Economic Growth Creation or Diversion? the Record of Trade Agreements in Latin America

By Barboza, Gustavo; Trejos, Sandra | Journal of Business Strategies, Spring 2010 | Go to article overview
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Economic Growth Creation or Diversion? the Record of Trade Agreements in Latin America


Barboza, Gustavo, Trejos, Sandra, Journal of Business Strategies


Abstract

This paper examines the effects of Preferential Trade Agreements (PTAs) and GATT/WTO membership on economic growth using a sample of seventeen Latin American countries for the period 1950-2004. In general, the evidence indicates that the proliferation of bilateral and multicountry regional and extra regional trade agreements has not resulted in faster economic growth. On the contrary, we find that PTAs and WTO only have a weak positive effect on increasing trade openness; but this relationship does not translate into faster economic growth when controlling for capital, labor force and trade openness. These results are robust to both static and dynamic model specifications, indicating that trade openness has a positive effect on per capita output growth, but PTA and WTO membership do not. Integration via de facto increases output growth while integration via de jure does not. Based on the results, PTAs create a net diversion effect on economic growth.

Introduction

Economists are known for disagreeing in many things. However, when it comes to trade, there is an overwhelming consensus that free trade is good. More so, they convey that--in most circumstances--freer trade is preferred over restricted trade, and more trade is preferred to less. The underlying assumption is that trade is an engine for economic growth. In this regard, economic reform moves countries from protectionism to freer trade regimes. The recent reform process has been characterized by a predominant proliferation of preferential trade agreements (PTAs) (both regional and extra regional), over multilateral negotiations along the lines of the GATT/WTO. A part of the proliferation of PTAs over multilateral liberalization is the result of a failure to achieve consensus as exemplified in the Doha-Round trade negotiations. However, with regard to PTAs, the contentious issue is whether integration through agreements--de jure--generates greater gains in relation to integration through market--de facto. In other words, do PTAs substitute or complement multilateral trade integration and do PTAs generate positive or pervasive effects on economic growth? Thus, there exists much controversy on the effects of PTAs on trade (diversion versus creation) and consequent effects on economic growth. Latin America is one particular economic region of interest, because of its fast adoption of PTAs.

Latin America and the Caribbean is an economic region composed of about 34 countries with an estimated combined market size of 400 million people. According to Cardoso and Helwege (1995), the proliferation of preferential trade agreements in Latin America, under the inward looking import substitution industrialization period, partially explains the underdevelopment observed in this region. It is during this period that regional preferential trade agreements, such as the Central American Common Market (CACM) and the ANDEAN pact, were implemented. (2) The growth paradox of these agreements is that while promoting more trade within the members, they were discriminatory to non-members, with the consequent degeneration into a net trade diversion effect. However, in an effort to restore the region's international competitiveness and promote dynamic industrial and service sectors, most Latin American countries have decisively implemented market-friendly reforms since the early 1980s. The new mantra emphasizes the promotion of freer trade as the engine of economic growth. As a result of the new economic and political regimes, there has been a surge and proliferation of intra and extra regional trade agreements, making the region a showcase for trade liberalization (Kuwayama, Duran, & Silva, 2005).

The proliferation of PTAs over multilateral agreements has been in part the result of specific applications of Article XXIV of the GATT that allows for the formation of PTAs, provided that those agreements cover substantial trade, free trade is the ultimate goal among members, and do not increase protection to the rest of the world (Krueger, 1999).

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