Chile: Trade Policy Brief and Recommendationsgozips.uakron.edu/~akp10/Prof_2/International Econ Paper... · Web viewMany changes can be seen in the past decade such as, Chile moving

Running head: Chile Trade Policy Brief 1

Chile: Trade Policy Brief and Recommendations

For Improving International Trade

Adam Pilz, Sam Myers, and Steve Smolik

International Economics

Chile Trade Policy Brief 2

Introduction

The history of Chilean trade policy starts with Salvador Allende, a socialist leader, who

led Chile into inflation rates of over one-thousand percent per year during his three years in

office 1970-1973. Chile citizens demanded economic market freedom instead of the government

created inflation, which Allende created when he demanded the printing of more money to

combat the the troubles in Chileans industries. As a result the people started an uprising against

Allende’s centralized government. He was eventually killed by a military coup, who through the

help of outside economic advisors educated at the University of Chicago, helped move Chile

towards a free market economy (Central Intelligence Agency).

As a result of the fall of Salvador Allende in 1973, Chile has moved from a closed

economy to a free market economy, and the trade policy of Chile has mirrored this economic

mindset of capitalism for the past thirty-five years. Many changes can be seen in the past decade

such as, Chile moving from a current account deficit to a current account surplus, a net demander

to a net supplier, and changing from a net creditor to a net debtor. Chile, while moving towards

free market principles, has used the formation of various Regional Trade Agreements in order to

reduce trade barriers among its major trade partners. By creating these numerous RTAs, Chile is

using market enlargement to stimulate investment, increase competition, and in turn accelerate

the advancement pace of technology and productivity.

Over the past decade, Chile has been seeing a deficit in its current account, up until 2004

when Chile registered a 2.075 billion dollar surplus, see figure 1 (Barrientos). 2004 is also the

year Chile signed a RTA with The United States, which has lead to the United States becoming

the leading importer of Chilean goods. Since 2004, Chile has only seen a current account deficit

in 2008, which is a possible result of the economic crisis affecting foreign countries preferences


for Chilean goods relative to domestic goods. However, in 2009, Chile is estimated to be a net

supplier of funds once again, with a 1.056 billion dollar surplus in it’s current account.

Chile’s exports have exceeded their imports every year for the past decade, but has

recently seen a drop in total number of exports in 2009 compared to 2008 (see figure 2 and figure

3). However, rapid growth previous to this period, points towards indications that this is simply

a result of the world economic recession, and rapid growth will continue to occur in exports of

Chile once we see a rise in the economies of its leading importers such as The United States,

who accounts for almost twenty percent of Chiles exported goods (Central Intelligence Agency).

Exports of Chile make up roughly forty percent of its GDP with copper, Chile’s leading export,

providing about one third of government revenue (Central Intelligence Agency).

Chile has taken all the necessary steps to move towards a free market economy, which is

shown in Chile’s economic freedom score of 78.3 in 2009, for the second half of 2007 and first

half of 2008, according to the heritage foundation’s economic freedom index (Miller, Kim,

Holmes). This score puts Chile at number one in Central America in economic freedom, and

places them just outside the top ten nations, right behind the United Kingdom, at number eleven.

This measure of openness in their economy is based upon ten measures of openness, and Chile is

above the world average in every area. These areas of freedom include business freedom, trade

freedom, fiscal freedom, monetary freedom, investment freedom, financial freedom, property

rights freedom, freedom from corruption, and labor freedom. Chile decreased in the areas of

business freedom, monetary freedom, freedom from corruption, and labor freedom, while seeing

a increase in trade freedom, fiscal freedom, and government size. Investment freedom, financial

freedom, and property rights all registered no change from 2008. Indications from this freedom


score show that Chile’s economy has rapidly advanced towards free market ideals, and has

embraced the concepts which allow for a healthy and thriving economy.

Since January 1st, 1995, Chile has been a member of the World Trade Organization

(World Trade Organization). After joining the WTO, Chile as created a uniform tariff rate of six

percent on almost all imports, excluding wheat, wheat flour, and sugar. As well as being a

member of the WTO, Chile has signed a regional trade agreement with fifty-seven countries in

the past fifteen years. Countries included in some of these agreements include, the United States,

S. Korea, all Latin American countries, and Chile is currently negotiating a RTA with India and

the People’s Republic of China (Vergara).

Chile has seen a rapid increase in foreign investment from countries abroad recently. As

seen in the chart “Chile as a net debtor,” over a spa of one year, Chile had an increase in direct

foreign investment abroad of 16.61 billion USD relative to a .02 billion USD increase in direct

foreign investment at home (Central Intelligence Agency). Foreign claims on Chile exceed Chile

claims on foreigners, which deems Chile a net debtor during this time in Chile’s trade history.


Figure 1:

Year of estimate

(For previous

year)

Current Account Balance

(in billions USD)

2000 -0.898

2001 -1.1

2002 -0.58

2003 -0.779

2004 2.075

2005 1.449

2006 7.154

2007 7.189

2008 -3.439

2009 1.056

Figure 2:

Year of estimation (imports for year previous) Estimation of imports (in billions USD)

2003 15.60

2004 17.40

2005 22.53

2006 30.09

2007 35.37

2008 44.03

2009 57.61


Table 3:

Year of estimation (exports for year previous) Estimation of exports (in billions USD)

2003 17.80

2004 20.44

2005 29.20

2006 38.03

2007 58.21

2008 67.64

2009 66.46

Chile Trade Partners

Chile is one of the most open nations in the world, economically speaking, and shares

free trade agreements with fifty-seven nations. Of these nations, major trading partners include

China, The United States, Brazil, Japan, Argentina, South Korea, The Netherlands, and Italy

(Central Intelligence Agency). Chile has a long history of trade growth. Over the years Chile has

pushed more and more for free trade agreement between themselves and larger nations. The


Chilean government is successful in allowing free trade with the United States and also with

China. This is important because these countries are Chile’s top two trading partners. As seen in

the pie chart, “Largest Importers of Chilean Exports” China, USA, and Japan make up over one

third of the imports of Chilean goods. These same three nations produce over one third of

Chile’s imported goods (see pie chart “Largest Exporters of Chilean Imports”). Chile has

Regional Trade Agreements with Japan and the United States, and is currently in negotiations to

create a RTA with China as well (Mercurio, Chong, Smith).

Chile Trade Patterns

Chile has over the past century tried to liberalize their trade. Chile has attempted three

notable times to liberalize it. The first attempt lasted from 1959 to 1961 and was an utter failure.

The second attempt to liberalize trade came during the years between 1968 and 1970. This

attempt was a great improvement over the first attempt in that the liberalization process has

started. A large amount of opposition came with this second attempt because countries that were

already trading with Chile had been benefitting from protectionist policies which allowed only


trade with those countries. The second attempt also included a transformation that would

ultimately grow the trade liberalization. Quantitative Restrictions (QR’s) were turned into tariffs

making it a possibility for any country paying the tariffs able to trade with Chile. The third and

final attempt was the opposite of the first. The third attempt was a success and took place in

1974. The liberalization of trade in Chile was now completed. In the following years Chile

would have growth in every aspect, including an annual 4.2% raise in gross domestic product

(http://countrystudies.us/chile/62.htm). After having much success with liberalizing trade

policies, let us now take a look at Chile’s current trade policy.

Current Trade Policy

The main point of Chile’s current trade policy is its central role it gives to Regional Trade

Agreements. Chile currently has twenty-one RTAs with fifty-seven trading partners in these

agreements. Chile has maintained a Most Favored Nation import tariff rate of six percent which

excludes goods such as wheat, wheat flour, and sugar. The MFN import tariffs of these items are

relative to the price band system associated with these products in the international market. In

the WTO’s most recent review of Chile’s trade policies, the WTO found that Chile has abolished

some import taxes as well as export subsidies, which have opened up Chile even more, as Chile

is the 11th most open nation currently.

Tariffs

Chile applies an ad valorem tariff to virtually all goods which is 6 percent. Importers

also must pay a 19 percent value added tax (VAT) calculated on the customs value plus import

tariff. When imports are duty free, the VAT is calculated on just the customs value. There are


several exceptions to the ad valorem tariff. For example, a higher effective tariff is applied to

wheat, wheat flour, and sugar. The higher tariffs result from the application of an import price

band system. This program is explained in greater detail in the non-tariff barrier section. The

US and Chile entered the United States-Chile Free Trade Agreement (FTA) January 1, 2004.

Under the FTA, the two countries eliminated tariffs on 87 percent of bilateral trade immediately

and will establish duty free trade in all products within a maximum of 12 years. (Foreign Trade

Barriers, 2007)

Import Controls

There are virtually no restrictions on the types or amounts of goods that can be imported

into Chile. All imports into Chile are supposed to be accounted for by either the customs

authorities or a commercial bank. Customs authorities must approve all imports valued at more

than $3,0001. Commercial banks are allowed to approve imports of less than $3,000. Larger

firms must report their import and export transactions to the Central Bank. Commercial banks

may sell foreign currency to any importer to cover the price of the imported goods. (Foreign

Trade Barriers, 2007)

Export Policies

Chile currently provides a duty drawback program for exports that reimburses firms a

percentage of the value of the items they export2. If capital equipment is imported, it must carry

a minimum value of $3,813. For imported vehicles to be used in an export business, they must

1 All monetary values named in this paper are USD.2 A Customs Duty Drawback program allows exporters of goods which were originally imported, or made from imported material, to obtain refunds for import duties already paid. For manufacturers who make products from imported components and distributors of foreign made goods, the duty drawback reduces their total costs and increases their competitiveness in the world export market. (http://www.jsmithco.com/duty-drawback-services.html)


have a minimum value of $4,830. Another export promotion program lets all exporters defer

import duties for up to 7 years on imported capital equipment or receive an equivalent subsidy

for domestically produced capital equipment. To comply with the FTA reached with the United

States, Chile is eliminating the use of duty drawback program for imports that are incorporated

into any goods exported to the United States. (Foreign Trade Barriers, 2007)

Under Chile’s VAT reimbursement program, exporters can recover the VAT they have

paid when purchasing goods and using services which are intended for export. To be eligible for

the VAT reimbursement program, exporters must have annual sales of less than $16.7 million.

(Foreign Trade Barriers, 2007)

Chile also offers the Guarantee Fund for small and medium sized companies. Through

this fund, Chile guarantees access to credit to these companies. This Guarantee Fund benefits all

nonagricultural companies whose annual sales do not exceed $8.2 million, and agricultural

producers with annual sales less than $460,000. (Foreign Trade Barriers, 2007)

Chile’s Development Promotion Agency provides credit for exporting companies. It also

provides credit to their export clients abroad. The maximum loan for Chilean exporters is $3

million. The program has been designed for Chilean companies with annual sales of up to $30

million that export goods and services. Through the Coverage of Bank Loans to Exporter

program, Chile provides loan default coverage to the banks that give loans to small or medium

sized companies. This benefit is only available for exporting companies with annual sales up to

$20 million. (Foreign Trade Barriers, 2007)


Export Controls

Chilean customs authorities approve all exports. Large firms must report all exports to

the Chilean Central Bank, except for copper exports, which are authorized by the Chilean Copper

Commission. Imports are exempt from duties and VAT if they are later exported as noted above.

(Foreign Trade Barriers, 2007)

Nontariff Barriers

Chile maintains a price band system for wheat, wheat flour, and sugar that will be phased

out by 2016 under the FTA for imports from the United States. The price band system was

created in 1985 and was intended to guarantee a minimum and maximum price for the certain

commodities. When certain cost, insurance, and freight prices fall below the set minimum price,

a special tax is added to the tariff rate to raise the price to the minimum price. The government

sets a minimum import price that is normally higher than both international and Chilean

domestic prices. Beginning in 2008, the minimum price will be adjusted downward by 2 percent

a year, until 2014, when Chile’s President will evaluate whether to continue the price band

system or eliminate it prior to the 2016 deadline. (Foreign Trade Barriers, 2007)

Policy Evaluation: Chilean Import Policy

Current Trade Policy and the Volume of Trade

Before analyzing the volume effects of trade policy in Chile, it would be helpful to

realize which model discussed in the text is applicable. Data from 2007 was used for this task

and for the construction of the following models. Some investigation reveals that the small

nation model should be used. In order to simplify the analysis we observe that Chile receives


98.8% of all wheat imports from just three countries: US, Argentina, and Canada3. We consider

only these three countries to see if Chile can influence its terms of trade. Consider the magnitude

of Chilean wheat imports to the wheat exports of its trading counterparts:

Chilean Imports- 1,088,000 metric tons (MT)4

US Exports- 34,000,000 MT5

Argentina Exports- 5,700,000 MT6

Canada Exports- 18,000,000 MT7

Chilean imports are rather insignificant when compared wheat exports of fellow traders. While

the text does not give an explicit definition or requirement to be considered a small nation, it is

the assumption of this paper that this requirement is fulfilled. Therefore, Chile is considered a

price taker, and cannot influence their terms of trade.

Below is a model similar to the small nation model in the text. However, it has been

modified to incorporate real figures from 2007 in regard to the Chilean wheat market. Notation

uncommon to the text is listed below the figure. The combination of the tariff and price band

together essentially form a price floor at the lower band, have normal tariff effects between the

bands and have diminishing tariff effects above the bands.(Smith, Goodwin, 1999) The graph

below reduces the analysis to the effects of the 6% tariff. An assumption of the model is that all

three countries can supply wheat at the same price. Obviously, trade has been restricted by the

tariff. Actual domestic production and imports in 2007 were 1,218,000 and 1,088,000 metric

3 USDA Foreign Agricultural Service Grain Report number: CI90064 Ibid.5 http://www.ers.usda.gov/briefing/wheat/trade.htm

6 Ibid.7 Ibid.

http://www.ers.usda.gov/briefing/wheat/trade.htm

Price

Q(000’s MT)

Sd

Dd

P1

P*

Chilean Wheat Market

Sw

Sw+6%t

23061218 1786 2306<DCDP<1218

P2A B

AR C US

1630


tons respectively8, totaling 2,306,000 metric tons. In the absence of these tariffs we would

expect to see domestic production at quantity (A) and total consumption at quantity (B). The

resulting imports are less than would be in the case of free trade (B-A).

S(w+6%t) – Supply of the world(US, Argentina, Canada) plus the 6% tariffBlue dashed line separates the market share of the respective exportersDP, DC- Domestic Production/Consumption respectivelyNote: The quantity scale is in millions of metric tons

Policy Evaluation: Economics of the US-Chile FTA

By 2016, the US-Chile FTA will have established completely free trade between the two

countries. Additionally, Canada has established a trade agreement with Chile which does not

include removal of the 6% tariff9. Therefore, US exporters will enjoy a comparative advantage

8 USDA Foreign Agricultural service. Grain Report # CI90069 http://www.international.gc.ca/trade-agreements-accords-commerciaux/agr-acc/chile-chili/chap-c26.aspx?lang=en#II

http://www.international.gc.ca/trade-agreements-accords-commerciaux/agr-acc/chile-chili/chap-c26.aspx?lang=en#II

http://www.international.gc.ca/trade-agreements-accords-commerciaux/agr-acc/chile-chili/chap-c26.aspx?lang=en#II


over Canada. Canada is a major exporter of wheat to Chile, representing nearly 15% of total

Chilean imports. Theoretically, US exporters will have a chance to absorb Canada’s entire share

of Chilean imports given the favored status. Also, Chile is an associate member of Mercosur

(trade agreement with other South American countries including Argentina), however that

agreement does not eliminate Chile’s 6% tariff on imports even among member countries10.

Consequently, the US will also have a comparative advantage over Argentina who is a much

larger wheat exporter to Chile than Canada, representing 37.9% of all Chilean wheat imports.

The same possibility exists that the US could absorb Argentina’s entire share of Chilean imports.

Depicting the changes caused by the US-Chile FTA is similar to the formation of a

customs union. While the above analysis is correct based on our assumptions, reality may prove

otherwise. Argentina may actually be a lower cost supplier than Canada and the US. This would

be possible if lower Argentine wages and transportation costs are not proportionately offset by

increased productivity in the US and Canada. It may also be acceptable to assume that Canada

and the US have similar production costs but that Canada has higher transportation costs. There

are actually three theoretical situations which may occur after the US-Chile FTA is in place

assuming that Argentina is the low cost supplier followed by the US and then Canada as the high

cost supplier:

Case One : If the increased competitiveness provided by the reduced tariff doesn’t

proportionately offset the supply price differential: Argentina may still be the low cost supplier.

Argentina would supply all the Chilean wheat imports.

10 http://actrav.itcilo.org/actrav-english/telearn/global/ilo/blokit/mercosur.htm

http://actrav.itcilo.org/actrav-english/telearn/global/ilo/blokit/mercosur.htm

Price

Q (000’s MT)

Sd

Dd

P*1

P*fta

Pd

Chilean Wheat Market: Case 3

SUS, ft

SA+6%t

SArg, ft

TC2DP1DP2

SUS+6%t

C

BA

TC1


Case Two: If the increased competitiveness provided by the reduced tariff proportionately offsets

the supply price differential: The US achieves supply cost parity with Argentina. In this

situation, the US and Argentina share the Chilean wheat imports.

Case Three(depicted below): If the increased competitiveness provided by the reduced tariff

more than proportionately offsets the supply price differential: The US becomes the low cost

supplier and absorbs all the Chilean imports.

DP1, DP2- Domestic ProductionTC1, TC2 - Total ConsumptionSUS,ft SArg,ft- Supply under free trade.

When lower prices result due to the FTA with the US, Chile’s consumption will rise. This is

shown in the graph as a movement from total consumption (TC)1to TC2 . The welfare gain

associated with this increase in consumption is represented by triangle B. The formation of the


FTA also yields a production effect that result in a more efficient use in resources. Eliminating

the tariff barrier against the US forces Chilean producers to face increased competition from

more efficient US producers and forces inefficient Chilean producers out of the market. The

reduction in costs while obtaining increased output, the production effect, is noted by triangle A.

The overall trade creation effect is the sum of the triangles A and B. There is a corresponding

trade diverting effect (area C) from the free trade case to this situation in which trade is diverted

from Argentina, which is the low cost supplier and is transferred to the FTA partner, the US.

Overall welfare analysis would conclude with the determination of which effect is larger.

Policy Evaluation: Distribution of Income

Income Effects- Rich vs. Poor

The import tariff and price band system employed by Chile is likely to have income

distribution effects. Wheat is typically resold as-is or used in the production of various food

products. Families with low incomes spend a proportionately larger share of their income on

food purchases. Therefore, these policies should have a disproportionately negative effect on

low income families in Chile. The more affluent persons in Chile will be largely unaffected by

this import policy. (Carbaugh, 2007)

Chilean academic research has been done which opposes the view held by our text. In an

in-depth study to estimate the effects of removing both the import tariff and price band system on

agricultural and food commodities in Chile, Holland and Figuera discover that potential gains in

welfare from lower agricultural prices are offset by increased urban unemployment and lower

rural wages resulting in net welfare loss in Chile. (Holland and Figueroa, 2002) This research is


in direct opposition of what we have learned this semester. Our text states “As long as it is

assumed that a nation accounts for a negligible portion of international trade, it’s levying an

import tariff necessarily lowers its national welfare.” (Carbaugh, 2007) The Chilean research

carries a rather static view about the employment opportunities of workers who are laid off

subsequent to the removal of trade barriers.

Income effects- Producers vs. Consumers

The Chart below shows the redistributive effects of income due to the tariff policy in

Chile. In the case of free trade, Chile’s consumers would have a consumer surplus equal to

Areas (A+B) in blue. The imposition of the tariff is reflected in the chart by the black arrow.

After this tariff, Chile’s consumers face higher prices. This is shown by the transfer of surplus

(income) from the consumers to producers depicted by “A” going from blue to red. In Summary,

for a small nation like Chile, a tariff placed on an imported product is entirely passed on to the

consumer in the form of higher prices. Consumer surplus (income) falls as a result.

Price

Q (000’s MT)

Sd

Dd

P2

P1

P*

Producers vs. Consumers

Sw

Sw+t

TC2DP1 DP2

A

B

C

A

TC1


Recommendations:

Based on the assumption that Chile is a small nation, our first analysis reveals the current

import policy restricts trade. This plays out in the Chilean economy in the form of higher prices

and less choice for the consumer. In this regard, it would be in the best interests of Chilean

policy makers to reduce or remove the restrictions on trade. The formation of the customs union

through the US-Chile FTA is a step in the right direction. Further reduction of trade barriers will

eliminate trade diverting effects inherent with the formation of the customs union and further

increase welfare in the Chilean economy. The third analysis shows that a reduction in trade

barriers will increase consumer income and thus reduce the burden of high prices on the low

income families in Chile. It follows then, that complete removal of all trade barriers is our

recommendation.


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