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Trade Reform in Latin America and The Caribbean

Author(s):
International Monetary Fund. External Relations Dept.
Published Date:
January 1993
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WHAT IS the key to successful trade reform in developing countries? The reforms that took place in Latin America and the Caribbean in response to the economic shocks of the early 1980s offer several lessons for implementing trade reform programs that will produce more open, globally oriented trade regimes.

During the 1980s many Latin American and Caribbean countries undertook far-reaching and fundamental trade policy reforms that have resulted in increasingly outward-oriented trade regimes. The reforms were spurred by a number of factors: the debt crisis that began in 1982, the success of outward-oriented regimes in other parts of the world, an international environment that increasingly favored liberal trade policies, and the positive results of domestic macroeconomic stabilization.

While Latin American and Caribbean countries had experienced sporadic macroeconomic crises in the past, those of the 1980s were especially harrowing. The two oil shocks of the 1970s raised import prices at a time when growth was already slow. Later, when interest rates rose, countries that had borrowed heavily to finance high import bills and sustain an investment boom in the public sector found themselves with growing debt burdens. Further borrowing to finance high deficits soon became impossible. Structural adjustment, including extensive trade reforms, was inevitable.

At the same time, the political regimes in many countries that undertook trade reforms were becoming more open to democracy. The economic crises that these countries experienced may in fact have acted as a catalyst for political change and democratization, especially in Argentina, Brazil, Chile, Venezuela, and Uruguay.

The trade reforms

When the trade reforms of the 1980s began in 16 Latin American and Caribbean countries—Argentina, Bolivia, Brazil, Chile, Colombia, Costa Rica, Ecuador, Guatemala, Honduras, Jamaica, Mexico, Paraguay, Peru, Trinidad and Tobago, Uruguay, and Venezuela—most of the countries had numerous trade barriers in place: high tariffs, foreign exchange restrictions, multiple exchange rates, quantitative restrictions on both imports and exports, and export taxes. Many of these barriers had been raised during the early 1980s in an effort to respond to balance of payments crises and had further reinforced, in varying degrees, the inward orientation that characterized these countries’ trade policies for much of the postwar era.

The extent and timing of the reforms differed among the countries, depending in part on their macroeconomic situation and the particular protectionist instruments that characterized their pre-reform trade regimes. Because the only significant trade restriction in place in Chile, for example, was a uniform tariff rate of 35 percent, the trade reforms initiated in 1985 simply reduced this rate. In Peru, on the other hand, trade policy had been characterized by high levels and dispersion of tariffs, extensive nontariff barriers, an overvalued exchange rate, a multiple exchange rate system, fiscal and financial subsidies for exports, export taxes and restrictions, and rampant use of discretion in the conduct of trade policy. Peru’s reforms, which began in 1989, were much more extensive.

Some indicators of trade regimes before and after reform
Country (pre-reform year, post-reform year)Average unweighted legal tariff rates (percent)Tariff range (percent)Coverage of Quantitative Restrictions (QRs) on imports (percent of tariff lines, unless otherwise noted)*Openness of economy (imports + exports as percent of GDP, 1980 prices)
Pre-reformPost-reformPre-reformPost-reformPre-reformPost-reformPre-reformPost-reform
Argentina (1987, 1991)42P1515–115P5–22621A few38.5754.32
Bolivia (1985, 1991)12M8NA5–10NAMinimal57.5183.97
Brazil (1987, 1992)51210–1050–6539Minimal21.1725.27
Chile (1984, 1991)35113511Minimal044.9656.34
Colombia (1984, 1992)61120–2205–2099128.2332.66
Costa Rica (1985, 1990)53P15P0–1400P5–20NA058.6678.97
Ecuador (1989, 1992)37P180–338P2–252100046.7350.84
Guatemala (1985, 1992)50P15P5–905–2061,30331.3135.56
Honduras (1985, 1992)41P15W,P5–905–20NA062.8261.76
Jamaica (1981, 1991)NA20NA0–45NA04105.51163.49
Mexico (1985, 1990)24W13W0–1000–2092120122.6334.31
Paraguay (1988, 1991)NA18NA3–66NAA few51.0163.14
Peru (1988, 1992)NA170–1205–251000430.3741.58
Trinidad & Tobago (1989, 1991)NA41PNA0–103PNAA few5124.09141.21
Uruguay (1987, 1992)321810–5512–240038.0445.10
Venezuela (1989, 1991)37190–1350–504010649.2553.29
Source: World Bank (various reports, staff estimates, and ANDREX).

Even where tariff line coverage is small, domestic production coverage may be significant.

including tariff surcharges;

import-weighted average tariff;

production-weighted average tariff.

Of domestic product.

Ecuador also has a specific tariff of 40 percent on automobiles.

Guatemala has significant QRs for health and safety reasons: pre-reform, they covered 29 percent of domestic manufacturing production.

Some QRs do exist for health and safety reasons.

On agricultural products only.

Another 8 percent of tariff items are restricted because of health reasons: pre-reform, the number was 5 percent.

NA: Not available.
Source: World Bank (various reports, staff estimates, and ANDREX).

Even where tariff line coverage is small, domestic production coverage may be significant.

including tariff surcharges;

import-weighted average tariff;

production-weighted average tariff.

Of domestic product.

Ecuador also has a specific tariff of 40 percent on automobiles.

Guatemala has significant QRs for health and safety reasons: pre-reform, they covered 29 percent of domestic manufacturing production.

Some QRs do exist for health and safety reasons.

On agricultural products only.

Another 8 percent of tariff items are restricted because of health reasons: pre-reform, the number was 5 percent.

NA: Not available.

While many of the reforms were begun at various times during the 1980s, some countries—specifically Argentina, Chile, Colombia, Peru, and Uruguay—had initiated reforms in the 1970s. Some of these were in part reversed in the early 1980s in the wake of the macroeconomic crises. Chile, which was among the first to undertake trade reforms in 1974, had an open and transparent trading system in 1980, with a low uniform tariff rate of only 10 percent and no nontariff barriers. After a brief partial reversal of these reforms in the early 1980s, Chile restarted the process of lowering its import barriers in 1985.

The reforms of the 1980s were aimed at replacing the prevailing inward orientation of the trade regimes with neutral incentives for imports and exports. Reforming import policy involved dismantling the tariff structures and eliminating nontariff barriers such as quantitative restrictions, official reference prices, and foreign exchange allocations. Export policy reform entailed reducing or eliminating price and quantitative barriers to exports and introducing or \improving measures for export promotion and diversification.

The process of trade reform, specifically the reduction of protectionist barriers to imports and the emphasis on export expansion, led these countries to seek General Agreements on Tariffs and Trade (GATT) membership, not only to bind themselves to GATT regulations but also to lock in their own trade reforms. GATT membership reinforced and expanded the reform process by forcing the adoption of GATT-consistent rules on customs valuation, antidumping, and subsidies. The 16 countries have continued to seek more active participation in the multilateral trade negotiations in areas critical to them, such as agriculture and textiles.

The effects of trade reform

The extensive trade reforms in these countries produced some dramatic results. A comparison of certain features of the 16 trade regimes before and after the reforms shows several common developments (see table).

First, nominal protection, as indicated by average tariff rates, was reduced dramatically. The reduction was more substantial in some countries (Brazil, Costa Rica, and Colombia, for example) than in others. In addition, the reforms substantially narrowed the range of tariffs, reducing the variance in protection; most of the current ranges include only a few tariff rates. The Central American countries now have only four legal tariff rates, Jamaica five, and Uruguay just three. Only Chile has a uniform tariff rate, however. While tariffs are down sharply from pre-reform levels, they are still high compared to those of industrial countries.

Second, quantitative import restrictions were also sharply reduced and are now negligible in almost all 16 countries. However, other forms of nontariff barriers remain in some countries. Uruguay still has some significant reference and minimum import prices, and Costa Rica has a prior deposit requirement of 30 percent of the value of imports. Some non-tariff barriers are more sector specific, such as the local-content rules that limit imports of automobile parts in Argentina, Chile, and Colombia.

Finally, the degree of openness, as measured by the sum of real exports and imports as a ratio of GDP, has increased significantly for all the countries. The overall average has climbed from a pre-reform level of 49 percent of GDP to a post-reform (1991) average of 58 percent, reflecting the positive effects of the changes.

The impact of trade reform on imports and exports

Source: World Bank (ANDREX).

Note: Pre-reform years are from 1980 to the start of reforms: reform years are from the start of reforms to 1991.

Real imports

The trade reforms had a marked impact on the average levels and growth rates of imports and exports, but the improved import performance cannot be attributed to liberalization alone. The concurrent economic recovery, which raised incomes and increased foreign borrowing, also stimulated imports.

The average level of real imports was higher during the reform years, increasing from $5.9 billion in the pre-reform period to $6.2 billion in the reform period (chart a). Import levels were also higher for 10 of the 16 individual countries. Costa Rica, Jamaica, and Paraguay saw increases of more than 50 percent, and six other countries enjoyed increases of more than 10 percent. Argentina, Colombia, Guatemala, Peru, Trinidad and Tobago, and Venezuela showed a decline in import levels from the pre-reform period, but all except Venezuela experienced an increase over the year immediately preceding the trade reforms.

The picture is more uniform in terms of import growth rates. The overall average growth rate for these countries increased from -1.1 percent in the pre-reform period to 7.2 percent in the reform years (chart b). The import growth rate increased in every country except Venezuela, which began its trade reforms rather late (in 1989); in 1991, however, the country saw its import growth rate rise by over 50 percent. Six countries had average annual increases of over 10 percent, with Mexico showing the greatest increase (24 percent) followed by Argentina and Chile (15 percent). Other countries—Colombia, Honduras, and Jamaica, for instance—showed more modest increases of around 2 percent.

While real imports have increased significantly, they have not shown the surge many expected, for several reasons. First, the trade reforms were introduced along with stabilization and structural adjustment policies that kept domestic demand low; in fact, many countries experienced negative growth rates during this period. Since domestic demand is a major determinant of import demand, import levels have also remained low. Second, in several instances the trade reforms were preceded or accompanied by major real devaluations that raised the domestic currency price of imports and kept them depressed. Third, foreign borrowing was no longer as readily available as it had been before the debt crisis of 1982.

Real exports

The average level of real exports also increased during the reform years, climbing some 38 percent (chart c). Only Guatemala and Peru had lower average export values, but again the levels were higher in both countries than they had been in the year immediately preceding the reforms. The average increase in real export growth rates during the reform period was 5 percent (chart d). Export growth rates increased in 11 of the 16 countries, with 4 countries showing average annual increases of more than 10 percent. Only Ecuador, Mexico, and Trinidad and Tobago experienced significant declines in their export growth rates, while four other countries had declines of less than 1 percent. (Exports showed strong growth in Trinidad and Tobago in 1990 but then stagnated in 1991, and Ecuador’s export growth rate has picked up since 1989.)

The context of the reforms

The trade reforms were introduced during a period of widespread economic crises for most Latin American and Caribbean countries, which were suffering from large debt overhangs, declining output, balance of payments problems, falling foreign exchange reserves, and high inflation. The intensity of these problems varied across countries. In the year immediately preceding the reforms, the inflation rate stood at over 1,000 percent in Bolivia, for instance, and at about 60 percent in Ecuador. In the five years preceding the reforms, real output had fallen by 12 percent in Bolivia, although it had risen 17 percent in Venezuela. The extent of the economic crisis is evidenced by the fact that, of the 16 countries initiating trade reforms, all suffered from at least three of the five problems mentioned, and three countries from all five.

For these Latin American and Caribbean countries, the fiscal boom of the 1970s inevitably gave way to the austerity of the 1980s. All the trade reforms were either preceded or accompanied by restrictive fiscal and monetary policies, which reduced real expenditures and facilitated the improvements in the balance of payments that enabled the trade reforms to proceed. Tight fiscal policies also ensured that the accompanying real devaluations of exchange rates were noninflationary.

Exchange rate policy

Exchange rate policy also underwent significant changes during the reform period. Many countries needed to unify their multiple exchange rates in order to reduce dispersion in the effective rates of protection and reduce the discretionary element of government action. (Of the eight countries with multiple exchange rates, all but Ecuador unified their rates during the reform period.) In addition, many countries also needed to adopt realistic exchange rates by making appropriate devaluations or floating their currencies.

In fact, the trade reforms were almost always preceded by or associated with significant depreciations of real exchange rates. In eight countries—Bolivia, Chile, Colombia, Ecuador, Guatemala, Paraguay, Uruguay, and Venezuela—the real exchange rate was continuously depreciated throughout the reform period. For six of these countries—Chile, Colombia, Ecuador, Guatemala, Paraguay, and Venezuela—the depreciations dated from before the trade reforms. Eight other countries—Argentina, Brazil, Costa Rica, Honduras, Jamaica, Mexico, Peru, and Trinidad and Tobago—experienced continuous depreciation of their real exchange rates either prior to or for some portion of the reform years. Of these, Argentina, Costa Rica, and Trinidad and Tobago had real depreciations both prior to and at the start of the reforms.

Only in Peru were trade reforms not aided by real depreciation, despite a substantial depreciation of the nominal exchange rate, since inflation stayed ahead of nominal depreciation. Peru’s real exchange rate appreciated during this period due to the country’s expanding unofficial exports, weak import demand, and large capital inflows attracted by the relatively high real interest rates that resulted from tight monetary policy.

The period of reform also saw a movement toward floating exchange rates. Just one country, Uruguay, had floated its exchange rate prior to the reforms, but nine more countries had done so by 1991. Some countries that did not float their exchange rates demonstrated greater flexibility in managing their fixed or crawling exchange rate regimes.

The political economy

The success of the trade reforms introduced in the 1980s was in part the result of the determination and boldness with which the governments initiated and pursued them. In many countries, incoming democratic governments adopted austere economic policies—including trade reforms—despite serious political opposition. Governments were willing to take such risky and unpopular steps in large part because the economic crises had irrevocably discredited past macroeconomic and trade policies. There really was no alternative: drastic reform provided the governments’ only hope for improving the economic environment and ensuring their own political futures. This conjunction of political and national interests facilitated bold action.

However, to restore economic growth, countries first had to resolve their foreign debt problems and gain access to international lending. Here, the IMF and World Bank became important factors, providing the confidence necessary to undertake strong and wide-ranging trade reforms.

A change in the political regimes in all 16 countries also helped to introduce or invigorate the reforms. In 15 countries (the exception was Chile) the trade reforms began under democratically elected governments. It is noteworthy that, with its return to democracy in 1990, Chile continued the restoration of the liberal trade regime that had been partially reversed during the crisis of 1982.

The success of democratic governments in implementing these reforms, which have suffered no major reversals, is significant in that it belies the conventional wisdom that democratic leaders are particularly vulnerable to powerful protectionist groups and therefore less able to sustain reforms.

Lessons of the reforms

Several important lessons can be derived from the experience of the trade reforms in Latin America and the Caribbean during the 1980s.

Trade reforms are successful if they are bold and extensive. Wide-ranging, vigorously implemented reforms send a powerful signal of the direction of government policy and liberate that policy from parochial and vested interests. In these Latin American and Caribbean countries, the boldness of the reforms was accentuated by the extenuating economic circumstances under which the reforms took place.

Successful trade reforms require a supportive macroeconomic environment. Trade reforms in all the countries were initiated and maintained in the context of tight monetary and fiscal policies. (Brazil is an exception, since its crawling exchange rate regime largely insulated the real exchange rate from macroeconomic imbalances.) Such policies are necessary not only to reduce real expenditures and improve the balance of payments, but also to ensure that the accompanying real devaluations are noninflationary. For example, in both Chile and Mexico, prudent fiscal adjustment has been crucial to the success of trade reforms and recent strong growth.

Successful trade reforms are, in general, preceded or accompanied by a depreciation of the real exchange rate. Real devaluations ensure the sustainability of trade reforms by offsetting the excess demand for tradeables that reforms induce. While the real exchange rate is not in itself a policy variable, it can be influenced by nominal devaluations and restrictive macroeconomic policies.

Successful trade reforms can be sustained by democratic governments working against pressure exerted by powerful interest groups. To the extent that the trade reforms in Latin America and the Caribbean were implemented in conjunction with painful economic stabilization measures, they attracted resistance in many countries. And in some cases, moving toward more open trading policies meant challenging the powerful vested interests that had been the primary beneficiaries of protectionist policies.

Challenges of sustainability

While the trade reforms in Latin America and the Caribbean have been successful, sustaining them remains a challenge. The experiences of these countries suggest that the best way to ensure sustainability is to promote and maintain a stable macroeconomic environment through prudent fiscal management, economic deregulation, financial sector reforms, and greater competition. On this count, the prospects are good, and many countries have already achieved success on this front. Some, such as Brazil, still have a long way to go.

Like GATT membership, recent efforts toward regional integration will help consolidate the reforms by providing a binding legal agreement among the countries involved to maintain their more open policies. The outlook for sustainability has improved since many of the countries in the region joined GATT and adopted GATT-consistent rules on antidumping, subsidies, and customs valuation. Successful conclusion of the Uruguay Round of multilateral trade negotiations would also, no doubt, facilitate the sustainability and deepening of the trade reforms. Latin American and Caribbean countries stand to gain tremendously from such an outcome, which would provide increased global market access, reduced agricultural subsidies in the industrial countries, liberalization of the Multi-Fibre Arrangement, and improved rules of behavior. Such transparent, significant, and tangible benefits can only undermine protectionist opposition within these countries and strengthen the voices of reform and openness.

For a detailed analysis see “Trade Policy Reform in Latin America and the Caribbean in the 1980s” by Asad Alam and Sarath Rajapatirana, Policy Research Working Paper 1104, The World Bank, February 1993.

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