A Tale of Two Regions

With official growth rates reported at 9.4% per year from the beginnings of its economic reform process, China has been the fastest growing world economy in the last 25 years. Latin American growth pales in comparison. Whilst China has gone from strength to strength, Latin America has remained largely in the doldrums. Overall growth for the region since 1978 has come in at a measly annual 2.2%. The mid-1990s saw a tentative recovery from Latin America's so-called 'Lost Decade', which followed the debt crises that swept through the region in the early 1980s, but GDP per capita once again stalled between 1998 and 2003. The average increase in Latin America is just 16% from 1978. In China the increase is over 700%, according to official Chinese government figures and 400%, according to figures adjusted by World Bank economists.

Threat and Opportunity

It was China's accession to the World Trade Organization (WTO) at the end of 2001 that really stoked fears in Latin America. The region was concerned that it simply would not be able to compete against the Asian behemoth's cheap labour and production costs. For many, this turned out to be the case, particularly those involved in the maquila (assembly) industry. Mexico's maquila industry has lost approximately 170,000 jobs over the last three years, while FDI inflows fell back from the merger-fuelled bonanza of US$26.6bn in 2001 to US$11bn in 2003. And it is not just in Mexico where investment has fallen. Brazil too has seen FDI levels fall sharply, as has the region as a whole - the UN's Economic Commission for Latin America and the Caribbean (ECLAC) puts the region's FDI inflows for 2003 at 37% down on its peak in 1999. While China is never going to be the sole cause for these falls (the decline of mass privatisations, for example, has also played its part together with a host of other factors), its recently acquired status as the pre-eminent global foreign investment destination with US$53bn of FDI in 2003 suggests that it is at least in part responsible.

Paradoxically, China's rise is also a key reason for an upturn in many Latin American economies in 2004. It is also set to be a major investor, particularly in South America.

Key countries, such as Brazil, Argentina and Venezuela, are all looking stronger than they have for some time. The spectre of default no longer hovers over Brazil. Argentina is recovering from its default crisis. Although growth in 2003 came in at just 1.5%, ECLAC estimates growth at 3.5% in 2004. Much of this upturn is due to international economic conditions, including low interest rates in Europe, the US and Japan, and favourable exchange rates. A pick-up in the US and Asia is also partly responsible, but it is the massive increase in demand in China, leading to higher commodity prices, that has been the most eye-catching, if not the most significant factor. 

There is now a growing realisation in much of the region that warming trade relations with China have potentially significant long-term benefits. Nowhere is this more the case than in South America. Despite fears of an imminent slowdown, China's economy continues to boom, with growth rates of around 9.1% in 2004. Industrial output is expected to increase by 16.1% and the country has a voracious appetite for commodities including steel, oil, gas, carbon, steel, cement, rubber, aluminium, platinum, nickel, copper, iron, soy and other foodstuffs. Into the breach has stepped Latin America, and in particular the Southern cone. Farmers across the region cannot plant soy fast enough to satisfy the Chinese demand. Brazil is selling huge amounts of iron ore, and Chile and Peru are producing vast levels of copper. Commodity exports from Brazil and Argentina alone helped Latin America towards a US$3.3bn trade surplus with China last year and contributed to a phenomenal 50% increase in overall trade to US$28.8bn. At the moment this booming trade relationship is overshadowing fears in countries such as Mexico, Honduras and the Dominican Republic, which depend on the US for exports of low-cost manufactured goods, textiles and electronics. Just as these manufacturing processing countries remain fearful of the China effect and their inability to compete, others are beginning to see its full potential as a complementary trading relationship evolves.

Trade Leads to Investment 

Increasing volumes of trade have had a knock-on effect in investment as Chinese firms 'internationalise'. In 2003 China invested approximately US2.9bn worldwide. This figure is bound to increase vertiginously as controls on outward investment are progressively eased. Over half of this amount went to other Asian countries, but more than a third went to Latin America, a region that not so long ago did not feature on the Chinese investment radar. 

Chinese Foreign Investment 2003
	Millions of US$	% of Total
Asia	1,534	52.6
Latin America	1,065	36.5
Europe	151	5.3
Africa	76	2.5
US and Canada	59	2
Oceania	33	1.1
Total	2,918	100
Source: Chinese Office of National Statistics

This trend towards increasing Chinese investment in Latin America was very much confirmed by a recent tour of the region by Chinese Premier Hu Jintao, which underlined just how important trade ties have become . In the wake of the trip the Brazilian government is hoping for and expecting around US$5bn in investment from Chinese companies in the modernisation and expansion of the rail system, which would allow for increased transport capacity for shipping commodities and raw materials to Brazil's ports. It is hoped another US$3.6bn will go to the mining and steel industries. Chinese firm Baosteel, and Chinese carbon producers Red Dragon, Yankuang and Yongcheng, are to build a new plant in the north of Brazil in conjunction with the local Vale do Rio Doce company (VRD). VRD is also about to construct an aluminium refinery with the Chinese firm Chalco in the same area. Other such plans exist in the wood sector, electrical goods and soy, where Brazil, with tax benefits and cheaper land, remains more competitive than neighbouring Argentina. The Chinese oil firm Sinopec has also been chosen by the Brazilian government to enter into a deal with Brazilian counterpart Petrobras for a US$1bn agreement to build the South-East-North-East (Gasene) pipeline, expected to be completed by 2006. 

Investment has been less significant in neighbouring Argentina, but is rising considerably. As part of his recent Latin American tour President Hu Jintao signed a series of co-operation agreements, marking the first phase of what he called a new 'strategic partnership' that could net Argentina up to US$20bn in investment over the next 10 years. At the moment investment in Argentina is less significant than that in Brazil and is focused mainly on the fishing sector, electrical assembly plants, textile factories and supermarkets. Even before Hu's visit investment was, however, increasing. For example, before the visit the state-owned Chinese firm Zhinsi announced a US$20m investment in a new tobacco factory in north-eastern Argentina, while the mining company Ling Cheng won a tender to resurrect the country's only iron ore mine in Patagonia. With Hu's November visit came the announcement of a series of trade and investment deals, expected to massively increase direct investment by Chinese companies and boost trade between the two nations. 

The Chinese leader said that his country planned to invest US$100bn in Latin America as a whole over the next decade. The two main beneficiaries of this grandiose plan will be Brazil and Argentina. After a private meeting, Argentine President Néstor Kirchner and Hu announced a series of investment accords in areas as diverse as rail, aerospace, education, tourism and trade. According to Lo Fong Hung, chief executive of the China Construction Bureau, US$20bn is earmarked for investment in Argentina: some US$8bn to finance urban and interurban railways; US$5bn in fossil fuels over five years; and a further US$6bn towards building 300,000 new homes and other infrastructure projects, including communications and satellite technology projects. Specific letters of intent include a potential investment of US$730m by China Beiya Escom, China Unicom and Hong Kong New World Group in telecoms and satellite equipment. China Beiya Escom and China Railway 20th Bureau Group are also looking at investing US$8bn over the next decade to expand Argentina's railroad system. This would be the biggest ticket item and includes a potential project to build a rapid rail link between Buenos Aires and the country's two next-biggest cities, Rosario and Cordoba. Chinese companies may also be involved in the construction of a 'rapid and dynamic' rail link between Buenos Aires and its international airport, Ezeiza, on the outskirts of the city and there are plans for Chinese capital to fund the electrification of the Belgrano and San Martin commuter rail lines within the greater metro area of the capital. Under the housing and infrastructure construction accord, another US$6bn from New World Property Development Limited and the China Construction Bureau/China Railway 20th Bureau Construction, is earmarked for construction and infrastructure projects that aim amongst other things to create some 300,000 houses during the next five years. Meanwhile, China Sonangol (a joint venture between China and Angola's national oil company) has tentatively offered to invest US$5bn in Argentine oil exploration over the next five years, aimed at developing resources for the internal Argentine market and for exports.

Of course these deals are merely tentative at the moment, but whatever happens it seems inevitable that Chinese investment in the region, and in Argentina and Brazil in particular, is set to increase significantly over the coming years, even if not by the exact amount stated. 

Latin America Eyes Market Economy Status with Suspicion

In return for these promises of massive investment both Argentina and Brazil, along with others including Chile, have recognised China's market economy status. This is a real boost for China as it seeks to integrate itself into the world economy - for one thing, market economy status would make it much harder for other countries to slap anti-dumping penalties on Chinese exports. For this very reason, many other Latin American nations, and even many businesses within Brazil and Argentina, are vehemently opposed to granting China market economy status. While it is true that on average Latin America is a winner from China's global economic integration, it is a very different case for the maquila industry, as well as textiles and electronics exporters, among others. Countries such as Mexico, Honduras and the Dominican Republic are likely to lose out from China's increasing market share in Latin America as they struggle to compete in areas where China has the advantage. For them China's increasing presence will mean, above all, a flood of cheap goods to world markets with which they cannot compete. Although increased levels of investment may help to reduce some of the risks for textile and electronics producers in countries such as Argentina, Brazil and Chile, little investment is likely to head their way. For them, and many other Central American and Caribbean nations, China's increased economic influence is likely to be simply negative. 

Risky Dependence Once Again?

Moreover, questions are already being raised over how sustainable this Chinese-led boom really is. Commodities are subject to wild price swings and dependence on a narrow range of primary products once again hangs over Latin American economies like a Sword of Damocles. 

Whilst Latin America has largely wallowed in the economic doldrums in the post-war period, Asia as a region has generally performed well. Like South America, the so-called Asian tiger economies were also mainly agricultural and primary product exporters. One of the key differences between the two regions and their development paths is that, having industrialised, Latin America continued down the path of Import Substitution Industrialisation (ISI), whereas the Asian tiger economies moved swiftly to export-led development. The latter was clearly the winning strategy. In the 1960s Argentina had a GDP per capita four-and-a-half times greater than South Korea's. Now the average South Korean income is four times that of Argentina. Another problem for Latin America was the ossification of the ruling classes and their vested interest in maintaining a form of dependence on primary product exports, vulnerable to massive price fluctuations. While Latin America's comparative advantage may help to keep the region's balances of payment on track, it also militates against development along the Asian tiger economy lines by encouraging a risky dependence on primary products open to wide swings in global prices, although with a more diverse economy that existed in previous decades this dependence would be less acute than it has been in the past. Latin America has another chance to make this a more sustainable process by doing what it has failed to do in the past - processing products and adding value on a larger scale. Processed coffee must start replacing coffee beans, steel replacing iron ore and so forth, if this opportunity is not to be squandered.

Overall the China effect offers many Latin American countries a golden opportunity to capitalise on their comparative advantage in commodities. This in turn affords the possibility of strengthening the region's balances of payment and reducing debt levels to reinforce macro-economic stability. Much will, of course, depend on the trajectory of the Chinese economy. Growth is set to come in at around 9% this year, but it is set to slow next year as authorities impose macro controls to bridle the recent unstable investment boom behind the recent growth cycle. We are currently forecasting growth at 7.37% for 2005. That would be a small reduction, but could have a significant impact. Even a small fall in Chinese growth, and the corresponding decline in demand, could have a large impact in commodity prices. While we predict continued strong demand in China for Latin American commodities into 2005, the more distant future remains less certain, which is one reason why it is so crucial for those that can to build on this current opportunity. 

A Seismic Shift in Latin America's Foreign Relations?

Of course, the increasing economic relations between the two sides have political ramifications too. China is notably ramping up its diplomatic presence in Latin America just as the US has been showing little in the way of interest in the region. When he was elected in 2000, US President George Bush pledged to make Latin America a priority. He started off well. Indeed, the first foreign visit of his presidency was to Mexico, but the region's high hopes were soon shattered. The terrorist attacks of 11 September 2001 ended this inchoate Pan-American heyday before it had even really begun. From then on, Latin America was once again placed on the back burner as the war on terror diverted Washington's energies. While the Bush administration has engaged with Latin American leaders on an ad hoc basis to progress trade treaties or demand enhanced security co-operation, it has come in for sharp criticism for failing to respond adequately to economic and social crises facing Argentina, Bolivia and Haiti. The fact that Chinese President Hu spent more time in South America during his recent visit than President Bush has in four years will not have been lost on many Latin American leaders. 

Sino-Latin American relations are now developing on several levels other than pure commerce. For example, China has recently sent security personnel to Haiti to help with the UN peacekeeping mission there. The monthly 'China Today' publication has set up shop in Mexico City. More Chinese language and cultural centres are set to spring up around the region as ties develop. Yet despite all this momentum, there is unlikely to be a fundamental change in the Latin American balance of power in the short to medium term. Of course countries such as Brazil are keen to talk up the importance of ties with China and there is indeed a great deal of potential for yet closer economic and political ties in the future. But China's importance should not be overstated. For a start the sustainability of this commodity-driven economy coming together remains in question. Furthermore, geography and culture will always remain important factors. The simple fact of the matter is that most Latin Americans would rather have stronger ties with the US. That said, however, the Washington Consensus, which pushed to promote democracy and market reform in the region in the post-Cold War context, is more or less in tatters. Painful financial crises across the region and the lack of progress towards improving human development indicators have made this abundantly clear. The region's increasing rejection of dogmatic Washington Consensus-style market-friendly economic policies is plainly evident from the rise of leaders such as Lula in Brazil, Kirchner in Argentina and most recently, Tabaré Vázquez in Uruguay. While countries such as Colombia, which receives massive US assistance, and Mexico are likely to remain firmly in the Washington camp for the foreseeable future, increased Chinese influence could help to accentuate divisions in the region over time and eventually assist the establishment of new regional power blocs. 

Key Predictions

Chinese demand for Latin American primary products will remain strong into 2005 despite a slight fall in Chinese growth. 

Over-reliance on notoriously volatile primary product exports could once again become an issue for some Latin American countries. 

Brazil and Argentina are set to be the main beneficiaries from increased levels of Chinese investment in Latin America over the coming years.

Maquila, textile and electronics industries in countries such as Mexico, Honduras and the Dominican Republic are set to be net losers from the 'China effect', especially if China finally manages to win market economy status. 

Increasing political and cultural ties will go hand-in-hand with burgeoning levels of commerce. In the short term there is unlikely to be a fundamental change in the Latin American balance of power, as most Latin American nations continue to prefer political and economic relations with the US. Nevertheless, increased Chinese economic and political influence could influence the emergence of new power blocs in the region in the medium term.

Raul Dary- WMRC
24 Hartwell Ave.
Lexington, MA 02421, USA
Tel: 781.301.9314
Cel: 857.222.0556
Fax: 781.301.9416
raul.dary@globalinsight.com

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