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Long Read: Chile’s lost trade policy consensus

Chilean national flag in the government area of Santiago. March 2023. Credit: Iana Dreyer.

A country known for being a poster child of free market economics and open trade is questioning its model amidst social disquiet at home and challenging geopolitics abroad. Iana Dreyer shares her insights into the trade policy of a resource-rich South American country with which the EU has upgraded an existing bilateral free trade agreement.

Sixteen months in, the government of Chile’s millennial leftwing president Gabriel Boric has hit serious roadblocks in its attempts to overturn how the country does business – including international trade.

The estallido’s long shadow

The coalition headed by president Boric was swept to power in 2022 in the wake of a social protest movement Chileans call the ‘estallido social’ – the social ‘explosion’ or ‘blast’.

The unrest was triggered in October 2019 by an increase in Santiago metro fares and resulted in an attempt at drawing up a new constitution. This came after half a decade of low economic growth which brought with it stagnating incomes and a halt to two decades of success in reducing the country’s notoriously high inequality rates.

The constitutional drafting process, which took place during the Covid-19 pandemic, has sought to draw the line under the Pinochet dictatorship and add a new social and environmental dimension to Chile’s societal contract.

The Boric government’s coalition stretches from centre-left moderates to hard-core leftist parties and includes also the communist party.

Boric’s initial attempts to steer away the most prosperous South American country – after tiny Uruguay – from its to-date successful free-market, free trading, small-government economic model rapidly crashed against some ingrained economic and institutional realities in the country.

The new constitution, put together by an elected 154-member assembly, put forward many radical changes, including dropping the country’s unitary state model, legalising abortion, and introducing many environmental and social norms. The draft put to the electorate was ultimately rejected by an overwhelming majority of 62% of voters in September 2022.

The attempted changes of the Boric government have also involved the country’s trade policy. But these have largely stalled too.

Staying the course on CPTPP

In October 2022, one month after the country rejected the constitution, an emboldened upper house, the Senate – which the draft constitution intended to abolish – finalised the ratification process for Chile’s accession to the Asia-Pacific trade accord CPTPP.

“The system has many locks,” Alejandro Jara, a former Chilean trade diplomat and former deputy director-general of the World Trade Organization, told Borderlex in Santiago in March. “You can’t change policy direction overnight”.

The Comprehensive and Progressive Trans-Pacific Partnership is the successor treaty to the TPP out of which the United States ultimately pulled out in 2017 after being its dominant negotiator.

Boric’s state secretary in charge of trade, José Miguel Ahumada – an outspoken opponent of CPTPP membership – delayed the coming into force of the agreement by seeking to sign side-letters with other members that suspend bilaterally the deal’s investor-state dispute settlement provisions.

Only a few side-deals materialised, only one of which is publicly available at the time of writing, namely the one with New Zealand.  Sources close to the cabinet of Ahumada said that there was a side letter with Mexico and that Chile and Malaysia also mutually agreed to suspended the application of a bilateral investment agreement concluded between them.

CPTPP finally came into force in Chile at the end of February 2023, with the more centrist wing of the coalition in government wanting the deal to materialised. Chile was the penultimate signatory country to ratify the treaty.

Ahumada for his part was ousted from government a few days after CPTPP came into force.

He lost out in a cabinet reshuffle that followed on a tax reform bill blocked by parliament. This left president Boric scrambling for support and for a new governing strategy. Boric then ushered in much more moderate and centrist figures.

The country’s new foreign minister, who is also half Dutch, Alberto van Klaveren, is an old hand in Chilean diplomacy. The trade secretary working under his watch, Claudia Sanhueza, is considered a moderate pragmatist politician.

Ahumada, an academic of the Latin American structuralist ‘dependency’ school of thought, had previously written against trade agreements of CPTPP hue and against the World Trade Organization.

Under this school of thought, these ‘neoliberal’ trade agreements, whose terms are seen as dictated by the world’s rich countries, reduce the policy space of peripheral economies and keep them forever tied to a role of commodity providers, thus stymying their development.

Investor-state dispute settlement, intellectual property right protections and restrictions on subsidies and local content requirements for industrial projects – typical commitments included in such agreement –  are seen as devices through which rich countries ‘kick-away the ladder’ of development to keep poor countries down, reduced to a role of raw materials providers.

While there is acknowledgement of China’s rise and of developing countries rising commodity export dependency on China, the core of the blame for ‘dependency’ and poverty remains the ‘neoliberal’ Western-led trading order – as laid out in an article Ahumada co-authored on ‘Center-periphery relations in the 21st century’.

Lost consensus on trade

Chile’s trade policy has for decades been anchored in an open-trade strategy that aims to boost exports globally.

Having someone in power such as Ahumada was a small shock to the tiny trade policy ecosystem in and around government. During his tenure there were many tensions between the state secretary and the highly experienced civil servants involved in trade policy.

Chile’s trade strategy was developed in the 1990s, after the end of the Pinochet dictatorship.

It included support for the WTO, where Chile is an active member of the subsidies-sceptic Cairns Group on agriculture. Today Chile is an Ottawa group member in Geneva pushing for reforms at the global trade institution. Chile holds the pen with South Korea for a new plurilateral investment promotion agreement at the WTO.

Chile has developed over the years a dense network of over 30 bilateral or regional free trade agreements, including with the United States, the European Union and China.

More recently Chile has pursued new digital agreements to boost electronically transmitted trade. Chile is one of the parties to the Digital Economic Partnership Agreement with Singapore and New Zealand – a deal that might expand to include Canada and South Korea.

Until recently too, Chile was a staunch advocate of foreign investment protections and old-school investor-state dispute settlement. This was a means to signal it is a country open for investors and a reliable place to do business in with low levels of corruption.

This trade policy model has long been seen as suited for a country with a small population of less than 20 million people and ample natural resources. It has also long been consensual among the Chilean electorate.

But this laissez-faire model has hit its limits.

Slogans such as ‘Vivir mejor sin TPP-11’ – ‘living a better life without TPP-11’ – are a common sight on the walls of Santiago. Picture credit: Iana Dreyer, February 2023

Large swaths of public opinion turned against CPTPP during the years when its core text was negotiated in the Obama era. Washington’s demands before it pulled out of the deal in 2017 on issues such as patent protections for pharmaceutical companies or investor-state dispute settlement.

Whilst the CPTPP removed the most controversial US-inspired measures notably on pharma, its image is tarnished.

Chile’s more technocratic circles also acknowledge that the population seeks a more inclusive way of doing business and trading across borders and that governments have lacked the ability to engage civil society groups early in the process of negotiating trade agreements.

Chile’s trade agreements are gradually veering towards greater consideration for other social and environmental issues, including some that are not ‘dictated’ by large powers such as the US or the EU on labour and the environment.

Chile, for example, has championed chapters on gender equality and convinced the EU to adopt gender norms in its own free trade agreement upgrade with the country, for example.

But to people like Ana Novik, a Chilean national working as head of the investment division a the OECD in Paris and to Paulina Nazal, a former Chilean trade official, Chile needs to go further in its trade agreements on social issues – while staying the course on being an open, outward oriented economy.

“An additional effort must be made to see how Chile better links its domestic policies, particularly labor, education, training, innovation and SMEs, in order to achieve a greater diversification in production and incursion into new productive sectors, including services,” the two write in a joint paper published in the Latin American Journal of Trade Policy in 2020.

A new ‘dependency’

Chile is finding that it has increased its economic and in particular commodity export dependency, notably to China. This is starting to be seen as risky economically and geopolitically, although rarely do officials articulate concerns in public.

Trade accounts for 64% of the country’s gross domestic product, with China alone taking almost two fifths of the country’s goods exports (38.9% in 2022).

In 2022, exports to China amounted to more than US$ 38 billion, almost four times more than to the entire European Union (US$ 9.9 bn), with the US taking only 13.5 US$ bn. Exports to the US declined in that post-pandemic year 2022, whereas those to China increased by 5%, reflecting a general trend for Chile’s export orientation.

Mining products alone make up 58% of Chile’s exports, most of which go to Asia, mainly China, Japan and Korea. In 2021 China absorbed $ 8bn worth of Chile’s copper. Korea, its second largest customer for copper, took four times less.

Chile also exports iron and the critical raw material molybndenum in large quantities, much more than the lithium for which the country is famous for in a world hungry for the material needed in electric vehicle batteries, explaining why the country is now being wooed by the big trading powers.

From salmon to pork to cherries, nuts and grapes as well as wine, Chile is also an agricultural export powerhouse – with China and the rest of wealthy Asia taking the bulk of those exports.

Latin America plays a relatively secondary role in Chile’s export prowess. It is an outlet for some of its products such as dairy and for some light industrial products, mainly produced by small and medium-sized companies. Chilean companies are investors in some Latin American countries. But high trade barriers and the continent’s relative poverty don’t make it Chile’s most important economic destination.

It is not clear which direction recent regional integration initiatives involving trade, capital and movement of people such as the 2011 Pacific Alliance – with Mexico, Colombia, Peru and Chile as members – with the current left-populist government in Mexico and political instability in Peru.

Chinese companies have recently taken a significant role as investors in critical infrastructure in Chile.

Chile’s main electricity company Compañía General de Electricidad is almost fully owned by Chinese SOE State Grid International since 2020. That same year the United States energy company Sempra Energy divested its Chilean business and sold it to a Chinese company.

Chile is planning to revive its railway transport network and it is a Chinese firm that is due to build the Santiago-Valparaiso high speed rail link.

A Chinese firm bought a 23.8 % share in Chile’s lithium miner SQM in 2019. In early 2022 a Chinese firm outbid the leading Chilean and US lithium players in the country on an extraction contract.

The ‘latent’ Chinese issue

“Chile’s relationship to China is a latent issue”, a former high official in Chile’s trade ministry told Borderlex.

Nobody in prominent government positions wants to change Chile’s course as a country that pursues good political and economic relationships with all major powers, be they China, European powers or the United States.

Chile values its good relationships with China and the preservation of its free trade agreement with the country. The last thing any government wants is to attract Beijing’s ire on any issue and be subjected to a trade blockade as for example Australia has in recent years over political issues.

But today’s geopolitics is lurking and some fear a reckoning.

A first crisis of Chile’s highly legalistic and market-and-efficiency focused approach that has been favourable to Chinese foreign investments erupted in 2021 when the United States intervened following an initially successful bid by a Chinese-German consortium to take over the task of printing Chilean passports and identification cards.

Washington threatened Chile with the suspension of its visa waiver if the deal went through. Santiago knew where its priorities were – and cancelled the deal.  But China was irked.

Some trade and investment policy experts in Santiago start asking questions. “Who in Chile right now really thinks hard about what we should to about China and the China-US rivalry? Nobody”, deplored a senior civil servant in Chile’s foreign ministry who did not wish to be identified.

Questions are being raised whether Chile might need an investment screening mechanism for national security reasons.

Overall, governments from the right of the political spectrum would want to avoid jeopardizing business with China. Governments from the left such as the one in power have not necessarily identified China as a potential issue.

A European think tank such as Merics, was very sceptical of the Boric coalition’s approach to China in a report released before the failed constitutional reform and the recent government reshuffle.

“The backbone of Chilean state policy towards China has been pragmatism based on economic and trade relations. It is possible that this pragmatism will continue with the center-left coalition of President Boric, but it is very likely that asymmetry in the bilateral relationship will be accentuated”, the report said.

“The current government has given a key role to the Chilean communist party, which is very close to the Chinese communist party and takes a favorable view of China,” the Merics report said.

Whether the recent re-centring of Chilean politics will genuinely lead to a reassessment of Chile’s policies towards China remains to be seen.

Out of love with investor-state arbitration

Across the political spectrum, there has been one obvious and easy initial answer given to Chile’s new trade dependencies: to seek diversification of its trade destinations. The process started under previous governments and is expected to continue.

Chile’s upgrade of its Association Agreement with the EU, concluded in late 2021, then confirmed in late 2022, is one such example.

Even the now ex-trade secretary Ahumada changed its position on the EU deal when in government and paved the way for signing an agreement that the previous centre-right Piñera government had practically concluded.

Small changes were made to the text in 2022, politically enabling the Boric government to ultimately conclude the deal with the EU.

Chile’s savvy negotiators, anticipating on the changing political winds in the country at the end of the Piñera presidency in 2020-2021, removed a key roadblock to a deal with the EU by his successor government: they signed up to the EU’s model investment protection agreement that includes a bilateral investment court and narrows down investor rights.

Chile was initially staunchly opposed to such a court. But criticism of the 1990s bilateral investment agreements that Chile signed, not least with a range of EU member states, has grown.

This criticism also runs in free-market circles in Chile that would be loath to see their country criticised for not abiding by principles of international rule of law or reneging on international treaties.

Theses 1990s BITs are generally seen by Chilean experts as too broad in scope and inciting frivolous investor claims that are costly for Santiago to rebuff: Chile only lost one ISDS case out of seven that have been brought against it in the 1990s and is battling a new case brought by a French airport operator in 2021 claiming it hadn’t received sufficient support during the pandemic.

The investment protection agreement with the EU – if and when it comes into force – will supersede the bilateral investor treaties with countries such as Spain and France that have enabled unpopular ISDS cases.

Although officials don’t like the idea of having to pay for a permanent roster of investment arbitrators to which they don’t believe they will ever need to resort to – a requirement in the deal with the EU – they tend to think getting rid of the 1990s BITs with European countries is worth paying a price for.

Under Boric, Chile has sought and said it has obtained the dis-application of bilateral investment protection agreements or relevant chapters in free trade agreements with the Pacific Alliance’s Mexico – with which Chile not only shares CPTPP membership but also has a bilateral trade agreement in place – and with Colombia.

Diversification efforts and the EU in all this

The upgraded EU agreement – called Acuerdo Marco in Spanish and Enhanced Framework Agreement in Brussels – is an important one for Chile both politically and economically.

For the more left-leaning parts of the population a rapprochement with the EU is a means of deepening ties with a part of the world which it sees as sharing many of its values.

The appointment of van Klaveren to the post of foreign minister was received positively in European diplomatic circles in Santiago. It is seen as a signal that Europe is considered as an important interlocutor.

But the upgrade of the EU agreement will only marginally affect Chilean exports.

The tariffs and quotas that the EU removed in the agreement are important for Chile’s agriculture exports.  Chile skillfully negotiated tariff rate quotas for some of its key products in areas where the EU is traditionally very defensive such as meat, processed fish and olive oil. It improves export terms for Chilean fruit and vegetables.

But it is Chilean businesses that will decide in the end if it is worth investing to meet the EU’s onerous SPS standards in light of the size of the allocated quotas.  So far the track record of tariff rate quotas in EU FTAs in enhancing market access for its partners is not very encouraging for Chile.

The Chilean officials and former officials Borderlex talked to are worried that the dairy sector will cry wolf once the realities of the geographical indications chapter of the agreement affecting food names such as mozzarella become clearer and local producers need to adapt their labelling and accept European competition on a small market.

The Chilean government is also not rushing into signing a new ‘critical raw materials partnership’ with the EU. The upgraded FTA’s critical raw materials chapter negotiation was highly controversial in Chile that is keen on developing a domestic processing industry for lithium.

The EU – keen to secure its long-term access to Chile’s mining resources – relaxed some of its requirements related to domestic pricing of critical inputs for the domestic industry to help smooth over the deal. The final touches to this flexible arrangement were negotiated by the Ahumada team.

The Chilean government is preparing a new lithium strategy and is not expected to move forward with Brussels until the process is finalised.

The EU agreement upgrade is not the only one Chile has been pursuing. There are talks with the European Free Trade Area states to upgrade their trade agreement. There are discussions with India to upgrade a currently very thin trade agreement as well as similar with the United Arab Emirates. Chilean argi-food exporters have set their sights in particular on the Indian market as a way to diversify their exports away from China.

There are no prospects for an upgrade of the bilateral free trade agreement with the United States in the foreseeable future. José Miguel Ahumada approached the US to reopen the bilateral agreement in the hope to cancel ISDS provisions – but the US did no pursue the matter due to absent Trade Promotion Authority from Congress. The US is also not opening its agriculture imports any further under the Biden administration.

Yet there seems to be no broader market-seeking trade policy strategy coming out of the government that would help boost trade diversification in a meaningful way.

Carolina Valdivia, who was foreign trade secretary and briefly Chile’s foreign minister wonders why Chile is not pursuing a free trade agreement with ASEAN, for example.

Countries Chile likes to compare itself with such as Australia and New Zealand – do have such an agreement with ASEAN. The ten South East Asian countries host 660 million increasingly wealthy inhabitants which global and Western businesses have on the radar as a means to diversify investment and trade away from China.

“ASEAN  is where in many ways the future lies for the world economy,” Valdivia said in a conversation with Borderlex in Santiago. “It is a good opportunity for trade diversification”.

An uncertain political landscape

Whether Chile’s government elites will have the time and capacity to develop a new trade and investment policy strategy that thinks hard about the new geopolitical and global economic landscape remains to be seen.

After four years of turbulence combined with the disruptions of a pandemic, Chile appears to be back to a semblance of political ‘normalcy’. But there is no avoiding the sense that the ‘estallido’, the failed constitutional process and the disruptions wrought by the pandemic have left their scars on a divided country.

The legitimacy of Chile’s state institutions among large parts of the population remains under question. A new constitution is being drafted by a small 50-member constitutional expert appointed by Congress.

Its new text will be subject to an obligatory vote at the end of 2023. Nobody is in a position to predict if this new text, produced by what many are likely to dismiss as ‘the establishment’, will muster the required majority amongst those disaffected by the failed constitutional process of 2022.

If the second attempt at a new constitutional order fails again, many fear an all-bets-are-off scenario, with political instability and uncertainty becoming the new normal in a country that hasn’t known these phenomena since the end of the Pinochet era.

Such a scenario would have many detrimental consequences for the country. It would certainly not help Chile find a new trade policy that meets its needs in today’s more complex and less benign world.

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