I am Scott Otteman, Director of International Trade Policy at the National Association of Manufacturers (NAM). The NAM is an organization of 14,000 member firms - 10,000 of which are small or medium-sized. Our members produce the vast bulk of U.S. manufactured goods and are world leaders in productivity and product quality.
I am pleased to be here this morning to discuss the financial and economic situation in Latin America and to present the NAM's views on how this affects American business, American jobs, and the U.S. economy. We can look at the relationship from three perspectives: (1) trade - the exports and imports of goods and services; (2) investment - the direct participation of U.S. firms in Latin American economies; and (3) the effect that financial instability in Latin America might have in terms of a spillover to the broader global economy. While the first two aspects are of considerable significance, it is the third aspect that is probably of the greatest concern to the business community.
The U.S. - Latin American Commercial Relationship
To begin with, Mr. Chairman, I think it is useful to review the size of the U.S.-Latin American economic relationship. It is an important relationship for the U.S. economy, but it is especially critical for the Latin American countries' economies. For purposes of my testimony, Mr. Chairman, today I am going speak only of the countries in South and Central America. Mexico, while sharing language and cultural heritage with the rest of Latin America, over the past ten years has been integrating its economy with North America through the North American Free Trade Agreement (NAFTA). As a result, Mexico's economy is increasingly insulated from economic winds that may affect Central and South America.
U.S. exports to Central and South America last year were almost $60 billion, about 8 percent of U.S. exports to the world. Imports from the region were $67 billion last year, about 6 percent of our global imports.
Fully 88 percent of our exports to Central and South America are concentrated in manufactured goods, including computers, aircraft, turbines, plastics, and a broad range of machinery and electrical machinery. Petroleum is our largest import from the region, accounting for about one-third of the total. Apparel is our second largest import from Central and South America, followed by a range of manufactured goods, agricultural products, and raw materials. Our imports are changing in the direction of more manufactured goods, as is seen in the fact that our largest imports from Brazil have become commercial jet aircraft and electrical machinery.
U.S. foreign direct investment in South America, both overall and in manufacturing, is about 6 percent of worldwide U.S. direct investment. In 2001, the value of U.S. investments in South America stood at $83 billion, with $36 billion invested in Brazil and $18 billion in Argentina - the two largest South American recipients of U.S. direct investment.
The Effect of Financial Instability
Argentina's economic and political crisis and its limited spillover effects to its neighbors have immediately affected U.S. companies in two ways - via a dramatic decline in U.S. exports to South America and by substantially worsening the conditions for doing business faced by U.S. firms operating in the region. Among the companies based in the region, clearly the hardest hit are those based in Argentina itself, though there are trade effects that have also impacted the business environment in neighboring countries.
U.S. exports to Central and South America so far this year have fallen 16 percent from the same period a year ago. The three largest proportional declines were to Argentina, Uruguay, and Brazil. Table I, attached to my statement, shows the changes in U.S. exports to all countries in the region.
U.S. exports to Argentina have plummeted a stunning 67 percent - dropping from an annual rate of $4.5 billion to $1.5 billion - a $3 billion fall. Exports to Argentina face a triple-whammy: 1) very low demand due to four years of recession/depression in that country; 2) a huge competitive disadvantage due to the 70 percent devaluation of the Argentine peso, which makes foreign imports much more expensive than similar domestic goods; and 3) foreign-exchange curbs imposed by Argentine authorities to improve the country's current account balance.
Exports to Uruguay have fallen 53%, though because Uruguay is a much smaller market, the dollar decline was only $240 million. U.S. exports to Brazil have dropped 26 percent, from an annual rate of $16.5 billion to $12.2 billion - a $4.3 billion fall.
As a rough rule of thumb, the Commerce Department estimates each $1 billion of exports supports approximately 12,500 jobs. This implies that the export losses over the last year to Argentina, Brazil, and Uruguay may have impacted possibly over 90,000 American jobs.
The declines in U.S. exports to Argentina and Brazil are in line with the decline in these countries' overall imports from the world. For example, Argentina's global imports so far this year have fallen 63 percent - meaning they are only about one-third as large as they were last year. Brazil's total imports have fallen about 23 percent.
U.S. investment in the economies of these countries has been sharply affected as well. U.S. balance of payments data show, in fact, declining investments to South America, concentrated in Argentina and Brazil. Income on U.S. investments has plummeted. U.S. foreign direct investments in Argentina have lost $2 billion in the last nine months.
Logically, those U.S. businesses with operations in Argentina are the ones that have been most severely impacted by that country's financial crisis. In responding to the crisis, the Argentine government has forced the conversion of dollar-denominated payments to local currency-denominated payments at a one to one ratio, when the real market exchange rate is closer to one to four (so-called "pesification"). This step alone has slashed the anticipated income stream of U.S. subsidiaries invested locally by 75 percent and made severely undermined the value of many of the underlying assets. At the same time, efforts to recoup these losses by seeking higher prices or charging higher rates for services have been in many cases forbidden, putting many companies - foreign and domestic - in an untenable position and causing many local bankruptcies.
Non-payment of contracts is perhaps the biggest fallout from the crisis for those on the ground in Argentina; it has sapped business confidence and resulted in suppliers demanding up-front payment rather than accepting credit. U.S. firms in Argentina are finding that even peso-denominated debts are often not being paid by bankrupt or near-bankrupt customers.
U.S. subsidiaries have been undermined further by a series of measures the Argentine government or legislature has taken to attempt to preserve foreign exchange reserves. This includes the institution of an export tax on a nearly across-the-board basis. For companies that are export-focused, as are many U.S. operations in Argentina, this new tax partially or wholly undermines the renewed competitiveness won at the altar of the devalued peso. Needless to say, this new tax, imposed as a last resort to raise hard currency, comes at a time of tremendous weakness for most firms.
In addition, the crisis has led the government to impose import controls, limiting the expenditure of dollars on critical inputs needed to sustain or augment production. For example, some U.S. agribusiness firms - which otherwise have good prospects for renewed growth because of the devaluation-related potential for increased exports - find their ability to take full advantage to be hampered by a lack of access to key inputs, such as seed, fertilizer and farm equipment.
Furthermore, even companies with dollar reserves are missing debt payments denominated in dollars because the Ministry of the Economy must grant permission for such transactions.
Add to these costly measures the understandable worker disgruntlement and the heightened kidnapping and security threats faced by business executives and their families as a result of the drop-off of more than half the Argentine population below the poverty line, and you see that U.S. companies - along with others - face a very challenging business environment in Argentina today.
Argentina's problems have also affected U.S. companies' operations in neighboring countries, though clearly to a lesser extent than those based in Argentina itself. The impact has occurred primarily because of lost trade due to the collapse of sales to Argentina, which had been a significant portion of sales for many export-focused companies in an increasingly integrated South America.
A broader "contagion" effect - with severe pressure on the domestic currency and the banking system, as foreign and domestic investors rush for the exits - has also been seen in Uruguay. But in the case of Brazil, our understanding is that most financial experts attribute the recent pressure on the Brazilian currency to uncertainty surrounding the outcome of Brazil's current presidential elections and the new government's possible economic team and policies rather than to fallout from Argentina.
The United Nations' Economic Commission for Latin America and the Caribbean (ECLAC) has done some estimates of the decline in intra-regional trade in South America due to Argentina's economic problems. ECLAC says Argentina's imports from its neighbors are expected to tumble from $6.5 billion in 2001 to $2.2 billion this year. Uruguay has been hit the hardest, with its goods exports to Argentina falling 70 percent in the first four months of 2002 compared to the same period in 2001. Brazil has also seen its merchandise exports to Argentina slide dramatically. Argentina accounted for 11 percent of Brazil's exports in 2000, but now only account for four percent. The 62 percent decline in Brazil's exports to Argentina so far this year is equivalent to an overall decline of seven percent in Brazil's total exports. U.S. companies' Brazilian and Uruguayan operations are among the firms suffering from these trends.
Perhaps the longer-term danger for U.S. business and for the interests of Latin America and the United States in the Western Hemisphere is the emerging perception among the people and politicians of the region that financial crisis and economic stagnation are somehow caused by free-market reforms. Over the past 15 years, newly democratic Latin American governments made tremendous strides in opening their highly regulated, over-protected economies - controlling inflation, attracting foreign investment, privatizing state enterprises, and lowering trade barriers. Until 1997, these reforms yielded substantial though uneven growth. It seemed only a matter of time before the open-market policies known as the "Washington Consensus" would deliver on the promise of broader prosperity across the region. Over the last few years, however, growth has slowed, and recurring financial instability has continued to be a major problem. Increasingly, leading actors on the Latin American political scene are raising questions about the free-market model's ability to provide sustainable economic growth and development.
The collapse of Argentina, whose governments in the 1990s were viewed throughout Latin America as among the most aggressive implementers of open market reforms, threatens to further inflame protectionism and anti-reform sentiments in the Americas. Attributing Argentina's current predicament to "outside forces" or globalization per se may be a popular way to win votes, but it cannot restore confidence or form the basis for a reactivation program that allows one to actually govern and deliver sustainable results to society.
In our view, any attempt to turn back the clock by returning to policies aimed at substituting inefficient domestic production for competitive imports or rolling back other reforms would be a costly and disastrous mistake. Although some of the reforms of the late 1980's and 1990's could have been carried out more gracefully - perhaps at a different pace, or in a different sequence - the main problem is that the reform process has not advanced deeply enough. Rather than return to the past, Latin America needs to continue opening its economy to trade and investment. The so-called "first generation" reforms I mentioned earlier need to be complemented with "second generation" reforms that promote respect for the rule of law (judicial reform), tax reform, labor market mobility, limits on government spending, educational reform, and sensible regulatory regimes. No amount of populist rhetoric can alter this reality.
An Even Bigger Concern: Brazil's Future Policies
If financial collapse were to spread to Brazil - either because of contagion from Argentina, uncertainty provoked by the new Brazilian government's economic and financial policies, or some combination - the potential negative impact on U.S. business would be vastly enlarged. Some 400 of the U.S. Fortune 500 companies have operations in Brazil, which continues to be South America's most dynamic economy and the eighth largest economy in the world. A Brazilian financial disaster a la Argentina would not only undercut the operations of U.S. firms invested and trading in Brazil, it could spread investor panic and depress growth prospects throughout Latin America and the perhaps the rest of the developing world, similar to what we saw initially with Mexico in 1994 and with Asia in 1997. I want to underscore that, in my opinion, we are far from this scenario, which is one that certainly can and must be avoided.
U.S. policy and the international financial community have important roles to play in avoiding this type of disaster. I will leave it to the financial experts to make recommendations to the U.S. government and international financial institutions.
However, the experience of NAM member companies as international traders and investors leads us to believe that the most critical role in avoiding such a crisis inevitably falls to the Brazilians themselves. Regardless of who wins the October 27th run-off, the new Brazilian president can do much to allay (or enhance) the uncertainties found in financial and business circles today. Here are a few suggestions:
Appoint an experienced economic team that understands international finance and recognizes the importance to Brazil's future of deeper and broader integration into the world economy.
Make clear that the new Brazilian government will honor its international debt and other obligations.
Reaffirm Brazil's commitment to successfully negotiating a Free Trade Area of the Americas by no later than 2005, as President Cardoso pledged, along with 33 other Western Hemisphere leaders, in 1994.
Take the lead among Latin American nations in insisting that the FTAA include chapters or provisions that fully protect foreign investors, fully respect and enforce intellectual property rights, expedite shipments through customs, and guarantee transparent, non-discriminatory competition for government contracts. (Naturally, Brazil should seek to negotiate an FTAA agreement that is strongly in its interest, just as U.S. officials are doing to promote the achievement of U.S. interests. But the important thing is that the incoming Brazilian authorities make it plain that, contrary to their campaign rhetoric, they recognize the FTAA is essential for Brazil's future.)
In the cases of Argentina, Uruguay and Brazil, one of the most important things that must be restored is confidence. Investors, both local and foreign, must become confident that government officials and international institutions can stabilize the situation and ensure the preconditions for resumption of growth. Local residents will not bring their savings back to their countries and foreign investors will not resume investing until they believe their capital will be safe.
Looking to the Future
Once the immediate threat of financial crisis is overcome, there are additional steps that must be taken to achieve the stable, democratic, and prosperous Western Hemisphere that should be the ultimate objective of U.S. foreign policy. In particular, I would call your attention to the need to advance several initiatives that aim to bring about a stronger rules-based system with improved adherence to the rule of law and to practices of good governance.
The most important step would be for Latin American governments, including Brazil as I mentioned earlier, to reiterate their support for the Free Trade Area of the Americas (FTAA) negotiations and urge that the agreement be concluded as quickly as possible. Prior to the U.S. Congress' approval of Trade Promotion Authority earlier this session, Latin American and Caribbean governments could legitimately question the United States' commitment to completing the FTAA. That is no longer the case, and with the U.S. prepared to issue its initial FTAA market access offers as early as this December, the ball is now in the Latin Americans' court. A clear signal from governments throughout the region that they want to negotiate seriously and expeditiously would have a strong positive impact on investors, for embracing the FTAA means that governments intend to face the future with a better and more transparent set of rules that will govern not just trade, but also investment and commercial practices. And more than anything else, embracing the FTAA demonstrates that governments intend their countries to be open markets - open internally and open to trade.
In this regard, it is instructive to recall the experience of Mexico in its two economic crises of the early-1980's and mid-1990's. In the 1982 debt crisis, Mexico nationalized its banking system, curbed imports, and took other steps that scared off domestic and international investors. As a result, Mexico was not able to regain access to international financial markets for seven years, and it suffered through the so-called "lost decade" of stagnant growth and deepened poverty. But in the 1994 peso crisis, Mexico was constrained by its membership in the General Agreement on Tariffs & Trade (now the WTO) and the NAFTA agreement from adopting similar anti-market, populist measures. After some initial financial miscalculations, Mexico took remedial measures in 1994 and 1995 that were market-sensitive and gave investors confidence in the economy. Though a deep downturn resulted, its length was limited, and a catastrophe was averted. Mexico regained access to international financing in just seven months.
Today, as we approach NAFTA's tenth anniversary, investors have many fewer fears about Mexico's future. Even though Mexico is suffering a mild economic downturn linked to its relative dependence on the soft U.S. market, investors remain confident because of its NAFTA obligations and because of the economic and political reforms that have been carried out during the NAFTA years. The same can happen in South American countries, where, in many instances, similar levels of confidence are now absent.
Chile's experience is also instructive. Chile is arguably the most open economy in South America. Its economic and trade reforms have led to the most rapid rate of economic growth in the continent and to an extremely high degree of investor confidence. This confidence is one of the reasons that Chile received an astonishing 70 percent of all new U.S. foreign direct investment directed toward South America last year.
Additionally, the Inter-American Convention Against Corruption should be rigorously implemented by all countries in the Western Hemisphere. The United States has long been a leader in the fight against corruption in world markets, starting with the Foreign Corrupt Practices Act of 1977. I recognize that the scandals of the past year demonstrate that no nation has its hands completely clean when it comes to corporate corruption. But the United States nonetheless has led, and must continue to lead, this fight throughout the hemisphere, because bribery distorts economies and corruption eradicates faith in governments and economic systems. Corruption undermines social values and democracy, and leads to massive diversion of scarce economic resources away from intended purposes. It retards economic growth and discourages foreign investment. Adherence to the convention, and the establishment of transparency measures for government procurement, would do much to help re-establish the confidence that domestic and foreign investors need.
Along with local businesses and companies around the world that do business with South America, U.S. firms are clearly being impacted by the economic downturn in South America. This includes both U.S. exports to the region and U.S. company production and other business operations in South America. As is evident in the available data as well as in the anecdotal information, the effect is very marked - especially with respect to Argentina.
U.S. businesses and their employees, of course, want to see a restoration of stability and a return to economic growth just as quickly as possible. American firms are good corporate citizens of the countries in which they operate, and are concerned not just for their own operations but also for the conditions facing the people in those countries. The economic catastrophe in Argentina has brought with it a particularly tragic cost in terms of people's lives and their aspirations for the future.
It is our sincere hope that the U.S. government, the international financial institutions, and other governments in the Western Hemisphere can learn from the lessons of the past and work together to promote policies that not only avoid repeating such tragedies in the future, but also lay the groundwork for broadening prosperity throughout the Americas.
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