Hard Talk

Free trade agreements level the playing field by establishing clear rules of the game that help improve the quality of decision-making for businesses and investors. The FTA will grant permanent preferential access to the U.S. market, establishing mechanisms to address problems related to health and safety measures, nondiscrimination requirements and guarantees for the protection of investments. This will create clear and important incentives for business growth between the two countries.

In contrast, the previous agreement that governed U.S.–Colombia trade relations, the Andean Trade Preferences Act or ATPDEA, only provided preferential access in terms of tariffs. It wasn’t permanent and it did not cover nontariff measures.

The FTA will allow Colombian businesses to achieve parity with companies in other countries that are direct competitors in the U.S. market and that already have an FTA. This is the case with Mexico, Chile, Peru, and Central America and the Dominican Republic (covered under CAFTA-DR).

The delay in approving the FTA in the U.S. undermined business confidence in Colombia and—in the short term, at least—diverted investments to other countries. One Colombian businessman recently remarked that the delay led him to invest in a Central American country and to reduce his activities in Colombia. However, following approval of the FTA, he decided to build a new plant in Colombia, investing more than $100 million and creating more than 200 jobs in a medium-size city.

One of the expected effects of the FTA is an increase in both domestic and foreign investment. The size of Colombia’s domestic market and the diversification of its production structure make the country attractive to invest in to enter the American market.

Models that measure the impact of Colombia’s FTA with the U.S. indicate that there will be positive effects on economic growth, well-being, employment, and tax revenues.

Studies have shown that the fall in revenue from tariffs will be offset by an increase in other tax revenue as a result of higher GDP. Models indicate that GDP growth will increase between 0.5 and 1 percentage points, well-being by more than 1 point, and employment by 300,000 to 500,000 jobs. In the case of finance, one scenario in a study by Patricia Martín and Juan Mauricio Ramírez (“The Economic Impact of a Partial Free-Trade Agreement Between Colombia and the United States”) predicts a $289 million loss in tariff revenue, but a net positive effect on the tax balance sheet of $414 million.

The treaty will bear immediate fruit. In the case of agricultural products, for example, under the ATPDEA, 52.6 percent of Colombian exports had tariff-free access to the U.S. market. The FTA added another 47.3 percent of Colombian exports to the tariff exemption, which practically ensures full access for all Colombian exports from the day the treaty goes into effect.

But domestically, some of Colombia’s agricultural producers still struggle to compete with farmers in the United States. The FTA attempts to address this in several ways. One of them is the elimination of U.S. export subsidies. Another is the gradual elimination of tariffs, granting protection in several cases for more than 10 years, giving Colombian agricultural producers enough time to close the competition gap.
At the same time, under the agreement Colombia obtained tariff-free access for 99.9 percent of industrial exports. There will be immediate tariff exemptions for 81.8 percent of Colombia’s imports from the U.S., and the remaining 18.2 percent will be exempted in stages over the course of five to 10 years. Of the portion with immediate tariff exemptions, about 80 percent corresponds to capital goods and raw materials that are not produced in the country, and 20 percent to goods that already compete in international markets.

This balance will be very important for Colombia in the global business environment in the coming years. The price boom in mining and energy products and the threat of global food shortages present opportunities and risks for the Colombian economy.

The government’s adoption of structural measures (such as those governing fiscal responsibility, fiscal rules and the linkage of savings funds and royalties) to cushion excessive reliance on lucrative primary product exports (such as oil, natural gas and key minerals) will be crucial to the diversification of products in the export basket.

Preferential access to the U.S. market complements this strategy. Eliminating tariffs and preventing discrimination in business will allow different goods—not just raw materials—to continue competing in the market. The reduction of tariffs and the elimination of nontariff barriers will help offset the risk of an appreciating exchange rate that often results from rising commodity exports.

Of course, there are challenges, including developing infrastructure, shrinking the informal business and labor sectors, streamlining customs services, and improving health and phytosanitary standards.

The government, business and academic sectors are working together within the framework of the National System for Competitiveness to close these gaps. But the micro-level changes and gaps remain the responsibility of businesses: to advance technology, improve internal and logistical processes, strengthen human resources, and proactively seek out international markets.

Nor is it clear that the agreement will bring more foreign investment to Colombia. The World Bank’s 2005 Global Economic Prospects report warned that, across the globe, trade and investment agreements themselves do not necessarily translate into new foreign investment. More recent studies have made similar findings for Latin America. Articles in peer-reviewed journals Latin-American Research Review and the Journal of World Investment and Trade found no independent correlation between foreign trade or investment agreements and increases in foreign investment in the region.

In addition, reducing tariffs will strip the government of funds needed for combating guerrillas, fighting crime, developing the economy, and recovering from the financial crisis. According to a study by the Inter-American Development Bank, the tariff revenue losses for Colombia will amount to $520 million annually.

The financial services and investment provisions in the agreement could also prove costly to Colombia. They restrict Colombia’s ability to regulate cross-border flows of speculative finance.

Since 1993, Colombia has deployed innovative policies to smooth capital flows. In what is referred to as an “unremunerated reserve requirement” (URR), Colombia has required that a percentage of all short-term “hot money” inflows be kept as a deposit in local currency, at zero interest, for a certain percentage of the loan and a stated period of time. The goal of the program—which is activated when capital flows start to overheat and deactivated when things cool—is to prevent massive inflows of hot money that can appreciate the exchange rate and threaten the macroeconomic stability of the nation.

Econometric evidence has shown how Colombia’s URR has repeatedly reduced the volume and composition of net capital flows away from short-term capital. Colombia was less hard hit by the economic crises that swept Latin America and east Asia during the 1990s. Nor has it suffered like nearby Mexico under the current crisis. José Uribe, governor of Colombia’s Central Bank, said last year that it was important to have the URR in place in case the country needed to defend itself from unstable capital flows.

The U.S.–Colombia FTA essentially bans instruments like the URR in Colombia. Not only would such an instrument be frowned upon, but a U.S. firm could sue the Colombian government for anticipated losses to U.S. firms stemming from use of the instrument because they could be seen as tantamount to expropriation. Even the International Monetary Fund (IMF) allows for the regulation of cross-border capital flows. According to a recent report, the IMF supported URR-like measures in Chile, Colombia, Slovenia, Thailand, and the Philippines during the 1990s.

The agreement will also make it harder for Colombia to establish public policies that foster innovation, which are necessary to diversify the economy with higher value-added goods. While nations like Brazil and China—which only have commitments under the World Trade Organization and no FTA with the U.S.—are free to require technology sharing and partnerships with foreign firms and to experiment with ways to spur domestic industries, Colombia will  likely find this much more difficult.

If there are so many challenges to the deal, why did Colombia sign it in the first place?

Over time, with 40 percent of its exports destined for the U.S., the Colombian economy has become fairly dependent on the United States. Though Colombia already enjoyed significant access to the U.S. through its preferences program, because of its human rights record, those preferences were always in jeopardy of being revoked.

The good news for Colombia was that the deal would make those preferences permanent. But because there was a set of interest groups—mainly exporters to the U.S., such as those in the food and manufacturing industries—that stood to lose if those preferences were revoked, the gains of the treaty are concentrated in the hands of the few while the losses are more dispersed.

In a situation where there are concentrated winners and dispersed losers, the winners are closer to the policy and therefore perceive it as in their interest to see it through. But the beneficiaries of financial stability are more diffuse, and the beneficiaries of innovation policies and future industry are still small and weak—perhaps not even in existence yet—so they have little or no voice.

Colombia has to make the best of the deal or suffer as Mexico has. Under NAFTA, Mexico has witnessed slow growth, weak domestic investment, anemic job creation, and increased economic vulnerability—decimating many existing sources of livelihood, particularly in agricultural sectors.

Nations like Chile and Singapore have done better under their deals with the U.S.—but only by creating rigorous policies to link trade and investment with domestic growth and development.

Chile has an aggressive innovation program in which the government incubates small firms to maturity. Singapore cuts hard deals at the contract level for technology sharing with foreign firms, and supports small- and medium-size enterprises in the country that may benefit from foreign trade.

Colombia has plenty of work ahead.