Sharp contraction in the U.S. economy has hit Latin America where it hurts the most: in shrinking trade volumes. The so-called “vacuum cleaner effect,” or, the drying up of liquidity resulting from the collapse in U.S. credit markets, combined with decreased aggregate demand, has affected even the best-managed economies. The result is no surprise: falling trade numbers from around the region. Brazil’s imports in February 2009 fell a whopping 34.6 percent and its exports dropped 25.1 percent year-on-year—a stark contrast with the 44 percent increase in imports in 2008. In Chile, where lower copper prices had already flattened trade in 2008, exports collapsed by 41.3 percent in January, and imports shrank by 25.5 percent. Mexico, similarly, reported sharp reductions in total trade at the end of 2008 and in January 2009.
Lower trade volumes are not limited to Latin America, of course. They are a global phenomenon that reflect a fall in demand and the disappearance of trade credit. This lack of credit has a negative impact on short-term trade flows, but the more permanent and damaging effect comes from the lower demand of developed-country economies. And while it is hard to make concrete predictions, it is likely that Latin American economies will suffer more from decreased export volumes and lower export prices than from reduced imports.
In sharp contrast with the U.S., where financial difficulties and deleveraging reduce consumption and investment, the main impact on many Latin American countries comes through lowered exports and reduced foreign direct investment (FDI). The fall in U.S. absorption (consumption and investment) results in a reduction of the U.S. trade and current account deficits, but in Latin America it produces the opposite: a move toward a larger current account deficit and more difficulties in its financing. This means that in 2009 we can expect to see a sharp decline in Latin American export earnings either due to worsening terms-of-trade for commodity exporters or to significantly lower trade volumes.
Latin American countries will have to choose from a menu of unappetizing policy measures to deal with the fall in aggregate demand and the difficulties in financing current account deficits. The four likely choices include: voluntary reduction of consumption, investment or government spending; involuntary reduction of consumption and investment through currency depreciations; deployment of international central bank reserves; and improved country risk profile—through painful structural reforms—to reverse the fall in FDI and portfolio investment and avoid a sharp adjustment in employment and GDP growth.
Trade policy is the key to overcome the crisis. Latin American countries should defend free trade, building on the vocal role played in their opposition to the Buy American provisions in the original U.S. stimulus proposal. But with trade concessions unlikely from the Democratic-controlled U.S. Congress, Latin Americans also should unilaterally open to other partners, including China.
There are other creative ways that Latin America can leverage existing agreements to reignite global trade growth. One is to look at new ways to expand “cumulation of origin”—a trade instrument that allows material to be sourced and manufactured in multiple countries without the final product losing tariff preferences. For the first time, the Central American-Dominican Republic-United States Free Trade Agreement permitted the use of Mexican and Canadian fabrics as qualifying inputs for preferential access to the United States. This model can be extended further to permit the use of inputs for groups of countries that have trade agreements among themselves. For example, Chilean and Mexican inputs could be cumulated to export preferentially to the U.S., or U.S. inputs could be cumulated to export from Mexico to Chile. Many other combinations are possible.
Trade liberalization—allowing imports from multiple countries—should be the goal. For instance, Latin American Integration Association members could agree to cumulate inputs among them. Latin American countries could also propose an ambitious cumulation agenda to U.S. President Barack Obama and move forward with it as part of the Pathways to Prosperity forum. This would go a long way toward solving the conundrum of what to do with the dormant Free Trade Area of the Americas.
The region’s two most powerful players—Brazil and Mexico—should build on encouraging starts and play a lead role. In late February, Brazilian President Luiz Inácio Lula da Silva reversed a trade closing effort—a reaction to the Buy American provisions—promoted by some in Brazil. In December 2008, Mexican President Felipe Calderón dramatically lowered Most Favored Nation duties in spite of strong opposition by local industry.
But it is crucial they don’t stop there. These leaders must convince others in the Hemisphere—including the U.S. president—that more trade is the key to minimizing the impact of the crisis and to preparing the ground for recovery.
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Any opinions expressed in this piece do not necessarily reflect those of Americas Quarterly or its publishers.