PIIE Blog | RealTime Economic Issues Watch
The Peterson Institute for International Economics is a private, nonprofit, nonpartisan
research institution devoted to the study of international economic policy. More › ›
Subscribe to RealTime Economic Issues Watch Search
RealTime Economic Issues Watch

Will the Pacific Alliance Succeed in Latin America After Other Trade Pacts Have Failed?

by | May 23rd, 2013 | 03:57 pm
|

Pacific Alliance fever has set in. This trade grouping—which joins together the economies of Chile, Colombia, Mexico, and Peru—is holding its seventh summit on Thursday in the western Colombian city of Cali with more and more attention being paid throughout the region. The alliance has been lauded as “the most exciting thing going on today in Latin America” by Chile’s Finance Minister, characterized by the Economist magazine as a “hard-nosed business deal,” and crowned as “a new Latin American superpower” by MoneyWeek.

Why has this relatively modest initiative—which began as the Arco del Pacífico in 2006 but was launched as the Pacific Alliance in July 2012—generated such interest, and why now? Does this new regional trade agreement deserve these plaudits? Can it fulfill these promises? The answers depend on which path the countries follow. They would do well to draw cautionary lessons from an earlier failed regional trade initiative that was also full of promise: the Free Trade Area of the Americas (FTAA).

The four Pacific Alliance presidents are using the summit to announce the conclusion of a trade agreement aimed at marrying the overlapping free trade agreements (FTAs) among the members, creating free trade in 90 percent of goods traded among them. Barriers on the remaining 10 percent are to be phased out over the next seven years. This summit also marks the first expansion of the alliance, with the announcement that Costa Rica will come on as a new member, following its signature of a free trade agreement with Colombia.

The goals of the Pacific Alliance bear resemblance to those of its predecessor. The FTAA negotiations from 1998 to 2003 were aimed at creating a zone of free trade and investment from the Yukon to Tierra del Fuego, involving 34 countries of different sizes, levels of development, legal traditions, and trade philosophies. The FTAA began by riding a wave of trade liberalization between and among countries throughout the Americas, including the North American Free Trade Agreement (NAFTA), the modernized Andean Community, and the MERCOSUR (Southern Common Market). The FTAA was supposed to untangle the spaghetti bowl of overlapping agreements and lock in the free trade momentum then surging through the hemisphere with what was hoped to be a state-of-the-art agreement.

By the turn of the century, however, the FTAA’s goal of “concrete progress” stalled as it became apparent that not all participants were keen to be locked in. The concept of a single undertaking by 34 countries signing on to each and every provision, with the deal not finished until every part was finished, proved to be unworkable. The free trade zone of, at that time, 800 million people, with a combined GDP of more than $12 trillion, in which half of exports went to other FTAA members, was not to be.

The Pacific Alliance, by contrast, results from a “coalition of the willing”—countries interested in the benefits of the old FTAA, but also willing to achieve their goals on a more limited scale. The more limited size of the Pacific Alliance makes it a more modest undertaking. The countries of the Pacific Alliance represent about 40 percent of Latin America’s GDP and half of its exports. Spurred by the failure of the FTAA, the Arco del Pacífico, as it was called, brought four like-minded countries together to build on the free trade agreements they already had with each other and with the United States, Canada, and other countries. They tried to accomplish, on a smaller scale, what the FTAA could not. Recognizing the constraints of economic and political reality, they curbed their ambitions to avoid the pitfalls that killed the FTAA. Their guiding philosophy can be described as follows:

  • Limited size means bigger goals. The Pacific Alliance’s goals—at least for now—are at once more modest and more ambitious than those of the FTAA. Its architects do not seek to establish a template for modern global or multilateral trade negotiations. By aiming for a realistic agreement on freer flows of goods, services, capital, and people, they have accomplished more in less than a year than the FTAA accomplished in nearly a decade.
    • Between July 2012 and May 2013, the countries will have married their common FTAs and reduced 90 percent tariffs among themselves, with schedules for the remaining goods.
    • Steps have been taken toward capital market integration. The Mercado Integrado Latino Americano (MILA) has already joined the stock exchanges of Chile, Colombia, and Peru, with 556 companies listed to date. This market could grow substantially: Mexico is making legislative changes that will allow the Bolsa Mexicana de Valores (BMV) to join in 2014.
    • Steps have also been taken to free the movement of people. As of November 2012, the members started to eliminate the need for tourist visas for travel within the alliance.
  • A flexible and pragmatic approach has eased the way for eliminating trade barriers and duplication of rules while enhancing regional supply chains and linking them to world supply chains, including those in Asia. Progress has been hastened by the parties proceeding on steps they agree to without holding them hostage to lack of progress in other negotiations. Countries have also agreed to share diplomatic representation and trade promotion offices in a number of foreign countries.
  • Agreement of broad goals at the outset improves the chance for success. To join the alliance, countries must be committed to freer trade and sign on to a charter upholding democratic values. And they must demonstrate their readiness by having signed FTAs with each member country.

The Pacific Alliance’s chances of success look good but hard work is needed to go to the next step. To reach the goal of enhanced integration and increased exports to the growing Asian market, the alliance must improve competitiveness, strengthen hard and soft infrastructure, and educate and train more people in the skills demanded by the market. Latin America’s supply chain network remains underdeveloped, particularly compared to Asia’s. It is unclear whether this initiative will help stimulate regional supply chains and if so, which industries will benefit.

While congratulating themselves on their progress, negotiators should also keep in mind the cautionary notes of the past. They should not allow the Alliance to become intoxicated by its own success and international attention.

Observers from Latin America now include Costa Rica, Panama, Uruguay, Paraguay, Guatemala, and Honduras. In addition, Australia, New Zealand, Japan, Spain, Canada, and Portugal (as of this week) have gained observer status. Countries and entities as varied as China, the ASEAN bloc (Association of Southeast Asian Nations) and MERCOSUR are rumored to be signing on as observers. This is fine. But the alliance should be careful about whom they allow in the club. The current partners send a clear signal to investors: This region of Latin America is open to trade and investment. Tariffs are not likely to be hiked and assets are not likely to be expropriated without warning. But that could change depending on who joins up.

Expansion makes sense as long as the Alliance includes countries committed to openness and a steady path toward liberalization. Eventually, a link with Central America would make sense to enhance regional value chains and integration with Asia. Canada might also be a good candidate for entry. But adding members with different agendas could turn a hard-nosed business initiative into yet another politically driven Latin American talk shop. The region seems to have enough of those already.