On June 6, Chile and the United States signed a Free Trade Agreement in Miami which will go into effect at the beginning of 2004. The signing came after two years of tough negotiations and some final months of uncertainty as a result of the Iraqi war. Chile, the most open economy of the Southern horn, will finally have access to a market of more than 250 million people with significant purchasing power. Meanwhile, the United States will further advance its strategy – launched 10 years ago by former president George Bush – of deregulating the economies of the continent through the Free Trade Area of the Americas (FTAA).


This is not the first treaty that Chile has signed on the American continent. The Andean country has complementary economic accords with Mercosur – composed of Argentina, Brazil, Paraguay and Uruguay – and has been a commercial partner with Canada since 1997 and with Mexico since 1999. Canada and Mexico, along with the United States, form part of the North American Free Trade Agreement (NAFTA), a regional bloc to which Chile exported a total of $4.84 billion in 2002. Of that, $3.664 billion worth of exports were to the United States.


How will Chile’s free trade agreement with the world’s leading power affect all these countries?


“In the short run the treaty is going to be beneficial for Chile because the country will have access to an enormous market,” says Wharton management professor Gerald McDermott. Nevertheless, he warns that “the devil is in the details.” It is necessary to focus on the fine print in the [U.S.-Chile] agreement because “there are certain contradictions in the access period and in the opening [of markets].”


According to the terms of the agreement, “market access will be totally deregulated, without quotas or tariffs. After a period of 12 years, all products will have a zero tariff,” notes José Angel Fernández, an analyst for CESLA (Center of Latin American Studies) at the Autonomous University of Madrid. But not every product will receive the same treatment. While most products are being deregulated during the first four years that the treaty is in effect, some agricultural products will have to await the completion of the full 12 years. That was to be expected because “all developed countries protect their agricultural markets,” McDermott points out.


Fernández estimates that “80% percent of the total value of Chilean exports to the United States will benefit by getting immediate relief. Only five percent [of the total value] will have to wait the maximum period of 10-12 years.”


But “[market] access is going to be slow,” McDermott suggests, and you have to take into account that the Chilean economy is 80% dependent on exports of primary products, mainly from the food and fishing sector. Also its labor costs are low, and there is not a lot of labor protection. The problem for Chile is the restructuring of its economic profile in the long term.


“The Chilean economy needs to equip itself with the kinds of internal institutions that aren’t going to result from any direct or indirect incentives in the [U.S.-Chile] free trade agreement,” he adds. “In the European Economic Community, it’s a different situation because they have a [formal] plan for developing internal institutions for incoming [members].”


Mercosur’s Reluctance

With the agreement’s signing, Chile has become the first South American country to achieve a treaty of this sort with the United States. The negotiations lasted more than a decade during which time relations between the two countries passed through various phases of rapprochement and alienation. The initial contacts took place when President George Bush, father of the current president, began to implement the FTAA –a free trade agreement for the entire American continent that is still being negotiated and which is expected to go into effect in 2005. With President Bill Clinton, United States foreign policy took a different course and the agreement stagnated. Now Washington, under President George W. Bush, has once again focused its economic and political strategy on Latin America.


“His way of doing that is through the FTAA,” says Fernandez. “This strategy has led the United States to sign free trade agreements with the countries on its borders, Mexico and Canada … Since the Southern horn is the area where it is more difficult to do this, [the U.S.] decided to begin this strategy where it’s easier to get results – with Chile, a more advanced country than its neighbors when it comes to deregulation.”


Achieving this agreement “puts strategic pressure on the [entire] region to continue moving ahead with its FTAA negotiations with the United States,” comments McDermott. In addition, according to Fernández, the free trade accord between Chile and the United States is going to act “like a fairly extensive and detailed draft that will be used as a base for the rest of the [free-trade] treaties with Latin America” – including the FTAA pact. Moreover, Chile has been the spearhead for a strategy of the Bush administration which seeks to bring together the American continent through deregulation of its economies. According to Fernández, “they would be open economies, in that an American would be able to go there and invest, the same way a Chilean [could] in the United States.”


Although the U.S. has managed to advance its goal of establishing a free trade treaty for the Americas, thanks to signing the [U.S.-Chile] treaty, Mercosur does not appear to be as interested. “Perhaps they prefer to thoroughly explore the regional integration process, instead of tackling an internationalization process that is not only regional, but continental,” notes Fernández.


For the United States, it will be more difficult to negotiate with Mercosur than with the rest of Latin America “because it is quite a large bloc –more powerful insofar as GDP and population are concerned– and it is a little more reluctant to enter the FTAA. This is going to lead to problems for the United States in agricultural policy,” warns Fernández.


He also recalls the hard times that Mercosur has suffered over the past few years. “There was a major crisis with the devaluation of the real (the Brazilian currency) because Mercosur doesn’t have a single currency,” Fernández says. Now Mercosur is regulating standards and trying to arrive at more substantial agreements. It prefers to move step by step. First, consolidate the regional market and, second, [consider] the possibility of the FTAA. It’s a matter of priorities.”


Despite the willingness of the United States to integrate [its economy], the accord with Chile was in danger over the past months because of the war against Iraq. Negotiations for the treaty ended in December 2002, and the document was ready to be signed in March of this year, along with the free trade accord that the United States was negotiating at the same time with Singapore. “In Chile, however, alarms went off when [the U.S.] approved the treaty with Singapore but wouldn’t even put an alternative date on the agreement with Chile,” notes Fernández. The American attitude was interpreted as a “reprisal measure” for Chile’s refusal to approve the war against Iraq in the Security Council of the United Nations.


The chilling of bilateral relations was finally overcome as a result of the enormous expectations that both nations have for the plan. “The delay acted more as a wake-up call, since for Chile and the U.S. there are costs involved if this accord fails. Not to do it would have a high price,” Fernández says. Finally, in June [2003], Chile’s foreign minister, Soledad Alvear, and United States Trade Representative Robert Zoellick signed the accord in Miami, although the absence of their two heads of state is significant. It is expected that the treaty will go into effect in January 2004. The only thing missing is ratification by the congresses of the two nations.


Winners and Losers

With regards to political strategy, it is clear that the United States has much to gain from this agreement. But is that true in the economic realm? That is not so clear. Chile is a small country with only 15 million people and tariffs are already relatively low. What economic benefits can the United States derive [from the treaty]?


From now on, the American giant will be able to export – at more competitive prices – some of its products that are very much in demand by Chilean buyers, including software and technology, and machinery used in the mining and electronic engineering sectors. “Chilean consumers will benefit from the decline in prices, just as [Chilean] companies are going to be able to invest in cheaper capital goods that will help increase their productivity,” notes Fernández.


On the other hand, a very high level of legal protection will be created for [U.S.] investors “because from now on they are going to know perfectly well what they have to abide by,” comments Fernández. In his opinion, investors from the United States are going to move into the medical, insurance and, above all, financial sectors in Chile. “If they want to enter the market of the Southern horn, the most logical thing is to set up a central office in Chile in order to later extend operations into Argentina and Brazil, which are much bigger markets.”


Nevertheless, the physical distance that separates the signatories of this treaty is going to determine the [extent of] American manufacturing investment. “It is going to be more costly than in the case of Mexico because of the distance. If [new] companies arrive in the manufacturing sector, it will depend on what Chilean public policies there are for helping to promote them, because this is something new and different for Chile,” McDermott suggests.


For its part, Chile is going to “gain access to the largest market in the world under preferential conditions that no one else has, except for Canada and Mexico, which have signed similar treaties,” notes Fernández. In the short run, this will lead to growing commercial ties. Fernández estimates that Chilean exports [to the U.S.] will grow by 16%, which will mean [an additional] 0.7% of its GDP. And even though this will produce a parallel growth in imports, he expects that only 15% of imports will compete directly with locally made products.


The sectors that benefit the most will be exporters in agribusiness, fishing, mining, textiles, clothing, shoes and some services. The most fortunate products will be those that Chile typically exports, such as seafood, canned fish, salmon and especially agricultural products such as grapes and apples. “This will include products that until now had to enter the United States on an annual list that had low tariffs, but this list was discretionary. That is to say, one year it was approved and the next, if there was some sort of tension, they could raise tariffs as a means of pressure,” notes Fernández. With this treaty, all the products on the list will have low tariffs.


Who are the losers? “The traditional sectors, such as agriculture, are especially going to suffer,” says Fernández, referring to areas that still haven’t been restructured and may not be very productive, such as wheat.


With the signing of its latest free trade agreements, Chile is implementing a new fiscal structure. “Chile has a rule that its public-sector deficit can not exceed two percent. Internally, it self-imposes a maximum fiscal deficit that is quite strict. This means there is a problem, because until now it had certain revenues and certain expenses but now it is are going to have an imbalance,” notes Fernández. To cover the gap in [lost] tariffs, the country is considering such possibilities as cutting costs and increasing its value-added tax. In any case, the situation doesn’t appear alarming. “Since Chile is [already] a very open economy, tariffs are not going to go down too much. It is not a very big hole to cover.”


International Accords: Europeand Asia

In addition, Chile has agreements with the major European trading blocs. The most recent of these was signed June 26 in Kristansand, Norway, between the South American nation and the European Association of Free Trade (EFTA), which comprises Iceland, Lichtenstein, Norway and Switzerland. This agreement permits Chile to gain access to the market of those European countries, which are not members of the European Union, and which have a high per capita income of $33,445.  Once that agreement goes into effect in January 2004, 90% of commercial traffic [between Chile and the EFTA bloc] will have immediate [tariff] relief.


This agreement is going to be especially beneficial for Chile, because the products that it exports to the EFTA are more modern and higher value-added than the products that Chile sends to the European Union. For example, Chile will export goods and services for the fishing industry, ranging from ships to life preservers.


Moreover, the agreement with the EFTA will complement Chile’s accord with the European Union, which went into effect in February. Europe, especially Spain, made a heavy bet on Latin America in the 1990s. The bet paid off in October 2002 with the signing of a treaty of political and economic association between the European Union and Chile. From the moment that pact went into effect, it has meant an increase for Chilean exports of 3.3%, according to Chilean government data. Eighty-three percent of Chilean products [sent to the EU] and 91% of European products exported to Chile have been deregulated, and that figure will reach 97% of all products in 2012.


On the other side of the Pacific, in February of this year, Chile signed a free trade treaty with South Korea, becoming the first South American country to reach a commercial accord of this kind with an East Asian country. Chile expects to increase its commercial traffic with South Korea, one of its major trading partners. The accord also helps to boost Chile’s exports in Asia.


Chile and South Korea are so complementary that commercial traffic between them amounted to $1.149 billion dollars over the past year, according to the Central Bank of Chile. “Korea is a producer of commodities and computers, while Chile exports a lot of copper, which is quite convenient for the other side. Also, Chile exports products that are very much in demand in Korea, such as rice and fish,” notes Fernández.


With this agreement, Chile manages again to gain access to a much larger market than its own (South Korea has a population of 47 million and per capita income of $9,400.) Chilean products exported to Korea will enjoy an immediate [tariff] relief of 87%. This will be very advantageous for Chilean exports since the Asian country has some very high tariffs.


Chile’s policy of commercial openness has led it to negotiate treaties with countries or with trading blocs that are top ranked as well with others of lesser international weight. “What is most interesting for Chile,” says McDermott, “is Asia, Europe and Mercosur – as well as the United States.”


In any case, “the two free trade agreements that Chile has signed with the United States and with the European Union mean a step forward in the deregulation of a developing country’s commercial exchange, which is significant now that the Doha Round is under way,” notes Javier Oyarzun, professor of international economics at the Universidad Complutense of Madrid.


The Doha Round refers to the negotiations that are being carried out by the World Trade Organization in order to deregulate international trade between the 144 member countries. The focus of the WTO is multilateral, in that the free trade or regional integration agreements have a much more limited (regional or bilateral) scope. Today, there is a great debate about the compatibility of the two roads to deregulation. Concludes Oyarzun, “In my opinion, they are complementary.”