This report describes how entrance into the Free Trade of Americas Agreement could change the economic structure in Andean Community countries. The tool for the analysis is a global Computable General Equilibrium (CGE) model of trade and production. We find that Andean Community members should not expect large welfare gains from trade in goods under the FTAA. The central cause is that the FTAA agreement dilutes the benefits of the Andean Trade Preference Act (ATPA) by allowing all Latin countries equal access to US markets. This creates trade-diversion and causes CAN exports to the US to fall.

The overall effect is small, but the individual sectoral impacts can be important. Some industries expand substantially, while others shrink. Those sectors poised to expand are fruits, vegetables, oil seeds, labor-intensive sectors such as textiles, and primary resource sectors like minerals and energy. Sectors expected to decline are grains and cereals, light (exportable) manufactures, and tradeable agro-chemical products.

Several large benefits from the FTAA are not considered in this study which could supersede any losses from trade diversion. The benefits from service liberalization and knowledge transfer, such as product variety, service liberalization, and foreign direct investment, are likely to be more important to economic growth and welfare than traditional gains from trade in goods. Recent experience for developing countries has shown that most of the gains come from increased productivity rather than increased net-exports.

This approach uses an economic optimization model and a detailed global trade dataset to conduct “counterfactual analysis.” Different scenarios are considered in order to identify which trade effects are likely to be the most important. Some important characteristics of this approach are:

The main reason for the small (negative) impact is that most CAN countries already enjoy free access to markets with their two largest trading partners, the US and other CAN countries. The US grants zero import tariff rates for several goods to Colombia, Equador, Bolivia, and Peru under the Andean Trade Preference Act (ATPA)².

CAN member countries also have a free-trade zone within the Andean Community. In this regard, a move from the current state of the world, where CAN members enjoy preferential access to key markets, into a new free-trade area where all countries have equal access, will certainly lower exports and production for several CAN exporters and producers. Trade will be diverted from some producers in the Andean Community by other Latin producers (e.g., Brazil, Central America, and Chile) who will now receive full access to US markets. Some consumers and producers will benefit from FTAA because tariff elimination lowers prices in the home country and eliminates price distortions for imported goods, other producers face increased competition from foreign countries. The net effect is a small loss of welfare for most Andean Countries.

This section introduces some of the key considerations for CAN member countries who are considering accession to the FTAA. Each consideration is entered as a bullet point:

Tariff revenues Loss of tariff revenues will require a major tax-shift. Revenues in the United States account for 1% to total reciepts, while in the Andean Community, they account for 6-12%. In dollars, CAN members stand to lose between $400 million (in Equador/Bolivia) to $1,700 million (in Venezuela) when import tariffs are eliminated. A separate tax-policy study for Colombia estimates that if import tariffs were completely eliminated, then value-added taxes (VAT) would need to increase between 2 - 3% above current levels in order to recover lost tariff revenues.

Exchange Rate Effects Holding all else constant, an increase in demand for foreign goods pushes the value of the domestic currency downward. Tariff elimination in the Andean Community will push the value of local currency downward. The weaker Bolivar, New Sol, or Peso increase the value of commodity exports (when calculated in the home-currency). These exchange rate forces are large, but because tariff elimination occurs over a long period of time, the effects are unlikely to be highly visible.

Bilateral Agreements Whether Andean Community members negotiate bilaterally or as a group will be motivated by both economic and political considerations. Our framework is not appropriate to consider the political ramifications of bilateral agreements between CAN member countries and the US. However, we can consider the economic impact upon the CAN of a bilateral agreement between one CAN member (e.g., Colombia) upon other CAN members.

Increased Productivity The largest potential gains to the Andean Community will arise from increased productivity. Foreign Direct Investment (FDI) by multinational corporations typically increases domestic competition, provides training to local professionals, and improves industrial efficiency. The extent of these gains will depend upon how far the services sector is liberalized under the FTAA. Further research to quantify of the productivity effect for the Andean Community is recommended.

Agriculture It is not surprising to see that those who oppose trade most are major producers of agricultural products. Using a detailed agricultural disaggregation, we find that domestic production of cereals, grains, and rice - those goods which are produced cheaply by the United States - will fall. However, on average, we find that agricultural production will remain an important production sector. General agriculture will fall approximately 2-3%, oil seed production falls 2%, and grains and cereals fall by about 8%. Exports of agricultural goods where Andean countries have a comparative advantage will increase (flowers in Colombia, fruits in Equador, Fishmeal in Peru), and imports of agricultural goods where the US, Canada, or Brazil are efficient (grains and wheat) will increase.