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How can Latin America contend with current economic challenges amid a changing trade landscape?

June 2016

The growth and trade outlook in Latin America and the Caribbean (LAC) presents an uncertain picture. Set to endure a second consecutive year of recession – for the first time in over 30 years – regional economic activity as a whole is projected to decline 1.3% this year over, impacted by sluggish global growth that has hampered efforts to boost trade and investment, domestic challenges in regional giants Brazil and Argentina, and the end of the commodity boom super-cycle.

In South America in particular, where commodities make up more than 70% of merchandise exports and nearly 10% of GDP, falling prices have reduced fiscal revenues, slowed investment, and once again laid bare underlying structural weaknesses in growth strategies characterised by low-technology production structures.

Against this backdrop, investor confidence has slumped, while international bond issuances from LAC were down 61% at the end of 2015 by comparison with the previous year. Weakened stock market prices and a reversal of capital flows, further aided by an expected rise in interest rates by the US Federal Reserve, have contributed to exchange-rate depreciation in several economies. Given that much of the region’s debt is denominated in US dollars, currency depreciation has increased debt-to-GDP ratios, which under some scenarios could contribute to sovereign credit downgrades. High inflation rates have also plagued consumers, in particular in South American economies.

Brighter spots exist, however, with Mexico and Central America expected to grow at 2.7% and the Caribbean at 2.6% respectively in 2016. Despite continued falling export value, currency depreciation helped to boost exports, with the region as a whole expanded its share of world merchandise exports from 5.3% in 2014 to 7.4% in 2015. In Colombia for example, new opportunities emerged last year despite a gloomy economic outlook, with an 8% increase in exports to Japan relative to 2014 as a result of bilateral programmes targeting small and medium sized enterprises (SMEs).

In this economic environment central questions looking ahead include how to widen export baskets and increase sustainable investment, supported by further regional integration, while adjusting to wider tectonic governance shifts such as the new mega-regional Trans-Pacific Partnership (TPP) deal and the collective call for a shift to a low-carbon economy under the Paris Agreement on climate change.

Boosting integration and exports

Increased integration into global value chains (GVCs) encourages enhanced foreign direct investment, technology transfer, and knowledge spillovers. Generally speaking the LAC region is less well integrated into international supply chains ­– when discounting commodities – compared with other developing regions such as East Asia, where tight intra-regional connections boost trade with the rest of the world, and vice versa.

Regional trade gains among LAC economies have been more modest in the face of persistent hurdles beyond tariffs such as poor transportation and regulatory incoherence. For example, the existence of so many RTAs in the region with different rules of origin provisions (RoO) – which determine the conditions a product must satisfy to be deemed to originate from the country seeking preferential access – creates complexity for business and can divert trade patterns. On this front, the exception is the Pacific Alliance that has made gigantic advances in transforming the rules of origin established between its four members through their previous six RTAs, using an enabling harmonisation and cumulation scheme.

Failing to address incoherence among existing regional trade rules risks exacerbating disadvantages for LAC countries looking to attract investments and diversify exports in a world where goods typically cross borders multiple times. Promoting convergence among the region’s “spaghetti bowl” of regional rules could be helped by a new RTA Exchange initiated (as a first outcome of the E15 Initiative) by the Inter-American Development Bank (IDB) and ICTSD. This platform is geared towards improving information, understanding, and analysis around RTAs in order to navigate complex and overlapping regulatory requirements.

LAC economies could also look at better harnessing the digital economy, given that cross-border e-commerce can reduce the costs of accessing new markets, particularly for SMEs. To do so however, variable Internet penetration in the LAC, low banking penetration, knowledge barriers, and a range of regulatory obstacles need addressing, as well as convergence around regional or eventually global rules for cross-border information flows, online consumer protection, local infrastructure and local presence, among other things.

What about the TPP?

Further integration efforts are being pursued by the region’s major trading partners, including the US, Europe, and Asia through the TPP and ongoing Trans-Atlantic Trade and Investment Partnership (TTIP) talks.

The TPP, for its part, sets out rules on a number of hot-button trade topics such as e-commerce, SMEs, regulatory coherence, and so on, which in many cases should help to smooth trade hurdles between the group. The deal outlines a single set of RoOs and allows for regional cumulation, suggesting that participants become ripe for additional investment as players in a GVC. By contrast, this could tilt supply chains and investment away from non-TPP LAC economies, such as the six members of Mercosur.

Equivalence requirements for sanitary and phytosanitary (SPS) measures, or the mutual recognition of conformity assessment procedure results in the technical barriers to trade (TBT) chapter, could also create higher compliance and testing costs for non-TPP parties compared to those in the club. On the other hand, the TPP’s push towards the use either of international standards or objective scientific evidence in TBT or SPS contexts, could be seen as encouraging good regulatory practice more generally with benefits to all trading partners. In this respect, non-TPP parties could look for strategic opportunities to meet TPP or international standards, and take advantage of transparency efforts. Existing regional collaborative efforts, such as the Pacific Alliance where three of four members are TPP parties, could also be a stepping stone for eventually joining the deal.

Chile, Mexico, and Peru are participants in the TPP. For this group, the deal should among other things deepen economic ties with Asia, where demand from a growing middle class could help to further diversify their exports. The implementation of WTO-plus provisions on e-commerce, intellectual property rights, and trade in services will result in more updated domestic provisions that should render these economies an easier place to do business. In turn, this could also contribute to enhancing productivity, and moving towards higher-value economic activities.

In sum, the economic landscape is mixed, and the region stands at the cusp of both challenges and opportunities. There is not a moment to lose in identifying trade and investment tools at all levels to steer a path towards more sustainable development.

This article first appeared on the World Economic Forum’s Agenda blog.

Ricardo Meléndez-Ortiz is Chief Executive of the International Centre for Trade and Sustainable Development (ICTSD).

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