How Latin America Pays the Price of Protectionism

By Taos Turner & Paul Kiernan of the WSJ.

"For decades, South America’s two largest economies have tried to shield their workers from global trade, largely through high tariffs and regulations that promote domestic production over imports. The World Bank ranks Argentina and Brazil among the world’s most closed big economies.

In Brazil, locally made products are enshrined in the constitution. Gadget-loving Argentines often use the black market or go to Miami to buy iPhones, which were barred for years because Apple wouldn’t produce them in Argentina.

In Tierra del Fuego at Argentina’s southern tip, where cruise ships sell sightseeing tours of icebergs and penguins, one can see the results of an experiment to create a “Made in Argentina” electronics manufacturing hub. To help it thrive, the Argentine government slapped a tariff of up to 35% on imported electronics.

Now, 14,000 workers in 55 factories in this grimy industrial town and the nearby tourist paradise of Ushuaia churn out products including phones, TVs and air conditioners. Most of the components are Asian-made, imported duty free and assembled by Argentine workers, with a few local components like Argentine-made screws thrown in. Chinese, Japanese and Korean executives have moved to Tierra del Fuego to oversee the production of everything from Samsung phones to Sony TVs, officials at several factories said.

The cost to Argentina’s taxpayers of these jobs is steep: up to $72,000 per factory worker a year, including tax breaks and other incentives, officials say. The largess was needed, said former President Cristina Kirchner, because “without manufacturing, we’d have no country and no future.”

But for ordinary Argentines, the products’ price tag can be hefty. An unlocked Samsung J7 smartphone sells for $240 in the U.S. but costs nearly $500 in Buenos Aires.

“The irony is that people who live here don’t buy the products made here,” said Cintia Davalos, 27, who works in a Tierra del Fuego five-and-dime. She explained that residents will drive seven hours to free-market Chile to buy everything from auto parts to clothing to TVs.

“Taking a protectionist turn would be extraordinarily disruptive, not just for our trading partners but for the United States,” said Eric Farnsworth, a former U.S. diplomat who is now vice president of the Council of the Americas.

He and other advocates of free trade often highlight the self-inflicted wounds that protectionism has caused economies in Latin America. Here, import substitution gave Mexicans the notoriously unreliable Zonda TV back in the 1970s and left Brazil producing the 1950s-era Volkswagen Type 2, or hippie bus, until 2013.

Most countries have long abandoned that model. Mexico, for instance, has become a global leader in free trade, signing deals with 44 countries. Since 2010, Latin America’s open economies—tied together in the Pacific Alliance, which groups Mexico, Colombia, Peru and Chile—have grown by an accumulated 29.7%.

Meanwhile, members of Mercosur, the protectionist trade bloc led by Argentina and Brazil, grew 19.4% and had less investment and much higher inflation, according to a study by Santander Rio. In Brazil, Latin America’s largest economy, exports accounted for just 13% of GDP last year—a fraction of the ratio in trade-focused economies such as Mexico (33%) or Germany (50%). In Argentina, exports are 11% of GDP.

Critics warn that Brazil’s long history of protectionism bred complacency in its manufacturers, leaving them unprepared and vulnerable.

Consider Brazil’s auto industry, until recently one of the world’s 10 largest. Shielded for decades by high tariffs, it has devolved into a peddler of rinky-dink hatchbacks with one-liter engines that barely sell outside of the Mercosur bloc. After nearly three years of deep recession, with few export markets to support the industry, output has fallen some 45%. And for Brazilian consumers, cars are far pricier: A new Volkswagen Gol Comfortline lists in Brazil at $15,231—nearly twice as much as in Mexico, which has low tariffs and an efficient car industry.

The effects of protectionism go beyond cars. After big offshore oil finds a decade ago, Brazil’s government set “Made in Brazil” mandates for drilling vessels, refineries and shipyards. That drove up costs and fostered corruption.

But Nicolas Dujovne, a former Argentine central bank director, noted that Argentina—a big, resource-rich country with a relatively well-educated workforce—still hasn’t become an industrial country. “The losers from populism can be found everywhere,” he said. “They are the millions of jobs and hundreds of thousands of companies that were not created because of very disorderly macroeconomic policies.”