Getting to Hemispheric Trade by Sidney Weintraub

In December 1994 thirty-four American heads of state (all except Fidel Castro, who was not invited) agreed in principle at the Hemispheric Summit in Miami that negotiations for a Free-Trade Area of the Americas (FTAA) will be completed no later than 2005. Bringing the hemisphere's preferential trading agreements together into a single FTAA will be a formidable task, however. There are two broad options for achieving hemispheric free trade: 1. Accession of all countries to NAFTA, the most important of the existing subregional agreements in terms of trade coverage; or 2. The conclusion of agreements between the separate groupings until there is a free-trade network covering all the countries of the hemisphere. The choice between these two alternatives was deliberately left vague at Miami in order to achieve unanimity. In principle, the United States favored option 1, the NAFTA-accession route; Brazil supported option 2, which would keep intact its subregional arrangement-MERCOSUR (the Common Market of the South), the second most important subregional economic integration group in the hemisphere. Brazil claimed in Miami that geographic contiguousness strengthens subregional integration and that MERCOSUR should be consolidated before the subregion considers hemispheric integration. The United States does not necessarily disagree with the importance of geography, but is more concerned with having an agreement that deals with all critical substantive issues, as NA FTA does. There are a number of preferential trading arrangements of varying size and form in the hemisphere (see table 1). Only NAFTA and MERCOSUR actually approach their basic purposes; the others are largely shell agreements and do not merit the title of integra tion arrangements.   Complications Nestled within these various multilateral subregional arrangements are a host of bilateral and plurilateral agreements: The free-trade area between Colombia and Venezuela is more solid than is ANCOM as a whole. Mexico has three free-trade agreements, one with Chile, another with Costa Rica, and a third with Colombia and Venezuela, what is known as the G-3. Chile is engaged in two negotiations, one for full accession to NAFTA, the second for association-not full membership-with MERCOSUR. MERCOSUR is negotiating an association arrangement with Bolivia and has proposed a wider series of such agreements with other countries in South America, such as Colombia and Venezuela. Brazil has suggested the conclusion of a South American Free-Trade Area (SAFTA), ostensibly as a way station on the road to an FTAA. MERCOSUR is a customs union, a form of economic integration that calls for a common external tariff (CET) among the member countries and a common commercial policy. The level of the CET in a customs union defines members' tariff preference. NAFTA is a free-trade area under which each country is permitted, under the provisions of the General Agreement on Tariffs and Trade (GATT), to maintain its own tariff and its own trade policy toward nonmember countries. In theory, ANCOM, the CACM, CARICOM, and MERCOSUR are customs unions; thus, no single member country can conduct separate negotiations with either NAFTA or the United States because giving free entry to goods from a nonmember country would violate the cus toms union's CETs. Brazil undoubtedly insisted on the customs union format in part to prevent Argentina from simultaneously seeking accession to NAFTA, which President Menem had indicated about a year earlier was his original intention. Chile does not seek accession to MERCOSUR because its tariff is lower than MERCOSUR's CET. If Chile instituted a free-trade association with MERCOSUR, it could keep its tariff and MERCOSUR could keep its CET, but there would be free trade between them. If MERCOSUR and NAFTA reached a free-trade agreement, this, too, would permit MERCOSUR to keep its CET against non-NAFTA countries while having free trade with NAFTA countries.   Options for Establishing an FTAA Option 1 The first option, the NAFTA-accession alternative, has several advantages: uniformity; a single arrangement of countries; simplified trading practices, particularly for rules of origin (more on this later); and affiliation of all countries with the United States, the most important market in the hemisphere. (Taken as a whole, about 40 percent of hemispheric merchandise exports are sold in the U.S. market.) It is far from clear, however, that the United States, particularly Congress, is prepared now to consider free-trade arrangements with all the countries of the hemisphere. Free trade with Chile is a possibility; with Brazil, which has a more variegated an d substantial industrial structure, it is perhaps less likely, at least now. Obtaining congressional approval of free trade with Mexico was torturous, and there is little enthusiasm at this time for repeating that process with another country that present s many of the same problems, including a low-wage industrial structure that would attract considerable direct investment to augment its capacity to export to the United States. NAFTA was negotiated under what are known in the United States as "fast-track" procedures. In this type of negotiation, the executive branch agrees to consult meticulously with the Congress during all phases, thereby permitting a "yea" or "nay" congressio nal vote on the final implementing legislation without amendments. The Chilean negotiations are starting without fast-track authority in the expectation it will be granted later. It would be well nigh impossible to conclude the option 1 scenario by 2005 f or all hemispheric countries without fast-track authority, as the United States has learned from a host of recent trade negotiations, such as NAFTA itself and the Uruguay round of the GATT. Option 2 Option 2 emphasizes strengthening subregional integration before proceeding toward an FTAA. While the United States is the main market for goods from the hemisphere as a whole, this is not the case country by country. In general, the farther north a count ry is, the more it relies on the U.S. market. Thus, Canada and Mexico depend on the U.S. market for upwards of 70 percent of their exports. Central American and Caribbean countries ship, on average, 50 percent of their exports to the United States; Colomb ia and Venezuela, around 40 percent; the proportion declines to between 10 and 20 percent for Argentina and Chile. The Brazilian market is more important than the U.S. market for the other members of MERCOSUR. Brazil itself is a world trader and relies on the U.S. market for about 30 percent of its merchandise exports. Geography, it seems, is still significant to the direction of a country's trade, or perhaps, influence comes from ties that were created by proximity in the years when transportation and co mmunications were more primitive. In recent years, as preferential trade arrangements have developed in the hemisphere, trade among the countries of Latin America has grown substantially. Trade between Brazil and Argentina has grown manyfold during the past five years, as has trade betwee n Colombia and Venezuela since their free-trade agreement. There is a trade logic in strengthening these subregional links further.   A Compromise NAFTA and MERCOSUR account for the bulk of hemispheric gross domestic product (GDP) and trade. Thus, an arrangement between the two groupings would go a long way toward achieving an FTAA. Either scenario-if the MERCOSUR countries acceded en masse to NAFTA (option 1), or if the two concluded a free-trade arrangement (option 2)-would set up ineluctable pressures for other countries in the hemisphere to put their affairs in order so they could join the emerging FTAA. This was the basis of the compromise at t he Miami Summit. There can be no FTAA without the consent of both Brazil and the United States, and while each country has its own view of the best path, it was deemed preferable to leave this issue for later discussion.   Post-Miami Discussions The discussion has begun. The first post-Summit meeting of trade ministers took place in Denver at the end of June 1995, and a second was scheduled for the spring of 1996. The main options have not yet been joined, and perhaps never will be. At the moment , however, it appears that option 2 will emerge by default. If the United States were to show any disposition to open NAFTA to accessions beyond Chile's, the NAFTA-centered option might look highly attractive, however. At the moment, only MERCOSUR, at Bra zil's urging, is seeking the expansion of free trade to other countries in the hemisphere. As the countries of the hemisphere ponder the architecture of the FTAA, they must consider (1) rules of origin, and (2) external tariff rates. Rules of Origin A free-trade area allows free trade only of goods originating in the member countries. This prevents nonmember shipment of goods to a member country with a low tariff for later transshipment to another member country with a higher tariff. If all the count ries have a common tariff (CET), as in a customs union, transshipment is irrelevant. In this sense, a customs union is a simpler form of economic integration than a free-trade area. However, a customs union does entail diminution of sovereignty in that ea ch country gives up the right to set its own CET and to conduct its own commercial policy. Determining when a good originates in a member country is not a straightforward matter. Under NAFTA, when a product is "substantially transformed," it becomes a national product. This means that an imported product is eligible for free trade among NAFTA m embers (i.e., it becomes a national product) when its tariff classification is changed after further processing in the importing country, such as from copper to copper wire. However, NAFTA also calls for a minimum percentage of value added in the member c ountries for many commodities. The textile and clothing sector, for example, requires that products be made from domestic yarn and cloth and be assembled in a member country to qualify for free trade. Some rules of origin are so complex, for example, for automobiles, that producers often prefer to pay the U.S. tariff (2.5 percent) rather than to bear the cost of tracing the North American value-added content. An FTAA would require uniform, or at least consistent, rules of origin in the various trade groupings. A study detailing all the rules of origin in hemispheric trade arrangements was prepared by the Inter-American Development Bank for use at the Denver me eting. External Tariff Rates Tariff levels applied to nonmembers in the different groupings also are being examined. When these are highly disparate, the movement toward free trade is complicated. The NAFTA countries, particularly the United States, apply the lowest tariffs to nonmem bers. If MERCOSUR and NAFTA were to reach a free-trade agreement, MERCOSUR countries would have to reduce their external tariffs by much more than the NAFTA countries would.   Summary Economic, political, and technical issues will play a role in determining the path toward an FTAA-assuming that the FTAA objective is achieved. The choice between the hemispheric, or NAFTA enlargement approach (option 1), and the network of agreements between the many subregional arrangements that exist (option 2) must be made at some point. National aspirations, such as Brazil's leadership role in South America and that of the United States in the hemisphere as a whole, must be considered. The U.S. Congress's willingness to move ahead with the idea of hemispheric free trade in the aftermath of Mexico's financial and economic crisis must be taken into account Technical issues, such as consistency of rules of origin and the interplay between customs unions and free-trade areas in the hemisphere, must be understood. Reaching an FTAA is feasible, but the hurdles are formidable. Even if an FTAA is not instituted, much progress in freeing hemispheric trade is probable, and this is all to the good. Dr. Sidney Weintraub, an economist, is Dean Rusk Professor of International Affairs at the LBJ School. He also holds the William E. Simon Chair in Political Economy at the Center for Strategic and International Studies in Washington, D.C.