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South-South Trade – Rewiring the Global Economy

Andrea Leonel

Andrea Leonel
Latin America Regional Trade Executive
Treasury Services
J.P. Morgan

While economic growth has slowed in many parts of the world, in Latin America, notably Brazil, it is gathering pace once again, driven by investment and growing south-south trade.

When considering the major pillars of the late 20th century global economy — the United States, Western Europe, and Japan — their institutional maturity and economic prosperity in comparison to emerging nations seems obvious. It is easy to overlook that this is actually a new phenomenon, from a historical perspective. After World War II, the United States was just emerging from the privations of its “Great Depression,” while Europe and Japan faced the hardship of post-war reconstruction that would last decades.

Today, as a new generation of industrial powers assert their presence on the world stage, and new trading relationships make themselves evident on the map, some lessons from the past may help us better understand what the future may hold.

What was it that drove this rapid development of Western prosperity? The exploitation of cheap energy and the technical advancement enabled by the unfolding computer revolution are some obvious answers. Achievements in productivity and developed capital markets are others. But one key ingredient that enabled and accelerated all of this was an unprecedented boom in international trade. Without the efficiency and cost reductions driven by trade, a personal computer would still cost $3,000; cars would remain out of reach for most consumers, and supermarkets would not be able to offer fresh food from all corners of the world.

Beginning in the 1950s, there was a concerted U.S.-led effort to open up the world to free markets, most notably as a result of the 1948 General Agreement on Tariffs and Trade (GATT), which became the World Trade Organization (WTO) in 1995. Trade barriers were stripped away, tariffs removed and the result was an explosion in trade. Economic opportunity and prosperity spread amongst the participating countries. Global trade increased in value by a factor of nine, according to WTO figures, and by 1973 trade between developed countries accounted for 54% of global trade. However, some significant nations opted out, most notably the Soviet Union and China, but also India and to some degree Brazil, South Africa and Vietnam.

The situation has changed dramatically in the past 20 years. Missing the initial boom in international trade, these countries have opened up to the global system through a series of economic, social and financial reforms, and the growth in trade that those countries have since enjoyed is reaching a tipping point. With lower costs of production, a reduced emphasis on supporting comprehensive welfare states, and in many cases, an abundance of commodities, countries in Latin America and Southern Asia are decreasingly reliant on trade with the developed world, trading increasingly with one another.

Emerging markets draw trade

In particular, the emergence of so called “south-south” trade, with emerging markets trading more with each other, is poised to revolutionize the global economy. The potential consumer market within Latin America and Asia is vast, with a strong middle class developing rapidly in Brazil, India and China. There is a corresponding opportunity to leverage local commodities and develop products for the local market and, eventually, export to a neighboring market or to another emerging region.

According to the International Monetary Fund (IMF), south-south trade today accounts for almost half of the total trade of China, and almost 60% of the total trade of India and Brazil. What is more, the south-south trade of each of these countries will continue to outstrip their trade with the rest of the world all the way through to 2050, according to IMF forecasts.

Brazil's rapid development over the past 10 years is a perfect case in point. Historically, it focused its export efforts by targeting the “rich” markets of North America and Europe, while seeking to protect home industries. With the 2002 election of President Luiz Inácio Lula da Silva, all of that changed. Brazil’s traditional markets were mature, slow-growing and dominated by well-entrenched incumbents in the manufacturing and services sectors. Lula da Silva re-oriented Brazil's export efforts towards other emerging markets, both as markets for the country's agricultural and industrial commodities — not just the beef, coffee, sugar and soybeans that Brazil had been producing in abundance, but also growth industries such as iron ore, nickel and aluminum.

Brazil has been the most talked about success story of Latin America, but it does not stand alone. Chile, Peru and Uruguay have also prospered thanks to new practical political approaches to economic engagement and an emphasis on south-south, rather than south-north, trade. Sub-Saharan Africa has also joined in this process, but growing from a much lower base it still has yet to really make its mark. Indeed, a major engine of global trade — turbo-charged, at that — has been trade between Brazil and China.

In some respects, the approach and experiences of Brazilian and Chinese businesses over the past decade have been mirror images. Booming need from China for soybeans was largely met by Brazil, while Brazil's demand for consumer goods has increasingly been met by exports from China. On the flip side, although China has provided the low-cost manufacturing base for the well-established brands of North America and Europe, Chinese brands have struggled to establish themselves. Consumer markets of Brazil and other emerging markets have been more welcoming.

A stark example of this challenge is TCL Corporation, a large manufacturer of cathode-ray tube televisions, which sought to expand in Europe by acquiring the electronics brands and manufacturing operations of Thomson Multimedia in France. Its timing in late-2003, though, was catastrophic, coming just as the developed markets it hoped to conquer were switching to LCD televisions. Meanwhile, companies like telecoms equipment maker Huawei and white goods maker Haier have become global behemoths by focusing their branded sales efforts on emerging markets.

Cross-border trade drives investment

Inward investment into Latin America has long been focused on natural resources and other commodities such as iron and copper. While this continues to be a focus of many companies seeking to expand into Latin America, the latest round of investment has increasingly focused on manufacturing.

Latin America has particularly benefited from high levels of inward investment from China, which was maintained even during the global financial crisis. Chinese automotive manufacturers, such as Chery, are building new assembly plants in Argentina, Brazil and Uruguay. Japanese car maker Toyota is opening its third plant in Brazil — a $600 million investment in Sorocaba, São Paulo state, generating 1,500 direct jobs and plans to build a fourth.1

Even this is dwarfed by the investment demands of Brazilian energy giant Petrobras, part-way through a $236.5 billion development program kicked off when the company discovered a number of new oil fields. These fields hold an estimated 50 billion barrels of oil, four times Brazil’s previous oil reserve estimate, but extracting it is technically challenging — and will be expensive.

Brazil’s government wants to leverage this external investment for further internal development, but this approach has its tradeoffs. For example, Brazil has endeavored to use the investment to drive development of domestic engineering-related industries by trying to keep as much of the work in Brazil as possible. The exploitation of these new fields is being led solely by Petrobras, which means that it cannot easily access the expertise of companies that have been successfully extracting oil from deep-sea waters for decades.

Trouble on the horizon

There are challenges to the promise of booming south-south trade, and the biggest comes in the form of trade protectionism. Some recently trade-liberalized countries have reversed their open-door policies in the face of temporary economic setbacks. For example, in October 2011, Brazil proposed a measure to increase by 30% its “Industrial Production Tax” on vehicles with less than 65% locally sourced content – including vehicles manufactured in Brazil. Cars assembled in the Mercosur trade bloc — including Argentina, Paraguay and Uruguay — and those produced in Mexico with at least 65 percent of their parts made in Brazil would have been exempt. For Chinese car companies building new factories within Brazil, such legislation would have been catastrophic. Building a new car plant and ensuring that the products contain 65% local components from day one would be impossible, argued Jac Motors, a Chinese vehicle maker of cars, and in response halted the construction of its new production plant in Brazil.2

Although the government later backtracked on this particular measure, it nevertheless raised the Industrial Production Tax on a range of goods from 20% to 35%, affecting imports of products such as motorcycles, air conditioners and microwave ovens. Although charged by its critics with protectionism, the Brazil government asserts that it is concerned with protecting the economy from dumping.

In February 2012, Brazil also announced that it was “reviewing” a ten-year-old trade agreement with Mexico that had liberalized the vehicle trade between the two countries. The review had been stimulated by a burgeoning deficit with Mexico in passenger cars. In 2011, imports into Brazil of vehicles from Mexico rose by 40% to more than $2 billion, while exports in the other direction totaled just $372 million. The Brazilian government wanted Mexico to limit exports of vehicles to Brazil to just $1.4 billion and no more than 65,000 cars.3 The end of the agreement would have meant a 35% import tax would be slapped on all vehicles exported from Mexico to Brazil, as well as an additional Industrial Production Tax of up to 41% for vehicles without the required Brazilian component content. Fortunately, a compromise was reached and a trade war averted.

In many respects, the evolving issues of Brazil’s automotive market reflect the way that economies, in general, are not static, but continue to change. Increasing aggregate prosperity tends to mask the fact that an economy is composed of many individual components, and while certain sectors grow, others will decline. By obstructing such change, governments may risk doing long-term harm as the development cycle is prevented from following a natural path of evolution.

Bursting the bubble

Economic progress can bring unexpected challenges. For example, Brazil is battling some of the consequences of its recent successes: the government is trying to prevent speculative currency flows from pushing up the value of national currency, the real, while also trying to stop asset bubbles from forming as investors clamor for a slice of Brazil’s economic success. This has led to a clampdown on long-term pre-export finance deals. Brazilian authorities have been trying to combat a trend in which some companies were using longer tenured pre-export finance loans as an opportunity to engage in arbitrage — to borrow at the lower rate and then to invest speculatively, rather than in physical production.

In contrast to Brazil, Chile has sought to develop closer economic ties with the United States. In 2003, it concluded a free trade agreement, eliminating 90% of tariffs on U.S. exports to Chile and 95% of Chilean exports to the United States. Just six years later, bilateral trade between the two countries had increased by more than 140% to $15.4 billion. In May 2010, Chile became the first country in South America to join the Organization for Economic Cooperation and Development (OECD) and, perhaps underscoring the value of unfettered free trade, it today enjoys the highest nominal GDP per capita in Latin America, according to the World Economic Forum.

It could be argued that Chile’s reliance on a valuable metal — copper — that has boomed in value was more responsible for the country’s rising prosperity than anything else, but Mexico has also benefited from developing closer ties with the United States, rather than China. A major vehicle producer, it has hosted production plants owned by U.S. automotive behemoths such as General Motors, Ford and Chrysler since the 1930s. These automotive plants have stimulated domestic production of parts and a home-grown industry, centered on bus and truck-maker DINA and sports car maker Mastretta. Today, Mexico is the largest vehicle-producing nation in North America — ahead, even, of the United States4.

Argentina faces major challenges. Currently considered an “emerging market”, it is easy to forget that at the beginning of the 20th century, Argentina was one of the richest countries in the world. It competes with Brazil as a motor vehicle producer, making 829,000 in 2011, of which more than half were exported, mainly to Brazil. However, Argentina’s political instability and protectionist tendencies have tended to mitigate against the kind of inward investment that have helped propel Mexico and Brazil.

The biggest threat to these economies is the continuing slowdown in global growth this year, with many countries in the European Union returning to recession, U.S. growth slowing down to an annualized 1.5% in the second quarter’s figures, and even China registering a slowdown to 7.5%, with the possibility that it may fall lower. Brazil’s growth has, likewise, fallen with demand for metals and other commodities from China, demand which surged to 7.5% in 2010 before falling to 2.7% in 2011. Though lower than originally expected, growth has maintained a moderate pace of around 2% even as much of the rest of the world — including neighboring Argentina — has faltered.

Moving forward to the future

However, with long-lasting structural changes occurring in the global economy, perhaps even snapping back to the broad shape it had prior to the industrial revolution, south-south trade should continue to prosper. Much of their success, however, will depend upon remaining starring players on the stage of global trade — contributing to, and benefitting from a web of global expansion — and can only happen provided that countries in South America that have benefited from free trade hold firm to liberalized trade regimes and do not fall back into old but comfortable habits.

About the Author

Andrea Leonel is the Latin America Regional Executive for the Global Trade team within the Treasury & Securities Services division at J.P. Morgan. In this role, Andrea is responsible for the overall management and strategy of the trade business in the region including sales and advisory activities, trade product management and trade solutions delivery. Andrea enjoys more than 20 years of experience in trade with Bank Boston, Citibank and Deutsche Bank prior to joining J.P. Morgan in 2010. 

1 “Pimentel: New car plant is a response to those who think the crisis will have a large impact on Brazil”. Brazil.gov.br. Sourcing the Brazil Ministry of Development, Industry and Trade.

2 “Brazil stuns Chinese OEMs with IPI tax increase”, Jeannette Galbinski, October 5, 2011.

3 “Brazil may break car agreement with Mexico,” Marco Sibaja, February 2, 2012.

4 “Mexico Tops U.S., Canadian Car Makers,” UPI, December 11, 2008.


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