South America’s Newest Trade Bloc and America

The history of Latin America is marked by conflict between the disciples of laissez-faire policies and the champions of socialist and protectionist market alternatives. Recently, however, policy disputes that had previously been confined to individual states have gone supranational. The 2013 creation of the Pacific Alliance by Colombia, Mexico, Chile, and Peru stands to threaten the longstanding eminence of the Southern Common Market (Mercosur). While the constituents of Mercosur (Brazil, Argentina, Paraguay, Uruguay, and Venezuela) have largely rejected classical liberal institutionalist economic theories in favor of protectionism, the Pacific Alliance is ideologically grounded on free market principles, and thus poses a dual threat to Mercosur. The future of trade in Latin America hinges on the developments of and rivalries between these two trade blocs. Due to recent market developments such as the plunge in oil prices and China’s economic slowdown, the United States government can play a powerful role in steering Latin America towards liberalization and openness to foreign capital.

Mercosur, formally founded by Argentina, Brazil, Paraguay, and Uruguay in 1991, originated from a series of modest economic integration and regional trade liberalization initiatives between Argentina and Brazil that were implemented in the mid-80’s. Since its establishment, Mercosur has carried out a program largely based on economic development from or increased involvement with the United States or nonaligned economies. Fueled by a populist anti-American narrative, Mercosur has, in its twenty-five years, adopted increasingly protectionist policies toward its nonaligned trading partners. The implementation of the common external tariff (CET) — an effective tax on all goods imported from non-member or even associate member states—is one such example laid out in the organization’s founding charter.The CET rate currently hovers at 10 to 12 percent but, in the wake of the 2009 global financial crisis, Argentina and Brazil both pushed, unsuccessfully, to have the tariff raised to 35 percent. The CET rate is subject to fluctuation based on the internal politics of Mercosur constituents, which further disincentivizes foreign investors. With the Venezuela’s inclusion to the bloc in 2012, it is very likely that the CET will remain an important mainstay in Mercosur trade policy.

But while Mercosur has been a center for regionalist policy since the Treaty of Asunción in 1991, the founder states of the Pacific Alliance—Mexico, Peru, Chile, and Colombia—have long histories of free market alternative policymaking. These countries, referred to as the “Pacific Pumas” due to their economic similarities to the Four Asian Tigers of the 90’s, have held a globalist and laissez-faire orientation to capital structures in stark contrast to many of their Latin American neighbors. In the past, Alliance states have been quite receptive to American investment and to bilateral free trade agreements among each other. Since the founding of the Pacific Alliance, constituent states have eliminated trade tariffs on 92 percent of goods and services traded between member states.

In addition to jettisoning interstate trade barriers, Alliance members are also endeavoring to integrate their national stock exchanges into the Mercado Integrado Latinoamericano (MILA)—a supranational stock exchange founded in 2009 that has already allowed regional companies easier access to capital. With the recent incorporation of BOLSA—Mexico’s national stock exchange—into its system, MILA now boasts a 1.25 trillion dollar market cap (just larger than Brazil’s own BM&F Bovespa—a 1.22 trillion exchange). This aggregation of financial platforms gives foreign capital as well as member-state investors easier access to investment opportunities and likewise allows regional businesses the ability to harness greater overall market liquidity.

One additional point that sets the nascent Pacific Alliance ahead of Mercosur is the former’s adherence to and respect for institutions of which it is comprised. Mercosur has recently experienced a turbulent period in 2012 that resulted in Paraguay’s suspension from the bloc and the Venezuela’s inclusion. Paraguayan officials still contest that the grounds for the nation’s temporary expulsion from the bloc was unjustified and that there should be another vote on Venezuela’s ascension to full membership. This recent intra-bloc strife reveals the inherently hierarchical nature of Mercosur. Brazil and, to a lesser extent, Argentina, sporting GDPs of 2.246 trillion and 609.9 billion respectively, generally feel free to overshadow and in some cases strong arm smaller Mercosur constituents such as Uruguay (55.71 billion collective GDP). This de facto power divide will have to be addressed by the trade bloc if it is to successfully incorporate Venezuela into the fold and command a sustainable influence on the Latin world. At present, no such fundamental structural changes seem in sight.

While neighboring nations have, with the exception of Bolivia and Venezuela, been reticent to participate in Mercosur, states throughout the Latin world have taken notice of the Pacific Alliance and, in many cases, are eager to jump on the free-market bandwagon. Costa Rica and Panama are on their way to becoming the fifth and sixth members of the Alliance, with Guatemala following close behind. Even states historically disinclined to participate in trade liberalization have been forced to reevaluate their isolationist stances to global markets. Ecuador, sandwiched between Colombia and Peru, also shows signs of breaking with its far left history in favor of the open market. If integration and free market policies continue to bring rapid economic growth to neighboring countries, Ecuador may have no choice but to seek similar integration with its neighbors.

Though the creation of the Pacific Alliance presents new investment opportunities for individual firms, three global market trends—the collapse of crude oil prices, the rise in purchasing power of the dollar and a transition in China to a consumer-based economy — have changed the rules of the game in Latin America.

Though Latin America has enjoyed exponentially increasing demand in China for raw materials over the last twenty years, resource exporters are likely to see this trend ebb as Xi Xinping and the Communist Party look to reorient China’s economy towards service sectors. This is not to say Chinese foreign direct investment will cease to be a factor in the region’s overall trade prospects; for example, the 40-to-50 billion dollar Nicaragua Canal, which is currently under construction, is set to become the most striking example of Chinese investment. However, China’s shift away from infrastructural and manufacturing development will mean that South America, which produces 44 percent of all copper imported by China, will need to look elsewhere to export the its raw goods.

Some of the hardest hit by this change will be members of the Pacific Alliance, which are seeking to counteract this trend by trying to create a more attractive gateway, specifically for Asian investors. Peru and Chile, whose exports consist of 27 and 35 percent raw materials (excluding oil) respectively, will be hardest hit by the decrease in Chinese demand. Though the Pacific Alliance still has its eye on lucrative free trade deals with China, it may be in America’s best interest to present itself as a viable trade partner now. If the United States’ federal government were to sizably invest in much needed domestic infrastructure development, it could import raw materials from these resource-rich nations and open the door for future pan-hemispheric cooperation. This economical-oriented foreign policy could yield closer economic and political ties with Alliance members already more predisposed towards pro-Americanism than their Bolivarian neighbors.

Another reason to open up favorable deals with the alliance stems from the increased buying power of the American dollar vis-à-vis Latin American currencies. The current exchange rate is favorable for importers, and even by simply engaging with the Pacific Alliance more thoroughly through multilateral trade deals with all alliance members simultaneously rather than relying on bilateral agreements. Nations can accredit the organization with more diplomatic clout, increasing its membership and scope in Latin America. If the United States dealt directly with the Alliance, it would be a signal to the wider Latin American community that their northern neighbor respects the political sovereignty and economic self-determination of the entire region. This move would go a long way in healing the wounds in North-South diplomatic relations that have been festering since the latter half of the Cold War.

The collapse of crude oil prices is a final key economic factor in the region. Venezuela, already struggling politically in the wake of Hugo Chavez’s death, now faces further economic troubles. Petrocaribe is collapsing, and developing nations and net importers — namely the majority of the Pacific Alliance — stand to make huge temporary gains from this fall. This will shift the regional balance of power away from the petrol states — especially Venezuela — and position both the Alliance and the United States to fill the economic and political vacuum left in the wake of now hollow agreements such as Petrocaribe.

The United States has had many opportunities to craft South America to its will, and it has done so at times through heavy-handed and ultimately self-defeating means. The infamous Operation Condor initiative left much of Latin America wary of United States involvement, while the United States’ current transnational war on drugs and broken immigration policies have led to regional destabilization. The rise of a homegrown free-market liberal institutionalist movement is a positive factor for foreign investors, but it’s also an opportunity the United States cannot afford to miss. This is a chance to get things right, to develop budding economies via mutually beneficial multilateral trade agreements, to reap the benefits brought by a now favorable global macro-environment and to establish permanent ties with its southern neighbors that can someday transcend markets. It is said that by the time Washington realizes it needs Latin America economically and geo-strategically, it will already have lost it. The United States needs to prove the saying wrong.