Integrated Automobiles for Latin America?

This article attempts to evaluate the obstacles that stand in the way of economic integration of the automobile industry under the Montevideo Treaty governing the Latin American Free Trade Association.


This article attempts to evaluate the obstacles that stand in the way of economic integration of the automobile industry under the Montevideo Treaty governing the Latin American Free Trade Association.

Jack Baranson

SEEN AGAINST the potential advantages of common market arrangements, the obstacles to the integration of particular industries are often underestimated. Arguments for integration frequently stress that an enlarged internal market will produce a further expansion of industrial investments. This was the basic intent of the Latin American Free Trade Association (LAFTA), but in the automotive industry, at least, industrialization programs, operating under systems of national protection, already have expanded the production facilities of the LAFTA region to more than tenfold what would be economically justifiable. And each year new countries enter the industry, adding to an already overdeveloped regional capability. The unhappy reality in the automotive field is that, far from creating market opportunities, the LAFTA Agreement confronts member countries with the problem of disposing of excess plant facilities. This fact alone provides a major reason why so little progress has been made thus far in reducing internal trade barriers in the LAFTA region.

Background of LAFTA

The Treaty of Montevideo, signed in February 1960, provided for the creation of a Latin American Free Trade Association in no more than 12 years. The subsequent Declaration of Punta del Este of April 1967 further committed all Latin American countries, with U.S. support, to the creation of a common market. The assumption behind both these commitments was that a regional market would increase investment opportunities for member countries and improve efficiency of production as industrial plants came to serve regional rather than national demand. This was also, of course, the basic idea behind the European Common Market. But whereas European governments were committed to an automatic reduction of trade barriers and an intensification of competition among rival producers, this has not been possible under LAFTA. Existing national industries and associated vested interests have resisted the reduction of internal trade barriers which would eliminate industrial facilities no longer needed to serve regional demands. The reasons generally cited for failure to achieve progress of any substance under LAFTA are the disparities in national income and stages of industrial development among LAFTA members. But these obstacles to economic integration are overshadowed by the much more formidable impediment of overdeveloped national industries that have now been established in the more industrialized LAFTA countries.

Under the LAFTA Agreement, signed in 1961, internal tariffs and related restrictions were to be eliminated on “substantially” all products by 1973. Two mechanisms were created for the progressive liberalization of trade (known as “national list” and “general list” negotiations). One mechanism provides for the negotiation of bilateral concessions aimed at reducing average national tariffs by 8 per cent a year, concessions to be extended eventually to all LAFTA members. Under the second mechanism, every three years members agree to grant tariff concessions on a list of products representing one fourth of intra-LAFTA trade during the previous three-year period (to be applied cumulatively after 1973). Progress thus far in implementing LAFTA arrangements has been disappointing, and increasingly emphasis has shifted from trade liberalization to supplementary activity aimed at industrial complementarity.

National vested interests in Latin America have opposed trade liberalization; it is generally true in most fields of commerce that there are many willing sellers, but few willing buyers. If regional integration were to proceed, marginal producers would be eliminated. In the automotive industry during the seven-year period 1961-68, not a single automotive item has been added to the national list for tariff concessions. Rivalry also exists within each country between vehicle assemblers and parts manufacturers; a basic difficulty is that losses and gains cannot be traded off between countries and firms.



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Sources: 1963 and 1967 data furnished by U.S. manufacturers: 1957 data from Automobile Manufacturers Association, World Motor Vehicle Data—1966.

Production figures represent passenger cars and light trucks and buses.

Virtually none.

Based upon estimates of national content, which averaged about 30 per cent in 1957 and about 70 per cent in 1967.

Other formidable obstacles stand in the way of integrated trade and production. One is the fluctuation in price and foreign exchange rates in Argentina, Brazil, Chile, and other countries, producing disparities which can more than offset any lowering of tariffs among trading partners. Another is that domestic industries, built up under national programs of protection and import substitution, have left in their wake powerful commercial and political interests that are now difficult to eliminate. These vested interests, in turn, contribute to national sentiment opposed to foreign ownership, despite the fact that international corporations could play a most helpful role in rationalizing production and marketing in the LAFTA region.

Automotive Industry Under LAFTA

In the decade between 1957-67, the assembly of cars and trucks in LAFTA countries has increased at least sevenfold—at an average annual rate of 22 per cent. During this period, domestically produced vehicles almost completely replaced imports, and government decrees forced manufacturers to increase the domestic content of locally assembled vehicles—to about 90 per cent in Brazil and Argentina and to near 60 per cent in Mexico. Measured in terms of domestic value added, or per cent national content,1 this expansion of national industries is even more phenomenal—near 33 per cent average annual growth rate. It is only in recent years (1963-67) that the growth rate has leveled off to about 11 per cent per annum.

The manufacture of automotive products in developing economies poses a basic problem of scale. Even the largest and industrially most advanced of developing economies have experienced rising costs as they have displaced imported goods with local manufacturers. The rationale behind regional arrangements is to improve the use of resources and expand production opportunities by enlarging the size of the market. This, it is hoped, will lead to substantial increases in production efficiency, followed by subsequent cost reductions and a second round of expanded demand in response to price reductions.

Economies of scale are certainly much needed in Latin America. In the LAFTA countries, production has been fragmented among eight countries, with Brazil, Argentina, and Mexico accounting for 82 per cent of the total. The remaining 18 per cent has been spread among five other countries including Uruguay, where 1,000 vehicles a year are now being assembled. The total demand in the LAFTA group of countries ran to just over 650,000 vehicles in 1967, less than 3 per cent of world production. At the end of 1967, there were over 67 firms in the LAFTA region producing at least 200 basic models of cars and trucks, and over 10,000 component and parts manufacturers. These facilities, as has been mentioned, are already about ten times more than the region can support economically. Market demand in the largest country was just over 225,000 vehicles in 1967, but there were 10 firms manufacturing no less than 40 different models and makes. Chile is a classic case of fragmentation—about 16,000 vehicles were manufactured by some 19 firms.

Such fragmentation is particularly unfortunate in the automobile industry, since from the standpoint of production efficiency, vehicle and parts manufacture are highly sensitive to economies of scale. It is especially important, in markets of limited size, that the number of models and makes, along with the associated proliferation of components and parts, be held to a minimum. The scale factor is particularly critical in the manufacture of components and parts. But national systems of protection and import substitution in Latin America contribute to the opposite effect—the proliferation of models and makes and the diseconomies of short production runs.

Manufacturing Costs

As a consequence of the high degree of fragmentation of production facilities, manufacturing costs in Latin America are high by world standards. In Mexico, with only 63 per cent national content (including assembly), a light truck costs 58 per cent more than the imported equivalent. Locally manufactured parts cost, on the average, 119 per cent more than imports. The same light truck in Brazil, at 99 per cent domestic content, costs 80 per cent more than an imported truck. In Argentina, with 83 per cent domestic content, the same vehicle ran 145 per cent above import costs, while vehicle components averaged 210 per cent higher.



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Source: Jack Baranson, Automotive Industries in Developing Countries (World Bank Report EC-162), May 29, 1968, pp. 29-31.

U.S. cost represents an average for comparable Latin American vehicle. Latin American costs converted to U.S. dollars at official exchange rate, January 1967.

Figures do not include import content in domestically procured items. See also first footnote in this article.

Differences reflect in part overvalued exchange rates and tariff duties on imported content.

Developments Under LAFTA

In the seven-year period since 1961, no progress has been made in placing automotive products on the national or common lists for tariff reductions. The two developments that have occurred which affect the automotive field are complementarity agreements and the movement toward subregionalism. Under complementarity agreements, two countries agree to exchange certain components or specialize in particular classes of product. These plans are then formalized in intergovernmental agreements, permitting parts manufactured in one country to qualify as national content in another. A few such complementarity agreements have been negotiated since late 1965 between Argentina, Chile, and Mexico. These bilateral arrangements, however, have been very limited in nature and—contrary to the basic intention of the LAFTA Agreement—have actually increased production costs.

Two-way trading between Argentina and Chile has been extremely difficult for several reasons. Argentina has agreed to allow only a limited interchange of components (up to 6 per cent by Argentine vehicle value and not more than 30 per cent of any one local item). Chile insists upon the development of parts that “contribute to the country’s technological improvement.”

The value of trade must also be equalized in the long run. The difficulty has been that whereas Argentina is able to export a few high-value items (such as engines, transmissions, and rear-axle assemblies), Chile is only able to export a large number of low-value items (such as air cleaners, wire harnesses, hub caps, and various forgings and castings). It has been especially difficult to find items in Chile that come near Argentine quality and price.

Negotiations on lowering trade barriers between Argentina and Brazil began in November 1967, but Argentine manufacturers are fearful of the more efficient Brazilian parts manufacturers—an efficiency in terms of cost which is probably attributable to differences in the tariff and exchange structure, rather than to any significant differences in technical capabilities or market opportunities. However, new steps are being taken that give rise to new hopes. In place of the 6 per cent limit imposed on Argentine trade with Chile, it is proposed to initiate interchange at the 15 per cent level and move to 30 per cent within five years. Large firms in competitive positions have strong incentives to liberalize trade between the two countries because of mounting investment costs. Production facilities are especially costly for the manufacture beyond 40 per cent vehicle content, which involves engine and transmission, and sheet metal body work.

In May 1967, a proposal was made to form a sub-regional Andean group consisting of Bolivia, Chile, Colombia, Ecuador, Peru, and Venezuela. Under the proposed arrangements, there would be a duty-free trade in components and parts. Venezuela has delayed in signing the proposed agreement. But the fact is that the Andean market (about 100,000 vehicles) is half the size of Argentine demand. The subregional market is preferable to six more national industries, but integration into the larger LAFTA market would be even more advantageous in terms of over-all economic efficiency.

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Prospects for Improving Production

The LAFTA market for vehicles may be expected to double by 1975, providing a market for about 1,125,000 vehicles. Under U.S. conditions, production costs are minimized at approximately 240,000 units a year of a single basic vehicle type, which would mean no more than five major manufacturing complexes throughout the LAFTA region. But in fact average runs are somewhere around 10,000 and, as we have seen, costs are already well above import costs. It is evident that economic rationalization of automotive production will entail a reversal of the trend toward further atomization of production facilities and proliferation of models, makes, and vehicle components. By competitive production standards, a considerable portion of established plant and equipment will have to be converted to more efficient scales and specializations.

Production efficiency could be improved considerably by concentrating production in specialized plants located in different member countries, which would then serve the entire market—rather than, for example, establishing engine plants in several countries. An equitable arrangement might be to allow firms operating under national content regulations to assign manufacuring specializations proportional to the purchasing power for automotive products by each of the LAFTA country members. National content regulations should be broadened to a concept of “LAFTA” content. This arrangement would lead to a reasonable balance between minimized production costs and equitable shares in the regional division of labor.

Another alternative is to develop what might be termed an “outward oriented” regionalism which not only serves the inward-oriented LAFTA market but also develops manufacturing specializations for the international market. The U.S.-Canadian Automotive Agreement provides a model for such an arrangement. Under that Agreement, signed in early 1965, Canadian facilities for the production of automotive parts were expanded considerably for export to U.S. assembly plants, the basic aim of the Canadian Government being to reduce the balance of payments deficit and to obtain for Canada a fair share of the value added and employment based upon Canadian purchasing power. Similar arrangements were recently negotiated between Fiat of Italy and its manufacturing affiliate in Yugoslavia. It is quite possible that if foreign enterprise were given wider latitude to reorganize production facilities in the LAFTA region, it would then be possible to establish manufacturing interchange along the lines of these agreements.

Mexico appears to be in the vanguard in moving toward a more efficient cost structure. Two years ago, it negotiated an agreement with Massey-Ferguson, the leading world manufacturer of farm tractors, providing for investment in Mexican plant facilities, which included the manufacture of tractor parts for export to other Massey-Ferguson assembly plants. The interchange of parts, in lieu of excessive domestic content, keeps average production costs down. Similar agreements are now being negotiated with European automotive vehicle manufacturers. Proposed arrangements provide for assembly and some local parts content for vehicles sold in the U.S. market, in return for privileged access to the Mexican and LAFTA markets.

In spite of the difficulties, a promising future can be seen for an integrated LAFTA automotive industry if certain vital steps are taken. Specialized production for global marketing and manufacturing systems can help establish acceptance of LAFTA goods in world markets and thereby give a much needed impetus to LAFTA arrangements. Export orientation should also help reverse the trend toward a widening technological gap which has characterized industrialization under import substitution.

This article is based on a paper presented at the Conference on the Economic Integration of Latin America sponsored by the California Institute of International Studies in Palo Alto, California, from May 9-11, 1968.


National or domestic content refers to the percentage of vehicle components (by value or weight, depending upon the government regulation) manufactured and assembled locally, the remainder being imported content.