Salinas-León – The Future of Free Trade in the Americas

Roberto Salinas-León

Senior Policy Analyst, TV Azteca, Mexico D.F.

The Philadelphia Society

San Antonio, USA

October 4, 1997

"The Future of Free Trade in the Americas"

(Permission to quote this speech must be granted by the Author)

The North American Free Trade Agreement (NAFTA) is at a crossroads. The treaty is still an
object of dispute in North America, amid a bilateral atmosphere characterized by
"Mexico"-bashing, nationalistic backlash, and highly charged accusations on both sides of the
border. In this context, the new debates share an important feature in common with the old
debates: the vast majority of criticism tend to concentrate on issues outside the purview of the
commercial and investment objectives of NAFTA: job-losses due to trade liberalization,
environmental concerns on the effects of open trade, the infamous certification process, issues of
cultural identity, and the growing uneasiness with illegal immigration.

These topics are fundamental; but to factor them into the NAFTA equation represents an
ill-grounded admixture. NAFTA is about trade and investment, and a proper evaluation of its
merits and demerits should focus exclusively on these items, not on issues which are peripheral to
the treaty, albeit crucially important in their own right.

The Irony of the Trade Liberalization

At home and abroad, enemies of greater trade integration in North America seized on the massive
peso devaluation and the economic crisis of 1995 as "evidence" of the futility of market-oriented
reform. Indeed,, the entire notion of open regional trade and market-oriented reform in the
hemispheric continent has been put into question. This is a political fallout of the "tequila" effect
which the peso crash engendered in emerging markets. In other words, the devaluation unwittingly
invited NAFTA-bashers and anti-market forces into the heart of policy discussions about
hemispheric liberalization.

The post-devaluation scenario in Mexico constitutes a litmus test of the strategic benefit of NAFTA
in forcing public policy to undertake issue-specific measures such as greater liberalization and a
more profound privatization process as mechanisms designed to restore growth. Indeed, a salient
irony about the current politics of NAFTA is that it has gained far broader support in the
Latin-American region (a region with long statist and protectionist traditions) than in the U.S., the
supposed paradigm of free-trade. So construed, issues like the ban on tomatoes, the problems with
transportation, the tuna embargo and the torments of hidden protectionism are far more relevant to
the dispute than, for instance, the concerns prevalent in the environmental and cultural debates.

The countries now exploring the possibility of joining the NAFTA framework (such as Chile) are
likely to focus the issues in terms of the same questions and concerns which were addressed by
Mexico. For this reason, the forthcoming process of evaluation supplies a reliable indication of what
is likely to ensue (other things equal) in other nations which gain membership into the agreement.
Mexico’s role in continental trade liberalization is critical: it acts as a commercial and cultural bridge
between the rich North American region and the underdeveloped Latin-American region.

In a trade summit held in Guadalajara in 1994, former Undersecretary of Trade Pedro Noyola
delighted a mostly pro-NAFTA audience by stating that "sucking sounds are for suckers." The
allusion to Ross Perot’s cheap argument that NAFTA would create a "great sucking sound" of jobs
fleeing south in search of cheaper labor was obvious, but so was Noyola’s conviction that trade
liberalization between the U.S. and Mexico has produced and will continue to produce more
job opportunities in both countries. This conviction boasts some evidential support, although the
first results of NAFTA show that job gains have been negligible in comparison to other areas
directly affecting employment-such as monetary and fiscal policy. Indeed, as Paul Krugman has
argued, the NAFTA issues are not principally about jobs, but about facilitating exchange between
countries that are able to exploit their comparative advantages.

The debates should no longer focus on who has a deficit and who has a surplus. This assumes that
greater trade is a zero-sum game, which it is not. In fact, a surplus means that more must be sold to
buy less of what we do not possess. It does not mean that one market is more "competitive" than
the other. As Krugman suggests, a country is not a corporation. The increase in the total volume of
imports and exports means that the entire zone has grown richer as a result of lifting trade
restrictions.

Liberalization in the Americas

The strategic impact of full continental trade in Latin America and the Caribbean is a welcome
aspect of extending NAFTA beyond the North American borders. In addition, other arguments
highlight the importance of an arrangement like NAFTA for the region’s private sector. There are
four fundamental reasons for the desirability of forging closer commercial ties under the NAFTA
framework, everywhere from Chile to Curacao. In general, the treaty implies more business for
inter-american business.

As a recent update published in Investor’s Business Daily makes clear, manufacturing in the US is
losing billions of dollars per year in sales to Latin American countries because of bureaucratic
vacillation on open trade. This not merely means less business, but also threatens to generate a
process of balkanization, with nations signing separate trade pacts with each other, thereby
increasing the risk of elevating protectionism to a regional level. Indeed, despite the promise for
multilateral hemispheric liberalization, via an expansion of the NAFTA framework to places like
Chile, Colombia, Argentina, Venezuela, Brazil and other emerging markets, the post-NAFTA
period has been characterized by a flood of separate trade deals. Canada, Mexico, Europe and
Asia are working on new deals in Latin America, while China and Japan are targeting Brazil,
Argentina, Chile and Colombia. In addition, trade blocs are developing in Latin America, including
the notorious Mercosur pact, which establishes a common market of 200 million people and a
combined regional product of almost $1 trillion. Indeed, there are now more than 30 free trade
agreements in the Western Hemisphere, but the U.S. is a party to only one, namely, NAFTA.

So there are good reasons to seize on the opportunity to develop the framework of NAFTA
beyond the North American borders. The first argument centers on the need for order. Latin
America and the U.S. already enjoy a flourishing trade relationship. In 1992, multilateral trade
exceeded $80 billion US. This trade inertia will continue with or without a NAFTA-style
arrangement. The NAFTA framework represents an attempt to consolidate legal order to this
growing trade relationship.

The need for a neutral dispute settlement mechanism, for instance, is evident in view of the problem
of "unilateralism"; namely, the problem that U.S. accusations of antidumping practices or failure to
meet environmental standards, as in the case of the Mexican tuna embargo, Ecuadorean coffee and
Chilean fruit, were decided in U.S. courts. The cross-selection dispute solving mechanism
embodied in NAFTA avoids this problem by seeking neutrality in deciding trade disputes among
the three countries. This will prove highly beneficial for Latin America and the Caribbean

The Latin American and Caribbean markets enjoy enormous potential for trade liberalization. The
region has a population of 460 million consumers and GDP valued at close to $1billion US, with
total world trade of $245 billion. Such facts reveal that an agreement on NAFTA lines is superior
to a myriad of bilateral arrangements.

The second argument for NAFTA centers on diversification. In effect, open trade liberalization has
greatly transformed the structure of Mexico’s external sector. The latter has diversified its exports
and performance in the world markets. Manufactured goods are growing at a rate of 15% per
annum, and represent over 60 percent of the country’s external output. In contrast, prior to trade
liberalization, oil exports dominated the external sector by some 75%. Today, oil sales abroad
constitute less than 30%. Thus, NAFTA constitutes an opportunity to diversify underdeveloped
trade structures as well as to attain higher levels of domestic competitiveness via duty-free market
access.

The idea of competitiveness supplies the third fundamental argument for NAFTA in Latin America
and the Caribbean. The treaty lays the foundations of competitiveness, by providing broad-based
rules to allow for long-term planning, access to updated technology, incentives to specialize, and
free entry to the largest market in the world.

As a trade arrangement, NAFTA represents a source of increased competitiveness not just in
bringing together the largest trade zone in the world with the highest level of real purchasing power.
For Latin America and the Caribbean, it represents an opportunity to develop economies of scale
and specialization. The prevalence of trade quotas and other quantitative and technical restrictions
in the U.S. and Canadian market inhibits several firms south of the North American border from
reducing costs and thus strengthening their competitive position via economies of scale. NAFTA
stipulates that 84% of Mexican non-oil goods (some 7,000 products) now receive full duty-free
and quantitative-free treatment. Similarly, 40 percent of U.S. and Canadian goods are now subject
to immediate phase-outs as of the same date. Since this percentage is mostly constituted by high
technology and modern equipment, the phase-out norms are able to respect so-called "economic
asymmetries". This would apply to all Latin American and Caribbean nations.

A fourth argument for NAFTA is that this accord seeks to meet the capital needs of
underdeveloped economies. The 1990s are characteristically an era of acute capital scarcity. Of the
total stock of world investment today, only 25 percent is destined to the less developed world. For
Latin America and the Caribbean, it is imperative to continue attracting a large flow of new capital
investments. This is an extra-commercial aspect of the accord, albeit one that is crucially important
to the strategy of open trade and its contribution in supplying producers with long-term rules of the
economic game.

In effect, regional agreements like NAFTA embody an unnoticed strategic benefit in making
countries more competitive in domestic policy. For instance, in Mexico, crucial changes in agrarian
law, port and airport privatization, private management of infrastructure, water deregulation, and
much more, constitute indirect results of the salutary effects that trade opening has on making
domestic economic structures more competitive. In other words, the strategic value of NAFTA lies
in its potential for literally forcing government to follow trade-consistent policies. This means that
a policy which inhibits business will either tend to disappear, or adapt to change.

Does Devaluation Help Exports?

The Zedillo administration has attempted to sell long-term benefits of the peso devaluation in terms
of future net gains in increased exports. So construed, the adjusted value of the peso is supposed to
erode the problem with currency overvaluation and give domestic products a competitive edge in
the international marketplace. This, together with a more expensive dollar, is supposed to curb
import growth and thereby halt the disproportionate growth of the trade deficit. But the crucial
question is: does a cheaper currency constitute a condition to stimulate export-led economic
growth?. The answer is no, despite the popularity of the horrendous formula of competitive
devaluation.

At best, a currency devaluation provides an artificial advantage, not a competitive advantage. It
is baseless to claim that devaluation will "help" exports, insofar as the short-term gains derived from
exchange-rate adjustment are eventually wiped out by the rise in prices, demands for higher wages,
sharp increase in interest rates and more expensive capital equipment sorely needed for
modernization. This is exactly what occurred in the wake of Mexico’s monetary disasters of ’76,
82′ and 87′, and 1995 was no exception. Indeed, a maxi-devaluation constitutes a hidden and
exceedingly punitive tariff on goods and services. It acts as a roundabout subsidy of exports and
thereby inhibits the incentive to modernize, invest in new equipment and compete on the basis of
higher quality. The net long-term effect is an external sector with a backward productive
infrastructure. So construed, the benefits of exchange-rate modification are overwhelmingly
outweighed by the costs.

As Mexico’s economy has recovered, the inflows of private capital and the rise in aggregate
demand have pushed the trade accounts back into the red. This is a natural and perfectly
accountable episode of modernization and economic recovery. Yet, instead of celebrating this
scenario, exporters and businessmen are calling for new mechanisms that can adjust the value of the
peso with a "controlled" depreciation in order to maintain high export growth and avoid a new
crisis. According this logic, then, the economy’s most important asset (investment) is a source of
harm. this is the economic equivalent of a medical advice to quit taking vitamins lest the body
develop a healthy state. Or, in the example of Alan Reynolds, it is similar to "the medieval medical
practice of blood letting brought sick people closer to death"-with physicians now calling for
greater bleeding.

The popular formula of "competitive devaluation" reflects the ill-grounded belief that cheapening the
patrimony of local-earning citizens will enhance competitiveness, while de facto it leads to the
erosion of real wages so that a few select exporters enjoy an artificial subsidy will make the country
grow and be competitive in international markets. Such is the real motive behind calls for
depreciation: the loss of exchange-rate subsidies in the export sector, where earnings are in dollars,
financed by citizens who earn in pesos, in the form of a loss in real purchasing power. This is
exchange-rate "hoodrobinism": take from peso earners so that exporters can generate a greater
dollar earning without the toil and trouble of enhanced productivity, a better product or greater
training.

As Alan Reynolds has recently explained, "the explicit goal of devaluation is to worsen the terms of
trade"-for instance, to make Mexico trade more exports for fewer imports. Reynolds continues:
"…even if Mexico wanted to impoverish itself in this way, it does not work. When the peso was
devalued at the end of 1994 that did not result in Mexican oil or beer being one cent cheaper in
terms of U.S. dollars. After a devaluation, interest rates soar, real tax receipts collapse, and the
foreign debt burden increases. This causes a squeeze on the government’s budget, and on the
budgets of families, farms and firms. This is no way to make a country "competitive." Economic
growth depends on more and better labor and capital, neither of which are encouraged by a
currency of unpredictable value. A weak currency has never produced a strong economy."

To be sure, concerns surrounding currency revaluation are closely mixed with the fear of generating
a substantial trade deficit. Reynolds again explains the misdiagnosis of increased imports as a sign
of bad times: "current account deficits have nothing to do with ‘competitiveness.’ They are caused
by a gap between investment and domestic savings that is filled by foreign investment (which is
good) or loans (which are not so good). To the extent that a devaluation might "fix" such a
gap, it does so by slashing investment, not raising savings."

These words should be required reading for private sector leaders who seek perks and privileges
via exchange-rate policy and cheap money, but who exhibit a highly distorted understanding of
global trade and investment, and the role of money in generating sound economic growth. Mexico
and Latin America require greater export-oriented economies. However, this goal is less likely to
ensue via a devaluation of the medium of exchange rather than through hard work in cutting
countless regulations, reducing bureaucracy, and ridding the economy of the burden imposed by
costly legal and institutional obstacles. Indeed, domestic exporters will benefit far more from
increased productivity, flexible labor markets, high-tech equipment and cheaper credit, than from
the counterproductive stimulus of a devaluation.

In the words of Joe Cobb: a country never gets strong by weakening its currency.

Conclusion

Regional open trade represents an opportunity to consolidate market openness in the Western
hemisphere. In the end, despite the negative precedent set by Mexico following the peso
devaluation debacle, and the negative precedent set by Mexico in 1994 (one of the most turbulent
periods in the nation’s modern history), the debates concerning the economic benefits of
hemispheric liberalization must, in the final analysis, heed the simple truth of trade: when exchange
of goods and services is free and voluntary, everyone necessarily benefits-persons, corporations
and nations alike.