country’s market, guarantee current levels of access for services exports, improve temporary access by business persons to the other country’s markets, provide a dispute settlement mechanism, establish side agreements on labour and environmental cooperation, and phase out anti-dumping measures between the countries over a six-year period. The Canada-Chile Free Trade Agreement went into effect on 5 July 1997.

• Group of Three -- Mexico, Colombia, and Venezuela implemented free trade agreement January 1995.

• Mexico-Chile -- Free trade agreement implemented January 1992. Negotiations are under way to expand the pact’s coverage beyond goods only.

• Mexico-Bolivia -- Free trade agreement implemented January 1995.

• Mexico-Costa Rica -- Free trade agreement implemented January 1995.

• Chile-Venezuela -- Free trade agreement implemented July 1993.

• Chile-Colombia -- Free trade agreement implemented January 1994.

• Chile-Ecuador -- Free trade agreement implemented January 1995.

• Chile-Mercosur -- Free trade agreement implemented October 1996.

• Mercosur-Bolivia -- Trade liberalization agreement implemented January 1996. The agreement converts into single accord the existing bilateral agreements between Bolivia and individual Mercosur member countries.

• Free Trade Area of the Americas -- Hemispheric free trade negotiations are scheduled for completion in year 2005.

• NAFTA-Chile -- Providing that U.S. President Clinton is able to obtain fast-track negotiating authority, either Chile will accede to NAFTA or the United States will negotiate a bilateral free trade accord with Chile in 1998.

• Mexico-Central America -- In 1997, Mexico intends to conclude negotiations on free trade agreements with each of four Central American countries -- Nicaragua, Guatemala, Honduras, and El Salvador.(9)

• Mexico-Caribbean -- Mexico intends to begin free trade discussions in 1997 with three Caricom countries -- Belize, Jamaica, and Trinidad & Tobago.(10)

• Mexico will hold free trade discussions with Peru, Panama, and Ecuador in 1997.(11)

• Mexico-Mercosur -- Mexico and Mercosur are negotiating a trade liberalizing accord which is intended to be the first phase in a two-stage negotiation leading eventually to a full-fledged free trade agreement.

• Andean Group-Mercosur -- The two subregional trading blocs are currently negotiating a free trade agreement.

• Canada-Mercosur -- Canada and Mercosur are exploring the idea of negotiating a free trade agreement.

• Chile-Peru -- Chile and Peru have been negotiating a trade liberalization agreement. It is unclear how comprehensive the agreement will be or when negotiations will be concluded.

• Chile-Panama -- Chile and Panama are negotiating a trade liberalization agreement.

Under the Caribbean Basin Initiative (CBI) launched in 1983, the U.S. accords duty-free treatment to all Central American and Caribbean exports, except textiles and apparel, petroleum, canned tuna, footwear, some leather goods, and certain watches and watch parts. Textiles and apparel, which are Central American countries’ largest export to the U.S., do not receive duty-free access but do receive preferential U.S. quota treatment. Mexican products are believed to have captured U.S. market share from Central American textile and clothing exports as a result of the better access acquired under NAFTA. A bill now before the U.S. Congress would improve access by providing CBI textile and clothing exports to the U.S. with the NAFTA preferential tariff.

Caricom exports enjoy preferential access to Canada via the Caribcan program, which came into force in 1986. The agreement provides duty-free access to the Canadian market for most imports from qualifying Caribbean countries. Excluded from Caribcan coverage are textiles, footwear, lubricating oils, and methanol.

Under the Andean Trade Preference Act (ATPA) introduced in 1991, the United States provides duty-free tariff treatment for exports from the Andean countries of Bolivia, Colombia, Ecuador, and Peru. The non-reciprocal agreement excepts petroleum, canned tuna, footwear, some leather goods, and certain watches and watch parts.

The agreement was implemented January 1993. Venezuela provides non-reciprocal duty-free access for selected imports from Caricom countries for five years. Thereafter, negotiations are to begin to make the agreement reciprocal.

The agreement was implemented January 1995. Colombia provides non-reciprocal duty-free access for most imports from Caricom countries. More negotiations are planned to liberalize the remaining Colombian tariffs and to make the agreement reciprocal.

The Latin American Free Trade Association (LAFTA), the precursor to the Latin American Integration Association (LAIA), (12) was established by the Treaty of Montevideo signed in 1960. The LAFTA was supposed to eliminate, on a product-by-product basis, most barriers to intra-regional trade over a 12-year period of continuing negotiations. This gradual approach to trade liberalization soon bogged down, however, as participants were more willing to grant tariff concessions for primary products, which had been the traditional mainstay of intra-regional trade, rather than for manufactured goods. The reluctance of major countries such as Brazil and Argentina to liberalize trade quickly is also explained by the high degree of macroeconomic instability at the time.(13)

In 1980, LAFTA was transformed into the Latin American Integration Association (LAIA) by the Montevideo Treaty of 1980. The treaty provides for tariff preferences among members instead of outright free trade. LAIA members are divided into three country categories: most developed (Argentina, Brazil, and Mexico); intermediate (Chile, Colombia, Peru, Uruguay, and Venezuela) ; and least developed (Bolivia, Ecuador, and Peru). There are two types of trade liberalization envisaged by the 1980 Treaty of Montevideo: first, regional-scope agreements, such as the regional tariff preferences, which apply to all members; and second, partial scope agreements, which involve two or more member states. Partial scope agreements cover subregional trade agreements, such as Mercosur, and a number of bilateral agreements.(14) They may cover sectors, like agriculture, gas supply, tourism, environmental protection, and other areas. The LAIA has had limited success in liberalizing trade directly. A small percentage of goods have received the LAIA Preferential Tariff and the partial scope agreements contain few provisions for granting trade preferences.

The LAIA encourages formation of subregional trade agreements, such as the Andean Group and Mercosur, and it has an outward orientation which permits members to liberalize trade with non-LAIA countries. In 1994, the LAIA Council of Foreign Ministers decided that the organization should become the coordinating body for the numerous bilateral, regional, and multilateral accords undertaken by members. The LAIA’s aim is to form eventually a regional common market, although there is no specific timetable.

At the 1994 Summit of the Americas in Miami, the Leaders of the 34 participating countries signed a Declaration of Principles committing governments: (1) to preserve and strengthen democracy; (2) to promote prosperity through economic integration and free trade, (3) to eradicate poverty and discrimination in the hemisphere; and (4) to guarantee sustainable development. The Declaration’s second principle, involving economic integration and free trade, contains the Leaders’ resolution "to begin immediately to construct a Free Trade Area of the Americas (FTAA) in which barriers to trade and investment would be progressively eliminated." The Leaders further resolved to make concrete progress by the end of the century toward the negotiation of the FTAA and to conclude negotiations by 2005.

At the Summit, the Leaders also agreed to a Plan of Action for putting each of the Declaration’s four principles into concrete form. Items 9 through 15 of the Plan of Action deals with implementing economic integration and free trade principles. A Tripartite Committee, comprising the Organization of American States (OAS) Special Committee on Trade, the Inter-American Development Bank (IDB), and the United Nations Economic Commission for Latin America and the Caribbean (ECLAC), was enlisted to assist in the systemization of regional data and to study economic integration arrangements in the hemisphere. Commitments were also made to cooperate in the following sectors: Capital Markets Development, Hemispheric Infrastructure, Energy Cooperation, Telecommunications and Information Infrastructure, Cooperation in Science and Technology, and Tourism. The first steps were taken in the process of negotiating the FTAA with the establishment of a Schedule of future meetings of Trade Ministers of the Western Hemisphere.

Since the Summit of the Americas, the FTAA preparations have consisted of three main components:

• Trade Ministers of the Western Hemisphere, who are developing the overall FTAA work plan; (the Hemisphere’s Trade Ministers have met three times to establish and put into practice a work plan for the FTAA -- Denver, USA (June 1995), Cartagena, Colombia (March 1996) and Belo Horizonte, Brazil (May 1997)).

• FTAA Working Groups established by the Trade Ministers; (these are gathering and compiling information on the current status of hemispheric trading relations).

• Vice-Ministers of Trade of the Western Hemisphere; (these coordinate the efforts of the working groups and make policy recommendations to the Trade Ministers).

At the first Trade Ministers’ meeting, held in Denver in June 1995, the Ministers "agreed to begin immediately a work program to prepare for the initiation of negotiations of the Free Trade Area of the Americas (FTAA) in which barriers to trade and investment will be progressively eliminated." Although the FTAA would build on existing agreements in the hemisphere, it would represent a single, comprehensive undertaking comprising mutual rights and obligations. FTAA negotiations would be concluded no later than 2005.

At Denver, seven working groups were created in priority areas to carry out preparatory work for the negotiations and report back to the next Trade Ministers’ meeting, in Cartagena. These working groups covered: (1) Market Access; (2) Customs Procedures and Rules of Origin; (3) Investment; (4) Standards and Technical Barriers to Trade; (5) Sanitary and Phytosanitary Measures; (6) Subsidies, Antidumping and Countervailing Duties; and (7) Smaller Economies. The specific terms of reference for each of these groups is different. However, in general, their job is to identify and assess the various hemispheric practices in each working group area and to compile an inventory of these regimes. The groups are also responsible for recommending ways to improve market access, to enhance transparency, to harmonize rules, or to improve enforcement of rights.

At Cartagena in March 1996, Trade Ministers reviewed the work undertaken since the Denver meeting, including the reports of the chairpersons of the seven working groups established in Denver as well as the working groups’ recommendations for subsequent action. Four additional working groups were created: (1) Government Procurement; (2) Intellectual Property Rights; (3) Services; and (4) Competition Policy.

Trade Ministers also examined approaches for constructing the FTAA that would build on and bring together existing subregional and bilateral arrangements. They recognized that the possible approaches for constructing the FTAA are varied and complex and must be consistent with WTO rules on regional trading arrangements. Vice-Ministers were instructed to consider the various approaches to constructing the FTAA and to assess the timing and means of launching the FTAA negotiations. They were to make recommendations on these issues before the next Ministers’ meeting in 1997.

At the May 1997 meeting in Belo Horizonte, Brazil, Trade Ministers established a new Working Group on Dispute Settlement, charged with compiling an inventory of dispute settlement procedures in the hemisphere and with making recommendations on how to proceed with the construction of the FTAA dispute settlement provisions. Trade Ministers also reviewed the results of the Vice Ministers’ work on the various approaches for construction of the FTAA, and on when and how to launch the negotiations. Trade Ministers agreed:

• that decisions in the FTAA process would be made on the basis of consensus;

• that formal FTAA negotiations would be launched at a hemispheric heads of government summit to be held in Santiago, Chile, in March 1998;

• that the FTAA should be comprehensive in scope and constitute a single undertaking embodying the rights and obligations mutually agreed upon. The FTAA can co-exist with bilateral and subregional agreements, to the extent that the rights and obligations under these agreements are not covered by or do not go beyond the rights and obligations of the FTAA;

• that the FTAA would be consistent with the WTO agreements;

• that countries would be allowed to negotiate and join the FTAA individually or as members of a subregional group negotiating as a unit;

• that special attention would be paid to the needs, economic conditions, and opportunities of the smaller economies; and

• that a temporary administrative Secretariat is needed to support the FTAA negotiations.

However, disagreement existed on how the negotiations would proceed. Mercosur countries, led by Brazil, would like this to be done in stages with easier issues, such as unification of customs procedures, dealt with early and more difficult negotiations, involving tariff reductions and market access, left until 2003.(15) On the other hand, Canada, the United States, Chile, the Andean countries, Central America, and the Caribbean countries believe that negotiations on all elements of the FTAA should proceed simultaneously.

Source:  FTAA Website and U.S. General Accounting Office, Trade Liberalization: Western Hemisphere Trade Issues Confronting the United States, July 1997.

At Belo Horizonte, Trade Ministers instructed Vice Ministers to make recommendations, before the next Ministerial Meeting in San Jose, Cost Rica, in February 1998, concerning how negotiations would proceed, including such features as their objectives, approaches, structure, and venue. A Preparatory Committee consisting of the 34 Vice Ministers responsible for trade was established in Belo Horizonte and instructed to build consensus on the structure and method of operation of the negotiations.

At the Fourth Ministerial Meeting, in Costa Rica, the Vice Ministers of Trade will continue the practice of holding three meetings before each Ministerial. At their next meeting the Vice Ministers will review the reports of the working groups and, where appropriate, will approve their recommendations on work programs, areas for immediate action, and business facilitation. Before their next meeting Vice Ministers will recommend to the Trade Ministers how the working groups can be reconfigured into negotiating groups. A feasibility study will be undertaken by the Tripartite Committee (OAS, IDB, and ECLAC) to determine options for establishing a temporary administrative secretariat for the FTAA process.

Western Hemisphere economic integration is part of a global phenomenon in which world has tended to coalesce around three major growth poles: Europe, the Western Hemisphere, and East Asia. Economic integration in the Western Hemisphere is being hastened by the rejuvenation of existing subregional trade agreements and the growing web of new agreements. Despite increased intra-subregional trade during the 1990s, most LAC countries continue to rely heavily on the U.S. market for their exports. The FTAA offers LAC countries improved access to the U.S. market and to foreign investment and technology. For the United States the FTAA will enhance trade and investment prospects in one of the world’s fastest growing markets. In Canada’s case, LAC accounts for only about 1.6% of total exports. Nevertheless, this share has been growing in recent years, despite increased integration with the United States, which now absorbs over 80% of Canadian exports. In addition, Canadian exporters have in LAC a geographically closer alternative to East Asia for diversifying markets.

Substantial progress has been made in the preparations necessary to begin FTAA negotiations. Since the Summit of the Americas in Miami, there have been three trade Ministerials with substantial agreement achieved in a number of areas. The twelve working groups created have carried out useful technical work to prepare the way for actual negotiations. There are two potential risks to the FTAA negotiations. First, the FTAA will not become a reality unless President Clinton is able to obtain fast track negotiating authority from Congress. Second, Brazil, Latin America’s largest economy, must demonstrate that it is solidly behind the idea of hemispheric free trade.

Under fast track authority, Congress cedes to the President the authority to negotiate foreign trade agreements for a period of time. While Congress retains the right either to accept or to reject the entirety of any agreement negotiated under fast track, it cannot amend the agreement. During the last two years, President Clinton has been unwilling to bring the fast track issue before Congress because of domestic political considerations. Recently, however, U.S. administration officials have expressed the intention of sending fast track legislation to Congress in September 1997. If successful, this would provide President Clinton with fast track negotiating authority by the time of the Second Summit of the Americas to be held in Santiago in March 1998.

Without fast-track authority there is little chance that countries in the hemisphere will want to pursue free trade negotiations with the United States. For example, Chile has already made clear that it is not prepared to pursue either bilateral FTA or NAFTA accession negotiations with the United States unless fast track authority has been granted.(16) If the President is unable to obtain fast track by the time of the next Leaders’ Summit in Santiago in March 1998, U.S. credibility on the FTAA, which was high after the first Summit in 1994, will be severely damaged. Latin American and Caribbean countries may not want to invest the time and resources necessary to negotiate an FTAA without a clear signal from the United States that it is prepared to proceed.

Since the Summit of the Americas in 1994, Brazil has at times appeared hesitant to proceed swiftly with the FTAA negotiations. A recent example is the Belo Horizonte Trade Ministers’ meeting, at which Brazil proposed that FTAA negotiations should start with non-controversial areas, such as customs procedures, and leave more difficult issues involving market access until later. A slower approach to the realization of hemispheric free trade would allow Brazil’s industries more time to adjust to international competition. Brazil’s trade liberalization initiatives in the 1990s, both unilateral and under Mercosur, have placed competitive pressure on domestic producers, resulting in large Brazilian trade deficits.(17) Brazil has shown interest in pursuing a South American Free Trade Agreement (SAFTA), perhaps as an economic counterweight to NAFTA’s influence. A Mercosur-Andean Group agreement currently under negotiation, combined with Mercosur’s other active and potential trade agreements in the hemisphere, could form the core of SAFTA.

Other LAC countries will also face difficulties adjusting to the FTAA. Despite their membership in subregional trade agreements, some countries’ industries may not be ready to face the level of competition generated by North American companies. Nor are some countries able to assume the level of legal and technical obligations likely to be required in intellectual property protection, standards and technical barriers, sanitary and phytosanitary measures, and other areas. Smaller economies in Central America and the Caribbean will face difficulties in simply gathering the technical expertise to negotiate. In order that these countries can participate effectively in the FTAA process, the Working Group on Smaller Economies has been formed and mandated to make specific suggestions to the Vice Ministers on the matter.

Whether or not the FTAA ultimately succeeds, the Western Hemisphere is likely to continue to become more economically integrated. This conclusion is supported by a recent U.S. General Accounting Office report.(18) It states that Western Hemisphere countries have indicated the intention of continuing their own trade and economic integration initiatives, regardless of whether or not the United States resumes its role in the trade liberalization process. The report cites Chile, Canada, Mexico, and Brazil as countries that are pursuing their own commercial interests in the region by negotiating bilateral trade agreements.

U.S. government officials argue that the proliferation of trade agreements in the Western Hemisphere is creating disadvantages for U.S. exporters. To quote the same GAO report, "these disadvantages are beginning to be felt in various sectors, including agriculture, telecommunications, pharmaceuticals and the auto industry."(19) In one case, Canada was able to win a Chilean contract for telecommunications equipment partly because of lower tariffs offered under the Canada-Chile Free Trade Agreement.

However, it is not just the United States that should be concerned. The proliferation of free trade agreements is complicating the trading environment for all countries. A recent report on hemispheric free trade stated, "[I]n both conception and implementation, customs procedures are woefully outdated in nearly all 34 FTAA countries. Compounding the problems posed by national practice, the existing subregional arrangements have established an additional level of regulatory complexity; that is these arrangements have not been an opening to harmonization and simplification of customs rules and practice."(20)

Similarly, different sets of rules of origin are being established by the burgeoning of trade agreements in the hemisphere. Once established, rules of origin may be difficult to harmonize because domestic industries, which the rules are intended to protect from specific imports, have a vested interest in maintaining them. Different rules will also tend to complicate the trading environment in areas such as technical and health standards, government procurement rules, investment regulations, protection of intellectual property, services, and dispute settlement. From the standpoint of simplification, negotiating a single overarching free trade agreement would be a better way to achieve hemispheric integration than weaving a complex web of agreements throughout the region.

* This paper was originally prepared for the Delegation from the Parliament of Canada to the Parliamentary Conference of the Americas, September 1997, Quebec City.

** The Clinton administration's formal request for this authority was presented to Congress on 10 September 1997, in advance of the actual legislation. Although Congressional approval is probable, it cannot be guaranteed, given significant political and public opposition, notably from among the ranks of liberal Democrats, organized labour, consumer and environmental groups.

(1) United States International Trade Commission, U.S. Market Access in Latin America: Recent Liberalization Measures and Remaining Barriers (with a Special Case Study on Chile), USITC Publication 2521, Washington, D.C., June 1992, Chapter 2, p.3.

(2) Ibid., Chapter 2, p.8.

(3) Panama’s application to join the WTO is under consideration by a WTO accession working party.

(4) Alexander Yeats, Does Mercosur’s Trade Performance Raise Concerns about the Effects of Regional Trade Arrangements?, Policy Research Working Paper--1729, The World Bank, February 1997.

(5) The EU also intends to create a political union with a common foreign and defence policy and harmonized justice and immigration policies.

(6) Mercosur is the Spanish acronym; Mercosul is the Portuguese acronym.

(7) In 1995, the EU and Mercosur signed a framework agreement establishing the principles and guidelines for future negotiation of a free trade agreement.

(8) U.S. International Trade Commission, 1992, p. 3-5.

(9) Inside NAFTA, Vol. 4, No. 7, 3 April 1997, p. 23.

(10) Ibid.

(11) Ibid.

(12) In Spanish, the acronym is ALADI (Asociación Latinoamericana de Integración).

(13) Sebastian Edwards, "Latin American Economic Integration: A New Perspective on an Old Dream," The World Economy, Oxford, England, May 1993.

(14) A number of bilateral partial scope trade agreements, which are not mentioned here, have been negotiated under LAIA auspices.

(15) Subsequently, a Brazilian trade official indicated that Brazil would be prepared to be flexible with respect to the FTAA negotiation process. He said that all the issues could be put on the table at once and staged development could occur through natural selection in the negotiation process ("Brazilian Official Hints at Flexibility in Mercosur’s FTAA Approach," Americas Trade, Vol, 4, No. 11, 29 May 1997, p. 1, 16).

(16) While a Brazilian spokesperson indicated that negotiations on business facilitation measures could proceed without fast track authority, it seems unlikely that major issues, such as market access, could be resolved under these circumstances.

(17) United States General Accounting Office, Report to the Chairman, Subcommittee on Trade, Committee on Ways and Means, House of Representatives, Trade Liberalization: Western Hemisphere Trade Issues Confronting the United States, July 1997, p. 20.

(18) Ibid. p.18-19.

(19) Ibid. p. 13.

(20) North-South Center at the University of Miami and the Institute of the Americas, Free Trade in the Americas: Policy Recommendations and Issue Papers, May 1997, p. 4.