Trade, Integration and Economic Development: The EU and Latin America (Schriftenreihe der Österreichischen Gesellschaft für Europaforschung (ECSA Austria) ... Association of Austria Publication Series)

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European Community Studies Association of Austria (ECSA Austria) Publication Séries Volume 13 Schriftenreihe der Ôsterreichischen Gesellschaft fur Europaforschung (ECSA Austria)

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Gabriele Tondl (éd.) Trade, Intégration and Economie Development The EU and Latin America

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Prof. Dr. Gabriele Tondl Research Institute for European Affiars, Vienna University of Economies and Business Administration

Financial support was given by Bundesministerium fur Wissenschaft undForschung, Wien, and the European Commission, DG Education and Culture, Brussels This work is subject to copyright. AU rights are reserved, whether the whole or part of the material is concerned, specifically those of translation, reprinting, re-use of illustrations, broadcasting, reproduction by photocoping machines or similar means, and storage in data banks. © 2008 Springer-Verlag Wien Printed in Austria SpringerWienNewYork is a part of Springer Science + Business Media springer.com Product Liability: The publisher can give no guarantee for ail the information contained in this book. The use of registered names, trademarks. etc. in this publication does not imply, even in the absence of a spécifie statement, that such names are exempt from the relevant protective laws and régulations and therefore free for gênerai use. Typesetting: Caméra ready by editor Printing: Ferdinand Berger & Sôhne Gesellschaft m.b.H., 3580 Horn, Austria Printed on acid-free and chlorine-free bleached paper SPIN: 12064786 Library of Congress Control Number: 2008925001 ISSN 1610-384X

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Preface During the past decade, Latin American (LA) countries have become highly open economies. Trade agreements were implemented fostering trade relations both with other Latin American countries and with third countries, among them the main external trading partner, the EU and the US. This policy approach differs significantly from the import substitution policy dominating in LA in the 1970s. LA countries have developed manifold trade relations. At the same time economic integration has also developed in LA and become most advanced in the case of Mercosur. Especially for South America, Europe is an important trading partner and investor. Moreover, the economic integration process accomplished by the European Union (EU) is often seen as a role model for LA integration. For both regions, the EU and LA, it is important to understand economic developments in the region of the trading partner and to know why the other side pursues certain interests in the process of trade negotiations. To deepen the understanding of these issues, is the main objective of this volume. The volume is the proceedings of the International Conference – 7th Arnoldshain Seminar on “Trade and Integration. The EU and Latin America”, organized at Vienna Economics University, August 28 – September 1, 2006. It was the 7th conference of the Arnoldshain Network, a group of academics from the Johann Wolfgang Goethe University Frankfurt, the Universidad Nacional de Cordoba, Argentina, the Universidade di Sao Paolo and the Vienna University of Economics and Business Administration. The Arnoldshain network, named after the location of its first meeting in Germany, was founded under the wish to promote academic cooperation between researchers from Europe and Latin America and to support student exchange between the involved institutions. At the Vienna conference, the network concluded the foundation of the “International Association for Comparative Economics and Integration” which should henceforth become the institutional framework of the Arnoldshain Network to pursue its activities. The foundation meeting was attended by the network’ s initiator, Prof. em. Ulrich Peter Ritter, Prof. em. Roland Eisen (both Johann Wolfgang Goethe University Frankfurt), Prof. Díaz Cafferata, Prof. María-Luisa Recalde, Prof. Ángel Enrique Neder (all Universidad Nacional di Cordoba), Prof. Basilia Aguirre (Uni-

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versidade di Sao Paolo), Prof. Gabriele Tondl (Vienna University of Economics and Business Administration) and a number of new members from Europe and LA which contributed to the conference. The conference started with an introductory session where representatives from international institutions, government offices and academia introduced the conference subject and discussed the interests of both regions. Ricardo Santiago, at that time director of the Inter-American Development Bank, Paris, sketched the recent economic developments and trade integration in LA. Alfredo Valladao, Professor and Director of the “Chair Mercosur”, Science Po, Paris, talked about the aims and achievements of Mercosur. Marcel Vaillant, professor at Universidad de la Republica, Uruguay, explained the trade policy objectives of Mercosur vis-à-vis the EU while Philipp Dupuis, Deputy Head of Unit “Trade with Latin America”, Directorate External Trade, European Commission, introduced the EU trade policy and the EU Latin America Agenda, and Andreas Melán, Head of the Latin American and Caribbean Unit, Austrian Foreign Ministry, reported on the latest EU- LA summit in Vienna in spring 2006 and the EU´s foreign policy with Latin America. The conference also hosted a Round Table on “Institutions and Good Governance” with Ulrich Peter Ritter, Peter Eigen,Head of Transparency International, Wolfgang Hetzer, Head of Unit Intelligence, European Anti-Fraud Office, and Basilia Aguirre, Universidade di Sao Paulo. During the other parts of the conference some 30 papers were presented and discussed by academics. Most of these papers are included in this volume. The books starts with the address of the initiator of the Arnoldshain Network and a protagonist of Comparative Economics, on “James Fenimore Cooper: An Astute and Critical Precursor of Comparisons in the Social Sciences”. An introductory chapter by Gabriele Tondl follows explaining trade and integration within Latin America and with its main trading partners. The first part of the book on “Open Economy Macroeconomics” contains three papers: The paper of Sergio Barone and Alberto Díaz Cafferata discusses the relationships between exports, external debts and external solvency in Argentina before the 2002 crisis. Fernando Zarzosa Valdivia presents a general equilibrium model of an open economy with real exchange rate movements which explains the Dutch Disease and functional and sectoral income distribution. The paper of Michael Brei contains an empirical analysis of the impact of current account reversals on relative prices in the

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Brazil. Part 2 of the volume deals with “Institutions for Development: The Case of Corruption” and contains a paper of Wolfgang Hetzer on the EU budget asking whether it is a breeding ground for corruption, and a second paper by Basilia Aguirre discussing the multiple faces of wrongdoing in the case of corruption Brazil. The third part of the volume contains seven papers which address “Trade and Integration Issues”. The paper of Laura MárquezRamos and Inmaculada Martínez-Zarzoso investigates empirically the effects of distance in a gravity model of foreign trade. Dierk Herzer looks at the composition of trade in Chile and its relationship with productivity. Felicitas Nowak-Lehmann Danzinger, Dierk Herzer, Sebastian Vollmer and Inmaculada Martínez-Zarzoso analyse the role of price competition for the market share of Chile in different European product markets. María Luisa Recalde and Marcelo Florensa investigate whether the implementation of Mercosur has lead to trade creation or trade diversion. Rinaldo Antonio Colomé and Fernando M. Giuliano explain the differences of agricultural policies in the European Union and LA countries and its consequences for agricultural trade. Matteo Grazzi and Antonella Mori discuss the regulations of FDI in some LA countries and their impact on FDI inflows. Ángel Enrique Neder, Julieta Schiro and Jonatan Saúl give an assessment of financial integration in LA. Finally, part 4 deals with “Regional Issues”. It contains a paper by Jòse Luis Arrufat, Alberto J. Figueras, Valeria J. Blanco and M. Dolores De La Mata which analyses regional income mobility in Argentina. The second paper by Jorge Alberto Fornero investigates whether Mercosur countries converge in per capita GDP and finally the paper by Basilia Aguirre and Guilherme Dias discusses fiscal federalism in Brasil. The participants of the Vienna conference made a valuable contribution to develop research in the field of the objectives of the International Association for Comparative Economics and Integration. The Association welcomes that most contributions have found its way into this volumes. A special thank is owed to Nurgül Özen for her huge secretarial support to produce the publication. Gabriele Tondl President of the International Association for Comparative Economics and Integration

Table of Contents

Address of the Initiator of the Arnoldshain Seminars Ulrich Peter Ritter James Fenimore Cooper: An Astute and Critical Precursor of Comparisons in the Social Sciences

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Gabriele Tondl Trade and Integration in Latin America and with Its Main Trading Partners

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Part 1:

Open Economy Macroeconomics

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Sergio V. Barone and Alberto M. Díaz Cafferata Rigidities in Openness, Export Performance and Indicators of External Solvency in Argentina

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Fernando Zarzosa Valdivia Real Exchange Rate Movements, Dutch Disease and Functional and Sectoral Income Distribution

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Michael Brei The Impact of Current Account Reversals on Relative Prices: The Brazilian Experience Part 2:

Institutions for Development: The Case of Corruption

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Wolfgang Hetzer The European Budget, A Breeding Ground for Corruption?

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Basilia Aguirre The Multiple Faces of Wrongdoing – A Closer Look on Corruption

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Part 3:

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Trade and Integration Issues

Laura Márquez-Ramos and Inmaculada Martínez-Zarzoso On Distance Effects in Gravity Models – Short Versus Long Distances

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Dierk Herzer Trade, its Composition and Total Factor Productivity: Cointegration Evidence for Chile

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Felicitas Nowak-Lehmann Danzinger, Dierk Herzer, Sebastian Vollmer and Inmaculada Martínez-Zarzoso Chile’s Market Share in the EU Market: The Role of Price Competition in a Panel Analysis Setting

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María Luisa Recalde and Marcelo Florensa Mercosur: Trade Creation or Trade Diversion? An Application of the Gravity Model and Kalman Filter

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Rinaldo Antonio Colomé and Fernando M. Giuliano Agricultural Policies and Trade in the European Union and Selected Latin American Countries

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Matteo Grazzi and Antonella Mori The Regulation of FDI in Latin America and the Caribbean: What Impact on Host Countries?

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Ángel Enrique Neder, Julieta Schiro and Jonatan Saúl Financial Integration in Some Countries of South America The Use of Interest Parity Conditions as Indicators

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Part 4:

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Regional Issues

Jòse Luis Arrufat, Alberto J. Figueras, Valeria J. Blanco and M. Dolores De La Mata Analysis of Regional Income Mobility in Argentina

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Jorge Alberto Fornero Do Mercosur Countries Converge in Per Capita GDP and Productivity?

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Basilia Aguirre and Guilherme Dias Fiscal Reform and Federal Relations

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List of Authors

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Address of the initiator of the Arnoldshain Seminars and of the International Association for Comparative Studies in Economics and Integration Ulrich Peter Ritter

James Fenimore Cooper: An Astute and Critical Precursor of Comparisons in the Social Sciences I. Introduction and biography “Had I only read this book when I was still teaching my class on comparative economics.” I thought more than once, when I read Cooper’s memories of his travels in Europe as the first book after my retirement. I suppose most of us know his name, some characters from his books and maybe even some of his books from our days as youngsters. But I suppose few of us know him as a methodologically conscious and truth searching comparatist. That he deserves these attributes I want to show in my paper. In addition I want to make a case for making use of this historical material in particular and historical material in general in teaching comparative economics to our students. Also I want to show that Cooper was aware of problems of comparing that are still relevant for us today, but are often overlooked because of the seeming availability of numerical material. Why am I so enthused? Because I would certainly have used this book as an illustration in my class on comparative economics had I read it before. I learned that Cooper was a comparatist, if there ever was one. In his book “A Residence in France With An Excursion Up The Rhine, And A Second Visit To Switzerland”1, Cooper compares nearly everything from Goethe and Schiller (JFC 2004, Letter 1

A German version was published under the title „Lebensbilder aus Frankreich, den Rheinländern und der Schweiz”, in Braunschweig in 1837, Reprint Kelkheim 2001. The English version was published in the Internet by the Gutenberg Project and will be refered to further on as “JFC 2004”.

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XIV), the electoral systems in the US and the Canton of Vaud in Switzerland (JFC 2004, Letter XVII), wine prices and wine cultivation (JFC 2004, Letter XVIII), the differences between American and European hands and feet!!!! (JFC 2004, Letter XXVI), democracy in the US and Switzerland (JFC 2004, Letter XXIII) and more. Some of these comparisons are, of course, very banal, but some of them show a surprising amount of sophistication and awareness of methodological difficulties. In this paper I want to present to you Cooper, the comparatist, demonstrating this by two of his more interesting comparisons: - A comparison of the cost of living in Europe and the United States - The controversy about the costs of republican versus monarchic government, in the literature known as the Public Finance Controversy. But before I do so, let me give you some information about his biography and his works. He was born in Burlington, N. J. on September 9, 1779, three years after the Declaration of Independence, and he died one day before his 72nd birthday on September 14, 1851, 6 weeks before the Coup d’Etat of Louis Napoleon in France, in Cooperstown, N. Y., a town named after his father. Reared in the wild country round Otsego Lake, New York, on the yet unsettled estates of his father William Cooper, a judge and member of Congress, he was sent to school in Albany and in New Haven, where he Yale at the age of fourteen, remaining for some time the youngest student on the rolls. In his junior year Cooper was expelled from Yale after having committed a series of pranks, one of them being the training of a donkey to sit in a professor’s chair (Redekop 1986). Three years afterwards he joined the United States Navy; but after making a voyage or two on a merchant vessel, to perfect himself in seamanship, and obtaining his lieutenancy, he married and resigned his commission in 1811. He then became a settler in Westchester Country, New York. He was thus very familiar with what he was later to describe in his most famous novels, because he grew up in the wilderness in what was then the country of the pioneer settlers, the hunters and trappers and last but not least the various tribes of the Indians that later were to play an important role in his novels. His books on the life on the frontier have largely founded our knowledge and fantasies of the US in those times. His tales are still

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read the world over and still serve as the script for many a movie and TV feature. For him the American Indians were human beings. He did not believe in the stereotype of the cruel savage. As Karl Meyer Frommhold says in his edition of the Leather Stocking tales (1996), posterity owes it in good part to him that the American Indians were not completely exterminated. Cooper was the first and best known American author of his time and one of the most popular 19th century authors. His stories have been translated into nearly all the languages of Europe and into some of those of Asia. Balzac admired him as did Johann Wolfgang von Goethe; Victor Hugo pronounced him greater than the great master of modern romance, Sir Walter Scott, and this verdict was echoed by a multitude of readers, who were satisfied with no lesser title for their favourite than that of “the American Scott.” He has, of course, had also adversaries who critique his enormous vanity and his irritability. Wikipedia (July 2006), making reference to the Encyclopedia Britannica, says: “It is only as a novelist that he deserves consideration. His qualities are not those of the great masters of fiction; but he had an inexhaustible imagination, some faculty for simple combination of incident, a homely tragic force which is very genuine and effective, and up to a certain point a fine narrative power.“ James Fenimore Cooper is generally known as the first American writer to reach worldwide recognition, with his more than 30 books, numerous articles and essays and hundreds of letters, some of which are still not yet published. He is better known for his writings on naval themes and on the life on the big Frontier than as a comparatist. However, he lived for seven years in Europe between 1826 and 1833 and thus at a time when Alexis de Toqueville explored the United States. He then travelled widely in England, France, Germany, Italy and Switzerland. He wrote diaries during his stay that are full of comparisons, some of which deserve even to be called comparative studies. II. A comparison of the cost of living in Europe and the United States The first comparison I want to highlight is a comparison of the costs, or as Cooper says, “expences of living” in Europe and the U.S., published as the 7th of 28 letters of his book (JFC 2004, Letter VII).

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Cooper does not take this comparison lightly. He starts his argument with the phrase: “Your question, as to the comparative expense of living at home and of living in Europe, is too comprehensive to be easily answered…” One reason”, he points out, is that “prices vary so materially that it is difficult to make intelligent comparisons” (JFC 2004, Letter VII). That is why he limits himself mostly to a comparison between Paris and New York, a very smart decision in view of the scarcity of comparable data. Right in the beginning he introduces a definition of standards of reference: “so long as one keeps within the usual limits of American life, or is disposed to dispense with a multitude of little elegancies”. This restriction is necessary because “while no money will lodge a family in anything like style, or with suites of rooms, ante-chambers, etc. in New York, for the simple reason, that buildings which possess these elegancies, or indeed with fine apartments at all, have never yet been erected in the country.” He also formulates an initial hypothesis: “If one does this, New York has the advantage over Paris” (JFC 2004, Letter VII). He then goes on to explain why this is so. Cooper answers the question in a differentiated form. He first speaks about lodging, then about food and wine and then about clothes and clothing style. But he also speaks about tariffs, taxes, and habits, as well as the organization of commerce and the motivation of consumers and merchants. As to lodging he points out: “a family can be better lodged in a genteel part of the town for less money, than it can be lodged, with equal room and equal comforts, in a genteel quarter of Paris; always excepting the inferior distribution of the rooms, and other little advantages, such as the convenience of a porter, etc. all of which are in favour of the latter place.” In a footnote he explains this: “[Footnote 17: In New York, the writer has a house with two drawing-rooms, a dining-room, eight bed-rooms, dressing-rooms, four good servants' rooms, with excellent cellars, cisterns, wells, baths, water-closets, etc. for the same money that he had an apartment in Paris, of one drawing-room, a cabinet, four small and inferior bed-rooms, dining-room, and ante-chamber; the kitchens, offices, cellars, etc. being altogether in favour of the New York residence. In Paris, water was bought in addition, and a tax of forty dollars a year was paid for inhabiting an apartment or a certain amount of rent; a tax that was quite independent of the taxes on the house, doors, and windows, which in both cases were paid by the landlord.]” (JFC 2004, Letter VII).

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After this comparison of the cost of lodging Cooper goes on to compare the cost of food of all kinds. “Food is much the cheaper in New York bread alone excepted,” he says. This may not surprise us. But it is less self-understood, when he goes on to say that “Wines can be had, as a whole, better and cheaper in New York, if obtained from the wine-merchant, than in any European town we have yet inhabited. Even French wines can be had as cheap as they can be bought here (i. e. in Paris), for the entrance-duty into the country is actually much less than the charges at the gates of Paris. The transportation from Bordeaux or Champagne, or Burgundy, is not, as a whole, essentially less than that to New York, if indeed it be any less.” (JFC 2004, Letter VII) “All the minor articles of table luxuries, unless they happen to be of French growth, or French fabrications, are immeasurably cheaper in America than here i.e. in Paris.” Clothes are nominally much cheaper here than with us; but neither the French nor the English use habitually as good clothes as we; nor are the clothes generally as well made. You are not, however, to suppose from this that the Americans are a well-dressed people; on the contrary, we are greatly behind the English in this particular, nor are our men, usually, as well attired as those of Paris. This is a consequence of a want of servants, negligent habits, greediness of gain, which monopolizes so much of our time as to leave little for relaxation, and the high prices of articles, which prevent our making as frequent calls on the tailor, as is the practice here.” (JFC 2004, Letter VII) “My clothes have cost me more in Europe, however, than they did at home, for I am compelled to have a greater variety, and to change them oftener. Our women do not know what high dress is, and consequently they escape many demands on the purse, to which those of Paris are compelled to submit. It would not do, moreover, for a French belle to appear every other night for a whole season in the same robe, and that too looking bedraggled, and as jaded as its pretty wearer. Silks and the commoner articles of female attire are perhaps as cheap in our own shops, as in those of Paris: but when it comes to the multitude of little elegances that ornament the person, the salon, or the boudoir, in this country, they are either wholly unknown in America, or are only to be obtained by paying treble and quadruple the prices at which they may be had here ...We absolutely want the caste of shopkeepers as it exists in Europe. By shopkeepers, I mean that humble class of traders who are content

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with moderate profits, looking forward to little more than a respectable livelihood, and the means of placing their children in situations as comfortable as their own. This is a consequence of the upward tendency of things in a young and vigorous community, in which society has no artificial restrictions, or as few as will at all comport with civilization, and the buoyancy of hope that is its concomitant. The want of the class, notwithstanding, deprives the Americans of many elegancies and some comforts, which would be offered to them at as low rates as they are sold in the countries in which they are made, were it not for the principle of speculative value, which enters into nearly all of our transactions. In Paris the man or woman who sells a duchess an elegant bauble, is half the time content to eat his humble dinner in a small room adjoining his shop, to sleep in an “entresol” over it, and to limit his profits by his wants. The pressure of society reduces him to this level. With us the thing is reversed, and the consumer is highly taxed, as a necessary result. As we become more familiar with the habits of European life, the demand will gradually reduce the value of these minor articles, and we shall obtain them at the same relative prices, as ordinary silks and shawls are now to be had. At present it must be confessed that our shops make but indifferent figures compared with those of London and Paris. I question if the best of them would pass for more than fourth-rate in London, or for more than third-rate here; though the silk-mercers at home might possibly be an exception to the rule.” (JFC 2004, Letter VII) To finalize his comparison he concludes, “The amount of all my experience, on this point, is to convince me, that so long as one is willing to be satisfied with the habits of American life, which include a great abundance, many comforts, and even some few elegancies, that are not known here, such as the general use of carpets, and that of many foreign articles which are excluded from the European markets by the different protective systems, but which, also, do not know a great many embellishments of living that are common all over Europe, he can get along with a good deal less money in New York, than in Paris; certainly, with less, if he mix much with the world.” (JFC 2004, Letter VII) If we reconsider this comparison we must note that the author in his effort to present a correct, reflected, and plausible result used several methodological gimmicks, which only much later became a standard in comparisons of purchasing power. Thus he introduced a standard object of comparison, i.e., the normal American upper

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class New Yorker. He discussed the institutional effects on differences such as tariffs and taxes. He also mentioned the organization of crafts and commerce as an important factor and points out the importance of differences of habits, style, and motivation. All in all I find his comparison quite differentiated, informative, and reflected. III.

The controversy about the costs of republican versus monarchic government

As a second example of Cooper’s expediency in comparisons I want to use what in the literature about him is often referred to as “the public finance controversy”. It is what today we would call a hypothesis testing or rather a hypothesis refuting comparison. In the third letter of his report (JFC 2004, Letter III) Cooper tries to refute the hypothesis proposed in a 70 page article in Volume 5 of the Revue Britannique by an anonymous author argues that the cost of government in France was lower than in the U.S. i.e., as it was understood at the time, that a republican government is more expensive than a monarchy. If we were to look at this comparison with the eyes of a modern social scientist we could probably find many a flaw in it. Still I want to point out that this was no run of the mill comparison, but a rather sophisticated one if one looks at it from the point of view of the methodological refinement. Cooper goes about his refutation in four steps or on four levels. He criticizes his opponent on the basis of the four fundamental methodological questions in the critical analysis and planning of comparisons (Ritter 1996, pp. 311-313; Ritter 1997, pp. 313-361): Who compares why, what and how. In the first place he looks at the author of the comparison, i. e. the person or institution responsible for it. In the third letter of his Gleanings Cooper writes: “A controversy concerning the cost of government, was commenced some time in November last, under the following circumstances, and has but just been concluded. As early as the July preceding, a writer in the employment of the French government produced a laboured article, in which he attempted to show that, head for head, the Americans paid more for the benefits of government than the French. Having the field all to himself, both as to premises and conclusions, this gentleman did not fail to make out a strong case against us; and, as a corollary to this proposition, which was held to be proved, he, and others of his

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party, even went so far as to affirm that a republic, in the nature of things, must be a more expensive polity than a monarchy.” (JFC 2004, Letter III) In one sentence, the subject or author of the comparison was a partisan of monarchy and on the government pay role. This, as Cooper calls it, “extravagant assertion” apparently made a deep impression on the discussion in France and even beyond the borders of that country. It struck people, as Cooper says,” by the boldness of the proposition, as well as by the plausibility of the arguments by which it had been maintained.” (JFC 2004, Letter III) The reasons for making this comparison lay in the discussion and political disputes at that time inside and outside the French parliament. As a matter of fact there was a necessity to lower government spending and our anonymous author spends the first 14 of the 70 pages of his article to show in a very detailed form that to lower government spending the cuts and savings expected from an administrative reform and salary cuts were hardly worth the effort (Lettre 1831, pp. 273–287). He then sets out to explain the real purpose of his comparison. It was to prove that those in favour of the reforms were wrong, when they constantly pretended that the government of the U.S. was “Bon Marche”, i. e., cheap. At a time, when the battle between monarchists and democrats or republicans became an acutely pressing issue the article was, of course, very favourably received by the monarchists all over Europe and was seen by them as another proof or their cause. On the other hand it shocked not only Republicans, but also those who where in favour of constitutional or parliamentary monarchy. It was seen as a blow particularly directed at all protagonists of the American form of government, one of the most respected ones of these being the General Lafayette. In a letter dated November 22 1831, the latter points out to Cooper that he discovered many mistakes in the article, but lacked the time for a detailed refutation and would like to pass this task on to the better hands of Cooper. Cooper also looks critically at the object of the comparison and the method used to describe it. As we shall see, Cooper criticizes not only the data which the anonymous author of the offensive comparison uses but also the manner in which he uses it. And this is, where most of his detailed efforts are made.

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It was clear to our unknown author, that before comparing government expenditures of the two countries in total and per head they had to be made comparable by addition, subtraction and estimation. Some of the topics chosen for this end were: - The definition of government spending, the federal budget not including the expenditures of communities and states, which in the centralized government were part of the central budget; - The state debt and its repayment; - Taxes and duties; - Expenditures for wars; - Expenditures of the US president versus those of the president of the council of ministers in France: - Indemnities per day and travel allowances of state senators and house representatives and of the state secretaries; - their expenditures for their offices and for salaries; - The pay of the officers in the two armies; - The expenditures for the churches, the judicial and the educational system and for the infrastructure i. e. canals and roads. Using an astounding number of statistics and figures the author tries to prove, that per capita expenditures for governmental services were not lower but rather higher in the US than in France. In the year 1829 according to our anonymous author they amounted to 31 frs in France and 35 frs in the US. Cooper criticizes these impressive calculations item by item and tries to show that the author used false or incorrect numbers, presented contradicting facts, mixed up cause and effect, misunderstood or misinterpreted the data or even that there must have been errors in print (JFC 2004, Letter III). I cannot go into the details of these critiques here. I just want to give you two examples. Let us take the national guard as the first example. It is here Cooper says (Lettre 1831, p. 165) that the Revue britannique makes its gravest mistakes. Our anonymous author takes much pain in arriving at comparable figures for the two countries by calculating expenditures for food, clothing, training etc. And he arrives at the conclusion that one man in the militia costs around 500 frs. per year in France as against 2 500 frs. or 5 times as much in the US. Cooper points out the faults in this calculation and shows that the national guard is by far less costly in the US than in France. The flaws he mentions are among others, that in New York state time for service is less than

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half of what the other side calculated. Also the value of the time supposed by the anonymous author is only one third. As the anonymous author points out members of the national guard have to clothe and arm themselves at their own costs. But they do not have representative functions and therefore do not have to have fancy uniforms. They can borrow their arms from a neighbour, if they do not have them anyway. (Lettre 1831, pp. 165-167) Also these arms are only needed for training purposes. In case of war, arms are provided by the governments of the state and the federation. A second example is the cost of religious services. While these costs are included in the French budget, the state contributes nothing in New York, where the average salary of a minister does not surpass 400 dollars versus the 1000 Dollars our anonymous author has used for his calculation, these coming from the renting of seats in the church and voluntary contributions. (Lettre 1831, pp. 167168) At the end of his calculations and of his article Cooper comes to the conclusion that altogether a citizen of the State of New York pays per year 14 frs and 1 s for government services from the state and the federation, including payments for schools, clergy and the poor, this is quite a difference to the calculation of 35 frs. in the article in the Revue Britannique, the sum amounting to 40 percent of the sum his adversary had calculated. As we have seen, Cooper goes to great lengths to show where the sets of data cannot be compared with each other and tries to indicate which allowances must be made, mainly because of the cultural contexts themselves, which are so different, and he demonstrates how in each culture the players or citizens place different values on various objects or situations. Thus they might have the same amount of good X, if they wanted it, but the culture does not value X highly enough to want much of it. Cooper’s refutation seems to have more or less ended the public policy debate. In his words: “It was then announced that instructions had been sent to America to obtain more authentic information; and we were promised a farther exposure of the weakness of the American system, when the other side should receive this reenforcement to their logic”. But (Footnote 7): “No such exposure has ever been made; and the writer understood, some time before he quitted France, that the information received from America proved to be so unsatisfactory, that the attempt was abandoned”. Cooper goes on to say that the information since published, has confirmed

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the accuracy of his calculations, “the actual returns varying but a few sous a head from his estimates” (JFC 2004, Letter III). Cooper shows in his calculations the low tax burden of the citizens in the US, using New York as an example. But he refuses to compare them to France. In the last sentence of his letter he writes (Lettre 1831, p.182, translation by the author): “In no way do I want to compare these facts with France because I am sincerely convinced of the in aptitude of a foreigner for such investigations.....the example of the Revue Britannique still being too much present in my mind not to force me oo douter de moi meme for such a task”. And on page 177 he speaks of the fact that his critique shows the difficulties and problems of understanding the details of the customs of a foreign nation and the danger of writing about this subject if one has not personally studied them “from the closeness”. This is a more general piece of wisdom that all comparatist should be aware of when we compare even official data: they do not necessarily represent the same reality in one country as in the other. Cooper makes us aware of how important it is to have data sets that are comparable. It is easy to be wooed into comparing today with all the data which is available, but the problem of finding data that allow valid comparisons still exists. Cooper makes us aware of the pitfalls that are masked today by the elegant sets of figures at our disposal and our tendency to neglect cultural and historical contexts that colour the economic behaviour of the parties involved, making them difficult to compare in a straightforward way. IV.

Conclusion

I come to the conclusion that we cannot look at Cooper’s comparisons as models or scientific achievements. What we must realize is that he was a writer and journalist and not a scientist or university professor. Also, we must consider that the letters we are referring to in this paper were written in the 1830s, a time when social science was in its beginnings and knowledge of statistics was not very developed, not to speak of comparative sciences. That such a science could be developed, was unthinkable of at that time. However, what we can conclude from my little aperçu are three things: First, that it could be worthwhile to invest time to go deeper into the theme treated here, i. e., James Fenimore Cooper as a comparatist, by encouraging further research. Second, when the history not

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only of comparative economics, but also of comparative sociology and politics, will be written, it would be only natural to require that a chapter or at least a few paragraphs be included on this precursor. But what is most important to me is the third point: I think that international comparisons with their four subdivisions – comparisons of economic phenomena, comparisons of economic policies, comparisons of economic systems and comparisons of dealing with problems (Ritter 1996, pp. 311-313 and Ritter 1997, pp. 313-361) – should be included in the training of economists. Furthermore, I make a plea for having a history of comparisons included in such a curriculum; and I consider it desirable to make use of historical comparisons in the form of cases or case studies in our teaching, because this would add depth and insight to the learning of our students, help to widen their horizon as it did my own.

References

Cooper, James Fenimore (1970a), Gleanings in Europe: England, Robert E. Spiller (ed.), New York: Oxford UP. Cooper, James Fenimore (1970b), Gleanings in Europe: France, Robert E. Spiller (ed.), New York: Oxford UP. Cooper, James Fenimore (1986), Gleanings in Europe: The Rhine, Historical Introduction by Ernst Redekop and Maurice Geracht, Text established and Explanatory Notes prepared by Thomas Philbrick and Maurice Geracht, Albany: State University of New York Press, 1986. Cooper, James Fenimore, Lebensbilder aus Frankreich, den Rheinländern und der Schweiz, Braunschweig 1837, Reprint Kelkheim 2001. Cooper, James Fenimore (1960), The Letters and Journals of Vol. 6, James Franklin Beard (ed.), Cambridge, Harvard UP. JFC 2004: Cooper James Fenimore (2004), A Residence in France With An Excursion Up The Rhine, And A Second Visit To Switzerland, Paris, 1836, The Project Gutenberg EBook Release Date: July 22, 2004 [E Book #12990], : http://www.gutenberg.org/etext/12990 (last visit: 17.12.2007).

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Lettre (1831), Anonymous, Rapprochement entre les dépenses publiques de la France et celles des États-Unis, Revue Britannique, Paris, pp. 272 – 322. Lettre: Lettre au Général Lafayette sur les dépences publiques des États Unis, Revue des Deux Mondes Paris. Meyer, Frommhold Karl (1996), in: Cooper James Fenimore, Der Lederstrumpf, 23 edition, Reutlingen, pp. 651 – 652. Redekop, Ernest (1986), Introduction to Cooper, James Fenimore, Gleanings in Europe: The Rhine, Albany, State University of New York P. Ritter, Ulrich Peter (1996), Some Basic Considerations and Methodological Decisions in Comparative Research, in: Ulrich Peter Ritter (ed.), Problems of Structural Change in the 21st Century, National and Comparative Research from Argentina, Brazil and Germany, Frankfurt am Main, pp. 311 – 320. Ritter, Ulrich Peter (1997), Vergleichende Volkswirtschaftslehre, 2nd Edition, Munich. Walker, Jeffrey (1993), The Importance of Flotsam and Jetsam in Editing the Unpublished Letters of James Fenimore Cooper, in: James D. Wallace (ed.), James Fenimore Cooper: His Country and His Art, Papers from the 1993 Cooper Seminar (No. 9), The State University of New York College at Oneonta, Oneonta, New York, pp. 52-63. Wikipedia, the Free Encyclopedia: James Fenimore Cooper, : http://en.wikipedia.org/wiki/James_Fenimore_Cooper (last visit: 17.12.2007).

Gabriele Tondl

Trade and Integration in Latin America and with Its Main Trading Partners Abstract Latin America (LA) has opted for trade liberalization and opening up for foreign direct investment in the 1990s. The region has implemented a multitude of trade arrangement within the group. Since LA is a large, emerging market, the United States and the European Union have also a strong interest to establish free trade agreements with that region. Several such agreements have been implemented. In line with these agreements the main trading partners, US and EU, could affirm their trading position in the region but intra-LA trade also increased steadily. I. Recent Economic Developments in LA In the 1950, 1960s and 1970s, LA countries practised an economic regime characterized by market intervention and import substitution policies. Countries wished to shelter the development of own industries and to limit foreign influence. They enjoyed a relatively stable economic growth that reached on average 5 per cent during that period. However, the situation changed completely in the 1980s. In view of the excess liquidity in international capital markets after the first oil price shock, LA countries heavily borrowed on international markets. This brought them into a sever debt crisis in the early 1980s when interest rates substantially increased. Many LA countries slipped into serious recession and stagnation in the 1980s which entered as the "lost decade" in their economic history. Consequently, one after the other had to reconsider its economic model starting to foster market-orientation and to integrate into the world economy. The 1990s became the decade of reforms in LA. Reforms were designed in line with the Washington Consensus, a set of guidelines which the international institutions had proposed for LA. They focused on deregulation, privatization, reduction of government

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Gabriele Tondl

deficits, macroeconomic stabilization and liberalization of trade and direct investment.1 Consequently the region became ready for free trade negotiations with third countries and within the region and started to search actively to attract international investments, which will be discussed in detail below. Growth resumed in the 1990s reaching on average 3.3 per cent, but this was weaker than expected and certainly below the growth in other dynamic emerging markets. Moreover, the region was not immune to crisis. Mexico went into a deep financial crisis in 1994/95 caused by increasing public debt financing and declining oil prices, which lead to a substantial currency devaluation and economic decline. LA was also heavily affected by the Asian crisis in 1998 and suffered in that period a substantial decline in growth, a tightening of financial markets, consequent pressures on currencies and devaluations. Most dramatic was the devaluation of the Brazilian Real in 1999. Only Chile managed to remain almost unaffected by the Asian crisis. (Singh et al. 2005, Corbo et al. 2005) In the course of economic crises and successive attacks on currencies, countries such as Mexico and Brazil moved from a semifixed exchange rate system to floating exchange rates (ECLAC 1999). Argentina originally had adopted a currency board in 1991 with the aim to control hyperinflation. However, the fixed exchange rate brought the economy under stress when its mighty neighbour economy Brazil devalued its currency and world market prices for Argentina´s exports declined. The country entered into a severe recession. International investors raised the risk score of the country inducing massive capital flight. At the height of this financial crisis Argentina had to declare debt default and unfreeze the fixed link with the dollar in early 2002. A massive devaluation of its currency followed. Despite the profound pro-market reforms in LA in the 1990s, growth performance was disappointing. Moreover, poverty and inequality had not reduced. LA constitutes a big, growing market with 559 million inhabitants in 2005. There are important differences in economic development between LA countries. Argentina, Chile and Mexico lead in 1

Chile started economic reforms already in the late 1970s, earlier and more ambitious than the rest of the region. Thus it experienced a better economic performance and did not suffer a recession in the 1980s but grew at 7.3 per cent in the period 1985-97. (Corbo et al. 2005).

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per capita income (see Table 1), while countries like Peru and Venezuela reach just half of that income level. According to ECLAC (Economic Commission for Latin America and the Caribbean), LA reached an annual growth of 4.9 per cent in 2007. Growth was higher in South America (5.5 per cent) than in Central America and Mexico (3.6 per cent). Table 1 shows that among the main LA economies, Argentina, Venezuela, Colombia and Chile were heading in growth in the recent period, whereas the growth rate of Brazil and Mexico was slightly below 3 per cent (see Table 1). Macroeconomic stability has also improved in many LA economies. The major economies, Brazil, Mexico, Chile as well as Colombia and Peru have flexible exchange rate systems and inflation target monetary policies that helped to reduce their inflation rates. Argentina could stabilize its currency in 2003. (ECLAC 2006) Real interest rates have dropped and inflation became below 10 per cent, except for Venezuela (see Table 1). Gross fixed capital formation was fairly stable in the region (see Table 1). However, it declined substantially in Venezuela and increased significantly in Colombia. LA countries lead more prudent fiscal policies during the recent economic cycle and therefore could accelerate the reduction of their external debt. (ECLAC 2006; 2007; and Table 1). After the recent economic upswing, practically all major countries in LA show an increase in labour force participation and a decline in poverty (see Table 1). Finally, one has to note that LA countries have become highly open economies, with rapidly growing export rates reaching about 20 per cent in Colombia and Peru and almost 40 per cent in Chile (see Table 1). It is noteworthy that trade balances also turned into surplus in recent years. Particularly oil and mineral exporters like Venezuela and Chile benefited from high world market prices. Since the second half of the 1990s, foreign direct investment rose steeply, with a short drop in 2003 but an immediate gain thereafter. Annual inflows amounted to 2.2- 6 per cent in the major economies (see Table 1), Chile also leading in this area.

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Table 1: Basic economic indicators for the major LA economies (to be continued)

Argentina Brazil Chile Colombia Mexico Peru Venezuela

population (million) 2005 1998 38.7 36.0 186.4 166.0 16.3 14.8 44.9 40.8 103.1 95.3 27.9 2.5.2 26.6 23.4 period average 2003-05 1998-2002

Argentina Brazil Chile Colombia Mexico Peru Venezuela

GDP p.c. in PPP (constant 2000 internat. $) 11778.3 11766.0 7346.4 7126.5 10183.1 9148.9 6285.3 5989.1 9351.3 8929.6 5144.8 4712.6 5376.6 5722.5 goss fixed capital formation (% of GDP) 18.6 16.1 17.6 20.0 21.2 22.1 17.8 14.8 19.3 20.5 18.2 20.3 17.4 23.9

Argentina Brazil Chile Colombia Mexico Peru Venezuela

inflation rate 9.2 4.7 9.4 6.1 2.3 3.7 6.0 10.6 4.4 10.7 2.5 3.3 22.9 22.1

Argentina Brazil Chile Colombia Mexico Peru Venezuela

GDP in billion current US-$ 2005 1998 183.1 299.0 882.5 788.0 118.9 73.1 122.9 98.5 767.7 421.0 79.4 56.6 144.8 91.3 period average 2003-05 1998-2002 real GDP growth % 9.0 -3.1 2.6 1.7 5.5 2.5 4.6 0.5 2.8 3.2 5.2 1.7 6.5 -1.5 external debt (% of exports) 402.4 497.6 209.6 383.0 121.8 165.7 180.6 211.5 84.2 101.6 210.0 351.2 103.2 152.9 real interest rate 1.0 16.2 44.5 57.5 0.1 9.8 7.6 13.0 0.9 5.8 10.3 21.0 -8.8 8.1

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Table 1 (cont.): Basic economic indicators for the major LA economies period average 2003-05 1998-2002

Argentina Brazil Chile Colombia Mexico Peru Venezuela

labor force participation rate 71.2 68.2 72.4 71.9 58.7 59.6 74.9 72.8 62.2 62.9 72.1 70.0 72.5 67.8

period average 2003-05 1998-2002 poverty rate 20.2 12.3 21.4 22.7 5.6 9.6 17.8 21.7 11.6 23.7 30.6 34.9 40.1 29.2

exports in % GDP trade balance (% of GDP) 24.9 14.1 7.8 2.3 17.1 11.4 4.2 -0.9 39.7 31.0 7.1 1.0 21.5 18.9 0.0 -1.0 29.1 29.4 -1.8 -2.0 21.2 15.2 2.9 -2.7 37.0 25.3 17.6 5.8 FDI inflows % of GDP Argentina 2.2 3.5 Brazil 2.3 4.6 Chile 6.4 6.8 Colombia 4.6 2.6 Mexico 2.5 3.2 Peru 2.7 2.8 Venezuela 2.2 3.3 Source: Own calculations based on Word Development Indicators 2007. Argentina Brazil Chile Colombia Mexico Peru Venezuela

In the next section we shall discuss the present status of LA trade and integration agreements, both within the region and with its major trade partners, the US and the EU. II. Integration and trade agreements of LA countries A. Intra – LA Integration and Trade Agreements Within LA plans for integration and free trade areas have been repeatedly launched since the 1960s. The wish to strengthen its own political identity, to define its own strategy independently of the

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Gabriele Tondl

political ambitions of its mighty Northern neighbour, the US, and international institutions has been the major motivation for such plans in LA. The first initiative for a Latin American free trade area goes back to the LAFTA (Latin American Free Trade Association) of 1961, an agreement foreseeing the creation of a free trade zone between South American countries and Mexico originally by 1972, then by 1980. In 1981 ALADI (Asociación Latinoamericana de Integración, Latin American Integration Association) succeeded LAFTA. ALADI aims at the creation of a free trade area, but also considers the possibility of subregional free trade agreements (FTA) under its umbrella. Under ALADI several such subregional free trade agreements were concluded: the Andean Community (CAN), MERCOSUR (Mercado Común del Sur) and the Grupo de los Tres (Colombia, Mexico, Venezuela) (see below). The five Central American countries Costa Rica, El Salvador, Guatemala, Honduras and Nicaragua created the CACM (Central American Common Market) already in 1963, establishing a free trade area (Hummer 2005). Due to the political turmoil in the region and the war between El Salvador and Honduras, the organization was ailing in the 1970s and 1980s but saw a revival since 1991 (Hummer 2005). CACM has established free trade in goods except for sugar cane, coffee, alcoholic beverages and petroleum products (SIECA 2007). Each of its members maintains bilateral free trade agreements with Mexico since the period 1995 – 2001 (SIECA 2007). The Andean Community (CAN, Comunidad Andina) was established in 1988 between Colombia, Peru, Venezuela, Ecudador and Bolivia to create a customs union. Venezuela left the Andean Community in 2006 claiming that it could not pursue its goals with that community and moreover it did not agree with the free trade arrangements that Peru and Colombia planned with the US. The Grupo de los Tres was established between Colombia, Mexico and Venezuela in 1995 to establish free trade. The Mercosur entered into force between Argentina, Brazil, Uruguay and Paraguay in 1991. It is a customs union and aims at creating a common market following the model of European integration. Chile and Bolivia are associated members of the Mercosur since 1996 and covered by free trade regimes. Venezuela signed an

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accession protocol to Mercosur in 2007 and is expected to become member in 2008. Chile, originally member in the predecessor of the Andean Community, maintains this mentioned association agreement with Mercosur but also a number of bilateral free trade agreements with other LA countries: with Venezuela (1993), Colombia (1993), Ecuador (1994), Peru (1998) and Mexico (1998) (Hummer 2005). There are several initiatives between LA states to promote intraLA political and economic integration. In 1994, 27 Central- and South American states proclaimed with the declaration of Quito the creation of a free trade area comprising all LA, the LAFTZ (Latin American Free Trade Zone) (Hummer 2005). There are also several projects to promote integration within South America. In 2004, the South American States proclaimed the CSN (Comunidad Sudamericana de Naciones) aiming to create a political, social and economic integration area between South American states. Also in 2004, Venezuela launched ALBA, the Boliviarian Alternative for Latin America, that wishes to establish an integration area characterized by strong social policies, heavy state intervention and renationalization among LA, opposed to the projected FTAA launched by the US (see below). A major element of this initiative is the integration of Latin American oil markets under the leadership of the region´s most important oil producer Venezuela that wishes to diversify away from its primary export destination for oil, the US. At present, Cuba and Bolivia joined Venezuela under this initiative. The principles of this integration project which are centred on state intervention and state ownership stand in sharp contrast to the other integration concepts for LA which are based on economic deregulation and liberalisation. The initiative of Venezuela is likely to separate again the subcontinent and delay intra-LA integration. LA has entered and negotiated trade agreements with the US and the EU (see below). Mexico, Peru and Chile are also involved in the APEC (Asia-Pacific Economic Cooperation) which includes the US, Australia, New Zealand, China and Japan among others and aims to achieve a free trade area by 2010.

o H

(N

Trade and Integration in Latin America and with Its Main Trading Partners

25

B. Free trade agreements LA – US The US has always been interested to assure its political hegemony in LA and to improve political stability in the region, above all in its backyard Central America and the Caribbean Basin. Consequently, these countries show a strong presence of US investors and have mainly exported to the US markets, even before the agreement of free trade areas. In 1993, the US launched an initiative for a regular summit of the 34 states of the Americas (Summit of the Americas). The aim of these summits is the cooperation in the fields of democratization, human rights, social policies, environmental protection, the fight against terrorism, drugs and corruption, and trade liberalization. Since 1994, Mexico is part of NAFTA (North American Free Trade Agreement) which has manifested in a strong engagement of US-investors in outsourcing in Mexico and an extremely high share of Mexico´s exports to the US (over 80 per cent). The NAFTA agreement relates exclusively to trade liberalization. However, cooperation in environment policy and development in labour standards was agreed in two separate agreements. In 2004, the US and the other Central American countries signed the free trade zone CAFTA (Central American Free Trade Agreement). (Hummer 2005) Both agreements guarantee the dominance of the US as major trading partner. The US launched an initiative for the FTAA (Free Trade Area of the Americas) in 2003 which should comprise 34 countries from the Americas, however, many LA countries show reluctance to enter into such arrangements. Many LA countries, above all Brazil, Argentina and Venezuela, fear that the US would dominate such an agreement and that they should foster intra-LA integration. Consequently, progress of the FTAA repeatedly was weakened. The summit of the American States in Argentina in 2005 was accompanied by heavy protests against the FTAA. Consequently, the US attempted to enter into bilateral trade negotiations with several priority LA countries. Shortly after the EUChile trade agreement, the US signed a free trade agreement with Chile in 2004. For the US Chile is an important market for machinery and transport equipment, but also for some agricultural products. The agreement foresees unrestricted market entry for manufactured and agricultural goods and all kind of services, in-

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Gabriele Tondl

vestment and government procurement. (Office of the United States Trade Representative 2002) The US started also free trade negotiations with Peru, Colombia and Ecuador in 2004 with a wish to secure stability and better prosperity in the region. Free trade agreements were signed with Peru and Colombia in 2006, supposed to enter into force in 2008. They foresee a gradual elimination of access barriers for industrial products (10 years) and agricultural products (15 years) in the case of Peru and an immediate access in the case of Colombia, access to the service sector and free access and protection of investors (Office of the US Trade Representative 2007a, 2007b). The US agreements require the parties to enforce national environmental and labour regulations and compliance with fundamental ILO labour rights. Critics stress that the FTA would yield more satisfactory results for the US than for the LA countries. For example, in the case of Mexico the NAFTA agreement was blamed to have caused a sharp rise in corn prices harming the consumers. Others argued that too little capacity and competence was devoted to negotiations by the LA governments and that the agreements would mainly benefit the exporting sector without improving employment and reducing inequality. The US favours to include Latin America in a common free trade area, i.e. to establish the FTAA, and watches the creation of intra-LA agreements with reservation since that would weaken its political influence in the region and strengthen intra-LA political relations. C. Free trade agreements EU - LA The European Union member countries, particularly its member countries Spain and Portugal, have long historical and cultural ties with LA. Therefore, the EU has increasingly searched to institutionalize the political and economic dialogue with the region since the 1990s. The increasing economic influence of the US in LA and the conclusion of the US free trade arrangements with single countries and groups of countries, such as the NAFTA, has been observed by the EU with much attention. Being aware that it would risk to lose its role in the region as the US moves on to establish FTA, the EU has also searched to intensify political and economic relations with the region. On the economic level, LA constitutes a large and growing market for the EU offering high market potential to export its high

Trade and Integration in Latin America and with Its Main Trading Partners

27

technology products and services and a market that lends itself also to increase presence through foreign direct investment, more and more in the privatizing service sector. Despite that fact, trade with LA accounted for only 0.5 per cent of total EU trade in 2005 (UN Comtrade). LA countries expect to reduce the predominance of trade relations with the US when entering into free trade agreements with the EU. Diversification of trade destinations and FDI ownership is an important goal for LA. Given the trade deficit with the EU in the 1990s, LA has become increasingly concerned to gain market access for its agricultural products in the still highly protected EU markets. Trade with the EU accounts for around 15 per cent of LA trade (UN Comtrade). An institutionalized political dialogue between the EU and the Latin American and Caribbean countries takes place since the Rio summit in 1999 every other year. At a lower level, the EU maintains a special dialogue with Mercosur, the Andean Community, Central America, Mexico and Chile. (European Commission, DG External Trade 2006a; 2006b; 2004) Cooperation programmes of the EU cover the regions as a whole, its subregions and countries. These programmes encompass the fields: social support and enforcement of labour regulations, promotion of regional cooperation and integration in LA, reinforcement of human rights, democracy, good governance and prevention of conflict, cooperation in the field of higher education (ALFA programme), and environmental protection. The EU wishes to enforce an advance in political rights and stability in LA, therefore the agreements foresee that a violation of the commitments of LA in this area would lead to the suspension of the trade agreements. The cooperation agreements have been in force with the Andean Community since 1993, the Central American republics since 1999, the Mercosur since 1999 (in addition bilateral cooperations with the single Mercosur countries have been operated since 1991- 1995), and Mexico in 2000. With Chile an association agreement has been enacted in 2003 which includes also the trade agreements. At bilateral level, one can name the EU–Brazil cooperation agreement established in 1992 as an example. It covers higher education issues and foresees scholarships under the Erasmus Mundi programme and the establishment of European Studies Centers,

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Gabriele Tondl

social programmes and environmental support to fight deforestation (European Commission, DG External Relations 2007). The Mercosur countries constitute the major trade relation of the EU with LA. For the Mercosur countries the EU is their principal market for agricultural exports, while the EU sells manufactured goods on Mercosur markets. The EU–Mercosur FTA was intended to go beyond the WTO and considered as a single undertaking. The EU has a strong interest to gain unrestricted market access for manufactured products and in the service sector while the Mercosur countries wish to have free access for agricultural products. Both parties still watch important restrictions under the current WTO regime. Since the conflicting interests of the two parties in the WTO negotiations of the Doha Round – Mercosur requests a larger cut in agricultural subsidies then the EU is willing to accept, while the EU demands substantial cuts in tariffs for industrial products and access in services – the negotiations for an EU-Mercosur FTA have come to a standstill. Moreover, the bargaining power of the Mercosur has been repeatedly weakened by political tensions between its member states. The accession of Venezuela to the Mercosur in 2008 brings a new member with a distinctly different political ideology into the group and will once again threaten the political decision power of Mercosur. The planned agreement of the EU with Mercosur envisages to achieve an opening of public procurement, agreements on wines and phytosanitary measures, regulations on investment as well as a dispute settlement mechanism. Given the standstill of the EU-Mercosur negotiations, the EU has searched to enter into bilateral negotiations within the group. Its most important trading partner in Mercosur is Brazil, where it exports machinery and transport equipment. In these sectors relatively high tariffs are still in effect. In addition, the EU is a principal investor in telecommunications, energy, financial services, automotive and agri-food industries. In contrast, the EU imports mainly primary products from Brazil. (European Commission, DG External Trade 2007) For the Andean Community (Colombia, Peru, Ecuador, Bolivia, Venezuela until its exit in 2006) the EU is the second important trading partner after the US and most important FDI source. Countries of the Andean Community presently trade with the EU under the GSP, in addition those combating drug production have duty free access to EU markets in products covered by the GSP and a number of sensitive and even agricultural products. The applica-

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bility of the GSP is subject to the implementation of the main international conventions on human, social and environmental regulations. In 2003, plans for a free trade agreement between the EU and the CAN were launched. The start was linked to the attainment of a sufficient level of intra-regional integration within CAN. (European Commission, DG External Trade 2006b) In contrast to this planned trade agreements, the EU maintains two important bilateral trade agreements with Mexico and Chile. The EU-Mexico association agreement includes three pillars, political dialogue, cooperation and trade. It entered into force in 2000. Considering the predominance of the US as a principal trading partner, the EU is subordinate for Mexico. No more than 4 per cent of its exports go to the EU and 10 per cent of imports originate from the EU. In contrast to the trade product structure with other LA countries, EU-Mexican trade comprises in both directions mainly machinery, transport equipment and chemical products. The EU has become an important investor in Mexico, holding 23 per cent of all foreign owned companies in 2003, mainly in the service sector and car production. The EU-Mexico FTA - the first transatlantic agreement of the EU - covers liberalization of trade in manufactured goods, agricultural products (by 2010) and services, and investment (European Commission, DG External Trade 2006c). All these areas are highly important for the EU that wishes to participate in the large Mexican market and to benefit from the NAFTA agreement by investing in Mexico. The association agreement with Chile was implemented in 2003. It covers trade in manufactured and agricultural goods, services, government procurement and investment, going well beyond the WTO commitments. It includes sections on technical regulations and phytosanitary measures. However, the association agreement comprises not only this trade agreement but also agreements on political dialogue and cooperation. The latter includes specific initiatives of the EU to promote education and social support in Chile. The EU imports mining and agricultural products from Chile and exports mainly consumer goods and machinery there. (European Commission, DG External Trade 2006d) Trade of the EU with the CACM is covered by the GSP and the drug regime. While trade with the EU accounts for around 10 per cent of trade for the Central American countries, it is negligible for the EU.

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III.

Free trade agreements and trade partners of LA

For historical reasons and promoted by the recent free trade agreements described above, Latin America has developed important trade relations with the US but also more and more within the subcontinent and with the EU. Given their natural abundances, LA countries have a high share of agricultural and mineral products in their exports: Argentina is a major exporter of beef and soybean, Brazil of coffee, meat and sugar cane, Chile exports fruits, wine and fish such as salmon, the Central American countries export pineapples, bananas and coffee. These agricultural products dominate in their exports to the US and the EU. Mexico and Venezuela are major oil producers and Chile is the world´s major copper producer. Oil producers possess also a key product to develop intra-LA trade. However, some Latin American countries have developed a diversified economic structure and export also more advanced manufactures: For example, Brazil exports motor vehicles and pharmaceuticals, Mexico exports machinery and components, to a large extent products of its maquilladora industries, and Costa Rica produces electronic circuits (SIECA 2007). Those manufactures lend themselves to develop export relations with third countries but also within LA. The US is the most important export partner for Central America, the Andean Community and Venezuela, where 30-50 per cent of exports go to the US (see Table 2). In the case of Mexico the exports to the US reach an extreme share of more than 80 per cent. Venezuela and Ecuador are also very focused in their exports on the US market with around 50 per cent of exports. For almost all countries in this group exporting to the US has grown in importance, a development favoured by the free trade arrangements of NAFTA and CAFTA. A remarkable exception is Bolivia which substantially reduced its exports to the US and also to the EU in favour of intra-LA trade. In Central America the EU closely follows the US as export partner but has lost to some extent. However, intra-LA trade relations have well developed and have become even most important for countries such as Guatemala and El Salvador (see Table 2 and SIECA 2007). Exports to South America are negligible but CACM receives 5-6 per cent of its imports from Mercosur and CAN (2007b). The developments in the export structure of Central

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America are closely linked with the strengthening of CACM after 1991, bilateral FTA with Mexico and CAFTA. In the Andean Community, the EU is a much less important export partner than the US and has also lost in importance. These developments will be influenced by the implementation of bilateral trade agreements with the US and further trade agreements with the EU which are planned as mentioned above. The only country in CAN which exports equally to the US, the EU and LA is Peru. As already mentioned, the reorientation of Bolivia´s export towards its intra-LA trading partners is most noteworthy. With Venezuela one observes a decline of intra-LA exports which is due to an export decline to Colombia after Venezuela left CAN in 2006. In turn, Venezuela´s exports to the Netherland Antilles, Cuba (the two are not included in the group LA) and China increased. Table 2: Latin America´s export partners (to be continued)

year Central America, Mexico Mexico 95 06 Honduras 95 06 Nicaragua 95 06 Costa Rica 95 06 Guatemala 95 06 El Salvador 95 06

export partners (per cent of total exports) US EU Intra-LA

83.4 84.8 42.6 32.5 41.9 46.0 40.1 42.4 31.3 31.4 17.5 28.2

4.2 4.3 36.4 25.9 32.4 21.6 30.7 17.8 15.7 7.7 30.9 11.9

4.5 4.3 6.4 31.1 20.1 21.1 16.3 11.5 36.4 40.7 44.9 43.0

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Table 2 (continued): Latin America´s export partners

year Andean Community Ecuador 95 06 Colombia 95 06 Bolivia 95 06 Peru 95 06 Venezuela (left CAN in 2006) Mercosur Brazil Argentina Paraguay Uruguay

export partners (per cent of total exports) US EU Intra-LA 43.2 53.7 35.6 40.8 31.5 10.0 18.7 21.9

17.9 11.5 24.1 15.4 18.8 6.0 27.7 23.0

18.6 24.5 25.6 26.7 40.2 66.4 18.3 21.7

95

50.8

8.5

22.7

06

48.8

8.0

6.6

95 06 95 06 95 06 95 06

18.8 17.6 8.6 8.8 4.8 3.5 6.0 13.8

27.9 21.5 21.4 17.0 19.4 5.9 20.6 16.9

22.1 23.6 46.3 41.1 64.9 59.2 53.3 35.2

Chile 95 12.6 26.1 (Mercosur associate) 06 15.5 26.5 Source: Own calculations based on UN Comtrade.

19.5 16.4

For the rest of South America, namely for the Mercosur and Chile, the EU is a more important export partner than the US. Argentina, Paraguay and Uruguay have a very high share of intra-LA exports which relates to their membership in Mercosur. Recent small declines in intra-LA trade are related to some re-implementation of trade barriers in Mercosur. Bolivia´s high intra-LA trade can also be explained by its association with Mercosur since 1996.

Trade and Integration in Latin America and with Its Main Trading Partners

33

In LA trade relations are generally fairly concentrated on one single trading partner, e.g. the US in Central America, the Mercosur with Argentina. However, the most advanced LA economies Chile and Brazil managed to diversify their export destinations. They focus on EU trade but are almost equally engaged in intra-LA trade and trade with the US. For the European Union, trade with LA plays still a subordinate role accounting for just 0.46 per cent of its exports. As mentioned above, LA would offer a high market potential for the EU having reached a stable growth performance and a relatively high level of development in some countries. It should therefore be considered as a more attractive market than presently done. In contrast, LA become much more important as an export partner for the US. In 1990, the US exported 11 per cent of its goods to LA, in 2005 this share has climbed to 19 per cent. It should be noted that it is not only the US neighbour Mexico which accounts for this high share, but other LA countries as well. (In 1990, 7 per cent of the US exports went to Mexico, in 2005 13 per cent.) (UN Comtrade) Although trade between LA and the US is favoured by their closer geographical location, there is good reason to suppose that the EU has too much neglected a potential market in LA. In summary, as shown in Prüfer and Tondl (2008), increasing trade openness had a positive effect on LA growth performance. Trading acted as an important channel for an increase in productivity, either because exporters are forced to improve their competitiveness on markets or because imported products introduce new technologies in the countries. IV.

Foreign direct investment in Latin America

In the process of economic reforms and liberalization, LA countries increasingly considered the attraction of foreign direct investment as a key strategy to promote development and growth. Consequently, the stock of foreign direct investment rose steeply since the second half of the 1990s and peaked for example, 84 per cent of GDP in Bolivia and 74 per cent in Chile (see Figure 1). FDI from North America and the EU dominates in the major LA economies (see Figure 2). In the smaller LA countries there is also a significant share of intra-LA FDI. The representation of the EU and the US closely follow their role as a trading partners that was discussed above. Thus we observe that the EU has become the most important investor in most South American countries, such as

34

Gabriele Tondl

Argentina, Bolivia, Chile, Colombia, Ecuador, Peru, Paraguay and slightly in Brazil, whereas North America is traditionally the most important investor in Mexico, Central America and Venezuela. Favoured by the free trade regime of NAFTA and CAFTA, parts of the production chain were relocated from the US to Mexico and Central America to benefit from lower labour costs. Thus a lot of greenfield investment in Mexico and Central America went into the machinery, motor and electronic industry. European investment in LA is predominately market seeking, horizontal FDI, e.g. the automotive investment in Argentina and Brazil. In addition, European companies used privatization of public utilities in LA to invest in the service industry, such as telecommunication. There has also been a rising investment of European banks in South America, in particularly Spanish banks entered into the market. Foreign direct investment had a positive impact on growth rates in LA when accompagnied by political stability and sound legal systems. (Prüfer and Tondl 2008). Foreign owned companies often have higher technological standards and are more productive than local ones. However, they also foster competition in their host countries and thus force local companies to become more productive. Figure 1: Development of FDI stocks in LA countries (share of GDP) 0.9

0.8

ARG BOL BRA CHL COL CRI ECU SLV GTM HND MEX NIC PRY PER URU VEN

0.7

0.6

0.5

0.4

0.3

0.2

0.1

0 90

91

92

93

94

95

96

97

98

99

Source: Own calculations based on Unctad data.

00

01

02

03

Trade and Integration in Latin America and with Its Main Trading Partners

35

Figure 2: EU- vs. North American FDI stock in LA countries in 2003 (share of GDP) 0,3 0,25 0,2 EUR-FDI

0,15

NA-FDI

0,1 0,05

SLV

CRI

GTM

PRY

HND

URU

BRA

M EX

VEN

ECU

NIC

COL

PER

CHL

ARG

BOL

0

Source: Prüfer and Tondl (2008).

V. Conclusions In the 1990s, LA countries became open economies. They actively searched liberalization of trade and opened to foreign direct investment. LA countries concluded a number of free trade agreements with their main external trading partners, the US and the EU. Given the large market potential in LA, both world trading powers competed in negotiating trade agreements with LA. However, LA was also very active in paving the way to intra-LA integration aiming to reduce the predominance of the US in trade relations. Mercosur, the Andean Community and CACM are free trade areas which are well established and which have impressively fostered intra-LA trade. In a number of LA countries, such as Argentina and Bolivia, intra-LA trade has now become most important. Other major LA economies like Brazil and Chile managed well to diversify their export markets. The implementation of FTA also promoted FDI flows into LA. Thus Mexico and Central America received important FDI from US companies which aimed to benefit from lower labour costs in their host economy and the easy trading of components within NAFTA or CAFTA. The motives of EU companies are different. For them access to large markets is the main reason for investing in LA. EULA trade agreements also facilitated that investment.

36

Gabriele Tondl

In summary, one can conclude that becoming more open economies has benefited the economic performance of LA countries.

References

Corbo, Vittorio, Hernández, Leonardo, Parro, Fernando (2005), Institutions, economic policies and growth: Lessons from the Chilean experience, Central Bank of Chile Working Papers no. 317, Santiago. ECLAC-Economic Commission for Latin America and the Caribbean (1999), Economic Survey of Latin America and the Caribbean 1998-1999, Santiago, Chile. ECLAC-Economic Commission for Latin America and the Caribbean (2006), Economic Survey of Latin America and the Caribbean 2005-2006, Santiago, Chile. ECLAC-Economic Commission for Latin America and the Caribbean (2007), Economic Survey of Latin America and the Caribbean 2006-2007, Santiago, Chile. European Commission, DG External Trade (2004), Bilateral Trade Relations Central America, http://ec.europa.eu/trade/issues/ bilateral/regions/central_america/index_en.htm, last visit 02/02/2008. European Commission, DG External Trade (2006a), Bilateral Trade Relations Latin America and the Caribbean, : http://ec.europa.eu/trade/issues/bilateral/regions/lac/index_en.ht m (last visit 02/02/2008). European Commission, DG External Trade (2006b), Bilateral Trade Relations Andean Community, : http://ec.europa.eu/trade/ issues/bilateral/regions/andean/index_en.htm (last visit 02/02/2008). European Commission, DG External Trade (2006c), Bilateral Trade Relations Mexico, : http://ec.europa.eu/trade/issues/ bilateral/countries/mexico/index_en.htm (last visit 17/01/2008).

Trade and Integration in Latin America and with Its Main Trading Partners

37

European Commission – DG External Trade (2006d), Bilateral Trade Relations Chile, : http://ec.europa.eu/trade/issues/ bilateral/countries/chile/index_en.htm (last visit 02/02/2008). European Commission, DG External Relations (2007), Brazil, Country Strategy Paper 2007-2013, : http://ec.europa.eu/ external_relations/brazil/csp/index.htm (last visit 02/02/2008). European Commission, DG External Trade (2007), Bilateral Trade Relations Brazil, : http://ec.europa.eu/trade/issues/bilateral/ countries/brazil/index_en.htm (last visit 16/01/2008). Hummer, Waldemar (2005), Integration in Lateinamerika und in der Karibik. Aktueller Stand und zukünftige Entwicklungen, Verfassung und Recht in Übersee 1/2005, pp. 6. Office of the United States Trade Representative (2002), Free Trade with Chile, : http://www.ustr.gov/Document_Library/ Fact_Sheets (last visit 16/01/2008). Office of the US Trade Representative (2007a), Colombia Free Trade Agreement, : http://www.ustr.gov/Trade_Agreements/ Bilateral/Colombia_FTA/Section_Index.html (last visit 16/01/2008). Office of the US Trade Representative (2007b), Peru Trade Promotion Agreement, : http://www.ustr.gov/Trade_Agreements/ Bilateral/Peru_TPA/Section_Index.html (last visit 16/01/2008). Prüfer, Patricia, Tondl, Gabriele (2008), The FDI-growth nexus in Latin America: The role of source countries and local conditions, CentER WP, Tilburg (forthcoming). SIECA – Secretaria de Integracion Economica Central Americana (2007), State of the Current Central American Economic Situation, Guatemala. Singh, Anoop, Belaisch, Agnes, Collyns, Charles, De Masi, Paula, Krieger, Reva, Meredith, Guy, Rennhack, Robert (2005), Stabilization and Reform in Latin America: A Macroeconomic Perspective on the Experience since the Early 1990s, IMF Occasional Paper no. 238, Washington. UN Comtrade, Commodity Trade Database, United Nations. Unctad, Foreign Direct Investment Statistics, Geneva. World Bank, World Development Indicators 2007, Washington.

Part 1: Open Economy Macroeconomics

Sergio V. Barone and Alberto M. Díaz Cafferata

Rigidities in Openness, Export Performance and Indicators of External Solvency in Argentina Abstract This paper emphasizes the restriction posed by exports performance as determinant of the perceived capacity to fulfill external debt obligations. A long-run implication is that a degree of openness, determined by structural factors of an economy, sets admissible levels of external debt in foreign currency, and breaking this solvency condition causes CA reversals. Empirical results for Argentina 1949-2004 show: The debt burden exhibits a rising trend throughout the period. CA reversals are preceded in seven out of eight cases by a negative between required and expected exports. Argentina suffers continuous solvency problems after the debt crisis of the early 1980s. Similar results are found when filtered exports series are used. I. Introduction A. Export performance, external balance and crises in Argentine, a long-run historical perspective Why cannot Argentina sustain current account deficits if other countries can? By focusing attention on the role of exports and on a long-term horizon this paper brings to the forefront the influence of structural export capacity in setting a limit for "safe" borrowing levels, as far as it carries information about the ability of this economy to regularly serve debt payments in external currency in the future. We argue that exports may be the key variable in the perception of external solvency. Operating through the interdependencies between real and financial processes for a borrowing country, the external financial weakness of Argentina has been related to the unsatisfactory long-run performance of exports. We explore also

We thank Elena Resk and Emanuel López from the IEF for active and valuable research assistance.

42

Sergio V. Barone and Alberto M. Díaz Cafferata

whether the relationship between exports and external debt may serve as indicator of alert, by pointing out when the stock of debt (or current account deficits) become “excessive”. Our contribution lies in the emphasis placed on the links between exports and external solvency, and the application to Argentina in a historical perspective.1 Structural, slowly changing features of the economy drive the long-run evolution of exports that determine through the solvency condition an "admissible level" of the long-run debt, a restriction which is only broken at the cost of an external crisis. In a nutshell, we argue that a historically rigid exports/GDP ratio is determined by structural factors, and that in consequence the past carries information about future exports performance. Therefore, structural rigidities in exports provide a threshold on agents beliefs regarding the future capacity to pay. B. External crises: multiple causes and weaknesses in the strategy concerning exports and solvency Analysts agree that multiple domestic and external problems interacted to cause the Argentine crisis in 2001-2002. Domingo Cavallo (2003) mentions three main sources of problems since 1999: limited bank credit for the private sector, the Real´s devaluation at a time when Brazil accounted for almost one third of Argentina’s foreign trade, and the over-appreciation of the dollar-pegged peso. A consensus exists that the convertibility peso-dollar was a two-edged sword that helped achieve price stability but also, in combination with fiscal deficits caused real exchange overvaluation and damaged the strategy of exports expansion. Regarding the role of multiple causes, references in the recent literature are Domínguez and Tesar (2005), Bleaney (2004), Izquierdo (2002), Calvo (2005), and Mussa (2002). Kaminsky et al. (1998) provide results of several empirical studies on currency crises. An additional ingredient with policy implications that is worth noticing here, is the peculiar mix of errors and bad luck in the process. Some authors have pointed out policy errors in the evolution of the crisis, but it has been recognized that there was also bad luck in the timing of unexpected unfavorable events in the world economy, complicating otherwise more manageable difficulties. 1

Under the import substitution growth strategy until the mid 1970s, followed by the time of globalization of financial flows.

Rigidities in Openness, Export Performance and Indicators of External Solvency in Argentina

43

Regarding the critical Current Account (CA) reversal, Reinhart (2002) argues that the surge of capital inflows to emerging economies was encouraged by the sustained decline of interest rates in the industrial world and the direction reversed with the tightening of monetary policy in the USA. She points out that "it certainly seems a mystery why these wide swings in capital flows recur", and that "even the best policy mix cannot altogether avoid the eventual reverse of capital". There was also a negative impact of the devaluation by Argentina’s major trading partners which reduced profitability in the tradeable sector; the Russian crisis of August 1998 as well contributed to the unexpected halt in capital flows to emerging markets (Izquierdo, 2002). This paper starts from the interpretation that this type of attention to the short-run may hide the presence of factors belonging to more stable characteristics of the economy that should in consequence be examined in a larger time horizon.2 Therefore, to broaden the perspective it is advisable to adopt a long-run approach and to focus on the structural exports performance. C. Historical evolution of the current account and long-run motives to borrow Let’s provide some relevant background information and interpretation of the Argentine long-run current account (CA) since 1935 to our days. Díaz Cafferata et al. (2005), state the following stylized facts: a) the mean CA is close to zero; b) there are no persistent deficits: changes of sign are found every 3 years (3.35 on average); c) recurrent external crises and frequent reversals of the current account occur every 7.7 years between 1935 and 2004.3

2

3

For example, Reinhart et al. (2003) discusses the influence of reputation built on a country’s history as a factor in the development of an external crisis. A reduction in the CA deficit of at least 2.48 per cent of GDP is called a “reversal”. This percentage was calculated by taking the average of the CA deficits in the whole period. The first reversal was in 1939 and the last one in 2002.

44

Sergio V. Barone and Alberto M. Díaz Cafferata

Table 1: Argentina. Reversions of the Current Account (Changes t 2.48 in percent ) year of reversion 1939 1950 1953 1963 1973 1976 1988 1995 2002

' CA%

-4.51 -2.67 -6.64 -4.07 -3.02 -3.61 -2.82 -2.51 -7.67

' GDP%

before 2.05 -0.05

0.00

-1.98

2.91 -0.30 0.32

after

5.59

9.73

2.36

3.41 -0.67

1.40 -7.71

1.47 -4.42 6.81

8.93

Note: * Average of CA in deficit years. ** In percent average change in GDP in Argentine pesos; the first row refers to the two years before the reversal, the second row to the two years after the reversal. Source: Díaz Cafferata et al. (2005).

This is indeed a puzzling combination of facts, because frequent external crises have happened despite the occurrence of relatively small CA deficits. The authors point out that these stylized facts are not consistent with an expected path under the “stages of the balance of payments” hypothesis, such that the sign of the current account would be influenced by the degree of development: if external savings were used in early stages of development to finance growth, CA deficits would be observed chronologically early during several periods, followed later, after a change of sign, by sustained surpluses when the debt is being paid. Rational motives for international borrowing exist, to smooth consumption or to accelerate growth. Fulfillment of the intertemporal budget constraint would generate a long-run path with early persistent deficits of the CA, a change in sign, and persistent surpluses when the debt is paid.4 Despite the plausibility of the stages hypothesis, there is scant evidence of its occurrence in the international experience;5 numerous empirical studies after Feldstein and Horioka (1980) have found a high correlation between investment and domestic savings, suggesting a reduced contribution of external savings to finance investment. Rather, persistent deficits 4

5

It is possible in theory for a growing economy to run perpetual deficits. Cfr. Obstfeld and Rogoff (1997). On the stages hypothesis and empirical evidence cfr. Halevi (1971); Kindelberger (1968); Calderón et al. (1999); Debelle and Faruqee (1996); Díaz Cafferata et al. (2005).

Rigidities in Openness, Export Performance and Indicators of External Solvency in Argentina

45

are more frequently seen as a signal of danger and are not commonly found. However the hypothesis of stages is not rejected in several cases; a few countries can be mentioned such as Canada, Korea, Ireland, South Korea and Australia among others, that have been able to sustain persistent CA deficits (Milesi-Ferretti and Razin, 1996; Obstfeld and Rogoff, 1997). An interesting point is that the mere accumulation of debt along extended periods does not seem to be necessarily a problem for international lenders. D. Synthesis and scheme of the paper A question is posed about the recurrent external crises in Argentina focusing the explanation on the role of the long-run performance of exports. As shown in Figure 1, during 1949-1976 the exports to GDP ratio is continuously below 10 per cent. Two episodes of trade liberalization after 1976 and in the nineties were accompanied by a rise in the local trend. The working hypothesis is that along these decades the structural exports performance sets admissible levels of external debt through the intertemporal budget constraint of the economy. In this sense, a structural rigidity in the exports to GDP ratio is consistent, ceteris paribus, with an also rigid debt to exports ratio and with small and transitory CA deficits as the casual observation suggests. We will explore if external crises in Argentina are empirically related to the evolution of exports, based on the framework of the intertemporal approach to the CA and the intertemporal budget constraint that provides the specific values of exports, or of the trade balance, consistent with external solvency. In synthesis, we are interested in both the relevant mechanisms linking exports and solvency and to identify empirical magnitudes, helping understand in which theoretical cases, and when in practice, export is the relevant variable among the determinants of solvency, and among the predictors of CA reversal, in terms of the long-run perspective. Are the sustainable CA deficits related to some specific structural characteristics of the economy? More punctually, is there a structural degree of openness that can be related to the size of long-run sustainable CA deficits? Is the exports to GDP ratio a relevant variable regarding the sustainability of CA deficit?

46

Sergio V. Barone and Alberto M. Díaz Cafferata

Figure 1: Argentina. Exports to GDP ratio. Current prices in pesos. Mean and mean plus standard deviation, 1884-2005. 0,35

Max 1919 = 33,78%

0,3

Mean + SD

Mean St. Dev. 1949-2001 8,75% 1,94% 1949-20056 10% 4,96%

0,25

Mean

0,2

Mean - SD

Mean + SD

0,15

Mean 0,1

Mean - SD

0,05

0 1884

1894

1904

1914

1924

1934

1944

1954

1964

1974

1984

1994

2004

Source: Díaz Cafferata and Fornero (2003), Statistical Annex; MECON.

In the rest of this paper, first a succinct exposition of the longrun external solvency, and of the role of exports in the solvency condition is provided in Section II. Section III, discusses how to move from the formal expression to the empirical application and the peculiarities of the Argentine case. Section IV reports empirical exercises to establish relationships between exports, the burden of the debt, and the occurrence of CA reversals. The paper concludes in section V with a summary and policy implications.

6

Since GDP in the denominator includes tradeables and non-tradeables, the exports ratio rises with the devaluation. On January 11th 2002 the exchange rate jumped from 1.0 Peso/U$ during convertibility to 1.7 Peso/U$; as of February 2007 the nominal exchange rate is 3.1 Peso/U$.

Rigidities in Openness, Export Performance and Indicators of External Solvency in Argentina

47

II. External solvency: the role and relevance of long term export performance The frequency and costs of episodes of crisis and default in several countries along the 1980s and 1990s, which constitute the dark side of financial globalization, have caused concern and stimulated theoretical and empirical research to understand the evolution of the crises and extract policy indications for the future. There are different approaches to the issues. One area of intense research has developed with specific interest on currency crises, on which the seminal paper of Krugman (1979) addressed the question of the policy problems to keep a fixed exchange rate. Kaminsky et al. (1998) provide a useful revision of the empirical evidence after the turmoil of the second half of the 1990s and examine the possibility to find leading indicators of the crises. Attention is placed on the exchange market evolutions, the nominal exchange rate, liquidity problems, and short-run causes. Alternatively if emphasis is placed on the CA rather than on the exchange market, the relevant price is the rate of interest and the critical problem is the sustainability of CA deficits. The intertemporal optimization and the dynamic CA is the usual setup in the literature to analyze the behavior of the stock of international debt and to discuss under which conditions a country’s intertemporal budget constraint is satisfied. One issue in this framework is the magnitude of trade surpluses the economy must generate to pay, i.e. the “burden” of the debt for the economy (Obstfeld and Rogoff, 1997; Milesi-Ferretti and Razin, 1996, 1998). An alternative way to pose the question is to ask when the CA deficits become “excessive” (Milesi- Ferretti and Razin, 1996; Lanteri, 2008; Saksonovs, 2006). As regards this matter it has been argued that the difference between countries that are able to run persistent deficits in contrast with other countries that fall in crisis is whether the economy is able to generate enough trade surpluses, i.e. whose present value is enough to repay the debt in the future.7 Milesi-Ferretti and Razin 7

Let us remark at this point the constraint for a country of being unable to issue international bonds in their own currency, named in the literature the "original sin". This economy is in consequence subject to two budget constraints, because additional to required taxing, debt payments need to be done in external currency, such that exports in relation to the external debt or to the flow of interest payments is a

48

Sergio V. Barone and Alberto M. Díaz Cafferata

(1996) call this condition “solvency”; but crises develop not only because of solvency problems. Consider the issue of sustainability: if the current policy stance is maintained, and the turning point from trade deficit to trade surpluses is likely to occur smoothly, without drastic change in consumption and economic activity, these authors define the current policy as “sustainable”. In contrast, “unsustainability” appears when an event triggers a "drastic" policy shift, showing external vulnerability or some lack of capacity to undertake adjustment policies. A related point is that an economy at a certain moment may be solvent, in the sense that the intertemporal condition is fulfilled, but its payment ability be temporarily impaired by liquidity problems. Even when solvency at a point in time is determined by the discounted value of future trade surpluses exceeding the stock of net external debt, flow imbalances also matter. A distinction between liquidity and solvency helps identify the role of exports. For example, the debt-to-GDP ratio is a measure of solvency and the same happens with the long run expected path of exports compared with interest payments in the future; on the contrary, short-term debt over exports and debt service over exports are liquidity measures.8 In other words, from a temporal point of view shifting attention from liquidity towards solvency implies also focusing in longer run determinants rather than on immediate causes. Note that a liquidity problem can be generally solved by rollover or issuing bonds. But an economy must be solvent to have this solution open; and, on turn, solvency depends –among a set of determinants- on exports. To emphasize the point, we argue that historically external crises in Argentina have been caused mainly by the difficulties to export enough in the long run to keep external solvency. Phenomena of external disequilibrium in a sense boil down to solvency, as in the case of the Argentine economy which has recurrently reached the “rigid” long run export constraint even with relatively low debt ratios. This line of reasoning justifies our focus on export performance and on the hypothesis that the long-run export rigidity constrains the “admissible” debt to a structural level. Therefore, only with a

8

signal of the capacity to obtain needed foreign currency to make those payments. Manasse and Roubini (2005).

Rigidities in Openness, Export Performance and Indicators of External Solvency in Argentina

49

structural change in the export ratio the economy might bear a higher long-run debt ratio. Then, why cannot Argentina sustain CA deficits if other countries can? Even when it is clear that there are multiple causes, such that exports appear as only one piece of a complex mechanism, it is also true that this particular piece may become in occasions critical for the external equilibrium of a borrowing country, and our starting point in this paper is that the structural component of exports may be the key for the long-run solvency condition. Miscalculations may be costly. Gandolfo (2001) asserts that many countries have indebted themselves to finance ambitious development programs, and that the reason for the difficulties is that "the hoped-for huge export increases with which to get the foreign exchange to service the debt did not materialize".9 Structural rigidity of the exports ratio, coupled with the fact that imports were tied closely to GDP as the consequence of the import substitution strategy, helps to explain why the economy was capable of using external savings only in scanty amounts and for short periods. We expect to find out how exports as “required” by the long-run external solvency condition compares with actual trend exports, and whether there is a coincidence of observed reversals of the CA when there is a gap between them. If the Argentine crises have been the result of the operation of multiple causes, as the recent literature shows, the required-actual exports gap is not expected to provide a precise advanced signal of crisis. It gives nonetheless indication of external fragility, and the distinction between trends and cycles might help identify relevant thresholds.10 Two dimensions of solvency shall be kept in mind. An indebted economy needs keeping two intertemporal budget constraint restrictions. One is fiscal solvency (with payments capacity derived from tax collection in domestic money and limits to the levels of internal tax pressure). The other is external solvency (concerning net flows of hard currency in balance of payments accounts). By focusing on external solvency we are looking at only the latter of these two restrictions; a critical question is when one or the other, or both, are 9

10

He adds that difficulties were caused partly because of the unfavorable economic situation. There are certainly “country specific” threshold levels at which a gap becomes relevant, showing the presence of other determinants of sustainability, like reputation.

50

Sergio V. Barone and Alberto M. Díaz Cafferata

binding. Assume that with a given GDP and taxing capacity a government is able to collect the needed amount of taxes in domestic money. The problem becomes in this case the requirement to buy external currency in the market or to reduce reserves at specific points in time when payments are due. Our perception is that in our period of observation after the end of the 1940s the dismal exports performance has created permanent strong restrictions to the admissible levels of sustainable external indebtedness of the Argentine economy. A. The intertemporal constraint and the steady state solvency condition: highlighting the role of exports. The CA surplus flow is:11 (1) where NFA is the stock of net foreign assets, Y is the GDP, r is the international interest rate, C is private consumption, G is government current expenditure and I is total investment. Multiplying (1) by minus one and rearranging we get: (2) (1  r ) NFAt C t  Gt  I t  Yt  NFAt 1 which iterated T-times forwardly12,, can be written as: CAt

NFAt 1  NFAt

t T

(1  r ) NFAt  ¦ ( s t

Yt  rNFAt  C t  Gt  I t

1 s t ) (Ys  G s  C s  I s ) 1 r

(

1 T ) NFAt T 1 1 r

In the limit when T o f , (1 1  r ) T NFAt T 1 o 0 , replacing

(Ys  G s  C s  I s )

TBs , where TB is the trade balance, the

constraint becomes: 1 s t (3) ) TB s 1 r If the trade balance for every years s is TBs TBs 1 (1  g ) , where the trade balance grows at the same rate g as the economy, the Equation (3) can be written as: f 1 s t ) (1  g ) s t (4)  (1  r ) NFAt TBt ¦ ( s t 1 r  (1  r ) NFAt

f

¦(

s t

11

Cfr. Obstfeld and Rogoff (1996); Milesi-Ferret and Razin (1996); IMF (1993).

12

We obtain NFAt 1

Yt 1  Ct 1  Gt 1  I t 1 NFAt  2 , by forward  1 r 1 r

substitution in (2). Iterating until t+T, we get (3).

Rigidities in Openness, Export Performance and Indicators of External Solvency in Argentina

51

In the RHS of Equation (4) the trade balance at each point in time s is TBs (Ys  C s  I s  Gs ) , equal to the excess of GDP over absorption or, for an indebted country, the net amount of output the economy transfers to foreigners each period. Operating13 in Equation (4) the solvency condition becomes: 1 r  (1  r ) NFAt TBt ( ) ; or TBt (r  g ) NFAt (5) rg And for an indebted economy net foreign assets is negative, such that D = -NFA and the economy maintains a steady state debt to output ratio Ds Ys . The CA flow deficit identity implies for every time s in the steady state an increase in debt Ds 1  Ds r * Ds  TBs . Writing variables as ratios of GDP with lower case letters, the trade balance consistent with solvency is: tbs (r  g )d s (6) Where s denotes steady state values and Equation (6) provides the trade balance to output ratio (tbs) required to maintain constant the ratio of debt to output ds. Given d and g, the required trade surplus ratio is an increasing function of the rate of interest. B. The rate of interest and the rate of growth Obstfeld and Rogoff (1997), point out that a growing economy can run perpetual CA deficits and still maintain a constant ratio of foreign debt to output, when the country pays out the excess of the interest rate over the growth rate. There is indeed a critical role of the difference between the growth of the economy and the interest rate paid in the external debt. Consider a highly indebted country with d= 0.5, a long-run GDP growth of two percent, and an interest rate of 5 per cent. The required surplus ratio is tbs= (0.05-0.02)0.5= 0.015. If the rate of interest is higher, r=0.08, then tbs= 0.03, and the economy has to double its trade surplus ratio to keep constant its debt ratio. The usual set up assumes g0, r=0, the trade deficit each year s is equal to the CA (because the service account is zero); the debt increases by the amount of the CA deficit at the same rate as the GDP while keeping the debt to GDP ratio constant. ii) Consider the oposite case, when the economy is not growing and there is a positive rate of interest: g=0, r>0. This limiting case of a stagnant economy with a long-run rate of growth g=0, unfortunately is not far from the Argentine experience in some periods;14 the condition implies that the CA deficits (i.e. the long-run CA deficits) shall be also zero, and the service account deficits be compensated by trade surpluses.15 iii) When the economy is growing at the same as the rate of interest r=g>0 the trade balance is equal to zero; there is a permanent roll-over, such that the debt increases in an amount equal to the interest to be pay. iv) In the case of g>r>0 the economy may keep not only the trade balance but also the CA in deficit. The trade balance to output ratio required to fulfill condition (6) is negative, meaning that the economy might run perpetual trade balance deficits given the steady-state debt to GDP ratio ds. In this case the external debt increases beyond the amount of interest payments, still keeping a constant debt to GDP ratio. The two last cases are interesting because they show that it is theoretically possible for a country to keep CA deficits for long 14

15

The GDP per capita in 2003 was the same as in 1973. Cfr. Díaz Cafferata (2005). Further note that an economy with a positive but declining trend growth would find out that increasing exports relative to GDP are required to maintain a given steady-state debt to GDP ratio.

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periods if its growth rate is higher (or equal) than the international rate of interest, and as we know this has been found in practice. But an economy cannot accumulate debt forever if an intertemporal budget constraint must be fulfilled giving rise to the issue of a turning point to which we will come below. C. The role of exports in solvency and the turning point In synthesis, the notion of external solvency implies that a country has the ability to generate sufficient trade surpluses in the future to repay existing debt, i.e. that the present value of transfers to foreigners must be equal to the value of the economy initial debt, such that if the country has run in the past CA deficits, thereby accumulating external debt, the solvency condition requires a turning point from trade deficits to surpluses. Milessi-Ferretti and Razin (1996), indicate that the solvency condition is “silent about timing and nature of this shift”, but nonetheless we shall say something on the matter. Further, external payments capacity is not all that matters. A related question of whether CA imbalances are sustainable is formulated by these authors as follows: the current policy stance is defined as sustainable if the turning point from trade deficit to trade surpluses is likely to occur smoothly, without drastic change in consumption and economic activity, i.e. without a crisis. In both cases the solvency condition requires a turning point from trade deficits to surpluses, and the change of sign in the trade balance occurs smoothly when the CA deficit is sustainable. MilesiFerretti and Razin (1996, p.8) state that “a higher growth rate can facilitate a smoother switch in the trade balance”. To drive attention specifically towards the importance and the role of exports performance, Equation (6) can be rewritten in terms of the required exports ratio to output that maintains stable the ratio of debt to GDP; assume at this point for simplicity that imports are a constant fraction of the GDP, as follows. x (r  g )d  m (7) Equation (7) implies that a country´s exports to GDP ratio must be equal to the imports ratio plus the excess of interest rate over the growth rate for the economy to be solvent. In this case, the export growth is equal to GDP growth, and the economy is in steady state. It is useful to see that given a constant degree of openness measured by the X/GDP ratio (i.e. with exports growing at the same rate as output) the upper limit of the debt to GDP ratio is also given. A strong practical implication of Equation (7) is that, other things

54

Sergio V. Barone and Alberto M. Díaz Cafferata

given, a structural (long-run) value of exports relative to GDP determines uniquely the debt to GDP ratio. To see why, let for simplicity h=1/(r-g) and write d as the dependent variable, d h˜ x  h˜m (8) such that d appears as the limit of the initial debt an economy can bear for a given long-run export performance or, in other words, provides at a given point in time the “admissible” structural debt ratio for a country as a function of the structural exports performance. Interestingly, written in this way, the budget constraint provides indeed the “turning point” Milesi-Ferreti and Razin (1996) asked for. Equation (8) gives in effect a “stop” signal. If d is below the “admissible” value for given exports, the economy may borrow further in the long run. But only to the point where the steady state debt ratio reaches the limit given by the exports performance, because borrowing beyond that limit breaks the long-run solvency condition. Only transitory, shock absorbing, additional debt is allowed for this country.16 Figure 2 presents a comprehensive graphical vision of the issues, in the space of three variables: i) the export ratio X/GDP; ii) the debt ratio D/GDP; and iii) the tax ratio T/GDP. Note that all these variables are steady state values and forward looking. For a given steady state debt ratio do the point v along the line mv provides the burden OxR or exports required. In the lower panel the tax requirement OtR is determined in a similar way. Alternatively, the figure shows the “admissible” debt OdA given the structural export ratio.17,18

16

To highlight these relationships, variables may be written in terms of the, unobserved, permanent (trend: T) and transitory (cyclical, C) components. x xT  xC ; d d T  d C from Equation (7):

d

h ˜ xT  h ˜ xC  h ˜ mT  h ˜ m C and the “admissible” trend debt

is: d T 17

18

h ˜ xT  h ˜ mT .

The structural upper-bound for the tax ratio would similarly point out to the long run solvency condition from the fiscal side. The ratios frequently used by analysts such as D/X or D/Y are not measures of solvency.

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55

Figure 2: External and fiscal solvency

m+(r*+ ij(d)-g)d

x = X/GDP

w

xR Gap

m+(r*+ ij-g)d

v

S

x

m m’ 0 g’

d

d0

d = D/GDP

g

tR tS t = T/GDP

g+(r*+ ij-g)d

Our approach to the problem of solvency is based on the assumption that agents in the financial markets expect the economy to running into problems when the perceived future structural (longrun) export ratio is below the (expected) burden of the debt. We call this difference the “export gap”, equal in Figure 2 to: Export gap Ox S  Ox R (9) For the empirical application the expected values of the solvency condition are replaced in (8); the formula used for the calculations is in consequence: Export gap Ox s  > ( r * M  g ) d  m @ (10)

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Sergio V. Barone and Alberto M. Díaz Cafferata

The ability of the economy to maintain at a given point of time a debt ratio d=do depends in consequence on the perception of the future evolution of the export ratio, given the current information. We call xS in the empirical application of section V the “observed” (expected) export ratio, in the sense “proxies” for the steady state that forward looking values are obtained operating with the observed series. It shall be evident at this point that the computations depend heavily on the assumptions about future scenarios at each point in time. The rate of interest relevant to calculate the service of the debt has been written as r r *  M (˜) with two components, the Fed rate and country risk. Rewrite for convenience the solvency condition (7), x (r  q) d  m or x rd  gd  m . If the country risk increases with the debt ratio, rd (r *  M (d ))d ; the dotted line going through m and w assumes M (d ) M ˜ d such that M ˜ d r ˜ d  M ˜ d 2 . Import substitution and government consumption are shifters of the solvency condition: m’<m and/or g’