Finding Allies in the Back Yard: NAFTA and the Southern Cone

Felipe A M de la Balze. Foreign Affairs. Volume 80, Issue 4. July/August 2001.

The United States—preeminent but not hegemonic—cannot maintain its global leadership without the cooperation of like- minded nations that share its interests and values. In fact, in the coming years, American preeminence will likely remain stable only in regions where the United States has signed agreements with countries that have congenial economic and sociopolitical systems.

Fortunately, creating agreements based on the promotion of regional economic growth, integration into the world economy, and the consolidation of democracy is feasible under certain circumstances. Witness the successive expansions of the European integration project (now the European Union), which incorporated Italy in the 1950s, Spain in the 1970s, and then Greece, Ireland, and Portugal in the 1980s.

Now a similar opportunity for integration exists in the Southern Cone of South America. A core group of countries—Argentina, Brazil, Chile, and Uruguay—have made great strides in recent years and are poised, despite their short-term economic problems, to make steady political and economic gains over the next decade. The right incentives are critical, however, to ensure that these nations become fully democratic, market-oriented allies of the United States.

To this end, the best incentive the United States can provide is an expansion of the North American Free Trade Agreement (NAFTA) to the Southern Cone, making these South American nations members of the pact alongside the United States, Canada, and Mexico. But economic integration will not succeed without a compelling political rationale as well: namely, the promotion of democracy and regional security that could follow the creation of a “super NAFTA.” Such a comprehensive treaty system would offer great advantages to all its participants, helping to stabilize and enrich the Americas, and would further the process of hemispheric integration.

Integration Express

A seven-state NAFTA, incorporating democratic and security accords as well as economic agreements, would offer a wide array of benefits to the entire hemisphere and could eventually integrate other Latin American countries. Before joining, however, a number of potential members—particularly Andean states such as Bolivia, Colombia, Ecuador, Peru, and Venezuela—would need to be brought up to speed. These countries need help in addressing endemic problems such as economic instability, low per-capita income, illiberal democratic practices, and narcoterrorism. In much of South America, public services remain poor. Bureaucracies stifle innovation; legislatures are feeble and, along with judiciaries, are sometimes corrupt. Bringing economic growth and social stability to South America will require not only a vibrant private sector and functioning markets but also public education for the young, job training for the unemployed, public health care for the poor, and courts and police that treat all citizens alike. Improving government and reducing corruption, therefore, will be an essential condition for expanding NAFTA.

Again, Europe provides a good precedent for how to accomplish these tasks. The European Union and NATO have successfully employed both carrots and sticks to encourage candidates in central and eastern Europe to undertake the political, military, and economic modernization that membership requires.

A new, comprehensive set of agreements between the United States and South America would have significant advantages over a pact limited to trade liberalization. For example, the Free Trade Area of the Americas (FTAA) now under discussion would progressively reduce trade barriers but would include no measures for political or security integration. Furthermore, its drafters hope that by 2005, the FTAA would include a large number of diverse countries: 34 in total. But getting that many countries to agree on anything will inevitably require watering down the provisions, as has occurred, for example, in the multilateral trade negotiations organized under the aegis of the General Agreement on Tariffs and Trade (GATT) and its successor, the World Trade Organization (WTO), since the Tokyo Round of talks in the 1970s. The FTAA will thus end up as a lowest-common- denominator agreement. With so many players, the FTAA negotiations will lead to nothing more than large-scale window dressing or, at best, a shallow economic integration project.

NAFTA, however, has much greater potential. Launched in 1993, the agreement initially met wide criticism in the United States from labor groups and others who opposed free trade. In Mexico, groups that rejected closer links to the United States fought NAFTA on protectionist and nationalist grounds. Since then, however, the Mexican government’s decision to join the agreement has become increasingly popular. Former critics have noted the expansion of trade between the United States and Mexico, from $76 billion in 1993 to nearly $246 billion in 2000. Also credited (at least in part) to NAFTA is Mexico’s strong economic recovery since 1996 and its successful transition to full democracy after 70 years of one-party rule.

In the mid-1990s, the success of NAFTA generated a lot of talk about creating a more extensive trade pact to embrace additional countries in the hemisphere. Momentum was lost, however, when President Clinton failed to obtain renewal of the “fast track” negotiating authority from Congress that hammering out a new pact would have required. Subsequent discussions of a hemispheric free trade zone bogged down over technical and bureaucratic issues. In its final days, the Clinton administration began bilateral trade negotiations with Chile, but this effort failed to reverse the decline in enthusiasm in Washington and most South American capitals. Now, President Bush’s declared intention to reach a trade agreement with Chile before the end of this year and his active participation at April’s hemispheric summit in Quebec City suggest that the United States has once again become interested in expanded trade pacts. It is time for Washington to start acting on these impulses.

Lessons Learned

The economic restructuring and policy reforms implemented in some South American countries during the 1990s brought lower inflation, increased exports, and expanded access to international capital and foreign investments. Not surprisingly, the three countries that implemented reforms early reaped the greatest benefits. During the 1990s, average annual per capita income grew by 4.6 percent in Chile, 3.5 percent in Argentina, and 2.8 percent in Peru. Growth was slower elsewhere, however: just 2.2 percent in Uruguay and 1.7 percent in Bolivia. Brazil, the largest country in South America, managed only a 1 percent growth rate. Even worse, a disturbing number of countries – – including Colombia, Ecuador, Paraguay, and Venezuela—lost ground, such that their per capita income in 1999 amounted to less than or almost the same as in 1990.

The global financial turmoil of the last few years, meanwhile, has revealed that South American economies are highly vulnerable to external shocks. Most countries in the region have faced current account deficits of 3 to 5 percent of GDP over the last few years. Successive financial and currency crises in Asia, Russia, Brazil, and Argentina generated intense pressure on capital markets, caused interest rates to skyrocket, and weakened the external accounts of all South American countries.

Even the Southern Cone common market (known as Mercosur, which includes Argentina, Brazil, Paraguay, and Uruguay)—the most important preferential trade agreement in South America—has had a difficult time in the last two years. Brazil’s devaluation of its currency, the real, in early 1999 created serious tensions within the group. And these proved hard to overcome, due to Mercosur’s weak dispute-resolution machinery. The problems were also exacerbated by a growing tendency of Mercosur members to negotiate individual trade agreements with third countries and by their excessive, unilateral use of non-tariff barriers and subsidies to promote foreign direct investment.

The troubles within Mercosur illustrate two principles that any future trade pact should take into account. Successful trade integration requires a core set of common institutions and rules to define and implement trade policy and resolve disputes. It also demands at least minimal stability in real (that is, adjusted for inflation) exchange rates between the member countries. These conditions were not met by Mercosur. Hence, when the politics of economic integration became difficult, member governments succumbed to temptation and resolved domestic problems at the expense of their neighbors.

Coming Together

Despite the current gloomy atmosphere, however, there are reasons for hope. For the first time since the countries of South America won their independence, the priorities of local governing elites and public opinion are converging with those of the United States. However, the process of consolidating democratic governments and market-oriented economies in South America and integrating them into the global system is far from complete. Substantial political progress has been made, but democracy is still threatened in several Andean countries. The external balance-of-payments bottleneck still looms on the horizon. With the partial exception of Chile, South American economies have not fully succeeded in becoming steady and diversified exporters to world markets.

The problems that remain have varied and complex causes. The domestic protectionism that South America followed for 45 years after World War II inhibited export growth and diversification. And difficulties in gaining access to the markets of the most advanced countries have made it hard for South America to compete.

Now a populist backlash could ensue if new democracies and market- oriented economies fail to deliver reasonably high rates of economic growth and fairer income distribution over the next decade. Such popular resentment against reform could be manipulated by authoritarian and corporate interests. Forces opposed to modernization remain a threat in much of the region, even if they now take different forms than in the past. Worrisome signs can be found in new alliances between guerrilla movements and narcotics traffickers, in the emergence of populist authoritarian regimes in countries such as Venezuela, and in a weakening of the rule of law in the northern Andean region. Unrest in afflicted countries could spill over into other nations. Washington’s economic and political influence over South America would diminish, and U.S. political, security, and business interests could all suffer as a result.

It will not be easy, therefore, to consolidate the recent positive trends in the region. If reforms are to succeed, South American nations need to grow rapidly and maintain a strong export orientation. In addition, they must win the confidence of local and international investors and reduce the excessively high interest rates that currently burden government finances and severely limit local entrepreneurship.

The best way to do this will be for South American countries to work together. Led by the Southern Cone and working with the United States, these nations should gradually develop a new multilateral architecture for the continent. This new system should be based on common adherence to democracy, rule of law, and free markets, and should be effected through the gradual extension of NAFTA and a network of regional political and security agreements. This effort would entail a two-track strategy. The first track would aim at consolidating the important gains already achieved by the Southern Cone nations by bringing them into a “super NAFTA” by 2003. The second track would then gradually incorporate the remaining countries of the region into the new economic, political, and security accords.

Such a strategy shows great promise. The Southern Cone countries form a stable core where neither military dictatorships nor populist or inward-looking economic strategies are likely to be reestablished. Today, none of these countries would seriously consider shutting the door to foreign investment, renationalizing privatized enterprises, or moving away from sound macroeconomic management. Their militaries have been brought under firm civilian control. These nations need no longer worry about preserving democracy; they can focus instead on how to deepen it and ensure its fairness. Doing so will be slow and time-consuming and will require stronger institutions, more citizen participation in government, and sustained, export-oriented economic development.

To lock in the region’s democratic advances, the new arrangements should include conditions that require members to meet a certain democratic standard before being admitted, and to maintain that standard once they have joined. Such an agreement should also include specific provisions for oversight and penalties for failure to comply.

Meaningful security arrangements, meanwhile, will take time to evolve. A first stage might consist of regionally coordinated border controls and exchanges of intelligence and information about force structure. In the long term, however, the parties should strive for a more comprehensive agreement, one that features a common defense policy and institutions that can cope with drugs, terrorism, and arms control—all transnational issues that require transnational solutions.

But in the short term, the heart of any new regional arrangement must be economic. To get the Southern Cone countries to take negotiations seriously, the United States must assure them access to its markets. Of course, selling NAFTA expansion to the U.S. public will also not be easy. Powerful U.S. interest groups, particularly labor unions and environmentalists, oppose free trade. The domestic economic impact of expanding NAFTA, however, will not be as formidable as it might seem at first. Last year, the total exports of Brazil, Argentina, Chile, and Uruguay into the U.S. market were modest—amounting to less than U.S. imports from Singapore. In fact, in the same year, the value of all U.S. trade with Southern Cone countries was just $45 billion, or about 18 percent of the trade between the United States and Mexico.

The United States has also enjoyed a large permanent trade surplus with these four countries over the last decade, which should help assuage the fears of American protectionists. Meanwhile, U.S. investments in Southern Cone countries are already substantial and have grown rapidly in recent years. These investments reached $58 billion in 1998, outstripping American investments in Germany ($42 billion), France ($40 billion), Mexico ($30 billion), and Hong Kong ($20 billion). This large U.S. investment provides another important reason to push for regional integration.

For their part, American trade unions that oppose free trade out of concern for labor conditions need not fear NAFTA expansion. Southern Cone countries have the capability to meet internationally recognized and enforceable labor standards; they respect workers’ rights to organize and strike and have banned sweatshops and child labor. And the great distance between the United States and the Southern Cone means that illegal immigration will be far less a problem than it is with Mexico.

To gain congressional approval, a new trade pact would also have to be accompanied by measures to safeguard the environment. This issue might be harder to resolve, since in South America—particularly in Brazil—foreign environmental standards are often perceived as an infringement on national sovereignty. Even so, Brazil has in recent years updated its environmental protection legislation and moved to meet some of the most important environmental concerns.

In addition to American fears, opposition to an expanded “super NAFTA” might come from the European Union, since such an extended South American trade pact might displace trade with EU countries and others outside the hemisphere. Europe has a strong historical, cultural, and demographic relationship with the Southern Cone. The EU accounts for approximately 30 percent of these countries’ total foreign trade, and European multinational corporations have established a major presence in the area, where they account for nearly 40 percent of all foreign direct investment. The EU will naturally want to protect and promote its substantial economic and political interests in the Southern Cone; to this end, it has already begun negotiations to establish a free trade area with Mercosur. But these talks are unlikely to advance before the U.S. initiative moves forward. The recently signed trade agreement between Mexico and the EU, which represents Europe’s response to NAFTA, has set the pattern for future arrangements.

As all of these factors suggest, achieving a new, comprehensive trade pact for South America will not be quick or easy. But the region is primed for an assertive U.S. initiative, such as a “super NAFTA,” to consolidate the convergence of ideas, institutions, and interests now underway. A successful initiative would help establish a closer and more mutually beneficial relationship between the United States and the nations of South America. Furthermore, it would help the United States maintain its global leadership by establishing a group of like-minded allies in the hemisphere. And finally, it would launch the South American nations into a virtuous cycle of economic growth, greater social equality, and democratic deepening that would leave all parties better off. This is an opportunity that the hemisphere cannot afford to miss.