Although the Brexit decision has created great anxiety across the world as it was a highly unanticipated decision, the potential effects on the Latin American region most likely will be very limited. The biggest reason for this is that trade linkages with the U.K. are, today, very small. Perhaps the most important impact will come from an expected slowdown in the growth rate in the European Union compared to the forecast we had before the decision and assuming the U.K. had chosen to stay in the EU.
On the positive side, if the U.K.’s economy opens up to trade once it is out of the EU then it may actually be positive for the Latin American region as today’s trade with the country is almost negligible. Having said this, the uncertainty and the time it will take for the U.K. to get out of the EU will continue to affect the future relationship between the Latin American region and the U.K. We do not, however, expect any change in the relationship between the region and the remaining EU countries, even though, we expect the current negotiation between the Mercosur and the EU, which had taken on some more importance due to the change in governments in Argentina and Brazil, to be put on a back-burner for now as the EU and the U.K. try to come to agreeable terms regarding Brexit.
Free Trade Agreements and Customs Unions
Perhaps one of the most important considerations to take into account when it relates to Latin America is that the expansion of global trade during the past several decades has been impactful for the region’s economic growth that not many countries are planning to close their markets to international trade. If we look at the presidential political discourse in the United States and take the recent decision by the United Kingdom to start its exit from the EU, it appears that Latin America may also try to jump on this bandwagon. However, this seems far from what is actually happening.
Before getting into the potential consequences from Brexit on Latin America, it is important to clarify some misconceptions about free trade. What is normally little understood by many, or at least incorrectly discussed in the media, is that free trade agreements (FTAs), or in the case of the European Union, a customs union (CU), are not similar to free trade. The reason why countries engage in free trade negotiations to come up with either FTAs or CUs is because there is no free trade between those countries or group of countries. Thus, a negotiated FTA or CU is just an attempt to try to make trade freer rather than accomplishing free trade. That is, after an FTA or CU is put in place, trade would be freer than before.
Furthermore, the European Union is not an FTA; it is a CU, which is different than a FTA. In the Brexit case, one of the arguments of some of the groups that wanted to leave the EU was that they wished to take back their country’s ability to make independent decisions regarding trade because the EU, as a CU, did not allow the U.K. to make its own trade-related decisions. Thus, in principle, many of those who promoted Brexit were not against free trade, just against the CU, which is different than what the media has reported. It is true, however, that many seem to have voted against the CU because they blame “free trade” for other ailments, i.e., lack of jobs, lack of wage improvement, etc., which, in some sense is similar to the U.S. political discourse today. However, that does not seem to have been at the heart of how Brexit was sold. Moreover, it seems that an important component of the “leave” vote was also related to the fact that the U.K. had very little control over its borders in terms of immigration and this seems to have had a large impact on the vote to leave.
Latin America Is Pro-Trade Today
It is true that barriers to trade still exist in Latin America and in the rest of the world even if there are FTAs and/or CUs as we have argued. It is also true that some Latin American countries have meddled with trade during the past several years as economic growth weakened and in an attempt to improve these countries’ respective international reserves positions. This is reminiscent of times gone by when many of them implemented import substitution industrialization (ISI) strategies after the Second World War. However, the current environment is far from the ISI times and countries look at trade as an economic growth driver, or at least complementary to economic growth and not competing against it used to be. That is, Latin America is, today, and for the first time in many decades, fundamentally pro-trade. Furthermore, these countries know that the recent depreciation of their currencies would help them grow through exports at a time when domestic demand has weakened considerably, which adds arguments to the pro-trade contingent of each country’s political class.
In addition, the United Kingdom is not a large export market for Latin America, accounting for only 1.1 percent of total Latin American exports in 2015 (Figure 1). There are some countries, however, whose exports to the U.K. have grown in importance during the past several decades but still remain a very small percentage of the region’s total exports. At the same time, although we expect the U.K.’s economy to suffer a modest recession at the end of this year and into early next year, our expectation is that the U.K. economy will start growing again relatively soon.
What is interesting for the Latin American countries is that in some sense it will probably be easier to negotiate a free trade agreement with one country, in this case, the United Kingdom, than with a group of countries. However, because the U.K. economy is not a large destination for Latin American trade, the lengthy process of exiting the EU would probably delay any positive development in this direction.
Perhaps most important for Latin America is the fate of the EU’s economy, as Latin America has a larger percentage of exports going to the EU-27 (10.1 percent) while at the same time countries and trade regions in Latin America have been trying to negotiate trade agreements with the EU over the past several decades. This negotiation may be further jeopardized or at least delayed further, by this new development. Our expectation is for the EU’s economy to slow a bit in the next several quarters, but continue to grow, which will still be supportive of exports from the Latin American region.
Latin American Exports to Europe
Although we expect a negative ripple effect from the recent U.K. decision, the effect will more than likely be limited in size. We expect a mild recession in the U.K. and weaker-than-expected growth in the EU to set off a chain of events. However, the effects to regional trade will vary greatly by country. As shown in Figure 1, regional trade to the EU, U.K. and EU-27 (which excludes the U.K.) makes up 11.2 percent, 1.1 percent and 10.1 percent share of total Latin American exports, respectively. Of the 1.1 percent share to the U.K., there are several countries that are more exposed than others, such as the Dominican Republic, Costa Rica and Nicaragua (Figure 2). Even then, the share total of these three tiny economies is only about 13 percent of total Latin American exports to the United Kingdom—a relatively small share. The larger Latin American countries, which include Brazil, Argentina and Mexico, only export 1.5 percent,
1.4 percent and 0.5 percent, respectively, to the U.K. (Figure 2). That is, any slowdown in demand from the U.K. should not weigh too heavily on Latin American exports as none of the major Latin American economies send a sizable amount of their exports to the U.K.
Source: IHS Global Insight and Wells Fargo Securities
On the other hand, if the entire EU is included, a much larger share of Latin American goods are exported to this region. As shown in Figure 3, Panama, Honduras, the Dominican Republic and Costa Rica, each export more than 20 percent of their goods to the European Union-27 (which excludes the U.K.). In addition, the larger economies such as Brazil, Colombia, Ecuador, Argentina and Peru export 16.2 percent, 14.9 percent, 14.2 percent, 13.1 percent and 12.3 percent, respectively, of their goods to the EU-27. If a slowdown or even a recession in the U.K. were to slow the EU-27’s economy, the effect would be greater in Latin America than a direct slowdown in demand from the U.K. Furthermore, due to proximity, most Latin American countries export a greater share of their goods to the United States or to other Latin American countries (ex. Mexico). In the case of Mexico, this economy has a limited exposure to trade with the EU
(4.2 percent) and even less exposure to the U.K. (0.5 percent). While slower growth from the EU-27 and the U.K. could affect trade from Latin America to Europe, slower growth in the US would have a much larger impact on Latin American exports.
Source: IHS Global Insight and Wells Fargo Securities
Trade Agreements Delay and Type of Products Exported
We are, however, more concerned that the Brexit decision may delay and/or divert negotiations between different countries and/or group of countries in Latin America with the EU. At the same time, interested countries in Latin America would have to start negotiations with the U.K. individually on the future of trade relations, which could take a very long time. First, the Brexit process is estimated to take about two years. Second, after that, the U.K. will have to start negotiating trade agreements with its most important trade partners and the Latin American region is probably not at the top of the list in terms of market importance to the U.K. economy. For sure, Mercosur or the Andean Pact, as group of countries, may have more sway in trying to negotiate with the U.K., but the process most likely will take a long time.
Another reason why we do not expect a large negative impact from Brexit is that a large percentage of Latin American exports to the U.K. and the EU are commodity exports, which tend to be highly inelastic. This means that if income in the U.K. or in the EU countries increases, commodity exports from Latin America will increase but by a small percentage. Conversely, if income in the U.K. or the EU drops or slows, as we expect, then commodity exports from Latin American countries to the EU would drop, but only by a very small percentage. For example, Latin American exports of primary products represented 68.2 percent of total exports in 2015, according to the European Commission’s Directorate-General for Trade, while manufacturing exports to the EU were 28.6 percent of total exports. Conversely, primary products only represented 9.4 percent of the EU’s exports to the Latin American region while 87.1 percent were manufactured goods. Furthermore, it is much easier to redirect commodity exports in case some export markets falter than it is to redirect manufacturing exports due to demand weakness.
This decision, as some of the leaders of the “leave” vote argued, could open the U.K. market to exports from other countries and then the Latin America region could benefit from negotiating independently with the U.K. on continued, and perhaps expanded, access to the U.K. economy. This is because the U.K., as a member of the EU, had to buy some goods for which Latin American exporters are very competitive, from other EU members due to the common external tariffs of the CU. However, if the U.K. leaves the CU, it will not be bound to buy these goods from other EU members and could start to “shop around.”
Today, however, there is very little information about what will happen and the uncertainty about the future of the relation between Latin America and the U.K. will remain for some time, affecting trade in the short- to medium-term.
Although the Latin American region enjoyed a rebirth of economic growth driven by its external trade sector due to the commodity boom cycle that started in the early part of this century, the size of its trade to the United Kingdom remains very limited. In 2015, only 1.1 percent of the region’s trade went to the U.K. Thus, the decision by the U.K. to leave the EU will have a limited effect on the Latin American region’s trade sector. More important for the region is its relationship with the EU-27, to which it sends 10.1 percent of its total exports.
Furthermore, the region remains highly pro-trade today and for now we should expect this stance to continue in the short- to medium-term. Perhaps the most potentially negative effect over the Latin American region could be a further delay in the negotiation between Mercosur and the EU, an agreement that has been stalled during the past several years but that has seen some renewed interest since the advent of the new administrations in Argentina and Brazil.
Perhaps the biggest negative effect over the Latin American region will be the increased uncertainty that this decision has put over the future of global trade, from which the region has benefited considerably since the turn of the century.
Invitado de hoy:
Eugenio J. Alemán, Senior Economist
Julianne Causey, Economic Analyst
Las contribuciones de los autores invitados no expresan necesariamente la opinión de Calibar.