Trade Integration for the Americas: What Can Economic Analysis ...

June 2006Trade Integration for the Americas: What Can Economic AnalysisTell Us?byWilliam Tyler *Universidade do Estado do Rio Janeiro (UERJ)AbstractMuch recent discussion - both analytical and polemic - has centered around thegeneral topic of trade integration of the Americas and various forms of tradingarrangements that such integration might take, including such diverse arrangementsas the MERCOSUL, NAFTA, the proposed FTAA, CAFTA, the United States’bilateral FTAs with different countries, etc. The paper presents an analyticaldiscussion of the economic benefits and costs of such arrangements. The use ofcomputable general equilibrium (CGE) models is discussed, and a presentation ismade of various simulation results. In general, the analytical findings are that theFTAA would bring greater benefits to its members than bilateral FTAs, but asuccessful Doha Round could bring even greater welfare improvements forWestern Hemisphere countries.I. IntroductionIn the years immediately following World War II the international trading system,as depicted by the agreed rules of the GATT and the WTO, embodied multilateralism,with its emphasis on nondiscrimination of trade policies among countries. In other words,the most-favored nation rule applied, whereby a trade concession granted by one countryto another was extended to all “most favored nations” (MFNs). The successive rounds ofmultilateral trade negotiations, held under the institutional auspices of the GATT/WTO,succeeded in substantially decreasing trade barriers and opening markets.Recent years however have witnessed a weakening of multilateralism in tradearrangements. The number of regional trade agreements (RTAs) has increased markedly,mostly in the form of free trade areas (FTAs), as opposed to deeper economic integrationin the form of customs unions formation (with a common external tariff and otherpossible features). As of December 2005, the United States had entered into seven suchfree trade agreements (NAFTA, CAFTA and separate bilateral free trade agreements withIsrael, Jordan, Singapore, Chile and Australia). The European Union, whose growth and* Visiting Professor of Economics, Universidade do Estado do Rio de Janeiro (UERJ). An earlier versionof this paper was presented at the 2006 Meetings of the Latin American Studies Association, held inSan Juan, Puerto Rico, March 2006. The author expresses his gratitude to the Fundação de Amparo àPesquisa do Estado do Rio de Janeiro (FAPERJR) for generous financial support and to Jan Peter Wogartfor helpful comments. Author’s Email address: wtyler@attglobal.net.

2success has motivated the formation of many RTAs, has entered into 50 separate RTAs,31 of which are with developing country partners entered into since 1989. 1The worldwide proliferation of RTAs in recent years is dramatically demonstratedin Table 1. Under prevailing international rules, GATT/WTO must be notified of theformation of a regional trade agreement. The number of RTAs in goods made effectiveand notified to the GATT/WTO during the period 1958-2005 reached 141, with 63 ofthose taking place since 1990. The formation of RTAs has accelerated in recent years.These arrangements include agreements among or between developed countries,developing countries, and developed and developing countries, with no apparent timetrends among those types of arrangements. The formation of RTAs in goods has beenaccompanied by RTAs for trade in services. There are presently 131 notified RTAs inforce; of those 109 are intended to be free trade areas (FTAs) and 11 are, or have the goalof becoming, customs unions. 2 The remaining 11 RTAs are partial scope arrangements,some of which are intended to eventually become FTAs. These RTAs have emerged inall the world’s regions, but are especially prevalent in Asia and the Western Hemisphere.Table 1: Regional Trade Agreements (RTAs) in Goods* by Date of Effectivenessand Type of Partner, 1958-February 2005Dates Total ofwhich:Developed-DevelopedDeveloped-DevelopingDeveloping-Developing1958-69 4 2 0 21970-89 21 8 6 71990-99 53 6 10 92000-05 63 2 20 12Total: 141** 18 36 30Notes: * as notified to the WTO.** Sums do not add across types because of omission of transitioncountries.Source: WTO (www.wto.org) and Crawford and Fiorentino (2005). .In the case of the Americas, the experience with RTAs dates back to the 1960s,which saw the formation of the ambitious Latin American Free Trade Association(LAFTA), the Central American Common Market (CACM), and the Andean Pact. (SeeAnnex Table A1 for a listing and description of the major RTAs in the Americas.) Theseearly RTAs are either now conveniently forgotten failures (e.g., LAFTA) or arrangementswhich have had problematic histories with slow progress in terms of trade integration.The Caribbean Community arrangement (CARICOM), despite low levels of intrabloctrade, has emerged, among the early RTAs (i.e., those originating before the 1990s) as asuccess. The 1990s saw the formation of MERCOSUL and NAFTA, both of which have1 Information on existing RTAs is available on the WTO website (www.wto.org).2 Crawford and Fiorentino (2005), p. 3. Intention is a matter of interpretation. Practically all FTAs arephased in over time, frequently up to 20 years.

4Aside from the proliferation itself of preferential trade arrangements two trendsare apparent: (a) the proportional increase in the number of cross-regional RTAs; and (b)the gradual emergence of continent-wide regional trading blocs. These trends, due in partto a fading international leadership for multilateralism, have adverse implications for anopen, transparent and nondiscriminatory multilateral system of tradeThe remainder of this paper discusses the appeal and economic effects of regionaltrade agreements in Section II. Section III examines the measurement and evaluation ofthose effects, followed by a presentation in Section IV of some general analyticalfindings and implications for the Americas.II. Economic Effects of Regional Trade AgreementsThe primary motivations for seeking entrance into RTAs may not be economic,but rather political in nature. Country governments are driven by security considerations– both intraregional and extraregional. Such considerations frequently weigh heavily asreasons to enter into an RTA. The most obvious example is the impetus behind Europeaneconomic integration following World War II. Similarly, a country’s internationalbargaining power may be increased with its entrance into a RTA, and such an associationmay also enhance its prospects for obtaining cooperation on such things as commonprojects and environmental concerns. Moreover, the entrance into a RTA may provide abasis for a country government to lock in policy reforms; such an incentive is exemplifiedby the Mexican quest for a FTA with the United States, which resulted in NAFTA.Economic advantages may also constitute an important appeal for a country toseek entrance into a RTA. On the trade side, the benefits from trade creation are offsetby the welfare costs of trade diversion. New markets may become accessible as a resultof an RTA, but losses may be incurred from diverting imports from the lowest costprovider to RTA partners. Assessing the balance between trade expansion and diversioneffects, amply discussed in the theoretical literature, has driven much of the empiricaleconomic analysis on RTAs. In addition to trade creation/diversion effects, a country’sterms of trade may also be affected by adhering to a RTA; those effects are a matter ofprice elasticities for the country’s products and its traded goods. The RTA’s impact on acountry’s economic welfare will depend inter alia on whether the terms of trade improveor deteriorate as a result of entry into the RTA. Less apparent, but equally important, arethe indirect effects relating to changes in demand, supply and prices across sectors in theeconomy, All of these static effects impact the country’s economic welfare.A RTA may also bring positive pro-competitive effects, including economies ofscale, greater efficiency and increased productivity. Increased inducements forinvestment may exist with a larger and more competitive market, and foreign directinvestment (FDI) may also increase. Indeed, one of the major effects for Mexicoderiving from NAFTA has been an increase in FDI. Similarly, greater (or lesser) marketcompetition may bring about changes in market structure and industrial organization. By

5the same token, but for reasons of sectoral production changes, changes in industriallocation and regional effects may also accompany a RTA (or, for that matter, trade policyliberalization or de-liberalization).III. Assessing the Impact of Regional Trade ArrangementsA. Computable General Equilibrium (CGE) ModelsIn assessing the effects of different trade policy arrangements, including regionaltrade agreements, three different, but complementary, types of economic analyses areappropriate and well suited. They involve the use of (a) computable general equilibrium(CGE) models and, secondly (b) sectoral studies founded on partial equilibrium analysis,undertaken to go beyond the insights afforded by CGE work and provide greater sectoraldetail and understanding. A third analytical tool – gravity models – also is pertinent andwill be discussed below. Quantification of the effects of trade policy changes is desirablein order to best assess the magnitudes of effects, the trade-offs and benefits/costs todifferent policy alternatives. The use of CGE models and sector studies complement eachother in terms of their quantitative results. (See Table 3 below.) Some important effectsof RTAs however are essentially non-economic or political, as indicated above. Theseeffects can not be quantified.Major Features of CGE Models. Over the past twenty years the use of CGEmodels has become commonplace in order to assess the effects – both direct and indirect– of economic shocks or policy changes. Advances in computational techniques havefacilitated the use of such models. The basic idea underlying a CGE modeling exercise isrelatively simple. It involves: (a) the construction of a mathematical model of aneconomy; (b) the collection of data for a time period for those variables for which dataare available; (c) calibration and solution of the model mathematically to establish theinitial equilibrium values; (d) imposition of a shock to the initial equilibrium in the formof some exogenous event, such as a policy change; and (e) the observation of simulationsderived from the introduction of the shock on various variable values.CGE models are founded on Walrasian general equilibrium theory in whichmarket prices and quantities are simultaneously determined. Economic agents comprisingfirms, households and government make economic decisions related to production andconsumption for different goods and services. Equilibrium conditions are established inthe multiple goods and services markets such that demand and supply conditionsdetermine prices and quantities. Factor markets – generally specified as land (foragriculture), capital and labor – are similarly specified. CGE models are general in thesense that they include all the economy’s sectors and economic agents. Consequently,upon solution all the effects – direct and indirect – of a given shock can be assessed.

6Table 3: Quantification of the Effects from RTAs: CGEs vs. Sector StudiesSectorEffectsCGE Models StudiesEconomic Effects:Static Economic Effects:Trade creation and diversion XX XTerms of trade XX XCross sectoral effects XX XNet changes in welfare/GDP XX XScale and Dynamic Effects:Pro-competitive effects X XXEconomies of scale X XXEfficiency/Productivity X XXInvestment X XXForeign direct investment N XMarket structure and industrial organization N XIndustrial location and regional effects N XNon-Economic/Political Effects:Enhanced Intraregional Security N NEnhanced Extraregional Security N NIncreased Bargaining Power N NImproved Regional and Project Cooperation N NLocking in Reforms N NNote and Key:XX quantifiable effectsX limited measurement, some quantification possibleN no quantification possible.Source: Author’s elaboration.The advantages in the use of CGE models for policy simulations are several. First,such models are based upon solid microeconomic theoretical foundations. Second, theyare complete in that they model the entire economy and can be used to capture andestimate total effects, taking into account interdependencies and linkages imbedded in thefunctioning of the economy. Third, CGE models generate quantifiable results for theimpact of policy changes, including for output, resource allocation, and welfare. Incomedistributional implications can also be simulated. Fourth, since policy impacts arequantitatively estimated, analyses of alternative policy packages can be assessed andranked in a consistent framework. Fifth, CGE models are well suited to analyze majorpolicy changes as opposed to minor or marginal changes.While the advantages of CGE models are powerful, serious shortcomings are alsopresent. First, CGE models require massive and detailed data inputs, building upon anelaborate social accounting matrix framework, including household consumer surveys,national account information, fiscal data, trade flow and restriction information, etc., forthe multiple regions (or countries) being modeled. Since the reliability of such secondarydata is often questionable, models employing such data to construct a benchmark periodequilibrium possess no real means to test the model structure, as is frequently possible

7with the statistical testing of econometric models. Moreover, the simulation results willbe heavily dependent upon the benchmark year data, as well as the model parameters andany other related assumptions. Second, the aggregation in CGE models, normallymandated by data limitation considerations, may mask important effects in anysimulation. In other words, sectoral detail can not reasonably be expected from CGEmodels. Third, the more elaborate and detailed the CGE model, the more likely it is tobecome a “black box” for which result interpretation is difficult. Fourth, there is no timedimension in a CGE model. The supposition is that with the imposed shock (e.g., policychange) the economy moves from one equilibrium to another. How long this adjustmenttakes is a matter of judgment. Fifth, there is no financial sector in CGE models. Sixth,and very importantly, despite efforts to dynamize CGE models, they are essentiallycomparative static models.Use of CGE Models in Policy Simulations. While initially confined touniversities and research institutions, CGE models are now also widely used bygovernments to assess the impacts of policy changes. A recent survey estimated thatgovernment CGE modeling capability and use were present in at least 20 countriesaround the world. 3 Policy simulation impact analysis using CGE models has taken placeto assess trade policy changes, public finance and fiscal reform, agriculture, migration,labor market issues, income distribution and structural reform. With time and theimprovement of modeling and computational techniques, the models have become moresophisticated, increasingly realistic and, at the same time, more difficult to interpret. The“first generation” of CGE models generally assumed that all markets were perfectlycompetitive, while a “second generation” of models has been able to include increasingreturns to scale and imperfect competition, thereby enabling the models to better reflectscale economy and competitive effects. “Third generation” CGE models have sought toendogenize some dynamic effects, including allowing for investment, productivitygrowth and externalities related to trade.When these different generations of CGE models are used to assess the impact ofregional trade and integration arrangements, the more simple “first generation” modelsgenerally show that most RTAs have positive, but very small, aggregate welfare effects.The net effect of trade creation and trade diversion effects, as simulated with suchmodels, has generally run less than 1 percent of GDP. The use of “second generation”models have increased the measured gains to an order of about 2-3 percent of GDP, while“third generation” models have presented net gains in the magnitude of around 4-5percent of GDP. 4 A recent study of Mexico’s entrance into NAFTA, in part based upon a“third generation” CGE model, has concluded that Mexico’s GDP has increased by 4-5percent of GDP as a result of NAFTA membership. 53 Shantayanan Devarajan and Sherman Robinson, “The Influence of Computable General EquilibriumModels on Policy,” International Food Policy Research Institute, TMD Discussion Paper No. 98 (August2002).4 For a discussion, see World Bank, Trade Blocs: A World Bank Policy Research Report (New York:Oxford University Press, 2000) and Harrison, Rutherford and Tarr (2004).5 World Bank, Lessons from NAFTA for Latin America and the Caribbean: A Summary of ResearchFindings (Washington: World Bank, 2003).

8A Case Study Example of CGE Modeling: Results of Policy Simulations for a Peru-USFTA and FTAALike many other Latin American countries, Peru has faced policy choicesregarding different options for trade policy arrangements. CGE models have been usedto analyze those choices: (a) unchanged present policies; (b) a Peru-US FTA; (c)Peruvian adherence to the FTAA; (d) continuation of the soon to be phase out USnonreciprocal preferential arrangement for Peru (ATPDEA); and (e) other conceivablearrangements. For illustrative purposes, these CGE modeling efforts and their basicresults are presented below.Universidad Católica. A basic CGE model has been established by a team ofeconomists in the Department of Economics of the Pontifícia Universidad Católica delPerú (PUCP). The model in use so far is a static model incorporating assumptions ofperfect competition and constant returns to scale. Efforts are currently ongoing to extendthe model to incorporate increasing returns to scale and imperfect competition for themanufacturing sector and to include some dynamic elements. The model used so faremploys the GTAP5 database and is calibrated for 11 regions and 8 sectors. The baseyear (or initial equilibrium) is for 1997 (dependent upon the database availability). Themodeling effort has been institutionalized at PUCP, and expectations are thatimprovements, including data updating, will be gradually incorporated.While the ongoing modeling effort is also intended for other policy simulations,some initial (and still preliminary) simulations have been undertaken for differingregional trade policy arrangements. The overall simulation results for ATPDEA and theFTAA are presented below in Table 4. 6 Simulated sectoral production results arepresented in Annex Table A2; the sectors where expansion is the highest includetextiles/clothing and food products. Simulations were also undertaken for the effects ofPeru joining a genuine free trade area for the Andean Community and for a free tradezone for South America. In both of these cases, the net positive welfare effects for Peruare substantially less than for the FTAA. This result is consistent with other work alsoshowing that the benefits for the South (or developing countries) are generally greaterwith entering into RTAs with the North (or industrialized countries) than with otherSouthern countries. 7Inter-American Development Bank (IDB). Over the past several years the IDB’sIntegration and Regional Programs Department has assembled a small team ofeconomists charged with developing a CGE modeling framework primarily for thepurpose of analyzing regional trading arrangements and initiatives. A Latin Americanbased CGE model has been developed. While the GTAP5 database is used as a starting6 For a summary of the preliminary results, see Gabriela Cuadra et al., “Escenarios de Integración para elPerú en la Economia Mundial,” PUCP, Presentación hecha em Power Point en Septiembre 2003. Nosimulation results are yet available for the proposed Peru-US FTA.7 One such study is Monteagudo and Watanuki, “An Empirical Assessment of North-South and South-South Agreements for Latin America,” IDB Working Paper, November 2003.

9reference point, the IDB database is built upon national social accounting matrixes(where possible), and the trade and trade restrictions information come from thehemispheric database assembled by the IDB in conjunction with the ongoing FTAAdiscussions. Different exercises have involved different regional and sectoral groupings,although the basic model runs with 15 productive sectors. The year 1997 is taken as thebase year. Efforts to make the modeling framework more dynamic have included theincorporation of elasticities for trade flows and productivity to reflect positiveexternalities linked to trade. Ongoing work to extend the modeling framework includesefforts to include increasing returns to scale and imperfect competition for manufacturingsectors.Using this CGE framework and the IDB hemispheric trade database, and anumber of different simulations have been undertaken. 8 Some basic simulation resultsare presented in Table 4. Unfortunately, separate estimates for Peru are not yet availablefrom the IDB work. 9 The simulation results presented in Table 4 for Peru+ include thegrouping of Peru, Ecuador and Bolivia. Since Peru accounts for about two-thirds of thecollective GDP for this group of countries, the results are presumably representative forPeru.Table 4: CGE Simulations under Different Regional Trade Policy Agreements:Estimated Effects for Peru (changes in %)Universidad Católica IDB (Peru +) 1Impacted Variable ATPDEA FTAA US FTA FTAAGDP 0.06% 0.27% 1.78% 2.98%Total Exports 2.1 9.7 4.4 8.3Total Imports 2.1 10.0 4.0 7.5Exports to FTA Partners 22.6 26.1 n.a. n.a.Imports from FTA Partners 2.6 26.9 n.a. n.a.Notes: 1. For the IDB simulations Peru+ also includes the smaller economies of Bolivia and Ecuador.Sources: Gabriela Cuadra et al., “Escenarios de Integración para el Perú en la Economia Mundial,” PUCP,Presentación hecha en Power Point en Septiembre 2003 and Monteagudo and Watanuki, “An EmpiricalAssessment of North-South and South-South Agreements for Latin America,” IDB Working Paper,November 2003.Comparing the simulations made with the PUCP and IDB CGE models, a numberof observations are relevant. First, it would appear, as expected that the ATPDEA, US-Peru FTA and the FTAA are all beneficial for Peru. GDP is seen to increase in all cases.8 Inter-American Development Bank, Beyond Borders: The New Regionalism in Latin America, Economicand Social Progress in Latin America: 2002 Report (Washington: Inter-American Development Bank,2002), pp. 52-55. Other IDB reporting on CGE simulations is contained in various papers by Monteagudoand Watanuki, op cit., as cited in this note’s list of references.9 Some very preliminary IDB results were presented in a workshop in MINCETUR in September 2003. Thepresentation however contained incomplete results and posed questions of consistency with other IDBsimulations. See Monetagudo et al., “Impacto de Diferentes Estrategias Hemisféricas en el Comercio dePerú,” Power Point presentation made September 18-19, 2003.

10Second, as simulated by the PUCP and IDB models, total Peruvian exports increase withthe FTAA by roughly similar amounts. Third, as expected, exports increase more with theFTAA than with the US-Peru FTA. The opening of Latin American markets is importantfor expanding Peruvian exports, and this of course is not provided with the bilateral FTAwith the US. Fourth, the net welfare gains to Peru (as represented by GDP growth) areseen as greater under the IDB model simulations as opposed to the PUCP simulations.The explanation for this is the inclusion of some dynamic effects into the IDB CGEmodel.Andean Community. The headquarters of the Andean Community has recentlyundertaken an analytical effort to assess the impact of different regional tradearrangements on the Andean Community countries. This effort has involved contractingan international consultant to undertake some CGE model based simulations. 10 The CGEmodel used is based upon the GTAP5 framework and database, employing 10 productivesectors and with separate breakouts for the Andean Community countries (althoughEcuador and Bolivia are lumped together for data availability reasons). The simulationsare first made of the effects of the ATPDEA (which, as expected, show positive netbenefits in terms of consumption and welfare, along with expanded trade flows) for bothPeru and Colombia, as well as for the Andean Community as a whole. There aredifficulties in assessing the results for the ensuing FTAA simulations, however. Thosesimulations are based upon an initial equilibrium with the ATPDEA effects incorporatedin the base. In reality, there is no sequential choice for the Andean Community countriesbetween sticking with ATPDEA or joining the FTAA. The ATPDEA provisions, grantedby the US government, are time bound, with expiration scheduled for 2006. In addition,even if the ATPDEA benefits were unilaterally extended by the US, there is no guaranteethat they would be permanent. The US could withdraw them at any time, whereas eitheran FTA or the FTAA would reduce this uncertainty with stipulated treaty commitments.B. Sectoral StudiesSector studies of trade policy effects, building upon partial equilibrium analysis,complement and extend in greater detail the indicative results from CGE models. Bothtypes of approaches are useful in assessing the impact stemming from alternative tradepolicy arrangements, such as a RTA. In most Latin American countries there are variedindividual sector studies available for different sectors, but these studies are seldomfocused on the impact of possible trade liberalization or other changes in trade policyarrangements. Indeed, some common special features and characteristics are central ifsector studies are to be useful to policy-makers in the discussion and negotiation ofdiverse RTAs.Questions that should be posed in such analytical work involving specific sectorsinclude the following:10 Comunidad Andina, Analisis del Impacto del ALCA en la Comunidad Andina (Lima: Secretaria Generalde la Comunidad Andina, 2003).

111. What are the sector specific net welfare gains accruing to the country as a resultof adherence to the proposed RTA? What are the related production effects likelyto result from the RTA? Using partial equilibrium analysis, sector specificwelfare changes stemming from the RTA can be estimated. Trade creation anddiversion can be determined and quantified, along with changes in producersurplus, consumer surplus and tariff revenues. Significant sector knowledge andunderstanding – both in for the country in question and the prospective RTApartners – are required to model and quantitatively estimate these changes. Pricecomparisons in the work are critical, implying much greater ease of analysis formore standardized products. In the case of a FTA with the US, the analysis shouldinvolve the use of domestic prices, US prices and international prices. The pricechanges associated with the FTA can be simulated along with their production,trade, consumption and revenue effects. 112. For those sectors where output and/or export expansion are anticipated as aresult of the RTA, is it likely that there will be a supply response to either theincreased relative prices and a more competitive environment? What are theimpediments to the sector’s supply response? A properly done sector should beable to identify such impediments, which may be caused by market imperfections,domestic regulation, institutional rigidities, or other market distortions.Recommendations as to how to deal with such impediments to market supplyresponse would be an important component for the envisaged sector studies.3. What are the sectoral employment effects likely to result from the RTA? WhileCGE simulation models can provide some notions of the employment effects,further and more in-depth analysis may be necessary. CGE models are generallybased on perfect competition assumptions in labor markets, and also nodistinction is commonly made between labor – and skill – categories. In reality,there may be considerable labor market rigidities or peculiarities which can not becaptured in more aggregative analyses. Since employment is of central concern toany government entering into a RTA, more in-depth analysis at the sector levelmay provide important insights for policy-makers.4. What are the implications of the RTA for market structure for the sector inquestion? And how might the existing market structure influence the outcome?Most manufactured and nontraditional service sectors are characterized byimperfect competition. Sector studies are necessary to examine the relationshipbetween market structure and trade. A RTA, for example, may make for a morecompetitive sector market and either increase or diminish concentration. Analysiscan be useful for policy formulation.11 An illustrative case study is a sector study done recently by Gary Pursell for the Indian cement industry.See Gary Pursell, “Study of India-Bangladesh Trade and Trade Policies: Case Study Simulations ofEconomic Welfare Effects of a Free Trade Agreement,” World Bank working paper, December 2003.

125. What are the likely effects of the RTA on sector investment? And how might theRTA affect foreign direct investment? In sectors which expand as a result of anRTA, new investment is likely to occur. Examining how, how much, where andwhat type of investment is likely to occur can be addressed in sector studies.6. What are the likely effects of the RTA on productivity and technologicalenhancement? One commonly observed effect of more open trade policyenvironments is an increase of productivity. This may be because of increasedcompetitive pressures or the embodiment of productivity enhancing technology innew investment. Sector studies can usefully address related issues.7. What are the implications of the RTA for industrial location and geographicaldispersion? One frequently observed feature of trade liberalization is that certaingeographic regions may be negatively impacted. Sector studies can help identifyregions either losing or gaining from a RTA.8. Finally, what can the Government do to enhance the gains for those sectorsbenefited by the RTA and to cushion and facilitate (but not forestall) adjustmentin negatively impacted sectors? Any proposed government interventions shouldbe seen as supporting the adjustment and transition to a more competitiveenvironment. They also should be budgeted and analyzed for cost effectiveness.There are several criteria available for selecting sectors that might be productivelyanalyzed. First, CGE simulations can indicate grosso modo which sectors are likely toexpand and to contract as a result of the RTA. (See Annex Table A2 for a Peruvianexample) The level of aggregation in the sector designation may hide important features,and more information about the outlying expanding or contracting sectors can be usefulfor policy-makers. Both the identified major “winners” and “losers” from the RTA meritmore careful analysis than that afforded from the CGE alone.A second criterion for selecting sectors for more in-depth analysis is to base thatconsideration on recent growth and export performance. How is the RTA likely to affectthat performance? Third, protection in the domestic market – including effectiveprotection – can be used as screening criterion for selecting sectors for study. With thepresumed reduction in protection, what will happen? Or is that protection redundant?Fourth, sectors important for the economy can not be neglected, and policy-makerscharged with negotiating RTAs need to have a sense of what the impact may be on thosesectors. All four of these criteria can be used to suggest some relevant sector studies tosupport a Government’s position for RTA negotiation.C. Gravity ModelsCommon sense has long told economists that geographical proximity is importantfor trade. Being close to your markets, everything else being equal, means lowertransportation costs (in both money and time) and easier access. It is also easier to tradewith those close-by if they speak the same language and share similar cultures. For these

13reasons, it is not surprising to find greater trade between neighbors than those located at agreater distance. On the basis of these simple contentions and observations, gravitymodels of international trade have been developed. The basic notion (and equation) positsthat trade between countries is a function of distance and GDP, i.e., the smaller thedistance between markets and the larger the market size (as measured by GDP), thegreater will be the trade flows between them. Empirically, the gravity models measuringbilateral trade in terms of variations of the distance and market size variables are veryrobust. 12 There is indeed a tendency for neighbors to trade more with each other than withthird, and more distant, parties.Gravity model estimation typically posits trade flows as a function of five basicexplanatory variables: market size, per capita incomes, distance, common borders andcommon languages. In general, in studying the formation of RTAs ex post, RTAaffiliation accounts for a positive factor beyond the five basic explanatory variables in theequation. This is taken to imply benefits from RTA formation.The limitations of gravity models to examine trade policy choices are fairlyevident. The models are best suited for examining bilateral trade and more difficultlyadapted for examining RTAs. The models measure trade flows, which are inherently lessinteresting than economic welfare, which is not measured. Moreover, gravity modelmeasurements are ex post rather than ex ante and therefore have little predictive value.For these reasons, gravity models, while capable of providing important insights, are notwidely used for examining the potential impact of different trade policy options orarrangements, including RTAs.IV. Some General Findings and Implications for the AmericasA. The FTAA Option Once Again: Anything New?Ever since the Free Trade Association of the Americas (FTAA) was firstproposed in the early 1990s, it has been surrounded by controversy, mostly of a politicaland/or ideological nature. This political discussion has most frequently dominated theeconomic discussion. But there are important economic dimensions as well. What, forexample, can be expected to happen to the economic welfare for the prospective membercountries? Will Country X be better off or worse off? There is indeed some evidencefrom economic analysis, which, predictably enough, is largely ignored by the politicalactors.The evidence regarding the most relevant economic effects – those for economicwelfare – has been developed with the use of CGE models. Some illustrative evidence ispresented in Table 5. The results for two different studies are reported: (a) a study byHarrison, Rutherford, Tarr and Gurgel (hereafter termed HRTG) undertaken under the12 For a solid analysis of gravity models, along with a development of the implications for RTAs, seeFrankel (1997).

14auspices of the World Bank 13 and (b) work by the IDB referred to above in relation toPeru. The two efforts are different in terms of statics. The HRTG/World Bank model isstatic in nature (and therefore underestimates gains), while the IDB effort attempts toinclude dynamic elements related to imperfect competition and externalities fromincreased trade. Unsurprisingly, the estimated impacts from the IDB exercise are larger.Table 5: Welfare Gains for Different RTAs, Selected Countries (% change)Country/RegionHRTG/WB CGE Model Estimates*50%MultilateralMercosul TariffFTAA -EU FTA ReductionFTAAIDB CGE Model Estimates**Mercosul-EU FTASAFTAAndeanComm.-US FTANAFTA 0.39 0.03 0.00 0.13Mexico 0.3 0.0 0.5 1.02 0.03 0.00 -0.05Canada 0.0 0.0 0.2 0.57 0.04 0.00 -0.01United States 0.0 0.0 0.1 0.35 0.03 0.00 0.15Central Am. & Carib. 4.3 0.0 2.1 2.22 0.04 -0.01 -0.07Andean Community 2.12 0.12 0.62 1.36Colombia 1.7 -0.1 1.0 1.32 0.05 0.28 0.92Peru 1.0 0.1 1.3 -- -- -- --Venezuela 1.1 0.0 0.9 2.08 0.12 0.37 1.40MERCOSUL 3.12 4.72 0.50 -0.01Argentina -0.2 2.3 0.8 2.49 4.20 0.61 0.0Brazil 0.6 0.9 0.9 3.39 4.94 0.46 -0.01Chile 1.1 0.9 1.3 2.84 0.11 1.14 -0.01European Union -0.1 0.5 0.8 -0.01 0.61 0.0 0.0Notes: * Estimates from Harrison, Rutherford, Tarr and Gurgel (2003). Welfare gains are expressed as a percentage ofconsumption.** Estimates from Monteagudo and Watanuki (2003). Gains are expressed as a percentage of GDP. The SAFTArepresents a hypothetical South American Free Trade Association.Source: Harrison, Rutherford, Tarr and Gurgel (2003); Monteagudo and Watanuki (2003).Turning first to the HRTG/World Bank estimates of welfare changes attributableto the formation of the FTAA, we see that the greatest welfare gains accrue to CentralAmerica and the Caribbean (consistent also with a gravity model interpretation). Theseare small economies. For the US – a very large economy relative to the rest of the region– the gains are negligible (but not negative). For Mexico, already with access to the USmarket afforded by NAFTA, the gains are modest and attributed to market access in thosecountries where it does not presently have a preferential trade arrangement. Larger gainsaccrue to Colombia, Peru, Venezuela, Chile and Brazil. The European Union – a13 The CGE model used for the HRTG/World Bank study has been developed and used by the World Bankin different forms and guises for various exercises. It entails a constant returns to scale (CRTS) assumptionand employs the GTAP5 database, with, in this case, some modifications for Brazil. Simulations areundertaken for 32 sectors for a wide variety of countries and regions. For a description see HRTG (2003).

15nonmember – suffers a slight welfare loss as a result of the FTAA, stemming from thetrade diversion associated with FTAA formation.Argentina presents an interesting case with the HRTG estimates. It incurs a slightwelfare loss as a result of the FTAA. The most plausible explanation for this isArgentina’s loss of its privileged position in the Brazilian market previously stemmingfrom MERCOSUL trade diversion. The FTAA eliminates this gain for Argentina (andloss for Brazil). The HRTG result for Argentina is not however uniformly obtained inother analyses. As also seen in Table 5, the IDB estimates show welfare gains forArgentina emanating from the FTAA. A roughly comparable CGE modeling exercisedone by the Argentine Government showed a similar welfare gain for Argentina fromFTAA accession. 14The IDB estimates tell the same basic story. Gains are experienced all around,except for the (excluded) European Union which incurs a small welfare loss resultingfrom trade diversion. The United States gains, but those gains are quite modest given thesize of the American economy. The Central American and Caribbean countries also gain,but less relatively than in the HRTG study. Brazil, on the other hand, shows much largergains than with the HRTG estimates. Gains for Chile are also significant, but those gainsmay be overstated, because of the more recent RTA of Chile with the US – not factoredinto the analysis.If the benefits of the FTAA are so apparent for prospective member countries,why haven’t the negotiations been completed and the FTAA enacted? Aside frommisunderstandings, the ideological rant, and economic ignorance, there are some genuineeconomic reasons why the FTAA has not come into fruition. Those reasons center onprotectionism. Some groups or activities would be negatively affected in all countries,and these vested interests most commonly outweigh in their political voice and influencethose that would benefit from the FTAA. Even though the net benefits for anyprospective member country may be positive, this by no means assures that the politicalprocess surrounding negotiation, agreement and adoption will proceed. Groups opposedto the FTAA, for whatever reason, have proved effective so far in delaying or derailingthe discussions. Clearly some of the arguments raised in the discussions have someeconomic merit; others are mostly smokescreens.A major economic issue relates to the treatment of agriculture. While the USagricultural sector is generally very competitive, there are some agricultural activities inwhich this is less so. In particular, the MERCOSUL countries are more competitive inmany gain products. In addition, the US heavily subsidizes many agricultural activities.Thus the elimination or reduction of agricultural subsidies plus market access foragricultural products is an important issue under discussion for the FTAA. The USposition is that agriculture-related issues are best discussed under the coming DohaRound of multilateral trade negotiations, where EU agricultural policies and subsidies14 CEI (2002). With a constant returns to scale assumption and the inclusion of trade relate externalities, theCEI CGE model simulations show that Argentina reaps a 1.3 percent of GDP gain as a result of the FTAA.

16will also be on the table. The Doha Round talks are also currently stalled. A related USargument is that the US can only provide concessions related to agriculture if theMERCOSUL countries make concessions related to the “behind the borders” issuesinvolving trade in services, intellectual property, government procurement, treatment ofinvestment flows, etc. And so forth. On the question of timing, there may be somerationale to proceed with the Doha Round first, before finalizing a FTAA negotiation. 15Is the FTAA dead? The future of the FTAA, until recently planned for signing in2005, depends mainly on the approaches adopted the United States, on the one hand, andMERCOSUL, lead by Brazil, on the other. Protectionism in the US presents real issuesfor Congressional ratification of a FTAA agreement. The recently ratified CAFTA, ekedthrough the Congress by a narrow margin and only with heavy (and expensive) lastminute executive lobbying, shows how effective protectionist interests (in this case sugar)can be. In the case of the FTAA, the vested interests negatively impacted are much largerand powerful (going beyond, but including, sugar). A recent study has shown that in 37US states at least 20 percent of the Congressional Districts were affected by “sensitive”product imports from Brazil, which could be expected to increase with the FTAA; in 17states more than 60 percent of the Congressional Districts would be affected. 16 In manyof these states, including the Farm Belt states, the governing Republican Party isespecially powerful. 17 It is apparent that political sensitivities and potential difficultieswith FTAA ratification are driving US policies with respect to the FTAA. This sensitivityand political calculus may be behind the US decision to pursue bilateral FTAs instead ofthe more ambitious (and beneficial) FTAA.US hesitancy in proceeding with the FTAA is more than matched by theMERCOSUL countries. In Brazil there is a strong anti-FTAA lobby and influence in thecurrent Government. This opposition to the FTAA includes both ideological andprotectionist elements. A clear rift on the FTAA exists within the present BrazilianGovernment, with reluctance to proceed on the part of the Ministry of Foreign Relations,which is charged with the negotiations. On the other hand, the Ministries of Agriculture,Development and Industry, see clear economic advantages for Brazil and are anxious toproceed. 18 In sum, the Brazilian Government has gone through the motions of reluctantly15 A good discussion of the negotiating issues and the question of timing is presented in Nogués (2005).16 Abreu (2005). “Sensitive” products were defined as orange juice, sugar and derivatives, tobacco, poultryproducts, beef, pork, cotton, soybeans, shoes and footwear, steel and trucks.17 The NAFTA agreement was ratified without the opposition of the agricultural lobby. Opposition camemostly from the more heavily democratic industrial states.18 In an important FTAA negotiating meeting held in Mexico in 2004, the Ministers of the Agriculture andDevelopment and Industry were not invited nor provided with the Government’s background andnegotiating documents. The Ministry of Foreign Relations instead invited labor union, indigenous groupand NGO representatives. The meeting ended in failure. After the meeting the left-out Ministerscomplained to the President, who in turn reaffirmed the authority of the Minister of Foreign Relations whilepromising greater participation in the discussions.

17negotiating the FTAA and in essence playing a waiting game in doing so. Theintransigence on the Brazilian side is matched by that of the present ArgentineGovernment and enthusiastically surpassed by the rhetoric and antics of the currentVenezuelan Government.To the question posed above of whether there is anything new on the FTAA front,the answer is “not really.” But this is a pity for those countries in the Americasimmediately concerned and potentially benefited.B. RTA Options: A MERCOSUL Free Trade Agreement (FTA) with the EuropeanUnionDiscussions regarding a possible free trade agreement between MERCOSUL andthe European Union were initiated several years ago, but have proceeded very slowly.From the MERCOSUL standpoint a major concern was to have these potentialarrangements as a possible bargaining counterweight in the discussions with the US onthe FTAA, and, since the overall EU policy has been to seek further liberalization andmarket access through new RTAs with the EU, negotiations have proceeded with intereston both sides.Evidence on the welfare impact of a possible MERCOSUL-EU FTA, as simulatedthrough CGE modeling, is presented in Table 5. The HRTG/World Bank estimates shownet welfare benefits for the MERCOSUL countries, and especially for Uruguay, withsuch an arrangement. Indeed, as seen in Table 5, those benefits for MERCOSUL exceedthose from the FTAA. 19 The EU, predictably, also benefits from the FTA. The IDBestimates, presented in Table 5’s data columns 4 and 5, show a similar story. ForMERCOSUL a FTA with the EU would bring greater net benefits than the FTAA. This isdue primarily to the MERCOSUL potential for expanding agricultural exports to theprotected EU market in those products. If trade restraints are however placed on thoseproducts, the benefits are accordingly reduced.The main economic issues in the MERCOSUL-EU negotiations are quite similarto those deadlocking the FTAA discussions. 20 MERCOSUL seeks concessions onagricultural products – both in terms of market access and subsidies provideddomestically and for export by the EU. The EU, on the other hand, has sought greater19 HRTG also undertook estimates of the welfare effects if MERCOSUL were to enter into both a FTAAand a FTA with the EU. In this case, the net benefits would exceed the sum of welfare benefits estimatedseparately. This occurs because of reduced trade diversion with both agreements in place.20 It can be noted that politically MERCOSUL has less of a problem negotiating with the EU than for theFTAA. With the latter, dealing with the US has a negative political image and accordingly presentsdomestic political constraints. Economically, however, dealing with the EU may be more difficult becauseof the European Common Agricultural Policy (CAP) and its imbedded protectionism. Also it should benoted that the EU has negotiated a number of bilateral RTAs (e.g., Morocco, Tunisia) where it hassubstantial regional political interests (and presumably more compelling reasons for granting economicconcessions). Yet, in none of these RTAs were there substantial agricultural product concessions on theEU’s part.

18access for its services and manufactured goods and concessions on the so-called “behindthe borders” issues such service regulation, investment issues, and governmentprocurement. As with the FTAA, MERCOSUL has requested concessions on agriculturalissues prior to substantive negotiation on other issues. And similarly, the EU – like theUS – has balked, arguing that progress on agricultural subsidies and market access canonly take place under the auspices of the Doha Round. No viable “credit for future orconditional concession” arrangements have been worked out to date.C. RTA Options: A South American Free Trade Association (SAFTA)A South American Free Trade Association (SAFTA) has been proposed atdifferent times. Indeed, the original LAFTA (dating from the early 1960s) embraced avariant of this idea. More recently, the Venezuelan proposals put forth in Mar del Plata atthe November 2005 Summit Meeting of the Americas for Bolivarian RTA presumablyembody such elements. The main feature of these proposals is that the United States andCanada are excluded. Such an agreement would be a South-South RTA, i.e., oneexcluding more developed countries.Table 5 presents simulations, undertaken by the IDB, of the economic effects of apotential South American Free Trade Association. When compared to the IDB FTAAsimulations, it is seen that for the presumed South American member countries, thebenefits of the SAFTA are substantially less than those for the FTAA. For the excludedCentral American and Caribbean countries the welfare effects of the SAFTA, due to tradediversion, are negative (although small). The estimated result showing lesser benefits forthe member countries with SAFTA than for the FTAA is consistent with other studies ofSouth-South and South-North RTAs. South-South RTAs consistently present fewerbenefits than roughly comparable RTAs which also contain more developed countries.This is because of: (a) the enhanced market access (and potential for trade creation)presented by participation of advanced countries; and (b) the greater economic efficiencyeffects on resource use coming from greater import competition.For comparison purposes, estimates of the effects of a Andean Community-USFree Trade Arrangement are also presented in Table 5. It is shown that the AndeanCommunity countries (Bolivia, Colombia, Peru and Venezuela) would gain more withsuch a FTA with the US than they would with the SAFTA, but considerably less thanwith the FTAA.D. RTA Options: Whither MERCOSUL?When the MERCOSUL was formed in 1991, it was met with considerableskepticism on the part of many economists. 21 Detractors pointed to the noncomplementarityof the economies concerned, the earlier failure of LAFTA, the record ofheavy protection in the member country economies, and the tendency – noted above – forgreater gains from developing country RTAs to occur when more developed countries are21 In a Brazilian university seminar, one such skeptic was quoted as referring to MERCOSUL as “anoutpouring of flowery political rhetoric to be matched by some counter trade.”

19also members. Such early skepticism has however proved exaggerated. Intrabloc tradeincreased sharply, especially in the early to mid-1990s, a reasonably effectiveinstitutional has been developed and the member country Governments have taken theinstitution seriously. Movements toward integration, however, have gone slowly and notwithout difficulties. A common external tariff (CET) was formally adopted in an attemptto move towards a customs union, but there are still abundant exceptions. 22 In addition,apart from inconsistencies and differences between domestic and international legalobligations related to MERCOSUL, there are very problematic procedures for disputesettlement.The last six years of MERCOSUL’s history have been more problematic than itsearly years. With currency overvaluation in both Argentina and Brazil in the mid-1990s,Argentina developed a comfortable trade surplus with Brazil. This began to change withthe Brazilian currency depreciation in 1999 and continued even after the collapse of theConvertibility Plan (and peso overvaluation) in 2002. 23 Pressure from Brazilian products,coupled with Argentine economic problems and protectionist interests, has put strains onBrazilian-Argentine economic relations and, by association, on MERCOSUL.There are a number of immediate issues facing MERCOSUL as an institution.They include: (a) improving the mechanism for intrabloc trade dispute settlement; (b)establishing a united front for effective trade negotiations (FTAA, FTA with the EU,Doha Round); (c) eliminating the many exceptions to the common external tariff; (d)implementing the intrabloc agreement on free trade in automobiles (scheduled forimplementation in 2006); (e) eliminating nontariff barriers on intrabloc trade; (f)elimination of Argentina’s special import tax on sugar; (g) designing a workablesafeguards mechanism for intrabloc trade consistent with the trade objectives ofMERCOSUL; (h) handling the possible entry of Venezuela (to be dealt with at thescheduled December 2005 meeting); and (i) possibly most importantly, finding a way tohandle the ongoing Argentine-Brazilian trade disputes without underminingMERCOSUL.Many of these issues indeed reflect the last one listed above – the festeringArgentine-Brazilian trade disputes To mention just few, the present ArgentineGovernment, acting out of its perceived national economic interests has: (i) imposedimport licensing requirements on Brazilian goods imported into Argentina for thoseproducts deemed sensitive; (b) induced Brazilian private sector associations, withBrazilian Government connivance, to impose “voluntary” export restrictions for goodssold in the Argentine market on their members in order to head off more drasticdiscriminatory import controls by the Argentine Government; (c) proposed a“safeguards” mechanism, decided unilaterally, to guard against imports from member22 The average MERCOSUL CET has remained high (currently about 12 percent) and unchanged overrecent years. The intended movement towards a customs union, with even deeper future integrationintended, dampened Chile’s enthusiasm for participation as a full member. It elected instead associatemembership enabling it to retain and pursue its own, more open, trade policies.23 In 2000, for the first time since 1994, Brazil developed a bilateral trade surplus with Argentina.

20countries deemed “excessive” or injurious to domestic production; (d) imposed a specialimport tax on sugar imports (from Brazil); and (e) sought to delay the implementation ofthe previously agreed automobile trade agreement.Is MERCOSUL unraveling? These disputes result from actions taken by amember country which are inconsistent with the letter and spirit of the MERCOSULtreaty. They raise questions about the future prospects of MERCOSUL itself. TheBrazilian Government response to these actions on the part of the Argentine Governmenthas been, in essence, to negotiate and, when necessary, to give in order to not imperil thefuture of MERCOSUL. When the Argentina Government has imposed restrictions onimports from Brazil of such products as refrigerators, stoves, washing machines, shoesand other products, the Brazilian Government has not responded by threats or actions inkind by suggesting similar, and retaliatory, restrictions on, for example, imports ofArgentine wines. To date the Brazilian policy has been one of appeasement and buyingtime in order to protect MERCOSUL in the hopes that the employment and economicsituation in Argentina will improve and/or that the Argentine Government will change orchange its policies.The possible accession of Venezuela to MERCOSUL will present a new set ofchallenges for the organization. The Venezuelan legislature would have to approve theaccession and the Venezuelan Government would have to both open its markets toMERCOSUL goods and adopt, presumably with some exceptions, the common externaltariff. In addition, there are implications for MERCOSUL’s trade negotiations, especiallywith the FTAA where Venezuela’s participation is likely to stiffen still furtherMERCOSUL’s reticence to enter into an agreement.E. Regionalism versus MultilateralismThe growing use of regional preferential trade arrangements as importantelements in countries’ approaches to international trade appears to be a permanent featurein the international landscape, These is no question, at least in economic terms, that thisregionalism is a second best economically. It is undermining the multilateralism in theworld trading system, which has served the world reasonably well over the past sixtyyears – a period of unparalleled growth and prosperity. If multilateralism, with itsemphasis of transparency and nondiscrimination, has served the world so well, whatexplains the movement towards regionalism?The rise of regionalism in international trading arrangements can be explained byfive phenomena. First, the demonstration effect from the success in European economicintegration has convinced other national governments that there is some replicability inthe EU experience, even though the original impetus behind European integration,growing out of World War II, was political rather than economic. Second, there has beensome dissatisfaction with progress in multilateralism resulting in further tradeliberalization. Successive (and successful) multilateral trade negotiation rounds haveindeed resulted in trade liberalization, but with some diminishing returns as the issues tobe addressed become more stubborn. In addition, taking the initiative to spearhead

21multilateral trade negotiations requires effective leadership, and there is a public goodsdimension to such leadership. In the past that leadership has been provided by the UnitedStates. However, the American economy is no longer the dominant force in the worldeconomy that it once was, and the US has seemingly abdicated that decisive leadershiprole. Third, and relatedly, one can argue that the US, with its new emphasis on enteringinto RTAs on a worldwide basis, is not only no longer leading but is now underminingmultilateralism. The US seemingly is no longer the champion of multilateralism that itonce was but instead, through its actions, is effectively eroding that system. In addition,the European Union through its own pursuit of preferential arrangements is playing asimilar, nonleadership role.A fourth reason explaining the rise in regionalism, at least as far as Latin Americais concerned, relates to what can be considered as a partial triumph of economicrationality. After years of emphasis on forced import substituting industrialization andaccompanying anti-trade biases in economic policies, recognition grew that those policieswere impeding growth. In backing away from autarchistic policies, there was a growingawareness among Latin American economists and policy-makers that trade is importantfor growth and that trade and other policies also matter. The experience of Chile witheconomic and trade liberalization, along with that of other countries, had an influence. Asa result of this increased economic rationality, Latin American countries began toundertake structural reforms and to emphasize trade more seriously. 24 A corollary to thisgreater economic rationality is an increased acceptance of having to live with the UnitedStates and other developed countries. Indeed those markets are important, and gettingaccess may be more than a matter of simply complaining about protectionism in the moreindustrialized countries. Finally, with many countries liberalizing trade policies and/orentering into RTAs, there has been something of a bandwagon effect. Many countriessimply may have wanted not to be left out of the growing proliferation of RTAs.US policies, as indicated above, have had an effect in promoting the proliferationof regional trade arrangements in recent years. The United States may have drifted intosuch policies rather than pursued them as part of a designed, ex ante strategy. Indeed, theUS was a stalwart defender of multilateralism into the late 1980s. In 1985 it entered intoa bilateral RTA with Israel for presumably largely political reasons; in 1988 a similartrading arrangement was initiated with Canada, this time for mostly economic reasons.An increase in the momentum towards regionalism came when the US entertained andaccepted a proposal from the Salinas Government in Mexico to join the US and Canadain their FTA. The formation of NAFTA marked an important departure for the US; theNAFTA Treaty included an accession clause envisaging NAFTA’s expansion.Subsequently, however, Chilean and CARICOM requests to join NAFTA were refused.This refusal pointed US policies in a somewhat different direction, involving “hub andspokes” RTA arrangements, while at the same time publicly reaffirming the stated USobjectives to pursue the FTAA. If the FTAA was ever a serious US objective, thepiecemeal expansion may have been the best way to proceed. With piecemeal accessions,the pressures would have eventually been high on Brazil (the rest of MERCOSUL and24 See Gurgel and Tyler (2005) for a discussion of the effects of trade policy liberalization in Brazil.

22other countries) to join NAFTA (presumably renamed at some point) to avoid being leftout and to attain desired access to the US market.What has emerged, perhaps unwittingly, for US trade policy strategy is apatchwork set of arrangements: periodic and varying commitments to multilateralism,ample rhetoric on the virtues of freer trade, and a mixture of RTAs, increasinglycharacterized by a “hub and spokes” framework of bilateral preferential trade agreements.Under such agreements there is intended free trade between the center hub (the US) andthe peripheral countries. But there is no free trade between the peripheral countries – asthere would be with the FTAA. The gains are concentrated for the US and the countrieswhich are left out of the bilateral arrangements suffer welfare losses as a result of tradediversion. In sum, this policy is discriminatory, nontransparent and potentially harmfulfor Latin America. 25 It is not the policy that any thoughtful US policy-maker concernedabout US-Latin American relations and development in Latin America would havewillfully designed.The Doha Round. Over the next several months critical steps will be taken whichwill shape to outcomes of the coming Doha Round of multilateral trade negotiationsundertaken under the auspices of the WTO. The potential gains for Latin America, aswell as for other countries, are substantial. It is impossible to predict that shape of anyDoha Round agreements at this early stage, since no clear liberalization formulas haveyet emerged in the different areas of negotiations. Nevertheless, some indicativeestimates are possible. HRTG/World Bank estimates, for instance, show that an acrossthe-board50 percent cut in tariffs would have welfare gains for Latin American, andother, countries exceeding those resulting from the FTAA, the MERCOSUL-EU FTA,the SAFTA or other potential RTAs for Latin American countries. (Table 5) It wouldappear that Latin America is best served to use its influence to help assure a favorableoutcome for the Round. Also, success in the Doha Round may help pave the way forbreakthroughs for negotiations for the FTAA and a possible MERCOSUL-EU free tradearrangement.25 Such policy is reminiscent, to a degree, of colonial trade policies previously prevailing in the Americas,where the colony was permitted to trade with the mother country but not with other countries or colonies.

23REFERENCESMarcelo Paiva de Abreu, “A Agenda de Negociações Comerciais do Brasil,” Palestra porocasião da comemoração dos 75 anos da Faculdade de Ciências Econômicas da UERJ,Rio de Janeiro, outubre de 2005.Mohamed Hedi Bchir, Yves Decreaux et al., “MIRAGE: A Computable GeneralEquilibrium Model for Trade Policy Analysis,” CEPII Working Paper No. 2002-12(December 2002), 58 pp.Centro de Economia Internacional (CEI), Alternativas de Integración para la Argentina:Un Análisis de Equilibrio General, Estudios dle CEI No. 1 (Buenos Aires: Junio de2002).Comunidad Andina, Analisis del Impacto del ALCA en la Comunidad Andina (Lima:Secretaria General de la Comunidad Andina, 2003).Jo-Ann Crawford and Roberto V. Fiorentino, “The Changing Landscape of RegionalTrade Agreements,” WTO Discussion Paper No. 8 (2005).Gabriela Cuadra, Alan Fairlie y David Florián, “Escenarios de Integración para el Perú enla Economia Mundial: Un Enfoque de Equilibrio General Computable,” PUCPInforme Parcial, Julio 2003.Gabriela Cuadra, David Florián y Alan Fairlie, “Escenarios de Integración para el Perú enla Economia Mundial,” PUCP, Presentación hecha em Power Point en Septiembre2003.Shantayanan Devarajan and Sherman Robinson, “The Influence of Computable GeneralEquilibrium Models on Policy,” International Food Policy Research Institute, TMDDiscussion Paper No. 98 (August 2002).Angelo Gurgel and William Tyler, “Brazilian Trade Policies: Some Observed andEstimated Effects of the 1990s Partial Liberalization,” UERJ Working Paper, January2005.Glenn Harrison, Thomas Rutherford, David G. Tarr and Angelo Gurgel, “Regional,Multilateral and Unilateral Trade Policies for Growth and Poverty Reduction inBrazil,” published in Brazil as “Políticas de Comércio Regionais, Multilaterais eUnilaterais do MERCOSUL para o Crescimento Econômico e a Redução da Pobrezano Brasil,” Pesquisa e Planejamento Econômico, Vol. 33, No. 1 (Abril 2003), pp. 1-60. Also published as part of World Bank, Brazil – Trade Policies to ImproveEfficiency, Increase Growth and Reduce Poverty, Report No. 24285-BR (Washington:World Bank, 2004).

24Glenn Harrison, Thomas Rutherford and David G. Tarr, “Rules of Thumb for EvaluatingPreferential Trading Arrangements: Evidence from Computable General EquilibriumAssessments,” World Bank Working Paper, 2004.Inter-American Development Bank, Beyond Borders: The New Regionalism in LatinAmerica, Economic and Social Progress in Latin America: 2002 Report (Washington:Inter-American Development Bank, 2002),Jeffrey A. Frankel, Regional Trading Blocs in the World Economic System (Washington:Institute for International Economics, 1997).Josefina Monteagudo and Masakuzu Watanuki, “An Empirical Assessment of North-South and South-South Agreements for Latin America,” IDB Working Paper,November 2003.Josefina Monteagudo and Masakuzu Watanuki, “Impact of Agricultural Reform in theWestern Hemisphere and the European Union on Latin America: Bright Prospects orDistant Illusions?” IDB Working Paper, November 2003.Josefina Monetagudo, Laura Rojas y Masakazu Watanuke, “Impacto de DiferentesEstrategias Hemisféricas en el Comercio de Perú,” Power Point presentation madeSeptember 18-19, 2003.Josefina Monteagudo and Masakuzu Watanuki, “Regional Trade Agreements forMercosur: A Comparison between the FTAA and the FTA with the European Union,”An Empirical Assessment of North-South and South-South Agreements for LatinAmerica,” IDB Working Paper, 2001.Julio J. Nogués, “The Roles for Multilateralism and Regionalism for Latin America,”Universidad di Tella, Working Paper prepared for CEPAL, April 2005.Roberta Piermartini and Robert Weh, “Demystifying Modelling Methods for TradePolicy,” WTO Discussion Papers No. 10 (2005).Gary Pursell, “Study of India-Bangladesh Trade and Trade Policies: Case StudySimulations of Economic Welfare Effects of a Free Trade Agreement,” World Bankworking paper, December 2003, 16 pp.World Bank, Lessons from NAFTA for Latin America and the Caribbean: A Summary ofResearch Findings (Washington: World Bank, 2003).World Bank, Trade Blocs: A World Bank Policy Research Report (New York: OxfordUniversity Press, 2000).

25ANNEXList of AcronymsALCAALALCATPDEACACMCAFTACANCARICOMCBICETCGEECEFTAEUFDIFTAGATTLAFTALAIAMERCOSULMFNMTSNAFTAPTARTASAFTAWTOAssociação de Livre Comércio das AméricasAssociação Latinamericana de Livre ComércioTrade Promotion and Drug Enforcement ActCentral American Common MarketCentral American Free Trade AssociationComunidad AndinaCaribbean CommunityCaribbean Basin InitiativeCommon External TariffComputable General EquilibriumEuropean CommunityEuropean Free Trade AssociationEuropean UnionForeign Direct InvestmentFree Trade AssociationGeneral Agreement on Trade and TariffsLatin American Free Trade AssociationLatin American Integration AssociationMercado Común del SulMost Favored NationMultilateral Trading SystemNorth American Free Trade AssociationReferential Trade AgreementRegional Trade AgreementSouth American Free Trade AssociationWorld Trade Organization

26ANNEXAnnex Table A1: Major Regional Trade Agreements in the Americas,(Acronym and Date of Effectiveness)RTA Members CommentsLatin American Free TradeAssociation (LAFTA, 1961)and Latin AmericanIntegration Association(LAIA, 1981)Central American CommonMarket (CACM, 1961)Caribbean Community(CARICOM, 1973)Andean Community (CAN,1988)MERCOSUL (1991)North American Free TradeAgreement (NAFTA, 1994)Central American Free TradeAgreement (CAFTA, 2006*)Argentina, Bolivia,Brazil, Chile,Colombia, Ecuador,Mexico, Paraguay,Peru, Uruguay, andVenezuelaCosta Rica, ElSalvador,Guatemala,Honduras, andNicaraguaCaribbean islandcountries, exceptCuba, Haiti and theDominicanRepublic, plusBelize, Guyana andSurinamBolivia, Colombia,Ecuador, Peru, andVenezuelaArgentina, Brazil,Paraguay, andUruguayCanada, Mexico andUnited StatesCACM countries,Dominican Republicand United StatesNotes: * pending ratification and implementation. US ratification in 2005.Source: Crawford and Fiorentino (2005) and Frankel (1997).Original intention was to form a commonmarket. Little success in liberalizing tradeamong members because ofprotectionism. LAFTA replaced by LAIAas a organizational format for negotiatingsectoral trade preferences.Original intention was to form a commonmarket, but progress has been very slow.Intrabloc trade barriers still exist, andthere has been little progress inimplementing a common external tariff.An intended earlier FTA (termed Carifta)was formed in 1968. CARICOM wasfounded as a customs union, with acommon external tariff (CET), and withintentions to pursue deeper integration.Little intra-bloc trade.Originally formed as the Andean Pact, asubgroup of LAFTA, in 1969 with theintention to form a common market. Chilewithdrew from the earlier group in 1976.Efforts to implement a common externaltariff (CET) have largely failed.Originally formed with the intention toform a common market, Success inincreasing intrabloc trade 1992-2003. ACET agreed upon but implemented withmany exceptions. Chile refused to accedeto full, rather than associate, membershipbecause of its unwillingness to accept theCET. Recent Argentine imposition ofnontarriff barriers on Brazilian goods hasraised doubts about future prospects.Success in increasing intrabloc trade.Favorable effects on Mexican FDI andgrowth. Positive welfare effects.Supercedes the Caribbean Basin Initiativeand will grant assured and continuedaccess to the US market for the CACMcountries.

27ANNEXAnnex Table A2: Peru: Simulated Sector Output Changes in Response toATPDEA and FTAA Arrangements (changes expressed in %)Sector ATPDEA FTAAAgriculture 3.42 0.64Livestock 1.88 1.13Mining and Metal Products -0.78 -0.65Food Products, including Seafood Products 1.50 0.78Textiles and Apparel 3.95 4.09Light Manufacturing, inc Wood, Paper and Leather Products 1.15 -0.14Petroleum Products, Heavy Manufacturing and Chemicals 0.62 -3.17Services 1.18 0.66Source: Gabriela Cuadra, David Florián y Alan Fairlie, “Escenarios de Integración para el Perú en laEconomia Mundial,” PUCP, Presentación hecha em Power Point en Septiembre 2003.