The development of the tradable sector has been, and remains, a permanent concern for policy makers in Argentina, Brazil and Chile (A-B-C). Strengthening international competitiveness is key to the region's perennial challenge to generate a net export surplus sufficient to finance debt-service obligations without constraining domestic demand growth. The policy debate on the tradable sector often focuses on the risks of specialisation in primary goods related to their declining share in international trade and price volatility. Until the early 1980s, trade barriers and low income elasticities of primary goods were used as an argument to justify import substitution policies and controls on imports of capital goods. Following trade liberalisation of the late 1980s and 1990s, a more horizontal approach was adopted. The main policy issues evolved towards how to diversify exports and produce more value-added products. In this context, the existing trade barriers in OECD countries are seen as an obstacle preventing these economies from realising their competitive potential. By limiting exports these trade barriers jeopardise sustainable growth. They reduce the capacity to import, in particular investment goods that underpin transformation and long-term growth.
Domestic policies have not always been consistent with the aim of developing the tradable sector. In Argentina, despite the economic drive from market-oriented reforms during the 1990s, the economy was unable to accommodate to the constraints of a fixed exchange rate enshrined in a currency board. Although a Competitiveness Law was passed in 2001, this was insufficient to reinvigorate the economy. In early 2002, Argentina had to abandon the currency board and fell into a severe economic and debt crisis. After defaulting on public debt and a large exchange rate correction, the Argentinean economy started to recover in 2003. In Chile, despite early and far-ranging liberal reforms, the slowdown of investment and growth following the emerging market crises of 1997-98 gave weight to the view that the country's traditional export structure is a handicap as it makes it less resilient to external shocks. Brazil, where structural reforms were undertaken in the early 1990s within a fragile macroeconomic framework, had to abandon its managed peg regime in 1999. Since then, the depreciation of its exchange rate and the successful control of inflation have supported a progressive reorientation of domestic firms towards foreign markets. More recently, the country has considerably increased its trade surplus and diversified exports in terms of markets and products.
The mixed performance of the tradable sector has been evoked as one of the causes of the weak growth performance in South America during the 1990s. Supporting this view is the fact that most of the crisis episodes in South America have been associated with a pronounced imbalance of the contributions to growth of the tradable and the non-tradable sectors. In times of fast growth and acceleration of imports, the domestic tradable sector was unable to keep pace. Ultimately, large trade deficits led to a tightening of macro-economic policies, a fall in domestic demand and a slowdown in economic growth.
Against this background, this study aims at contributing to the understanding of the market mechanisms and interactions supporting the strengthening and diversification of the tradable sector. A top-down approach is followed, starting with the discussion on the impact of exchange rate policies on the relative price of tradables to non-tradables. This has been one of the main channels influencing factor allocation between these two broad sectors. Along these lines, the first chapter relies on an econometric model to disentangle the role of fixed exchange rate regimes relative to other factors in explaining trends in relative prices, such as the traditional Balassa-Samuelson effect, capital inflows, government expenditure and terms-of-trade.
Within the tradable sector there are different types of markets. In those comprising relatively homogeneous products and small firms, labour costs are the main determinant of market performance, although exogenous trade barriers may be an obstacle to the emergence of the most competitive producers in international markets. In contrast, in markets featuring strongly differentiated products and few but large enterprises, the competitiveness of firms depends not only on labour costs, but also requires large investments in research and development (R&D) and marketing. In turn, these investments create endogenous entry barriers (through high sunk costs), which may constrain the ability of new entrants from emerging markets to upgrade towards differentiated products. Along these lines, Chapter 2 develops a taxonomy of market structures. It then discusses how market imperfections, together with policies, influence specialisation and export performance. In this regard, trends in A-B-C are compared with those in three OECD countries (Ireland, Korea and Mexico).
In markets characterised by imperfect competition, trade and international capital flows are actually complementary rather than substitutes. Foreign direct investment (FDI) also provides positive spillovers for the diffusion of knowledge, the adoption of best practices and improvements in the business environment. In particular, in order to penetrate markets with differentiated products, domestic enterprises can benefit from the global production networks of multinationals to overcome market-induced barriers. However, evidence from A-B-C in the 1990s, as discussed in Chapter 3, does not fully exemplify these propositions, notably because FDI to these countries has been mainly directed to upstream industries in the context of massive privatisation programmes.
Among the strongest revealed comparative advantages of A-B-C are agriculture and food products. A discussion of their potential and the constraints to further development is presented in Chapter 4. The chapter shows that the large potential to expand this sector has to be set against the many tariff and non-tariff barriers that limit market access, notably for more value-added agro-food products. Successful product differentiation strategies have helped to partially circumvent these barriers, but their scope could be further developed.
Finally, the development of the tradable sector also depends on the existence and performance of market institutions and policies. In particular, performance of the tradable sector depends on the degree of competition in non-tradable services, which are not exposed to external market discipline. In A-B-C, competition policy is particularly important as market concentration and state enterprises have been dominant features until recently. A review of the relevant literature and case studies in Argentina discussed in the last chapter provide reference arguments as well as insights from experience.
The most important findings of the study can be summarised as follows:
In Argentina and Brazil fixed or quasi-fixed exchange rate regimes contributed in the past to distort the relative price between the tradable and non-tradable sectors and pushed the centre of gravity of the economy away from the tradable sector. The Chilean experience, with a more flexible exchange rate regime, provides a counter example of these effects.
The tradable sector in A-B-C is confronted with pervasive market barriers. For homogenous goods in which South America has its main comparative advantages, exports suffer from tariff peaks and non-tariff barriers existing in OECD countries. For differentiated products, South America faces natural market barriers created by the need to incur high R&D or advertising outlays. While trade policy barriers could be reduced by trade agreements, endogenous market barriers could only be overcome by entering international production networks through joint ventures, sub-contracting and, perhaps most importantly, foreign direct investment (FDI).
All three countries have succeeded in attracting substantial amounts of FDI, but for the time being foreign investments have mainly targeted primary sectors in which these countries already have competitive advantages, and to specific segments of the non-tradable sector (mainly infrastructure and banking). In the light of these observations, FDI does not appear to have directly contributed to the diversification of the tradable sector in A-B-C. Except for some positive developments in niche markets such as the car industry, more efforts could be made to attract investment in sectors producing differentiated goods. In contrast to A-B-C, FDI contributed to a radical change in the structure of specialisation in Mexico. This case is unique in the region, but it may also be fragile in the light of a strong dependence on the US market and rather low levels of domestic R&D. Thus, Mexico could remain very sensitive to pure price competition.
Agricultural and food products are the largest contributor to exports in A-B-C and continue to have a strong potential for expansion. First of all, in Argentina and Brazil there is still a large amount of permanent pasture that can be converted into arable cropland. A B C also have room to increase labour and land productivity, and exports of processed food products. In this regard, Chile has succeeded somewhat in developing differentiated products out of primary clusters, the wine industry being a notable, but not unique, example. To increase production and exports of food products, A B C must lower the costs of logistics, improve access to credit, and have a better co-ordination of the different actors in the food chain. The increasingly concentrated structure in the food industry worldwide suggests that FDI may play a critical role to foster the development of this important segment of the tradable sector.
Promoting competition is not only relevant to tradables, but also, and even more so, to non-tradable sectors sheltered from international competition. A non-tradable sector sitting on high rents distorts the allocation of resources at the expense of the tradable sector. Competition policy in A-B-C has evolved from the enforcement of competition on the basis of private claims, to competition advocacy and its contribution to the design of regulatory reforms. However, A-B-C still need to strengthen their competition policies and regulatory frameworks, particularly in infrastructure. Notably, additional private investment in electricity is needed in all three countries but can only materialise if the regulatory environment is perceived by investors as sufficiently attractive and legally stable.
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