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International perspectives: the United States and Latin America: toward a theory of interdependence and full exchange.

The current recession reflects the need for the U.S. to restructure its own economy to meet the global challenge of competitiveness. In an era of growing interdependence, Mexico and the Americas offer large and expanding markets for the U.S., with increasing potential for complementary production. The interaction of economies north and south will permit wages and employment to increase jointly, provided that the U.S. restructures and grows in its own right. The author proposes a dynamic model of "full exchange" as the appropriate framework in which to design integration policies. These policies must be implemented together with the political will to restructure U.S. trade and production.

IN TODAY'S highly charged environment, the richest and most powerful country in the world has become an anachronism, less for lack of resources and capacity than for failure of political will. It is at such a time that we review the relationship between the U.S. and its North American partners as well as with the rest of the Americas. Some argue that at this difficult moment it is best to postpone issues of Hemispheric integration. However "silent integration" proceeds relentlessly, in response to market forces, regardless of policy makers' decisions. Moreover, U.S. structural adjustment can be facilitated by a closer linkage with our North American and Hemispheric neighbors if all parties take advantage of their respective complementarities.

Before the Canada-U.S. Free Trade Agreement (CUFTA), the two countries were already the world's largest trading partners. In our most important sector, automobiles, an auto pact forged in the 1960s had led to a massive two-way flow of goods produced and sold in both markets, with gains that accrued to both countries. This can be continued and improved upon by incorporating Mexico into the market as both producer and consumer of autos and auto parts, already one of the most dynamic areas of nontraditional trade between the U.S. and Mexico.

In the case of the U.S. and Mexico in prior decades, the more Mexico attempted to distance itself from the U.S. through protectionist barriers (to trade, investment, and technology transfer), and the more the U.S. imposed legal barriers against migration, the more the two countries have integrated around the obstacles, often with distorting effects on employment, wages, and productivity. Just as with CUFTA, the current negotiations for a North American Free Trade Agreement (NAFTA) are an attempt to formalize and to some extent channel the pattern of "silent integration" that already exists. Even if these agreements were to fail, some form of NAFTA will eventually have to take place.

In an era of interdependence, it is becoming evident that the old policies don't work. Decisions can no longer be separated into "domestic" and "international" categories. For example, the Full Employment Act of 1946 could no longer be written without taking into consideration the de facto integration of the world's labor markets through migration, trade and investment, facilitated by today's global technologies. It is no longer sufficient for a country unilaterally to attempt the restoration of aggregate demand and full employment while ignoring its trading partners. That lesson was learned among "developed" OECD partners in the 1970s. Today it also applies to our newly industrializing neighbors.

For the U.S. and Canada, as well as Mexico, it has become necessary to combine recovery with a restructuring of the productive base of the economy to realize the gains from fuller exchange and permit producers in North America to meet the challenge of global competition. Otherwise the stimulation of aggregate demand will merely give rise to an excess of imports over exports, devaluation, and inflation, forcing down real wages and profits. The failure of domestic capacity to match shifting tastes will leave plants idele and workers unemployed. As in developing countries that have not engaged in structural adjustment, the outcome will be stagflation and social unrest.

THE MODEL OF FULL EXCHANGE

What is offered here is a simple optic through which to examine the crisis faced by the U.S. economy and its hemisphere partners, along with some proposals for economic policy to relieve domestic problems while equipping ourselves to compete abroad. The underlying model is economic interdependence, in a framework that demonstrates that the degree of exchange depends on private and public decisions made in response to economic opportunities and political constraints. Where the opportunity cost of restraints on trade is high, there will be pressure to form "black" or "grey" markets, in response to the rents(1) that may be earned by circumventing such barriers, whether they be legal or illegal, natural or artificial.

What is proposed are some practical measures to respond to the challenges of a world market in which trade, investment, technology, and migration flows are moving faster than the preparation of quarterly annual reports. The conventional economic analysis is set in an open, dynamic framework to accommodate the forces of growth and structural change. Attention is given to convergence among economies at different levels of income, productivity and resource endowments. The impact of fiscal and financial policy on real economic behavior is incorporated with particular attention to the accumulation process. Expectations and institutions matter in this approach, along with values, tastes, and technology. Interdependence takes fully into consideration the feedbacks among economies that arise from increased interconnection along with the challenge they pose to policymakers.(2)

THE RECENT HISTORY OF TRADE AND INTERDEPENDENCE IN THE AMERICAS

Latin America

In spite of setbacks during the years of debt crisis and structural adjustment in the 1980s, many countries in Latin America, beginning with Mexico and Chile, but including other nations and subregions (including those of the Southern Cone, as well as the Northern tier countries of South America, particularly Venezuela and Columbia) represent bastions of potential profits and growth. After several decades of attempts to force-draft a shift from dependence on raw material and primary product exports, it was clear by the end of the 1970s that Latin America's import-substituting industrialization strategies had to change in fundamental ways, with less protection and interference by the state and greater competitiveness among private sector enterprises. Indeed the Latin American Crisis of the 1980s was part of the process of change.

The liberalization of the 1980s has opened up a new era fro many of the countries, with the opportunity for labor, capital, and resources to be shifted into more productive activities. From directly unproductive rent-seeking, there is now scope for new rents to be earned from market penetration (new directions of trade and investment) and innovation within a wider international framework.

Encouraged by international institutions such as the World Bank, IMF, and Inter-American Development Bank, the U.S. Enterprise for the Americas Initiative, and well-trained young economists, entrepreneurs, scientists, and engineers, as well as a new cadre of public officials, Latin American countries are themselves taking steps both to liberalize and integrate economically. Examples include Chile and Mexico, which have signed framework agreements with the U.S. and between themselves that unilaterally reduced trade and investment barriers, and which are looking toward broader free trade agreements within the Hemisphere; the "Group 3" (Venezuela, Colombia, and Mexico), which has recently determined to develop common liberalization policies; and the MERCOSUR (Argentina, Brazil, Paraguay, and Uruguay), which have made progress in integration negotiations and signed a region-wide framework agreement with the U.S. The trend is toward greater openness to the international system consistent with the global objectives of GATT (what some have called "open regionalism").

However, the structural adjustment and economic liberalization process has important social and political corrollaries. Who wins and who loses from the new policies, what is the time phasing of costs and benefits, to what extent is the regime in power identified with them, and how are adjustment assistance and compensation administered (especially if the costs precede the "liberalization and integration dividends"), all matter as the region redemocratizes. In the case of Brazil much of the fiscal imbalance, inflation, and instability arise from a failure of private sector elites to accept the bitter pill of austerity and readjustment, if it means a loss or privileges and the requirement to pay taxes. In the Mexican case a regime committed to privatization, structural adjustment, stabilization, and opening to the U.S. and international economy was able to earn sufficient credibility from private sector elites to permit it to get away with much stricter tax enforcement and reduced privileges to a favored few. But in Brazil there is the fear that increased fiscal authority combined with enhanced executive power, given pervasive social unrest, could play into the hands of "populist" authoritarianism from either political extreme.

The United States

The U.S. has only begun to face its own need for restructuring, although the devaluation of the dollar after the mid-1980s helped to change the signals and increase our international competitiveness. However, our management structures are still living as though they were earning "oligopoly rents" of the 1950s and 1960s (just as Latin America's managers were through the 1970s). Instead, they are borrowing abroad to earn "false rents" in the form of inflated salaries and dividends that should have been spent on research, development, and new investment.

Labor and the lower middle class have already faced a number of years of belt-tightening, and the recession of the 1990s has hit most middle-class households squarely as well as many professionals. While U.S. voters can for the most part accommodate the needed adjustments, with the exception of many single-parent families, youth, and minorities, those currently enjoying entitlements and excessive rent-seeking will have to settle for a lower standard of living. And as the well-to-do elderly excercise a disproportionately large political voice, they pose particularly severe obstacles to enlightened leadership from either party. The problem is less one of inadequate "technology policy" or lack of industrial incentives as it is a failure by the affluent to accept a reduction in today's "entitlements" in order to build for the future. The enormous gross financial savings of households currently channeled through private and public institutions (such as insurance and pension funds and social security) are converted in response to current market signals into consumption lending (net dis-savings), cancelling out their potentially positive effect on real savings and investment.

The Relative Size and Economic Contribution of the NAFTA

The North American Free Trade Agreement (NAFTA) countries -- U.S., Canada, and Mexico -- dominate output in the Americas, with $5.9 trillion dollars in 1989 (current value), compared with $650 billion for the rest of Latin America. Mexico's GNP in 1989 (by World Bank estimates) was $170 billion, compared with $455 billion for the MERCOSUR countries, $122 billion for the Andean region (Venezuela, Colombia, Ecuador, Peru, and Bolivia), $26 billion for the Central American region, and $48 billion for the rest of Latin America. The actual level of Latin American GNP including Mexico is about one-eight that of the U.S. and Canada combined.

However the potential for development in the region, once the barriers to exchange have been removed and investment is allowed to flow among the countries in response to dynamic comparative advantage, is enormous. The population of the NAFTA countries at the end of the 1980s was over 360 million (in excess of the European Community), and to this must be added 187 million from the MERCOSUR, 90 million from the Andean region, 25 million from Central America, and 35 million from the rest of Latin America. Because a much higher share of the population of Latin America is young, and the labor force participation rate for women is well below that of the U.S. and Canada, the labor productivity gap between north and south is less than that of income per capita. For example, average per capita income ratios are 8 to 1 between the U.S. and Mexico. However ratios of value added per worker between the two countries are only 4 to 1.

This makes the prospects for convergence in income per capita more favorable, because the more youthful population of Latin America will be maturing over the next twenty years, as birth rates have already declined sharply, while the population of the U.S. and Canada will be aging as life expectancy increases. There is scope for considerable investment in capital, technology, education, and technical training in Latin America, to permit productivity (and income per capita) to rise toward "northern" levels. But if the process of convergence in income and wages is to be upward rather than downward for the U.S. and Canada, it is also necessary for those in the "northern" countries to increase significantly investment in their own capital and skills.

In addition there is an extremely unequal distribution of income in Latin America, with a share of wages and salaries well below that of the U.S. and a correspondingly high share of profits, interest, and rent. The distribution of personal income is also badly skewed, as property ownership remains highly concentrated. Growth that brings increasing shares of the population into the modern sector at rising levels of productivity and real wages helps to mitigate such conditions, along with the benefits of widened domestic markets, improved skill levels, and scope for increased competition together with economies of scale. However, the crisis of the 1980s reversed the positive trends and plunged wages well below 1970s levels.

The 1990s offer more positive signs, as earlier levels are recovered and as the more efficient and competitive economies respond to domestic and international incentives. The facts that the region opens the decade well below full capacity, with opportunity for rapid increases in real wages and profits, that the share of GNP available for potential savings and investment is high, and that some of the "flight capital" held offshore remains relatively liquid, offer important potential areas for gains from integration within the region and with the international economy, including the U.S.

First, there is great scope for accumulation and investment from internal resources, once the conditions are present to secure a reasonable expectation of profits and political stability by the private sector.

Second, there is scope for expansion of the market from the present extremely small middle and upper income groups to the mass of the population consistent with the diffusion of investment, education, infrastructure, and labor productivity, which will require the productive use of fiscal revenues and private savings to provide economic and social infrastructure. In short, political and social instability in the Americas is the result of static failures to accumulate and invest in activities that favor both public and private interests. This can be changed, if and when decisions are made to mobilize resources in productivity and distribution-enhancing ways and once society at large recognizes that the diffusion of productivity, income, and welfare depend on such complementary strategies.

THE IMPORTANCE OF LATIN AMERICA FOR U.S. INVESTORS

Expanding Trade Flows Between Latin America and the World

Latin America's trade balance with the industrialized countries has become strongly positive since 1982. (Figure 1) This reflects the pressure for debt service in the 1980s, along with net capital outlflows in the face of increased economic and political risk in the region, and the resistence of international lending institutions to extend credit to already heavily indebted countries. (For some of the period even the net flows of concessional lending institutions such as the Inter-American Development Bank were negative!) However the figures also reflect the fact that domestic austerity measures freed up exports, while severe exchange rate devaluation helped to turn around the trade balances.

Note that the United States trade deficit with Latin America was well above that of the European Community through 1987, while Japan has tended to be a slight net exporter of capital to the region throughout the 1980s. It could be argued that savings outflows from Latin America to the U.S. played a role in financing the growing U.S. trade deficit with the rest of the world, so that service on the region's debt accumulated in the 1970s helped the U.S. to fund its deficit in the 1980s.

For future integration between the two regions, there will be pressures for net capital flows south rather than north (something that is already occurring with respect to Mexico), to take advantage of greater returns on capital and the ready availability of labor and resources in Latin America. This will make it all the more important for the U.S. to adjust its own savings upward, to fund not only domestic restructuring but investments needed to link the economies of the Hemisphere in the spirit of NAFTA and the Enterprise for the Americas Initiative.

Latin American imports and exports to the United States, the EC, and Japan also reveal intensive trade between Latin America and the U.S. relative to the other two regions. Latin Americans are developing a taste for U.S. products, especially since 1987 -- between 1987 and 1990 their U.S. imports increased by $15 billion. And the U.S. markets are welcoming Latin American goods as well, even more than those in Europe and Asia, with U.S. consumers spending $20 billion more in 1990 on Latin American products than they did in 1987. The United States and Latin America, although not often considered strong trading partners, have closer ties with each other than with any other major industrial region.

PROFITABILITY OF U.S. BUSINESS IN LATIN AMERICA

Figure 2 shows the rapid recovery and growth of U.S. direct investment in Latin America, surpassing increases in any other part of the world including Canada. This supports the arguments made earlier, indicating that U.S. investors are recognizing the enormous potential for dynamic gains from trade and from the expansion of regional markets under the impetus of structural adjustment and liberalization. The Enterprise for the Americas Initiative, which favors freer trade and private investment stimuli in the region, provides an "expectations effect" that reinforces trends already underway by the late 1980s. The economies that had been depressed by the debt crisis and adjustment of the early 1980s were beginning to recover, and with the recovery the growth in demand for imported capital goods, technology, high grade services, and entrepreneurial know-how that constitute important U.S. comparative advantage in the region helped to improve U.S. exports of goods and services.

U.S. investors have been achieving significant returns on investments in Latin America, with profits from the region exceeding those from ventures in Japan and Canada by 1990. While rates of return from U.S. investments in Asia and the Pacific remain higher than those in Latin America, the gap has narrowed dramatically over the past decade. While returns in Europe outside of the EC remain several points above those in Latin America, this is partly a reflection of the newness of such markets and their considerable uncertainty. The astonishing growth of Latin American stock markets is perhaps an exaggeration of the improvement in real business conditions, because many of the stocks were so depressed in the 1980s, and others reflect the effect on asset values of the privatization and capitalization of enterprises. Still there is great potential for the real growth of capital markets in which foreign investors can participate, given the region's considerable potential for future profits.

CONCLUSION

Latin America is growing rapidly enough to be considered ready for greater integration into the developed world. Investments by U.S. businesses in the region have grown steadily in recent years, so that Latin America has become among the chief destinations of U.S. direct investment abroad. Trade relations already show strong links between the United States and Latin America; in recent years, trade has grown even more. The EC is still an important recipient of Latin American trade, but the United States has maintained preeminence. One could argue that the recent increase in trade with the United States (1988-90), and the levelling in Latin America-EC trade during the same period, are the result of the "announcement effect" of NAFTA and the Enterprise for the Americas. This tentative agreement becomes even stronger as one considers the effect common external tariffs in the EC could have for Latin America. On the one side (NAFTA), overtures are being made for greater opening to trade, while on the other (the EC), the first moves toward the creation of regional blocs are taking place.

The nature of the U.S. recession as at least partly structural, reflecting changes in the international economy as well as domestic causes, illustrates that maximization of its potential requires a major domestic restructuring together with increased integration with the North American, Hemispheric, and international economy. The arguments in this paper indicated the need for a "theory of interdependence in the context of full exchange." Indeed, it would seem that much of the groundwork for hemispheric integration is now in place: trade and investment in Latin America is dominated by the United States. An increasing share of the new leadership in the Americas is rising above old models of power mongering, and responding to the potential for regional, hemispheric and international liberalization.

While the crisis of the 1980s made new directions mandatory, a democratizing society demands results, especially when so much was lost in the past decade. The question is whether the United States is up to the task of helping to make Latin American markets productive through sufficient investment, entrepreneurial effort, trade, and technology transfer, given the fact that this means opening up its own markets and permitting inefficient industries to be outcompeted. It is also necessary for the leadership in Latin America to stress growth with distribution. It takes two to tango. In the case of NAFTA and the Hemispher, the United States can either make the region a network of shared production and sales in pursuit of dynamic comparative advantage or it can squander the initial gains from integration by failing to restructure its own production to meet the needs of a more integrated hemispheric economy.

FOOTNOTES

(1)Economists have generalized the concept of rent (the term Ricardo used for returns to land and other natural resources) to include the return to any factor of production (input) that is in inelastic supply, either by its intrinsic natural qualities or through artificial barriers to competition. Hence to economists, economic rent (quasi-rent) is a crucial component of value added. It can have a static or dynamic character. Rents can represent returns that result from restraints on trade through the exercise of monopoly or monospony power as well as other legal and institutional obstacles (protection rents). Or rents can be dynamizing, arising during the process of full exchange as economies move from one equilibrium to another, whether they arise from more efficient patterns of trade and investment (market penetration rents) or from innovation and entrepreneurship (Schumpeterian rents). Entrepreneurial profits, even though they are transitory (disappearing when pure competition lowers price to marginal cost), are the component of rents most familiar to creative business enterprise. Reynolds, C., "The Political Economy of Interdependence in the Americas: Toward a Generalized Approach to Rent Seeking," Americas Program Working Paper #89-7, Stanford, 1989.

(2)An initial formulation of the "full exchange" approach was developed by the author in 1978, while a fellow at the International Institute of Applied Systems Analysis, Laxenburg, Austria. A paper based on the model, "The Implications of Full Exchange for Relations between Rich and Poor Countries," was presented in July, 1978, at a meeting of the Fellows of St. Anthony's College, Oxford University. The present article draws on the model and a decade of collaboration with Clyde Hartz, corporate economist and an Associate Editor of this journal. It benefits from more than twelve years of research and policy analysis of U.S.-Mexico-Canada relations by the Americas Program at Stanford University, of which the author is Director. The views presented here are being developed in a forthcoming book on The Economy of the Americas: Challenge of Interdependence.
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Author:Reynolds, Clark W.
Publication:Business Economics
Date:Jul 1, 1992
Words:3986
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