Chile Takes a Big Chance Expanding Free Trade

Article excerpt

This article is based on a North-South Center agenda paper by Glenn Harrison, Thomas Rutherford and David Tarr, and was written by Mr. Tarr, a lead economist at the World Bank.

The government of Chile has embarked on an international trade strategy that may be unique in the world, involves risks, but could potentially yield very large gains.

It is negotiating or planning to negotiate separate free-trade agreements with all its significant trading partners, while possibly simultaneously lowering its tariffs unilaterally.

Chile has already signed free-trade agreements with Mercosur (the trade group comprising Brazil, Argentina, Paraguay and Uruguay), Mexico and Canada, and is considering one with North American Free Trade Agreement (NAFTA) nations - which means adding the United States to its agreements with Mexico and Canada. Agreements with the European Union and other countries in Latin America are possible or have been concluded.

Free-trade agreements are not free trade: They are disadvantageous to the exports of countries not party to the agreement. And consequently, Santiago could lose revenue both ways.

First, the Chilean government forgoes tariff income from its free-trade partners. Then it loses again if Chilean importers shift purchases away from sources that still face tariffs to now cheaper providers of the same items in favored countries - a process known as "trade diversion."

My colleagues and I have estimated that each of the principal free-trade agreements considered by Chile, when considered in isolation, will reduce Chilean real income due to trade diversion costs unless significantly improved access for Chilean exporters can be obtained in the markets of partner countries.

We find that the United States market does offer sufficient access to Chilean exports to render a potential NAFTA agreement beneficial to Chile; but Chile must obtain improved access in non-grain crops in the United States, one of its key export sectors, or NAFTA will result in losses for Chile. It is an implicit understanding of these gains which has induced the Chilean government to pursue an agreement with the United States.

Although Washington has given indications that Chile would be the next Latin American country included in an extension of NAFTA, the signals from Congress are ambiguous.

Mercosur, however, does not offer sufficient access to Chilean exporters, and we find that Chile will lose from the Mercosur agreement as presently constituted. But Chile can gain from its participation in Mercosur if it reduces its present uniform external tariff from 11 percent to between 6 percent and 8 percent; the reduction of the external tariff leads to a reduction of costly trade diverting imports.

These results indicate that Chile should continue to push for NAFTA membership, but should simultaneously move forward with broader unilateral trade liberalization. …