Latin America’s current economic growth levels are among the world’s highest, and the region is preparing its regulations to meet new economic challenges. As such, the fostering of foreign trade and foreign direct investment (FDI) is important to increase GDP growth, create job opportunities, and improve logistics and production. In the pursuit of economic and social development, modern economies are implementing new regulations to develop strategies aimed at attracting new investments and facilitate trade. In this article, we analyse the most important regulatory tools that Latin American countries are developing, with the aim of improving their economic and social conditions, and ultimately consolidating Latin America as a region open to business with favourable conditions for the development of high-value investment projects.
Free Trade Zones
One of the region’s most important mechanisms for customs regulation is the free trade zone. This is generally recognised as an area where foreign companies can import materials, manufacture goods, export products, and benefit from special treatment regarding tax and customs. Colombia, Mexico and other Latin American countries are focusing on this as the cornerstone of economic growth. Each of these countries, while sharing the general principles of the free trade zone, has developed certain particularities adjusted to its individual economy to make this special regime a much more attractive instrument for business development. As of 2015, there were 445 free trade zones in Latin America, creating over 1.7 million jobs and exporting over US$27.6 billion.
As stated, each country has developed the instrument in a specific way, and they may have different names for it – for example, Colombia’s free trade zones are comparable to the special economic zones of Mexico and Peru. This instrument promotes foreign investment and develops economic and social policies enabling the growth of the national manufacturing and service industries. It offers prerogatives to users via conditions that allow them to compete efficiently, thus establishing regulations adapted to international regulatory trends. These conditions include financial, tax, customs, foreign trade and foreign exchange benefits.
Each country has its own regulation regarding the benefits it offers. However, there are some common conditions for foreign investment, such as:
- the centralisation of export operations and, consequently, the elimination of certain expenses;
- tax exemptions – no VAT; reduced or lowered income tax; and no tariffs;
- the development of productive operations without VAT or customs charges; and
- legal stability regarding the benefits provided by the countries to the free trade zones.
In Colombia, the free trade zones regime has evolved rapidly since its creation in the mid-1950s. It now has the largest number of free trade zones (over 100) and the total investment made in the country through this mechanism is about US$16 billion. The Colombian free trade zone regime has different types of users and was created to foster the development of both the manufacturing and service industries. It also allows companies to serve the local market (the current population of Colombia is almost 50 million), something that is restricted in many free trade zone regimes developed in Central America. On the other hand, free trade zones in Peru were established in certain areas to promote development in these specific regions of the country; currently, there are only four special economic zones and the instrument is only just starting to develop. This has also happened in Brazil: the government developed free trade zones in the north, a region isolated from the rest of the country. The objective was to promote the economic development of this area through the special regime of free trade zones. At present, the free trade zone of Manaus has successfully helped in the development of the automotive, electronics and chemical products industries. Argentina has nine free trade zones, all of them promoting the storage, commercialisation and industrialisation business industries. The instrument is used to simplify the different processes, and to promote trade and industrial activities in the country.
The use of free trade zones, then, aims towards the development of the region as well as the expansion of trade and industrial activities. Foreign trade is improved by free trade zones as they allow users to create a centralised operation, reducing costs according to the benefits established in each country’s regulations. The operations are more efficient, as users can consolidate exports from these zones; control information from one trade centre; and access markets through available free trade agreements. Through this mechanism countries can expect to increase export rates, enable national industry to access new markets, create more job opportunities in strategic areas and promote foreign investment.
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Free Trade Agreements and regional integration
Latin American countries are developing strong commercial connections with other economies, so as to expand market opportunities for their national industries. They are also serving as investment platforms for foreign investors looking for access to major markets (mainly the US) through the free trade agreement (FTA) network currently in place; these investors benefit from the strategic location of Latin American countries. The main benefits created by FTAs in this region are:
- better conditions to access other Latin American markets, meaning a reduction or elimination of tariffs and other barriers to trade;
- FTAs enhance cooperation regarding matters such as intellectual property and e-commerce;
- countries have increased their GDP growth by: allowing domestic industries to access cheaper inputs/raw materials; introducing new technologies at a more affordable cost and fostering competition and innovation;
- FTAs promote regional economic integration; in Latin America there are plenty of shared approaches to trade and investment through international organisations and economic integrated regions. They have adopted common rules of origin and product quality standards, as well as the unification of valuation methods; and
- FTAs have created legal security and stability in promoting foreign investment.
Chile, Colombia and Peru have the most developed FTA network in the region, having focused on the ratification of FTAs with industrialised economies such the US, the EU and Canada. They have also enabled domestic players to access cutting-edge technology, which helps them to improve production, safety standards and logistics.
Even though FTAs are key international instruments, they are not a widespread concept in Latin America. While most of the countries continue to sign and negotiate FTAs, Brazil – recognised as the region’s biggest market – hasn’t entered into FTAs to protect the growth of its national industry. It is also important to consider that, in the region, there are trade alliances that negotiate FTAs as an economic bloc.
As stated, regional alliances have also promoted growth and improved trade conditions in Latin America. There are customs unions such as the Andean Community of Nations (CAN), the Caribbean Community, the Central American Common Market and Mercosur, all of which have helped Latin American countries to unify customs-related matters such as tariffs, rules of origin and custom valuation rules. More than customs unions such as the EU, these alliances constitute strong trade agreements between key economic players with enormous growth potential, promoting economic advancement and facilitating busines development.
While Mercosur and the CAN have proven the region’s longest-standing agreements, in the past decade the Pacific Alliance (formed by Chile, Peru, Colombia and Mexico) has emerged as the ultimate means of economic integration, based on a privileged location and the mature economic development of its members.
Mercosur, a bloc composed of Argentina, Brazil, Paraguay and Uruguay (Bolivia is currently in the process of joining), is considered the fifth biggest economy in the world and it has developed strong commercial relations with other countries. The four countries have agreed to eliminate customs duties and implement a common external tariff on certain imports from outside the region. They have also adopted a common trade policy towards third-party countries. Mercosur has developed trade agreements with other countries and alliances, bringing economic growth to each country and strengthening the region.
The CAN is a customs union comprising the South American countries of Bolivia, Colombia, Ecuador and Peru. It works as an intergovernmental programme coordinating trade and public policy programmes in the region. The CAN promotes the free trade of goods between parties where no custom tariffs are charged. The CAN has played an important role in Andean countries, allowing them to specialise in the development of an interconnected economic area. It has also served as a political platform for the negotiation of key agreements with developed economies, such as the US and the EU.
Lastly, the Pacific Alliance is looking towards consolidation of Latin American countries bordering the Pacific Ocean, to become a strong economic coalition. It is mainly seeking to form strong economic relations with Asia and Oceania. The Pacific Alliance has a team concentrating on foreign trade, facilitation of trade and customs cooperation. The alliance is still in the process of being established, particularly through the negotiation of new trade agreements with countries in Asia and Oceania such as Australia, New Zealand and Singapore. The objective of the Pacific Alliance is to access these markets and build agreements that can benefit the region.
Though the effectiveness of bilateral investment treaties (BITs) has been debated, it is unquestionable that their ratification has had a direct impact on FDI in Latin America. Local economies understand that foreign investors are not only looking for a convenient location and tax benefits for the development of their investment projects, but also legal stability and the long-term protection of their investments.
Despite this, the protection of BITs has recently caused a stir in some South American countries. For instance, Ecuador, Venezuela and Bolivia recently denounced their BITs, stating that their benefits are outnumbered by the risks regarding sovereignty and the right of states to regulate. This backlash follows similar incidents – seen particularly in Argentina, which had to face multiple claims made by investors seeking to protect their rights by claiming BIT protection. Recently, Venezuela (on nationalisation/expropriation charges) and Colombia have started international litigations based on BIT and FTA investment chapters.
Even though direct investment is considered an opportunity for growth, Latin American countries must consider the risk of international disputes arising from ensuing compromises, as well as compliance with international treaties. They should weigh the benefits of foreign investment against the risks of international controversy. Looking at the current situation of many Latin American of the countries, the negotiation of BITs must be reconsidered and a new strategy must be devised to avoid future problems.
Latin America is a developing economy seeking new opportunities to grow and build a stronger social and economic environment. The region’s efforts have translated into important achievements, but Latin America still has a long way to go. For this, its countries must continually renew their strategies for foreign trade and foreign investment.