Small States and The Free Trade Area of the Americas(FTAA)

Trevor Harker

Regional Economic Advisor
United Nations Economic Commission
for Latin America and the Caribbean (UNECLAC)

Presented to the Colloquium on "Diplomacy after 2000: Small states and negotiating space in the new international trading environment" convened by the Institute of International Relations at the Kapok Hotel, Port of Spain, Trinidad from 8-9 October 1996. The views expressed are those of the presenter and not necessarily of the United Nations.

Contents
Introduction
Small States and FTAA
Free Trade Area of the Americas
Small Size and Free Trade Agreements
The Situation in Small Countries
Special Considerations for Small Economies
Conclusion

Introduction
I wish to thank the Institute, once again for the opportunity to share ideas with you in this colloquium. I believe that any initiative designed to improve our capacity to function in the global economy is timely. This includes the capacity to increase our negotiating space. Nevertheless, I think it is crucial that our negotiating stance should be predicated on a clear understanding of our potentials and limitations, as well as those prevailing in the international environment. It must have clearly in the forefront an understanding of the relationship between trade and small size, as well as the actions which need to be taken to make us effective in wider unprotected markets. I hope that my comments will contribute in some small way to the discussion of both issues.

The topic which I have been assigned, "Small states and the FTAA" is quite broad. It is delimited somewhat by the fact that Ambassador Bernal has been asked to discuss the structure and process of the FTAA negotiations and to comment on the adequacy of our preparations for them. My comments will, therefore, focus on the conclusions of two studies which we have carried out recently, as inputs to the working group on small states¹. If time permits, I would also like to make some comments on the relationship between the domestic change process and our negotiating positions.

Small States and FTAA
Small states, by virtue of their smallness, must depend on international trade to a greater extent than large states. This is borne out by the data, which show a universally high ratio of trade to GDP in the region. Accordingly, policies that bias us against efficient global trade extract a commensurately higher price from our people than would be the case for those living in the larger states. Accordingly, our domestic policies, and flowing therefrom, our foreign policies and negotiating positions, should seek to position us swiftly in a market space best able to absorb our current and potential outputs. They should also position us to obtain our manufacturing inputs and final consumption goods from the most efficient producers, irrespective of where they might be found.

The FTAA does not have universal membership, which is the optimal free trade area. Nevertheless, it covers a large number of potential member countries² , which display wide differences in population size, land area, economic structures, resource endowments, levels of income, levels of skill and technological development, quality of basic infrastructure and productivity. These differences are stark, between the industrial countries and some of the developing countries potential members of the proposed grouping.

Significant differences also exist among the developing countries themselves, which include small and large economies at different levels of development. For all practical purposes, therefore, a market of such size and complexity will present almost the same challenge to the relatively small Caribbean firms as the global market.

Free Trade Area of the Americas
The Summit of the Americas, held in Miami in December 1994, committed its participants to the establishment of a Free Trade Area of the Americas (FTAA) by the year 2005, which would seek the progressive elimination of barriers to trade and investment in the Western Hemisphere³ . Participants agreed to conclude agreements on several issues, such as tariff and non-tariff barriers to trade in goods and services, agriculture, subsidies, investment, intellectual property rights, government procurement, technical barriers to trade, safeguards, rules of origin, anti-dumping and countervailing duties, sanitary and phytosanitary standards and procedures, dispute resolution and competition policy. Several of these issues will require careful study by us and I will come back to them later.

The outward looking character of the Free Trade Area was indicated by the pledge of potential members not to raise trade and investment barriers to non-member countries and to remain committed to the international trade rules and disciplines of the General Agreement on Tariffs and Trade /World Trade Organization (GATT/WTO). The proposed terms of the FTAA indicated that its aim was to strengthen the substantial advances already made by the countries of the Americas in the area of trade liberalization and economic integration which are seen to be key factors for sustainable development. This gives a clear indication of the nature of the proposed agreement.

At the Denver meeting held in June 1995, a work programme was adopted to prepare for the negotiations leading to the FTAA which, it was stated, would be a single undertaking comprising mutual rights and obligations. Several working groups were established to begin work on various specialized issues, including one to make proposals for the effective participation of the smaller economies in the FTAA.

Small Size and Free Trade Agreements
The working group on small economies was created to examine and treat with the concerns expressed by these countries which is that unless they are given some special consideration they would not be able to participate effectively in the free trade arrangements. These concerns are worthy of examination since trade is supposed to be a positive sum game. Therefore, unless the small countries are able to earn sufficient foreign resources they would be unable to contribute to their full potential in the free trade arrangement. The arguments used to seek special treatment for small countries are varied and well known to an audience such as this. Some of the salient features of the CARICOM countries are illustrated in the table.

Some of the salient features of the CARICOM countries are illustrated in the table.

It is not evident to me that small size confers any inherent economic disadvantage. But it does limit the range of development options available to the policy-maker, since small countries have intrinsically open economies which are highly dependent upon trade. Small economies might also have a lower tolerance to policy error. This implies that policies which encourage an efficient interaction with the international economy would be amply rewarded, while policies which do not would be severely penalized. Examples of both types are to be found globally and also in the Caribbean. Examples of the former include Singapore, Taiwan, Hong Kong or Luxembourg, while in the Caribbean examples can also be found of small countries, some very small, which have achieved relatively high standards of living derived from their trade in financial and tourism services. The Bahamas and the Cayman Islands provide two such examples.

Essentially my main thesis is as follows. Small size obliges us to pursue policies to maximize our global interaction. Yet smallness and our limited capacity to influence external events means that our strategy should focus on being intelligent about global developments and responsive and resilient to them. Neither should we overstate this weakness to shape external events. There are several underlying global trends over which no one seems to have the capacity to predict precise outcomes or to give them direction and shape. Several tendencies are as awkward for some large countries as they are for some of the smaller ones. Our capacity to weather these changes will be determined by our capacity to discern and react intelligently to them.

We should also be mindful of the distinction between causes and consequences. Increased global trade is an underlying fundamental, the flurry of trade arrangements one of its consequences. We should ensure that we can adapt to the underlying fundamental and not get distracted by the frenzy caused by the consequences. Having said that, I do not wish to imply that we can ignore the negotiations. Rather, we should not be distracted by them and we should be careful to allocate resources just sufficient to get those benefits which we can realistically obtain. Mainly this will be information and insights as to the strategies we need to apply to fine tune domestic policy.

Following from the above it is evident that small countries must be sensitive to global developments. Yet, few Caribbean countries have consistently pursued the route of economic openness in recent times. Those that have tried to apply import substituting policies behind high tariff walls, have not recorded strong economic growth, since expansion has been constrained by chronic shortages of foreign exchange. Export earnings have been sluggish, unresponsive to the vagaries of export markets and, in some instances, industries have become dependent upon preferences for their survival. These countries must now face a steep adjustment curve if they choose to join the FTAA. They will need to reverse decades of inappropriate policies, if they are to mitigate the shocks which market opening will have on their economies and benefit from the opportunities which it will reveal.

The Situation in Small Countries
In most of the small Caribbean countries, efforts are being made to reform domestic macroeconomic and regional trade policies. However, within CARICOM the rate of domestic macroeconomic policy reform has been uneven as between members, while for some of them regional policies have changed more slowly than domestic policies, and have become inconsistent with them. Strains have also become evident as efforts are made by some to quicken the pace of regional trade policy reform, seen for example in attitudes to the pace and degree of reduction of the Common External Tariff (CET) and to the extent of market widening, evident in attitudes toward the ACS and the FTAA. Tariff reduction is complicated not only by the lobbying activities of domestic firms profiting from the preference but by reluctance on the part of governments to forego the tax revenues derived therefrom. While tax reform to reconfigure the tax base has commenced in some countries the process is not complete throughout the region.

Special Considerations for Small Economies
The proposed reciprocal opening of markets under the FTAA and the potential consequences thereof present small economies with special challenges, notably the probable elimination of preferential treatment and the consequent increased competition which formerly protected products will face in the hemisphere. Such competition in international markets is sometimes seen as unfair by small economies because it is conducted against their more developed partners which possess higher levels of skill, technology and productivity. Therefore, according to this view, it can only lead to the displacement of their exports and the demise of their import substitution industries. Ironically, somewhat similar arguments are being advanced in the industrialized countries against the opening of markets to less developed countries. They fear that low wages and what they deem to be lax environmental and labour standards in the developing countries will lead the closure of firms, lower wages and higher unemployment in the developed world.

The task of empowering our smaller economies to participate effectively in the FTAA lies primarily within the realm of internal policy reform. Our external initiatives should seek to support that process, seeking such technical supports as may be necessary to strengthen it. The internal policy measures necessary to permit the smaller countries to integrate effectively into the Free Trade Area of the Americas (FTAA), are consistent with the policy initiatives currently undertaken by several of our countries to reestablish macroeconomic balance and accelerate economic performance. However, the time-frames being mooted for accession to the FTAA require that these countries redouble their efforts and quicken the pace of reform in several areas, simultaneously. While this new timetable would advance the pace with which the smaller economies achieve viable and efficient productive structures, it could place greater strains on weak domestic enterprises, which must prepare themselves to face hemispheric competitors. It would also make greater demands on domestic and regional policy makers, putting a premium on the appropriate choice of policies, their expeditious implementation and proper sequencing. In all of these areas there is increased risk of policy error, social instability and policy reversal. Several of the smaller economies, will, therefore, benefit from technical and financial assistance to help them to quicken the reform process and ensure that this rapid transition is successful.

Internal policy measures fall into two broad categories. The first, which cannot be over emphasized, since it is a precondition for the success of the second, is in the realm of macroeconomic policy. Here the objective is to establish and sustain a relatively stable equilibrium in the economy, while applying other appropriate measures to encourage it to expand efficiently toward its production frontier. The second set of policy initiatives should seek to foster national consensus and build the human and institutional capacities which can lock-in and secure, those major policy precepts necessary to secure stable macroeconomic policies. They should also focus on removing the numerous impediments which limit the proper functioning of factor and product markets and which are endemic to smaller economies.

These policies encompass several important elements, some of which might be considered controversial. Time does not permit their in-depth discussion here, especially since they have been elaborated elsewhere⁴ . Moreover, given the focus of this meeting, which is in the realm of international negotiation, it might be more appropriate to suggest areas where the negotiator could best contribute to assisting our small states to function more effectively in the mooted FTAA. David Lewis, in a recent paper⁵ advised, "The region needs to focus less on threats and challenges posed by free-trade and NAFTA and more on opportunities for economic reform and restructuring, to become more competitive internationally". I agree with this position. Therefore, rather than being defensive, using the familiar well tried tactics to derogate from provisions or to delay implementation, our foreign policy might instead use the opening presented by the FTAA to harness international inputs to better advance what is in effect or should be our domestic reform agenda. The comments which follow are intended to stimulate your thinking in this vein and to suggest areas needing greater efforts and external support.

The first would deal with strictly macroeconomic aspects. I believe most of us by now accept the need for macroeconomic balance, although some of us still find it difficult to achieve on any sustained basis. Further work needs to be done in this area, even for those who seem to have achieved success over the past few years. Further efforts will be needed to remove the fears of policy caprice, for example in the run-up to elections or after a change of government. Monetary policy needs to be built on firm foundations to ensure consistency, reduce perceptions of risk and allow reduced interest rates. Cooperative efforts, through, for example, the Regional Monetary Institute, to exert moral suasion for the adoption of best practice is an initiative which needs support. This will allow it to work toward a public consensus that central banks should be given independence to secure low levels of inflation. Sound monetary policy will pay long term dividends in enhancing our productivity and better fit our small economies to functions in open markets.

Similarly, fiscal policy reform is underway in several of our countries. Nevertheless, for others a high dependence on trade taxes is complicating the calculus as to how soon and how far they can afford to open their markets. Assistance in tax legislation for such countries would be desirable, as would modernization of tax collection mechanisms. For most countries budget procedures need to be modernized since receipts and expenditures can now technically be recorded in real time, ensuring more rigorous budget procedures. Cooperative actions could be undertaken at the regional level to build consensus on the those elements necessary for sound fiscal policies and establish guidelines for sustainable debt ratios.

For small countries markets are inherently fragile, easily falling prey to monopolies and oligopolies. Market opening provides the sole realistic measure to reduce such market imperfections. But even then, market abuses remain a likelihood so that monitoring and regulatory polices need to be put into place and enforced to ensure equity and guard against predatory or criminal activities. This calls for fairly sophisticated policies regarding the market and the preservation of healthy competition.

In the realm of trade policy much remains to be done at the domestic level even before we contemplate fully opening markets to the FTAA. Trade reform, within CARICOM for example, has been so slow that accession to the FTAA would place a massive new slate of changes upon those which remain unfulfilled within it. Aside &from such broad based changes, work also needs to be done at the product level, to identify activities which can prosper in the new environment. It will also be necessary to identify those activities which can be saved, though with modifications, what these order. Finally, we need to know those sectors, or portions thereof which cannot survive and try to find alternative activities which might be put in their stead to absorb the idled resources.

Needless to say, all this information has a direct bearing on the negotiating brief which we will need to prepare. It is likely that we will require supplementary resources, both financial and technical, to prepare a team to cover the complex negotiations which are envisaged and to understand the several complex issues which will be treated in depth in the negotiations. To understand them and to understand their implications for us and for the proposed lines of development which we hope to pursue.

At a broader level of public policy, support will be needed for infrastructure to support the thrust into open markets. Transport and telecommunications are two major areas which spring immediately to mind. In both areas policy reform is needed as well as supplemented resources. Various institutions need also to be improved in quality, notably the public service itself which is being slowly reformed.

Finally, successful development and by extension social equity and the thrust into competitive global markets is predicated on skilled motivated people. The range of supports necessary to develop the appropriate human qualities, which range from basic health and nutrition to advanced education, skills training for all and technology, must be addressed as a matter of priority. This whole cluster of initiatives will require policy and material supports.

Conclusion
In closing, I would like to make some comments about the links which seem to me to exist between our negotiating positions and the domestic change process. Traditionally, our external negotiations have received a high profile, both in terms of the levels at which they are finally conducted, as well as the degree of public coverage which they receive in the national media. This is natural, given our small size and the importance which international issues hold for us. Nevertheless, we should also be mindful that our negotiating positions are likely to have a greater impact upon the domestic audience than upon our negotiating partners. Our small size does not allow compartmentalization of these arguments. Accordingly, a negotiating stance which is convenient for securing a negotiating concession could be counterproductive as a domestic prescription. Chances are that it will be ignored in the former context but accepted as the latter. Take the question of time. Time will no doubt be one of the elements we seek to secure in the negotiations. Yet as we try to persuade our negotiating partners of the difficulties of adjustment it will be domestic agents who take the arguments on board and react to them. Moreover, as we seek increased time to meet our policy agenda, we should be mindful that the longer we postpone adaptation the longer it will take our economies to respond to the changed circumstances.

The change process needs to navigate a fine line between complacency and despondency. For some, complacency is reinforced as long as change is postponed. For others despondency is reinforced by the arguments made for postponement, especially of the arguments magnify difficulties and then fail to elicit a concession at the bargaining table. Conversely, an optimistic approach reduces complacency, since the complacent are likely to react quickly in the expectation of imminent change. Similarly, the despondent become energized where a clear and manageable path of action is revealed.

Our negotiating positions should also be predicted upon a sound understanding of our domestic needs. We should be intolerant of policies which evolve simply via the dynamics of bilateral bargaining. There, the argument goes, that since our opponent will concede x, we should demand 3x in the hope that we get 2x. Maybe, objectively, we would be best off with less than offered, only one- half of x. Similarly, suppose we need to introduce a reform. We know we need to do it. We know our negotiating partners will require it for agreement. So, we postpone it. I have heard the argument used that we are saving it as a "bargaining chip". Yet, the reform might be urgent and a prior condition to fit us for the new agreement. If it is postponed, we could enter the new agreement unprepared to cope with or benefit from it.

We are currently in a phase of profound change. It presents us with opportunities and also with risks. The risk-averters will council inaction or resistance. However, this is not an intelligent choice when faced with an onrushing bus. Inaction or nostalgia, in the face of a rapidly changing environment, is costly escapism and a recipe for disaster.

I would like to close by emphasizing the following five points.

1) Our approach should be one of shrewd and rapid adaptation to fit our economies to global changes.

2) We should ensure that our external policies support this process of adaptation.

3) We should be careful not to overestimate our capacity to influence the negotiating environment.

4) Accordingly, we should not divert scarce resources, including policy attention, away from the task of domestic economic adaptation to ensure high productivity in our countries and a propitious investment climate for domestic and foreign capital.

5) In sum, we should not be distracted by symptoms but rather we should focus our attention on the underlying global fundamentals.

ENDNOTES

1. The first of these is entitled, "Factors affecting the participation of Caribbean countries in the FTAA", (ECLAC LC/CAR/G.459) dated 31 October 1995. The second is entitled, "Internal policy measures to facilitate the Integration of smaller economies into the FTAA" (ECLAC LC/R.1641) dated 31 May 1996.

2. Thirty four countries participated in the Summit, as follows: Antigua and Barbuda, Argentina, Bahamas, Barbados, Belize, Bolivia, Brazil, Canada, Chile, Colombia, Costa Rica, Dominica, Dominican Republic, Ecuador, El Salvador, Grenada, Guatemala, Guyana, Haiti, Honduras, Jamaica, Mexico, Nicaragua, Panama, Paraguay, Peru, St. Kitts and Nevis, St. Lucia, St. Vincent and the Grenadines, Suriname, Trinidad and Tobago, Uruguay, the United States of America, and Venezuela.

3. Summit of the Americas, December 9-11, 1994, Miami, Florida - Plan of Action.

4. ECLAC, "Internal policy measures.." Op. Cit.

5. Lewis, D., "Caribbean Regional Cooperation and Strategic Alliances", in "Choices and Change, Reflections on the Caribbean", edited by Dookeran, W. C., I.D.B., 1996