Professor Helson C Braga examines prospects for South American free zones under the Free Trade Area of the Americas.

The role of free trade zones in South America is not only to facilitate the trade liberalisation process in goods and services. It is also to provide a bureaucracy-free environment, free trade conditions (duty free machinery, equipment and materials) and stability of the rules of the game for investors that want to process raw materials for export.

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A free trade area or customs union is in many ways an enlarged domestic market. Therefore, the issue of whether or not free trade zone (FTZ) investors should be allowed to sell in regional markets is an extension of the domestic market sales issue. Consequently, the relationship between the FTZ and the free trade area (or the customs union) should be similar to that between the FTZ and the domestic market.

Mexican fortune

Recently established zones in Central America, the Caribbean and Africa do permit some domestic sales, if the import duty is paid on the imported content incorporated in the finished product. The Mexican maquiladora industry (firms operating under a free zone status) grew even faster following the North American Free Trade Agreement (NAFTA), due to the foreign investors’ confidence and the substantial difference between US and Mexican wages. From 2001 on, the maquilas were to be allowed to sell up to 100% of their production into the domestic market. These sales could benefit from NAFTA preferential treatment provided they meet rules of origin standards.

In the Central America Common Market (Guatemala, El Salvador, Honduras, Nicaragua and Costa Rica), the general rule is that FTZ production is to be exported. Yet, a part of the production can be sold domestically under restrictions of a maximum percentage of the production, the payment of corresponding duties and meeting other commercial regulations.

The countries of the Andean Community (Bolivia, Colombia, Ecuador, Perú and Venezuela) allow sales into the domestic market. With the exception of Venezuela, they treat the products coming from a FTZ as regular imported products. Venezuela charges duties only on the imported content incorporated in the imported product. Owing to the differences among national treatments, the Andean Community’s executive secretariat has been making efforts to harmonise these conditions.

MERCOSUR rules

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According to the MERCOSUR (Mercado Común del Sur or Southern Common Market) Decision 08/94, a product originating from a regional FTZ shall be treated as a third-country product and as such it will be charged with the common external tariff. Brazilian legislation goes even further: it prohibits a local FTZ from selling into the national market. For a country or a group of countries seeking to stimulate economic activity, it is illogical to place any producers there at a disadvantage.

A longstanding concern in the FTZ community has been to see that regional trade negotiations or World Trade Organization (WTO) rules do not reduce the freedom and efficiency of FTZs and EPZs. The lack of precise rules relating to FTZs leaves it open to the integration agreements to set such regulations, which may impair FTZs’ operation.

NAFTA rules, for example, eliminated the provision of duty-free importation of inputs regardless of origin, which is one of the most important characteristics of FTZs. Since 2001, whenever maquiladoras use non-North American inputs, the conventional duty drawback provision has applied. Under this provision, maquiladoras receive a duty refund for the lesser of duties paid in Mexico for imported inputs or the duties paid on the final product when entering the US or Canada.

This new rule did not result in a generalised increase of maquiladora production costs because the Mexican government decided to reduce the duties on third country inputs substantially, both for maquiladora and non-maquiladora firms. Thus, much of the original maquiladora scheme of allowing duty-free entry of inputs into Mexico, regardless of country of origin, has been maintained.

As it is most likely that the Free Trade Area of the Americas (FTAA) will replicate the NAFTA general provisions, a possible detrimental effect to South American FTZs can be expected, reducing the duty-free privileges that made these zones a powerful mechanism for the promotion of export-oriented industrialisation worldwide.

Desirable scheme

A more desirable scheme of harmonisation, used by most countries and equally consistent with WTO rules, would be to allow FTZ companies to import third countries’ inputs duty-free and charge them when the final product enters the regional market. People involved with FTZ development in South America should assist their national negotiators to the FTAA to maintain this understanding and try to make their NAFTA counterparts accept it. This scheme would facilitate the use of the FTZ mechanism for the attraction of foreign investments and the modernisation of regional industrial sectors.

Professor Helson C. Braga is at the Federal University of Rio de Janeiro and Getulio Vargas Foundation, Brazil, and is president of Associaçăo Brasileira das Zonas de Processamento de Exportaçăo (Abrazpe).

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