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We face a new and challenging trade and investment environment
World growth may be on the rise, but the region faces the challenge of adapting to lower commodity prices, higher interest rates, and a potential backlash against the trend towards greater globalization. The results of the BREXIT referendum, the recent decision of the United States not to ratify the Trans-Pacific Partnership (TTP), and calls to renegotiate the North American Free Trade Area (NAFTA) have halted the trend towards larger and larger preferential trade agreements (PTAs).
Currently, it’s hard to predict the path global trading arrangements will take. Major industrialized countries like the United States, Europe or Japan could lead a resurgence of the march to mega agreements; perhaps China will lead a new regionalism, marked by shallower and less ambitious deals; alternatively, the world could move to only bilateral agreements; or in the extreme, there could be escalating global trade frictions. Global post-war prosperity has, to a large degree, been built on a relatively open global trading regime so perhaps a modified status quo, with much greater emphasis on compensating those that have lost out, will win the debate. But the possibility of less benign outcomes should not be ignored.
Whatever the prevailing scenario, the region only stands to gain from a stronger, more efficient and fully integrated domestic market. The current mosaic of relatively small trade agreements–whose limited size does little to boost productivity –would become irrelevant amid a tide of larger agreements and it would hardly work as an insurance policy in more extreme, trade-conflict type scenario. By contrast, a unified market, worth about US$5 trillion or approximately 7% of global GDP, can offer tangible gains, at modest economic and political costs; it is a low-hanging fruit, in a world with few obvious alternatives.
For instance, IDB research shows that a regionwide FTA or LACFTA could double the use local inputs in the LAC’s export, providing a major boost to regional value chains. Likewise, it could almost halve the export losses in a scenario of increasing global trade frictions (e.g. if global tariffs increase by 20 percentage points, LACFTA would reduce export losses by 40%.)
Closer than You Might Think
Moving to a fully integrated regional market might seem an impossible task at first, but the region is much closer than conventional wisdom might suggest.
The network of agreements built over the last 25 years already cover 80% of all intraregional trade, providing LAC with a powerful platform to build upon. To fix the existing integration structure, countries should build a plain vanilla free trade zone focused on goods and services, with the aim of bringing greater efficiency to the current fragmented architecture. Other “WTO-plus” provisions like intellectual property rights, labor and the environment can be considered later, but should not be the core aim of the FTA.
The main goal should be to reach 100% preferences (zero tariffs) for all products and relationships (although sensitive sectors may be subjected to special treatment) and to unify the multiple rules of origin arising from the current 33 existing LAC agreements. The focus on liberalizing goods trade is critical, but efforts at liberalizing services is equally important given its increasing relevance for LAC. This should be done in a time frame short enough to make a difference in the current challenging environment—and avoid going through different political cycles—but not so short as to risk avoidable adjustment costs. LACFTA should also avoid complex architecture with supranational institutions, customs unions and hard-to-enforce areas. Instead it should be institutionally “light,” relying as much as possible on inter-governmental mechanisms and WTO rules. Finally, this architecture should be fully compatible with existing agreements or potential future accords with extra-regional partners, providing negotiation and accommodating different negotiation and implementation speeds.
To maximize its gains, LACFTA must be accompanied by action to address the region’s historical negligence of the nontraditional trade costs that arise from faulty logistics, cumbersome customs procedures, and ineffective export and foreign investment promotion.
For instance, a LACFTA initiative should explicitly include an ambitious agenda of trade facilitation measures, such as the regional inter-operability of single window systems, a technologically-driven modernization of customs, mutual recognition agreements of authorized economic operators, among many others. All these measures, which are critical for the daily operation of traders, would generate trade gains several magnitudes higher than just pure tariff elimination ever could. Finally, LAC should continue coordinating and financing transnational investments in transportation infrastructure and develop a harmonized and pro-competition regulatory framework.
Moving towards LACFTA– and unifying rules and filling product and relationship gaps along the way–it is not a panacea to solve all the region’s growth problems, nor is it a full insurance policy against escalating global trade frictions. Since the bulk of intraregional trade is already under preferences, most of the usually painful adjustment costs have already been paid. However, it has the potential to boost scale, efficiency, productivity, exports, and growth with likely modest economic and political costs. It does require though the highest level of political commitment to move from lofty ambitions to an action plan. LACFTA is in line with what countries across the region continue to profess: a commitment to deeper regional integration.