RaboResearch - Economic Research

Latin America: Trump-eting throughout the region

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  • A large-scale protectionist package by the US could affect economies in Latin America via lower exports, foreign direct investment and remittances
  • Vulnerability is high across the board in the region, with Central American countries being most exposed
  • Our base case is that President Trump will refrain from serious protectionist measures given their large adverse effect on the US economy, already visible in the short term
  • In the US, protectionist measures could shave off 6 percentage points (ppts) of economic growth over four years. These cumulative effects could be as large as 1.7ppts and more than 5ppts, for Brazil and Mexico respectively

On several occasion, US President Donald Trump has threatened to impose trade barriers in order to protect US manufacturing. In Trump’s opinion, the US’s large trade deficit illustrates dishonest trade practices by its trading partners. President Trump has been focusing on countries with which the US records the largest trade deficits and has promised to tear down NAFTA and introduce an import tariff of 45% on all Chinese imports, 35% on Mexican imports and 35% on German cars. Moreover, Trump has threatened to tax remittances.

However, the protectionist measures taken in the first nine months of  have been very limited. So far, he has only terminated negotiations on the so-called Trans-Pacific Partnership (TPP) and has announced an import duty on Canadian softwood lumber. Although it is still unclear what Trump’s protectionist policy agenda will look like, a large-scale protectionist package could seriously affect many economies in Latin America, via lower exports, foreign direct investment and remittances.

Exports

The United States is largest export market for many Latin American countries (Figure 1) and high added value manufacturing in particular. Mexico stands out with a whopping 80% of its goods exports ending up on US markets. Nicaragua, Honduras, Costa Rica and Ecuador also have a high export exposure to the US, but given the share of high manufacturing value added, Mexico and Costa Rica are most vulnerable to protectionism. If we shift our focus to Mexico, a country which has been in Trump’s crosshairs as a possible target for protectionist policies, we see that roughly four sectors are responsible for the US trade deficit: motor vehicles, mining, electronic products and electrical machinery (Figure 2).

Figure 1: US is the largest export market for many Latin American countries
Figure 1: US is largest export market for many Latin American countriesSource: IMF DOTS
Figure 2: Four industries are responsible for US-Mexican trade deficit
Figure 2: Four industries are responsible for US-Mexican trade deficitSource: OECD TiVA database

It is interesting to note that trade deficit of the US in these four sectors (USD 90bn) exceeds the total US trade deficit with Mexico (of USD 60bn), because of large trade surpluses in other sectors such as such as fuels. From a trade perspective, the motor vehicle industry is particularly important for Mexico. Data from the OECD STAN database shows that Mexico’s auto industry has a share of 3% within total Mexican value added, a share of 4.1% in Mexico’s gross operating surplus and provides jobs to 433 thousand people. Moreover, Biondi (2017) concludes that 70% of vehicle exports go to the US and Mexico is now the world’s 4th largest automobile exporter, behind Germany, Japan and South Korea.

FDI and remittances

The largest recipients of FDI in terms of percentage of GDP are Costa Rica (2.6%), Chile (2.1%) and Nicaragua (1.6%) (Table 1). However, considering the size of the current account deficit and the share of the US in inward FDI, it is actually Costa Rica, Mexico, El Salvador, Argentina and Guatemala, which are vulnerable to a reduction in FDI flows. In terms of remittances, the US is an important source of such flows for Central American countries and Mexico. However, US remittances are an important source of income for the current account only for Honduras, El Salvador, Guatemala and Nicaragua. A fall in US remittances thus would have severe consequences for the current account deficit of these countries.

Table 1: Economic indicators on economic ties between the US and Latin America
Table 1: Economic indicators on economic ties between the US and Latin AmericaSource: IMF, EIU, Moody’s

Expectations

Our base case, however, is that President Trump will refrain from serious protectionist measures given their large adverse effect on the US economy and the fact that it would materialize in the short term. Any protectionist trade barriers by the US would be retaliated by other countries, which would damage US households’ purchasing power. Moreover, such policies would be at the expense of political capital, could jeopardize WTO membership and would disrupt global value chains and revenue streams of US firms, thereby undermining corporate investment and profits (see Erken et al., 2017). To put this into perspective, analysis by RaboResearch shows that US firms are very prominently integrated in three Mexican industries: motor vehicles (18.1%), electronic equipment (17.2%) and electrical machinery (16.7%)(Figure 3). The percentages represent the share of US value added in exports to the US. Thus, protectionist measures would disrupt these supply chains and harm US firms and consumers. The deeper the integration of US firms within global value chains, the more difficult it is for the US to implement protectionist trade measures.

Figure 3: Breakdown of American value added in Mexican motor vehicle exports to the US
Figure 3: Breakdown of American value added in Mexican motor vehicle exports to the USSource: Rabobank

That said, these arguments are purely based on economic rationale, which might not prevail if President Trump continues to face major setbacks with his domestic policy agenda, including the repeal and replacement of the Affordable Care Act (Obamacare). Moreover, even with most outspoken nationalist advisor Steve Bannon ousted in August, there is still little chance that the Trump team will completely abandon its protectionist stance, as two key advisors and advocates of nationalist trade policies still remain in charge: US Trade Representative Robert Lighthizer and Commerce Secretary Wilbur Ross. Should the Trump team resort to protectionist measures anyway, scenario analyses by RaboResearch shows that the US economy could miss out on 6 percentage points (ppts) of economic growth over four years (compared to the situation where the US would not end up in a trade war). For Brazil and Mexico, these cumulative effects could be as large as 1.7ppts and more than 5ppts, respectively. The bottom-line is that a trade war initiated by the US would only create losers in the Americas.

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Author(s)
Hugo Erken
RaboResearch Global Economics & Markets Rabobank KEO
+31 6 2223 1650
Alexandra Dumitru
RaboResearch Global Economics & Markets Rabobank KEO
+31 6 2326 6856

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