Economic impact of deep trade agreements in Latin America and the Caribbean

The following analysis explores the potential trade and welfare impacts of DTAs in Latin America and the Caribbean. It combines network analysis to quantify the depth of existing trade agreements with a general equilibrium gravity model to simulate (a) the deepening of existing PTAs within the region (intensive margin), and (b) a scenario in which the region’s countries sign new DTAs with each other (extensive margin) (Fontagné et al. 2021).

Assessing the overall depth of PTAs is challenging because of the richness of their content and the variety of disciplines they include.6 This analysis uses a statistical procedure to classify the region’s PTAs into an optimal set of groups (map 2.4) where the PTAs present both the maximum similarity of provisions within groups and the maximum difference between groups.

Six Latin American and Caribbean PTAs, classified in a first cluster, have the largest impact on trade, so they are recognized as DTAs. They are European Free Trade Agreement–Chile; Canada–Chile; Chile–Japan; Peru–Mexico; the Andean Community (CAN); and the North American Free Trade Agreement (NAFTA).7

Twenty-eight agreements are classified in a second cluster of medium-deep PTAs. Of those, 7 are intraregional agreements (including such trading blocs as the Caribbean Community and Common Market [CARICOM]), and 21 are extraregional (such as CPTPP, European Free Trade Association–Central American States, and EU–Colombia–Peru).

Forty-eight remaining agreements are classified in the third cluster as shallow PTAs. Of those, 24 are intraregional (including Dominican Republic–Central America, the Latin American Integration Association [LAIA], MERCOSUR, and the Pacific Alliance); and 24 are extraregional (such as Chile–China, MERCOSUR–India, and United States–Chile).

Antidumping and competition provisions play a more important role in the first cluster than provisions in such areas as labor regulation. So, transforming a thirdcluster PTA into a first-cluster PTA would, on average, require putting more emphasis on antidumping, competition, and technical regulation.

To assess the impact of deepening existing PTAs, this exercise assumes that all the currently shallow and medium-deep agreements become deep. As expected, intensifying cooperation enhances trade among participating countries, with only marginal diversion from countries in the rest of the world and from isolated Caribbean countries (figure 2.9).

Map 2.4 Number and depth of PTAs in Latin American and Caribbean countries, 2017

Number of agreements 1 27

Depth

Low

Medium

High

Source: Fontagné et al. 2021. © World Bank. Further permission required for reuse. Note: The pie chart in each country depicts the country’s distribution of agreements between low, medium, and high depth. “Depth” refers to the number or share of essential, legally enforceable provisions (substantive commitments) in a preferential trade agreement (PTA) to deepen economic integration between the trading partners. No data are available for French Guiana.

A good illustration of the impact of deepening integration in Latin America and the Caribbean comes from the Pacific Alliance partners. Colombia’s exports within the region grow by 8.9 percent and its gross domestic product (GDP) by 0.4 percent; Peru’s exports by 4.1 percent and GDP by 0.4 percent; Chile’s exports by 2.9 percent and GDP by 0.6 percent; and Mexico’s exports by 0.2 percent and GDP by 0.3 percent.

If the measured impact extends to relations between Pacific Alliance members and the rest of the world, Colombia’s exports grow by 19.7 percent and its GDP by

Figure 2.9 Economic effects of deepening existing PTAs in Latin America and the Caribbean, by country

Colombia Peru Chile Costa Rica Bolivia Paraguay Guatemala Argentina Ecuador Venezuela, RB El Salvador Cuba Brazil Uruguay Honduras Latin America and the Caribbean Jamaica Dominican Republic St. Lucia Suriname Belize Trinidad and Tobago Nicaragua Bahamas, The Panama Barbados Mexico RoW Haiti

0 5 10 15 20 0 2 4 6 8 Change in exports (%) Change in GDP (%)

Within Latin America and the Caribbean Within Latin America and the Caribbean plus RoW

Source: Fontagné et al. 2021. Note: The figure presents general equilibrium effects of deepening existing preferential trade agreements (PTAs) for Latin American and Caribbean countries in 2017. GDP = gross domestic product; RoW = rest of the world.

1.0 percent; Peru’s exports by 17.4 percent and GDP by 1.8 percent; Chile’s exports by 13.8 percent and GDP by 3.2 percent; and Mexico’s exports by 0.9 percent and GDP by 2.1 percent.

But diversion effects are present, concentrated in relatively disconnected and small economies in the region such as The Bahamas, Belize, Haiti, Jamaica, St. Lucia, and Suriname. Because these countries participate only in one agreement—CARICOM, which already belongs to the cluster of medium cooperation agreements—the main effect on them in the simulation comes from indirect effects induced by third-country adjustments.

To assess the impact of signing new agreements, a second exercise assumes that each country within the region signs a shallow agreement with every other country. As a result, small Latin American and Caribbean countries that sign with large countries see their trade and GDP increase substantially (figure 2.10). Barbados is an extreme example, with exports increasing by 3.5 percent and GDP by 1.1 percent. But large countries (such as Argentina) that sign with small ones gain little.

If countries signed deep new agreements, small country gains would be magnified. Again, Barbados is an extreme example, with exports increasing by 8.0 percent and GDP by 2.6 percent.

Figure 2.10 Economic effects of new intraregional PTAs in Latin America and the Caribbean, by country and PTA depth level, 2017

Barbados Panama Haiti Belize Ecuador St. Lucia Jamaica Venezuela, RB Suriname Bahamas, The Dominican Republic Colombia Trinidad and Tobago Cuba Costa Rica Guatemala Uruguay Peru Brazil Argentina El Salvador Honduras Paraguay Bolivia Chile Mexico Nicaragua Latin America and the Caribbean

0 2 4 6 8 0 0.5 1.0 1.5 2.0 2.5 3.0

Change in exports (%) Change in GDP (%)

Shallow Medium Deep

Source: Fontagné et al. 2021. Note: The figure presents general equilibrium effects of Latin American and Caribbean countries signing new preferential trade agreements (PTAs) of varying depth (shallow, medium, or deep) with other Latin American and Caribbean countries in 2017. GDP = gross domestic product.

These results have two main policy implications for regional integration in Latin America and the Caribbean: First, the region’s larger countries already engaged in PTA networks would benefit more from deepening existing agreements than from extending their networks to new partners. Second, the region’s smaller countries would gain from signing new agreements, even shallow ones. (Deeper agreements would lead to higher gains but might be out of reach at first.)

DTAs present an avenue for promoting trade and GVC integration in Latin America and the Caribbean. Globally, deep provisions in trade agreements contribute to increases in GVC-related trade (Mattoo, Mulabdic, and Ruta 2017; Orefice and Rocha 2012; and Osnago, Rocha, and Ruta 2017). DTAs are also related to the way firms internationalize (inside the firm’s national boundary through vertical integration or outside it through arm’s-length transactions). And specific provisions in DTAs are linked with vertical foreign direct investment (Osnago, Rocha, and Ruta 2017, 2019).

DTAs and GVC integration are also positively linked in Latin America and the Caribbean. The value of GVC-related trade in 2017 (proxied by trade in parts and components)8 was on average higher for the region’s countries that had signed deeper agreements with their trading partners (figure 2.11). And estimates using a gravity framework suggest that deeper agreements, defined by the number or share of legally enforceable provisions, are associated with higher levels of GVC-related trade.9 One additional provision in an agreement is correlated with a 0.3 percent increase in GVCrelated trade. Similarly, GVC-related trade between countries that had signed the deepest agreements (with 30 or more provisions) was 12 percent higher than it had been before signing.

DTAs can also help countries upgrade the kinds of GVCs they participate in. The average numbers of a country’s DTA partners and DTA provisions both increase as countries advance along the GVC taxonomy, from participating in commodity GVCs to participating in innovation GVCs (see chapter 1 on the taxonomy). This suggests that deeper integration in PTAs is associated with GVC upgrading. Across countries worldwide, the average number of PTA partners between 2015 and 2017 was 22 for countries specializing in “commodity” GVCs, 35 for countries participating in “limited manufacturing” GVCs, but more than 60 for the “advanced manufacturing and services” and “innovative activities” GVC groups (figure 2.12). The latter two groups of countries had more than 200 provisions on average in their DTAs. The countries specializing in “innovative activities” GVCs had 100 more provisions on average than countries specializing in commodity GVCs (233 versus 128).

Figure 2.11 Average value of GVC-related trade in 2017 was higher for Latin American and Caribbean countries that had signed DTAs

Log of average GVC-related trade 15

10

5

0

No provisions ≤ 15 provisions 16–29 provisions ≥ 30 provisions

Log of average GVC-related trade 15

10

5

0

No provisions ≤ 15 provisions 16–29 provisions ≥ 30 provisions

Source: Laget et al. 2018. Note: The figure presents simple correlations between preferential trade agreements (PTAs) of varying depth and global value chain (GVC)-related trade. GVC-related trade is represented by trade in parts and components, defined as all nonfuel intermediates from the Broad Economic Categories (BEC) classification (codes 111, 121, 21, 22, 42, and 53). Here, deep trade agreements (DTAs) are defined as agreements containing at least 30 legally enforceable provisions.

Figure 2.12 Deeper integration in PTAs is associated with GVC upgrading

Number of PT A partners 80 70 60 50 40 30 20 10 0

Commodities

Limited manufacturing

Advanced manufacturing and services Innovative activities 320 280 240 200 160 120 80 40 0 Number of PT A provisions

PTA partners (left scale) PTA provisions (right scale) Sources: Winkler 2021; World Bank’s Deep Trade Agreements database; global value chain (GVC) taxonomy data from World Bank 2020. Note: The figure presents the average number of preferential trade agreement (PTA) partners and provisions for countries across regions globally, grouped by World Bank GVC taxonomy. It shows averages for 2015–17 and includes only countries that appear in the World Bank GVC taxonomy. Regions include only countries eligible for World Bank lending.