CREDIT: <a href="">Colombia Travel</a> (<a href="">CC</a>).
CREDIT: Colombia Travel (CC).

Policy Innovations Digital Magazine (2006-2016): Commentary: U.S. Free Trade Agreement Won't Benefit Colombia

Feb 14, 2012

The now-official U.S.–Colombia Free Trade Agreement (FTA) will dampen growth and make it harder for Colombia to put in place policies for innovation and industrialization. Colombia will also have fewer tools to confront financial instability, thus forcing it to work twice as hard to maximize the benefits of the agreement.

The agreement will bring only small gains to Colombia—and these will come at a significant cost. In terms of growth, the impact will be negligible, given that much of the U.S. market was already open to Colombia. Indeed, the impact may even be slightly negative. The Economic Commission for Latin America and the Caribbean (ECLAC) estimated in a 2007 study that Colombia will suffer losses of up to $75 million, or 0.1 percent of GDP, as a result of the trade agreement. According to the study, competition from U.S. imports will generate losses to Colombia's textiles, apparel, food, and heavy manufacturing industries, outweighing the gains from increased petroleum, mining, and other exports to the United States.

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 United States—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 United States, the Colombian economy has become fairly dependent. Though Colombia already enjoyed significant access to the U.S. market through its preferences program, those preferences were always in jeopardy of being revoked because of its human rights record.

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 United States, 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 United States, 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.

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