The Benefits and Cost of Trade Openness for Latin America
As the world’s economies become increasingly globalized and free, developing markets have much to gain -- and lose. Latin America is of particular interest to scholars like Adriana Kugler, professor and vice-provost for faculty at the McCourt School of Public Policy Georgetown University, who served as chief economist in the U.S. Department of Labor from 2011 to 2013, and is a member of the National Bureau of Economic Research (NBER).
Kugler’s enthusiasm for labor markets and policy evaluation in developed and developing countries has led to her numerous contributions in areas such as public policies, unemployment, and immigration. Thursday’s lecture was presented by the Latin American Studies Program and was made possible by the Dean of Faculty Office.
Kugler began by explaining that Latin American countries (LAC) gained independence from their former colonizers throughout the 19th and early 20th centuries. What is interesting, she pointed out, is that trade in LAC opened up pretty quickly after becoming independent, an uncommon trend worldwide. Additionally, the 1990’s and early 2000’s were a time of major reform in Latin America, which makes it a very interesting region to study.
Before World War II, some LAC, particularly those already with a lot of capital, were “just better positioned for benefiting from trade, as is the case today.” Another factor that stunted the full potential for economic growth in Latin America was the emergence of a primary commodity export in most countries, and thus almost no diversification.
Latin American economies in the early 20th century had three primary threats: commodity price volatility, reduced demand for primary products as income increased, and Europe’s protection of its own primary commodity markets. In response to this, LAC had to choose between two market models, Import Substitution Industrialization (ISI) or Export Promotion Growth (EPG), and chose ISI. By comparison, developing economies in East Asia chose to pursue EPG.
This meant that, with the goal of overcoming weak primary commodity markets and achieving industrialization, Latin American economies attempted to replace imported manufactured commodities with domestically produced goods. This Infant Domestic Industry would, ideally, become robust enough over time that it could be opened up for free trade, making LAC major players in a globalized market.
To encourage the consumption of domestic products, and to increase revenue for the government, high tariffs were ‘temporarily’ placed on foreign goods. However, the tariffs remained in effect until the reformation era of the 80’s and 90’s, when LAC moved toward open trade in response to the stagnancy produced by ISI and the Latin American debt crisis.
The International Monetary Fund (IMF) offered loans to LAC on the condition that they introduce a specific package of structural reforms and tariff liberalization, which decreased taxes on foreign goods by an average of 15 percent throughout the region, but as much as 60% in individual countries.
“Trade is considered to stimulate growth and development by promoting and rewarding the sectors of the economy that are strongest,” Kugler said. There are two main mechanisms: learning, which entails “incorporating your competitors’ techniques and business strategies in order to survive,” and reallocation, which means “moving market share from less profitable to more profitable firms.”
Trade optimists maintain that the country’s overall welfare should increase as the country’s industry’s become more specialized, leading to an increase in overall consumption. Trade pessimists, on the other hand, believe that redistributing trade income from domestic producers towards consumers means that domestic producers aren’t strong enough to withstand pressure from outside markets, resulting in the displacement of domestic workers.
Drawing on a vast quantity of data, Kugler concluded that, “although trade openness did help, [it was] mostly through reallocation and not learning.” She continued by stating, “Standard trade theory argues that [Latin American]firms should specialize in labor intensive fields because [those countries] have many laborers and specialization would increase the demand for unskilled workers.”
However, she also noted that “as tariffs increase on machinery, [LAC] may actually develop a higher demand for skilled workers, which would mean increased wages for those laborers and therefore a growing wage gap.”
Reallocation, often manifested in downsizing or a dissolution of the entire company, is even more detrimental in LAC than in the US because the region had “very limited social insurance,” like unemployment benefits. Kugler said that, “Although these problems do go away, the effects are long-lasting.” She reinforced this point by using Mexico and Colombia as examples of economies that took a full decade to recover.
Kugler then drew attention to a “middle ground” for Latin American trade: regional integration. Sub-regional blocs, like Mercosur and the Andean Group, merged in 2004, creating the Union of South American Nations (USAN) and economically uniting eight LAC.
Kugler concluded by summarizing, “Although there is evidence of either moderate or sizeable gains from trade liberalization in terms of productivity, these productivity gains are not seen due to better technologies and ‘learning,’ but rather as a result of downsizing, or closing, less productive businesses, which is detrimental considering the lack of social welfare programs.”