The Center for Latin American Issues at GW

The United States-Chile Free Trade Agreement:
Challenges and Opportunities

Andrés Bianchi
Ambassador of Chile
The George Washington University
Washington, D.C.
February 21, 2003

In my presentation today, I would like to address three topics. I will first briefly describe Chile’s trade policy and the remarkable economic and social progress we have achieved during the last fifteen years. I will then analyze at somewhat greater length the outcome of the recently concluded negotiations for a free trade agreement between Chile and the United States and the benefits we can derive from it. I will conclude with a few comments on some of the decisions that, in my view, will have to be made in order to turn the potential opportunities offered by the FTA into actual gains.

I. Trade Policy and Economic Progress

1. Chile’s gross domestic product was about 70 billion dollars in 2001. This implies a
per capita income of nearly 4700 dollars at current prices. However, measured at purchasing power parity rates, the World Bank estimates that Chile’s per capita GDP was 9400 dollars in 2001, the second highest in Latin America (after Argentina), slightly above the average of the countries that the Bank classifies as upper middle income economies, equivalent to 50% of the per capita income of Spain, and to one-fourth that of the United States.

2. Chile is a very open economy. Total external trade in goods and services represents 60% of GDP, and exports per capita are the highest in Latin America, except for those of Mexico and Costa Rica. By far, the main export product is copper, of which Chile is also by far the largest producer in the world. Other important exports are fresh fruit, methanol and other chemicals, cellulose and paper, forestry and wood products, salmon and -of course- wine.

3. Moreover, Chile’s trade is geographically very well balanced: total merchandise trade is divided in almost equal shares between Latin America (28%); Asia (25%); Europe (24%) and North America (21%). Individually, the U.S. is Chile’s main trading partner while Asia is its principal and fastest growing export market.

4. Due to its openness and relatively small size, Chile is linked more directly than many other countries to economic developments around the world. However, rather than view this with fear, Chile has embraced it as an opportunity. Indeed, we recognize that globalization represents a fundamental feature of modern development and we are hence prepared to both meet the challenges and take advantage of the opportunities that globalization offers.

5. Chile’s option for economic and financial openness is based on the acceptance of two fundamental facts:

(1) that in a developing economy, persistent and strong economic growth is a necessary –although certainly not a sufficient- condition for raising living standards and attaining social equity, and

(2) that in a small economy, sustained and rapid economic growth requires a vigorous expansion of trade with the rest of the world.

6. Hence, since the mid 1970s, Chile has pursued a policy of unilateral trade opening through the systematic and sustained lowering of import tariffs and the nearly total elimination of non-tariff barriers. As a result of this pioneering program of trade liberalization, our single, uniform import tariff stands as of January 1st of this year at 6%.

7. Along with tariff reduction, in the early 90s Chile began implementing an active trade policy which led to economic complementarity agreements with all the Andean countries by 1995, to associate membership in Mercosur in 1996, and to free-trade agreements with Canada in 1997, Mexico in 1998, and Central America in 2002. Simultaneously, Chile continued to support the liberalization of trade at the World Trade Organization (WTO), became a full member of the Asia Pacific Economic Cooperation Forum (APEC), and has been a proactive participant in the negotiations aimed at establishing a Free-Trade Area of the Americas (FTAA).

8. Moreover, in 2002, Chile successfully concluded negotiations to establish free trade agreements with the European Union in May, South Korea in October, and the United States in December.

9. The results of these policies of ever-closer integration into the world economy have been remarkable. Thus:

(1) Between 1975 and 2001, merchandise exports increased more than eleven-fold and became more diversified both in terms of products and markets. In fact, the number of products exported soared from 200 in 1975 to 3750 in 2001, while the number of exporting companies rose from 500 to over 6000, and the countries in which Chilean products were sold increased from 60 in 1975 to 174 in 2001.

(2) Since the early 1980s, Chile has not suffered a single balance of payments crisis, in stark contrast with the experiences of most of the emerging economies of Latin America and Asia.

(3) International reserves sky-rocketed from less than $2 billion in 1987 to over $15 billion in 2001, and

(4) This increase in international reserves, combined with a sizeable reduction of the public external debt (from $16.4 billion in 1987 to $5.8 billion in 2001) generated a dramatic turnaround in the net external indebtedness of the government, which moved from being a net external debtor of over $14 billion in 1987 to being a net external creditor of $9 billion in 2001.

10. In part because of this sustained and vigorous expansion of foreign trade, Chile grew at an unprecedented pace. Between 1985 and 1998 GDP rose at an average annual rate of over 7%, which allowed per capita income to double in real terms during that period. In fact, in the 1990s Chile was the fourth fastest growing economy in the world, being surpassed only by China, Singapore and Ireland.

11. This strong and persistent economic growth, coupled with well-focused social policies, led to a sharp reduction of poverty - which fell from 45% of the total population in 1987 to 21% in 2000 - and to substantial improvements in health, education and housing conditions.

12. At the same time, inflation declined gradually but persistently from 27% in 1990 to 3% at the present, while, starting in 1987 and for eleven years in a row, the central government’s accounts closed with a surplus.

13. It should be noted, however, that this extraordinary process of economic and social progress has been less intense in recent years. Thus, after suffering a mild recession in 1999 - due primarily to the negative impact of the Asian crisis and the sharp fall in the price of copper (which in real terms fell in 1998-99 to its lowest level since the Great Depression of the 30s) - economic activity increased by 4.4% in 2000, by 2.8% in 2001, and is estimated to have risen 2% last year.

14. These rates - although considerably lower than those of the 1990s - clearly surpassed the average rates of growth recorded during the same years by the industrialized countries as well as by the emerging economies. In fact, confronted with an external scenario characterized by the sharp deterioration of global trading and financial conditions and by political uncertainty and economic crises in several Latin American countries, Chile’s economic growth has continued to exceed that of most countries in the world, while simultaneously monetary and balance of payments equilibria have been maintained and budget shortfalls have been quite small.

15. Chile has therefore maintained its investment-grade rating throughout the recent worldwide economic slowdown and has been able to place sovereign bonds on the international financial market under very favorable terms. Thus, just one month ago Chile launched its biggest bond deal ever, raising one billion dollars, and it is worth noting that the issue was oversubscribed four times and that it was priced at a spread of only 163 basis points over U.S. Treasuries.

16. It is hence in this context of a country clearly committed to an open trade policy, which has successfully internationalized its economy, and which during the last 15 years has reaped substantial economic and social benefits from this process, that one has to analyze the recently concluded negotiations to establish a FTA between Chile and the United States.

II. Towards a Partnership for Development

A. The Agreement

17. Moving towards a free trade agreement between our two countries has been a long-term process whose origin goes back to the early 1990s. But the outcome of this decade-long quest has certainly been positive. In effect, the deal reached in the final round of negotiations in Washington last December represents a comprehensive, well-balanced and state-of-the-art free trade agreement.

18. The pact includes provisions on an unusually wide array of subjects, ranging from the traditional liberalization of merchandise trade and the definition of rules of origin to very novel ones such as electronic commerce and express delivery, copyright and trademark protection for digital products, openness of government procurement, and ground breaking customs procedures.

19. The agreement also includes provisions to protect domestic labor and environmental conditions and establishes fair and transparent mechanisms to enforce them. Through these labor and environment provisions both the United States and Chile want to foster strong institutions and effective legislation, and seek to discourage the abuse of labor and environmental conditions as means to gain unfair competitive advantages. Conversely, they also seek to avoid that these provisions might be used to raise artificial obstacles to fair trade.

20. In merchandise trade, the pact establishes that on the day it enters into force nearly 88% of bilateral trade will become duty-free. After four years, tariffs will be eliminated on 95% of all exports. Restrictions on the remaining 5% will be phased out gradually, with all tariffs and quotas being eliminated in a maximum period of 12 years, after which complete free-trade between the two countries will prevail.

21. The lowering of tariffs will be especially fast for exports of manufactures, 90% of which will gain immediate duty-free access, and almost 100% of them will be totally liberalized after four years. On the other hand, and as was to be expected, the lifting of restrictions will be somewhat slower in the case of farm and agro-industrial products, on about three quarters of which all restrictions will be eliminated when the agreement enters into effect, but around 10% of them, including import-sensitive products, will become duty-free only after 12 years.

B. Benefits

22. Although difficult to quantify precisely, it is clear that the effects of the agreement will be positive for both Chile and the United States. Nevertheless, because of the immense differences in the two countries’ economic, geographic and demographic size and the also wide gaps in their technological and scientific levels, the relative magnitude and especially the nature and scope of these gains will be quite different for the United States and for Chile.

23. In our case the benefits will accrue principally from the growth and diversification of bilateral trade, the wider access to external financing at lower costs, and from larger inflows of foreign investment.

24. Chilean exports will be stimulated, in the first place, by the elimination of tariffs on 95% of the goods presently exported to the United States on the day the agreement enters into force, by the subsequent and gradual phasing out of import duties on the remaining products, and by the complete elimination of tariffs and quotas on all goods after 12 years.

25. But the lowering of tariffs will not be the only mechanism that will contribute to increase exports. In fact, for those products now entering the U.S. market under the Generalized System of Preference (GSP), the biggest advantage will be the shift from the present situation, in which they pay low or no tariffs according to an arrangement that is temporary and that can be unilaterally revoked by U.S. authorities, to a new one in which this preferential access will be the result of stable and permanent rules established bilaterally in the agreement. The greater certainly that this change will entail for the business and investment decisions of the producers of these goods will be a second incentive for the expansion of exports.

26. A third benefit for actual as well as for potential Chilean exporters will come from the gradual de facto reduction and ultimate elimination for Chilean exports of the United States system of differentiated or escalating tariffs, according to which higher duties are placed on goods with a higher value added. This feature of the American tariff system has up to now limited or impeded the possibility of exporting a number of Chilean agro-industrial and manufactured products to the United States. In contrast, once the agreement is in place, the gradual convergence to zero of all American tariffs on Chilean exports will allow that new products be exported to the United States. Hence, at the same time that the volume of our exports will rise their composition will become more diversified.

27. But trade is, of course, a two-way process. And so, as a consequence of the lowering of Chilean tariffs, imports from the United States will also increase. This will benefit all Chilean consumers and most Chilean producers, while it will generate a new competitive challenge for firms engaged in import-competing activities.

28. The welfare of consumers will be enhanced by their access to a broader array of imported goods of better quality and/or lower prices. For the same reason, the majority of producers will gain from being able to buy intermediate imports and capital goods at reduced prices, with the consequent fall in production costs.

29. On the other hand, for producers in import-competing sectors the increased availability at lower costs of consumer, intermediate and capital goods imported from the United States will imply a competitive challenge that they will have to meet by introducing productivity-enhancing innovations.

30. The larger volume of bilateral trade induced by the agreement will also represent a challenge as well as a stimulus for services that support foreign trade. Sectors such as telecommunications, domestic road and rail transport, port infrastructure and operations, airports, shipping and freight transportation will be positively impacted by the rise in demand, but will need to expand and upgrade their installations and improve their operational efficiency.

31. In addition to the gains that Chile will get from the growth and diversification of bilateral trade, the agreement will generate positive financial and foreign investment effects.

32. These will derive to a considerable extent from the fact that, once the FTA is in place, Chile will become a member of a rather exclusive club that so far includes only five members: the United States and the four countries with which it has FTAs: Canada, Mexico, Israel and Jordan.

33. By becoming a member of this club Chile will receive a virtual seal of quality. Moreover, the effects of this new status will be reinforced by the fact that when then the agreement with the United States goes into force, Chile will have had working comprehensive FTAs with Canada and Mexico since the late 90s, with the European Union for a year, and with South Korea for close to six months. From the perspective of international financial markets, this will bring about a further reduction of Chile’s already low credit risk with the consequent fall in the cost of external financing for both the government and Chilean businesses.

34. Finally, the close integration of Chile to the world’s largest markets, together with the framework of stable rules and disciplines included in the FTA, will represent a powerful incentive for investments by American, European and Asian companies, that, taking advantage of Chile’s social, economic and political stability, as well as its rich endowment of natural resources and adequate supply of skilled labor, will be able to use Chile as a platform from which to export to, or do business with, other Latin American countries in which we enjoy preferential access.

III. Opportunities, Challenges and Domestic Efforts

35. In concluding, allow me to touch briefly on the relationships between the opportunities and challenges the FTA creates for us and the efforts we will have to make to transform those opportunities into realities.

36. As you can infer from what I have said, I am convinced that we have negotiated an excellent agreement, an agreement, in fact, that can provide an essential foundation for constructing in Chile a 21st century economy.

37. Indeed, the opportunities the agreement offers are enormous. If we take full advantage of them, along with the opportunities opened by our recently concluded FTAs with the European Union and South Korea, Chile will make great strides in the process of building both a dynamic, stable and competitive economy and a fair society.

38. But all that will require work, hard work. After the agreement is approved and when it enters into force, we will just face potential opportunities and critical challenges. And it will be only by addressing the latter successfully that we will be able to turn those potential opportunities into actual gains.

39. In this context, let me share with you a few brief comments on some - just some
- of the tasks we should carry out to make this possible.

40. We will need, of course, to preserve the invaluable macroeconomic stability that we have achieved through the steadfast implementation of sound and responsible fiscal, monetary, wage and exchange rate policies.

41. We will need, as well, a better educational system. This requires substantially raising the quality of the education provided by our public basic and secondary schools, in which nearly all the children of poor and middle-income families study; it requires to multiply and improve the centers for training and retraining our workers and creating better public-private partnerships to develop top-notched technical schools that meet the real demands of firms; and it also requires to strengthen our schools of engineering, science and management. The 21st century economy - the economy of this FTA - will be a knowledge-based economy. We will therefore need to invest in knowledge and in all forms of human capital.

42. We will also need to continue to invest heavily in our physical infrastructure. Our goods will not be able to benefit from zero-tariffs and zero-quotas if they cannot get speedy, reliable and low cost access to foreign markets. Hence we will need to invest in roads, ports, airports, telecommunication networks, power grids, shipping, and air transportation.

43. But, above all, we will need to approach these and other equally demanding challenges considering them not just as the exclusive responsibility of the political coalition temporarily in control of the government but as truly permanent national tasks that require the full participation, strong support and resolute commitment of all key social, economic, political and civic groups.

44. In summary: Our trade partners have agreed to open their doors; the FTAs we have negotiated provide a framework for renewed economic and social progress. But at the end, it will be up to us, Chileans, through our efforts and our hard work, to seize the new and promising opportunities that have thus been created.

Thank you.