For a long time, Latin America has been a strong candidate to lead the global economy, given its wealth of natural resources and sizable population. But the region has never fulfilled the destiny that history seemed to have reserved for it.
Nowadays, favorable winds are blowing for Latin American economies, although the pace of development is still a lot lower than in other emerging areas, such as Southeast Asia. High liquidity in international markets and high prices for raw material exports such as oil helped the region attain a GDP growth rate of 4.3% in 2005. Last year was the third consecutive year of growth, and forecasts are for continued growth of about 4.1% this year. South America and the Caribbean are prospering more than Central America.
Economic growth, the rising volume of exports, the remittances sent by emigrants, and favorable terms of trade have all contributed to produce something new in the region — a growing surplus in the balance of payments, amounting to 1.3% of the GDP last year. Governments are taking advantage of the surpluses to cut their debt and clean up their public finances in a faster way than in the industrialized countries.
The periods of hyperinflation that occurred in past decades have led to stronger controls of prices. Nevertheless, the growing value of Latin American currencies has begun to be a source of worry for managers. Long term, it could become an obstacle to their competitiveness.
The global economic powerhouses are increasingly interested in developing potential trade with Latin America. It is a growing market where they can sell their exports and try to make up for their trade account deficits.
Geographical Proximity Rules
For the moment, Latin American trade relations are ruled by geographical proximity. Half of all trade is with the United States; 13% is with the European Union; 4% is with Japan, and 3% with China. “Geographical proximity, history, closeness, culture and so much time spent working in these markets – these are the keys to the success of the United States in Latin America,” explains Luis de Sebastián, an economics professor at ESADE. Europe’s position has not improved because “it has been only slightly concerned” with the South American market.
Juan Carlos Martínez, a professor of economics at the Instituto de Empresa, notes another key reason for the privileged position of the United States. “Latin American countries trade very little among themselves, which is entirely the opposite of what happens in other regions such as Europe or Asia. Only 15% of all trade is carried out with neighbors, which has helped the U.S. Because of its proximity and influence, the U.S. has figured out how to take advantage of this situation.
Experts agree that market shares of foreign products in Latin America are also characterized by other factors such as direct investment. There is more interest, especially on the part of European companies, in manufacturing in the region, rather than exporting their products to the region. “You also have to consider the type of trade, when you talk about commercial relations,” emphasized De Sebastián.
Spain provides one of the best examples that explain this situation. Spain ranks third in the world when it comes to investing in Latin America – surpassed only by the United States and the Netherlands, according to the latest report by the Economic Commission for Latin America and the Caribbean (ECLAC). However, only 4.7% of Spain’s exports are sent to South America. “We export twice as much to Portugal as we do to all of Latin America,” recalls Pedro Moriyón, managing director of promotion for ICEX, the Spanish institute of foreign trade. He adds another worrisome fact: “Over the last five years, our trade deficit with the region has grown five-fold.”
The current trend is that the United States is slightly reducing its relative importance in the South American market, while China is the trading partner that is strengthening its position the most.
Keys to Becoming More Important in the Region
Juan Carlos Martínez believes that Asia “is starting to become concerned” about the South American market. “China is interested in creating strong commercial alliances with this region because it needs raw materials. For their part, the Latin American countries see Chinese products as a good opportunity because they are cheap,” he says.
“China has a very aggressive trade policy, but you have to realize that the Asian giant is buying a great deal in South America,” comments De Sebastián. “It is acquiring soy beans in great quantities, as well as petroleum, minerals… And it is also selling its own products. It has a much stronger presence than it appears.”
De Sebastián believes that this is one of the keys to carving out export niches in this market for the great economic powers. “There has to be reciprocity,” says De Sebastián. “It is not only a question of selling; you also have to buy.”
Luis Fernando Agudelo, a professor at the University of Medellín (Colombia) believes that the essence of successfully entering South America is “the homogenity of its languages (Portuguese and Spanish) and some cultural traits.” At the same time, he notes another important point – which is “recognition of the differences, regulations and tastes of each country, as well as detection of market niches that are widely accepted in the country and have growth possibilities … Despite the apparent cultural homogenity, South Americans place a lot of value on recognizing national differences, as well as regional differences, within each country.”
The great powers are trying to strengthen – and, in some cases, expand – their presence in Latin America by signing trade agreements. The United States, which has the most agreements with its neighbors to the South, is negotiating free-trade agreements with several countries. Japan and Mexico have signed an agreement, as has Chile with South Korea. The European Union is negotiating with Mercosur.
A good example of this success is Chile. It is making the most of its free trade agreement with the European Union. Since it went into effect in 2003, trade volume between the two partners has almost doubled.
Chile, a small South American market with only 16 million people, has signed 50 other international treaties, which makes it the Latin America country whose economy has opened up the most. The goal of the government of Michelle Bachelet is to convert the country into “an export platform to the rest of the world,” according to Patricia Braniff, representative of ProChile, the government’s trade agency, in Spain.
Martínez believes that trade agreements are the road that the big powers follow so their exports can find markets in South America. “They are fundamental because they are a way for Latin countries to solve a problem they have always had – the lack of trade. The example to follow has been [NAFTA,] the free-trade agreement between Mexico, the United Sates and Canada. Latin American countries have seen the benefits that the agreement brought to Mexico, which has a surplus in its trade with the Americans, although it was expected that the total opposite would happen.”
De Sebastián warns that “treaties do not create trade; what they do, generally speaking, is to activate and intensify the trade that already exists. If there is no previous exchange of goods, you are not going to create a flow of merchandise just by reaching lots of bilateral agreements … With or without treaties, you can export.” When there are products, markets, business incentives and good distribution networks in the country of destination, then a trade agreement “facilitates” the functioning of all that machinery.
Products made by great powers face a significant number of obstacles on their arrival in Latin America. “The principle challenges they face are differences regarding regulations in each country (security, tariffs, transportation, import requirements, taxes), which add to transaction costs, especially since the main initiatives for integration (such as Mercosur and NAFTA) have also faced obstacles of this sort, more than any obstacles in the tariffs, notes Agudelo.
“Another big problem,” adds Agudelo, “is known as ‘stop and go.’ That’s when economies in the region undergo very pronounced economic cycles because of their institutional weaknesses. Those processes throw large segments of the population below the poverty line, which makes it very hard to predict long-term demand, and to do business as a result.”
De Sebastián says that one of the greatest problems is the special characteristics of the South American market. “The Latin America market has two large segments. On the one hand, there is the luxury market, which comprises about 10% of the population. Then, there are 40% of the people who have a subsistence level of consumption, and therefore do not buy any imports. In reality, that means only 50% of the people take part to some degree in any sort of mass consumption, in which foreign products are admitted, although not many. So the true market for imports is with the 10% of the population who have a high level of buying power. They buy imported cars, fabrics, perfumes, furniture…This is a narrow market because the middle class is weak.”
Martínez agrees that it is hard to get to the point where you offer imported products that have an optimal ratio of quality to price so that they can be consumed in massive amounts. But he notes that “remittances from emigrants are providing the middle class of South American countries with higher buying power that is used for consuming foreign products.”
Prospects for the Future
What will happen in coming years to trade relations between the great powers and Latin America? Several electoral processes in Latin America are changing the political map of the region. Generally speaking, leftist governments are winning, to the detriment of conservative parties. The exceptions, for the moment, are Colombia and Mexico. Looking more closely, one can spot a broad range of options among the Latin American leftist parties, ranging from the macroeconomic pragmatism of Brazil, Chile and Uruguay to the anti-liberal and anti-American front comprised by Venezuela, Bolivia and Cuba. “China will continue to win markets, but it is never going to substitute for the United States,” predicts De Sebastián. He “doubts” that the new populist movement led by Venezuelan president Hugo Chávez will wind up weakening U.S. exports [to the region]. “I don’t believe that that these movements are going to achieve much. They can’t, and people are not going to permit it.”
For his part, Martínez believes that China could wind up ousting the United States in some countries where it is gaining a lot of strength, such as Mexico, Peru, Colombia and Chile. Regarding populist political movements, Martínez predicts, “They can make it hard to sign treaties with the United States, and as a result, restrain export growth in some countries of the region.”
Agudelo believes that the situation can change in coming years if the Latin countries put different economic policies into effect. “The countries of South America have taken the wrong road in trying to globalize their economies through exposure of their financial markets, and by making foreign investment possible, without caring about the conditions under which that should be done.”
For Agudelo, Latin American economies should take a new path. It is “important not to lose sight of regional [trade] possibilities and to have a minimum of protectionist barriers, while also requiring foreign investors to pay taxes and fair salaries. Investors must reinvest part of their profits, and keep at least a minimum of their investments [in the country]. Governments must play an important role by supporting productive regional development projects that enable investment by bringing in outside knowledge, especially in products and services that are valued outside the country. Strategies that make opening up trade a focal point of economic policy are roads that offer no rewards in social terms. They also make it hard to construct competitive structures that, over the long term, are not only good business for investors, but also solve the problem of the postponed payment of the social debt.”