Presentation at the Center of International and Strategic Studies

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(1)Presentation. by. Roberto. Frenkel. at. the. Center. 1. for. International and Strategic Studies. Washington D.C. September 25, 1997. 1.The Alianza's economic diagnosis. The Alianza's critical diagnosis of the Argentine economic situation can be synthesized in three characteristics: the fragility of the growth process, the high rate of unemployment and the trend towards an increasing inequality in income distribution. These three characteristics are interrelated and constitute the most negative profile current orientation.. of. the. economic. policy’s. The fragility of the external sector implies the difficulty of sustaining high rates of growth without increasing the risk of an external crisis like the one the country experienced in 1995. This is in itself a negative characteristic because it compels the economy to evolve on a relatively low medium- and long-term growth path. Additionally, it impairs the job creation capacity of the economy. Behind the fragility of the external sector lies the low average international competitiveness of domestic economic activities. Competitiveness did not improve in spite of the strong sectoral productivity gains observed since 1991. During the same period, the change in relative prices neutralized the effects of rising productivity. on. the. international. competitiveness. of.

(2) 2. most domestic activities. This “trade opening cum exchange rate appreciation” process did not count with public policies oriented to facilitating the transition and modernization of small- and medium-size firms. Without the countervailing effects that such policies could have introduced, both the effects of the relative price change and the segmentation of the financial system generated the destruction of jobs and domestic activities. A great proportion of the employment contraction originated in the reduction of employment in the manufacturing sector, composed of the reduction of employment in large firms and the bankruptcy of many small-and medium-size firms. At present, the set of relative prices and the functioning of the highly concentrated financial system are inhibiting production and job creation in many activities that could be exporting or substituting imports. The third characteristic is mainly a consequence of the first two. High unemployment in itself and the downward pressure it exerts on wages determine a persistent trend towards growing inequality. Some economists perceive this trend as the main device for solving the problems of low competitiveness, external fragility and high unemployment. This belief is probably the underpinnings of the present economic authorities’ orientation. From an analytical point of view, it could be said that the international development record shows no successful case of that kind. Even if it were viable, it would be a long and painful experience. From a more normative perspective, the Alianza reacts against the.

(3) 3. unfairness and inefficiency of the current trends and pursues a simultaneous reversion of the three negative trends of the economic setting. We do not believe that the solution can be found in just a few macroeconomic measures. Rather, it lies in the intensive workings of an honest administration firmly committed to two targets. On the one hand, it is essential to strengthen a set of small- and medium-size firms who can create jobs by producing high quality goods and services at internationally competitive prices. On the other hand, it is also crucial to deal with the needs of those excluded from economic activity and work for their efficient re-absorption. The main instrument for the first target should be a set of public policies which would enhance production capacity and job creation by helping those firms to coordinate their activities, finance their investments and improve their technological abilities. 2. Regional integration We trends. believe that current economic and political are indicative of a continental economic. integration in the long term. Incentives and pressures in this direction come not only from the trade trends but also from the increasing role of multinational firms and the growing international diversification of portfolios. This long-term view is shared by most of the relevant political forces. The trade policies exerted by the countries at the national or regional integration.

(4) 4. levels are not seen as permanent but as necessary steps for an even more open setting in that long term.. With regard to the effects of the deepening financial integration on the development of trade integration, it should be stressed that trends similar to those experienced in the nineties - trade opening and rising financial flows- had already been observed in the seventies and early eighties. At that time, the financial flows were abruptly interrupted by the debt crises. The crises induced strong falls in imports and the partial reversion of trade opening. The rise in tariffs and the renewal of trade restrictions were mainly the consequence of the lack of external financing. It is apparent. that. the. nineties. Latin. American. financial integration process was not free from crisis and there is no guarantee that similar situations will not arise in the future. Yet, recent episodes in Mexico and Argentina had different resolutions and consequences than those in the early eighties. In the recent cases there was an adequate reaction from the US administration and the multilateral financial agencies. Contagion effects were observed, although they were limited and relatively brief. Both factors contributed to overcoming the crises and avoiding the consequences observed in the eighties. An important lesson can be drawn from these experiences. It seems clear that the persistence of the present trade and integration trends depends on the avoidance. of. the. financial. rationing. conditions. that.

(5) 5. characterized the eighties. Efforts should be made to assure that in the case of a new crisis, it will find a resolution like those of Mexico’s and Argentina’s recent episodes. Trade integration and international financial stabilization issues are discussed in the international setting at separate and distant forums. It is apparent that both are intimately related and should be treated together. In the short run, the Alianza shares the view that MERCOSUR is Argentina’s trade integration priority. Priority must be given to the completion of trade liberalization and the deepening of the agreement in order to reach higher levels of coordination in broad areas of national economic policies. This naturally includes trade negotiations with the rest of the world. MERCOSUR has faced some criticisms signaling the inefficiency of the integration process. These opinions are unfounded. The process has been beneficial both to the partner countries and to the rest of the world. Since the Asunción Treaty was signed in 1991 trade flows have risen swiftly. While total exports of Mercosur member countries augmented by 63% between 1991 and 1996, intra-Mercosur trade tripled. Intra-Mercosur trade represented 11% of total exports in 1990 and jumped to 21% in 1996. Between those years Argentine exports to Brazil and Brazilian exports to Argentina incremented by approximately 350%. By the way, let us underline that this symmetry must be qualified by the different size of the countries’ external trade : Argentine exports to Brazil in 1996 represented 28% of.

(6) 6. total sales abroad, while Brazilian exports to Argentina in the same year represented 11% of total. exports. Besides the strong increment in the volume of trade there are other characteristics that indicate the deepening of the integration process, such as the prevalence of manufactured goods proportion of intra-industrial trade.. and. the. high. It has to be stressed that the above-mentioned trade trends should not be attributed exclusively to the integration agreement. They can also be explained by the significant reforms and macroeconomic changes experienced individually by the Brazilian and Argentine economies, in parallel with the advance of the agreement. In the. first. place,. in. both. economies. external. trade was unilaterally liberalized and opened in the nineties. Between the late eighties and 1994 the average of tariffs was halved, reaching in 1994 14.3% in Argentina and 13.2% in Brazil. So, the schedule increasing preferences that ruled Mercosur trade between 1991 and 1994 operated on declining tariffs. In the second place, stabilization programs have been implemented in Argentina since 1991 and in Brazil since 1994. In both cases the programs caused exchange rate appreciation and a strong expansion in domestic demand. In both cases there was a substantial increment in imports from all origins, which included the imports from Mercosur partners. Between 1991 and 1996 Argentine and Brazilian total imports augmented by 187% and 153%, respectively.. Taking. these. data. into. account,. the.

(7) 7. relative importance of the integration process can be better assessed by looking at the changes in the ratios. of imports originating in the agreement partners. In the Argentine case, imports from Brazil passed from 15.2% of total imports in 1991 to 22.4% in 1996. In the Brazilian case, the proportion of Argentine products in total imports passed from 7.6% in 1991 to 12.2% in 1996. Another factor should be added to the incentives induced by the integration agreement and the effects of the reforms and macroeconomic changes. Geography matters and so proximity advantages should also be considered a factor explaining the trade increment between neighboring countries within a context of rapid expansion in external trade. There is an alternative approach to help discriminate between the relative weight of macroeconomic effects, on the one hand, and the relative weight attributable to unilateral trade opening, trade agreement and proximity on the other. An equation was estimated in each of the countries, explaining the increment in imports from the partner by local macroeconomic variables (exchange rate and domestic demand expansion) and another variable capturing the other effects. In both Argentina and Brazil the variable capturing the other effects is highly significant, indicating the relevance of those effects. Macroeconomic variables are also significant. In the case of Argentine imports from Brazil, Argentine macroeconomic variables explain 55% of the 1990-1995.

(8) 8. increment. Argentina,. In the case of Brazilian imports from Brazilian macroeconomic variables explain. 37% of the 1990-95 rise. The importance of macroeconomic factors in the expansion of intra-Mercosur trade indirectly stresses the role resources. the fluid played in. availability of the integration. international process. The. incremental trend of intra-Mercosur trade formed part of the generalized expansion of imports induced by the jump in domestic demand, the exchange rate appreciation and the trade liberalization and opening. Taking into account the growing trade and current account deficits, it seems apparent that the availability of external financing process.. was. a. crucial. factor. in. the. integration. By expanding their markets, the regional integration process generates beneficial effects on the activities in each of the member countries. The increasing proportion of intra-industrial trade also suggests that economies of scale and efficiency gains from specialization are being advantageously exploited. Besides, the significant expansion in imports from the rest of the world also implies beneficial effects on activities in the exporter countries. How can the persistence and sustainability of those trends be assessed? Necessary conditions for the persistence and sustainability of the trends can be traced both in the local and international contexts. At. the. international. level,. it. is. important. to.

(9) 9. stress once again that the persistence of the conditions of fluid access to the international financial markets seems to be a necessary condition for the regional and continental integration process. At the local level, it should be mentioned that as a consequence of the effects of the stabilization policies, the two largest countries and the Mercosur block, taken as an economic unity, confront a trade-off between growth and external sustainability. Current account deficits tend to rise dangerously when expansion accelerates. The present performance of exports seems to be incapable of sustaining the accelerated increment in imports associated with relatively high rates of growth. This constrains growth and trade expansion. In fact, the economic policies are betting on the productivity rise to overcome the tradeoff in the medium term and on the capital inflows increment to sustain the process in the meantime. To back the first bet, active economic policies should be implemented in each country in order to reduce growth fragility by enhancing competitiveness. To preserve the symmetry of incentives, the continuity of the agreement would necessarily require the coordination of those policies. With regard to the second bet, it is essential to avoid negative or contagion effects on the neighbors caused by unilateral measures or financial perturbation in either Brazil or Argentina. Events of this kind could jeopardize the entire integration process. For this. reason,. the. coordination. at. the. macroeconomic.

(10) level also seems to be a necessary condition. In conclusion, incentives and difficulties. 10. which. the countries are confronting points to the Mercosur agreement deepening in coordinating broad aspects of national economic policies. Each country is deeply interested in the financial stability of the partners and also in their ability to sustain high rates of growth and imports. Taking into account both the present difficulties and incentives, the Mercosur agreement stands as the best context within which today’s problems can be tackled - minimizing the costs and maximizing the probability of successfully correcting the distortions..