The U.S.-Chile Free Trade Agreement: Economic and Trade Policy Issues
Released: 2003-09-10T00:00:00

Why a U.S.-Chile FTA?

Trade agreements evoke strong reactions from supporters and opponents alike. Nowhere isthis debate more alive than in the U.S. Congress, which for eight years was at an impasse overpassage of trade promotion authority (TPA) until it renewed TPA in August 2002 as part of theTrade Act of 2002 ( P.L. 107-210 ). Without TPA, the politically charged nature of trade negotiationsmade passage of implementing legislation for multilateral and regional agreements more uncertain. In addition to complex multilateral trade arrangements, the United States has pursued simplerbilateral agreements that were expected to be less politically sensitive and therefore more likely togain congressional approval, especially if TPA had not been renewed. On September 28, 2001, forexample, President Bush signed into law the implementing legislation for the U.S.-Jordan FTA ( P.L.107-43 ). Bilateral FTAs with Singapore and Chile were pursued with the expectation of similarsupport.

Opposition to bilateral FTAs, however, has heated up for both economic and politicalreasons. Economists, even those who support free trade, point out that bilateral (and regional)agreements are poor substitutes for multilateral arrangements. Although both countries in a bilateralarrangement may see their welfare improve through trade creation, the agreement may also causetrade (and investment) diversion, which can negatively affect those both in and outside of theagreement. Although trade diversion is often difficult to assess, it is a real consideration in pursuingnegotiations below the multilateral level. (1)

In addition to economists' questions over the trade effects of bilateral agreements, there isvehement opposition by various interest groups. Perhaps first among many are the import-competingindustries that bear the brunt of the adjustment costs of a trade agreement. Despite the welfare gainsto society as a whole (e.g. more efficient resource allocation, lower priced imports, greater selectionof goods), those industries subject to increased competition face potentially serious pressure to adjusttheir operations to become more efficient, lower-cost producers. Competition is generally acceptedas a tenet of doing business in a market economy, and on a national level, these adjustment costs maybe small and lead to greater productivity. When the rules change because of trade agreements,however, affected workers and industries resist strongly and their concerns are an integral part of thetrade liberalization debate.

Strong criticism of virtually all trade agreements also arises from groups arguing that anyarrangement is unacceptable unless it includes strong provisions addressing the impact of the tradeagreement on labor and environmental conditions. When joined with other groups protesting"globalization" in general, a formidable coalition is created. Collectively, these interest groups raisethe question of whether trade agreements enhance the social welfare of participating countries. Given the intensity of debate and amount of effort and resources needed to consummate an FTA,some questioned whether the marginal gains from a U.S.-Chile bilateral agreement would bejustified given that Chile is a small and distant U.S. trade partner, and already has a relatively openeconomy.

Advocates of the U.S.-Chile FTA responded that it offered both economic and political gains,with Chile seen as a potential strategic foothold in South America, a region historically linkedclosely with Europe and Asia. From an economic perspective, U.S. business interests consideredChile a prime target for expanding exports and repeatedly stressed the need to reduce the highertariffs they faced relative to Canada and other countries that already had FTAs with Chile. Lower-cost U.S. imports from Chile also provided benefits to individual and business consumers. Further, some of Chile's exports to the United States have zero or low tariffs already, suggesting thatthe adjustment costs to import-competing firms could be low (see Appendix C ). U.S. investors alsosaw Chile's political and economic stability as attractive for foreign investment.

From a trade strategy perspective, it was argued that a U.S.-Chile FTA would support U.S.initiatives with the Free Trade Area of the Americas (FTAA), currently under negotiation, byencouraging greater Chilean support for U.S. issues and perhaps even helping define key negotiatingparameters (e.g. labor and environment provisions) that could be precedent-setting. (2) The U.S.-Chile FTA was alsooffered as a compelling case for passage of TPA legislation, which would serve as a signal to LatinAmerica and the rest of the world of the U.S. commitment to pursue and complete trade agreements.

Chile also saw a logic in prioritizing an FTA with the United States because exportpromotion has been a building block of its growth and development strategy. Guaranteed access tothe large U.S. market offers opportunities for increased and perhaps more diversified trade. Chilealso envisioned increased foreign investment as an attendant benefit of the FTA, and argued that itswell-established track record on economic and trade reform made it the Latin American country mostready to negotiate a bilateral FTA. In short, despite its relatively small economy, Chile presenteditself as a country ready, willing, and able to negotiate a mutually beneficial FTA with the UnitedStates.

In addition to the benefits that were expected to accrue to U.S. businesses, investors, andconsumers, an FTA with Chile was also seen as an opportunity for the United States to supporteconomic and trade reform in Latin America, for which Chile had become a regional model. Tradewas a big part of the economic growth and development story in Chile, and linked directly toincreased productivity, higher standards of living, greater diffusion of technology, and overallmodernization of the country. Therefore, the United States, it was argued, should support these gainsbecause they are a foundation for continued economic, social, and political stability and progress inthe region. Trade agreements were also presented as playing a role in development and have theadded benefit of "locking in" reforms, lending a sense of permanence to economic and politicalconditions that is conducive to attracting and keeping foreign trade and investment.

Clearly, there were competing viewpoints on the desirability of a U.S.-Chile FTA. A lookat Chile's economic development is one way of addressing many, if not all, of the issues highlightedabove precisely because Chile has been an early and aggressive reformer of economic and tradepolicy in Latin America. In this light, to the extent that the welfare of Chilean society has improvedwith economic openness, it may be one indication that freer trade can support a broad array ofeconomic and political goals. It is with this approach in mind that this report integrates a discussionof Chile's economic growth and development with trade policy issues raised in both the United Statesand Chile.

Economic Reform in Chile

Chile has become one of the most open, reformed, and developed economies in LatinAmerica, a rebuilding process initiated under the military dictatorship of Augusto Pinochet(1973-90) and accelerated under civilian government following the return of democratic rule in 1990. Chile transformed its state-dominated economy into one grounded in market-based economicprinciples, first by stabilizing the economy and then restructuring it (e.g., lifting price controls,deregulating labor markets, privatizing state enterprises, reducing trade and exchange raterestrictions). As part of the process, Chile weathered some devastating domestic setbacks, includingthe 1982 economic collapse, followed by the sudden onset of the Latin American debt crisis. Chilesurvived it all, however, and eventually thrived economically, although not without incurringsignificant social costs along the way. (3)

Economic reform has continued into the 21st century and actually coincided with a period ofstrong economic growth that held for most of the last decade (see table 1 ). Currently, Chile isadjusting to the slower economic growth experienced both at home and abroad over the past twoyears. In 2002, Chile's gross domestic product (GDP) rose by only 1.7%, which was higher thanmany of its neighbors. Although, this reflects a slower growth rate compared to average economicgrowth of over 5% in the late 1990s, Chile's economy has proven resilient in the face a globaleconomic downturn and contagion from the Argentine financial crisis.

Table 1. Chile: Selected Economic and FinancialIndicators

Data Source: International Monetary Fund and Central Bank of Chile.

Chile's current macroeconomic management rests on three policy pillars: a flexible exchangerate; inflation-targeting monetary policy; and strict fiscal discipline aimed at generating a publicsector surplus. On the positive side, tight fiscal control has kept Chile's public external debt positionrelatively low, helping restrain inflation to 2.4% in 2002 and leaving room for monetary policy tosupport economic growth as well as price stability. Productivity levels have been sufficient to seereal wage growth, as well. On the negative side, unemployment has remained around 9%, a naggingproblem facing Chilean policy makers.

Trade reform began in the 1970s and helped transform the economy. By dismantling itsmultilevel tariff schedule and reducing nontariff barriers, Chile sought to engage foreign marketsmore aggressively and open itself to international competition. The uniform average nominal importtariff rate fell from 105% in 1973 to 15% in 1988, and to 11% in 1991 under civilian government. Chile then reduced the tariff rate by 1 percentage point each year until it reached 6% on January 1,2003. Although not without adjustment costs, the competitive pressures of trade reform have clearlyincreased productivity and economic growth.

Continuing a trend since the mid-1980s, Chile has recently made a number of simplifyingcapital market reforms, including abandoning its exchange rate band in favor of a floating system,eliminating most controls on foreign capital, including the one-year, non-remunerated reserverequirement, and reducing and equalizing capital gains treatment of domestic and foreigninvestment. (4) Changes incapital controls and exchange rate management have been essential to spurring Chile's export-ledgrowth. Privatization and deregulation have also progressed beyond financial services to includetelecommunications, energy, and selected public infrastructure, with Chile also leading LatinAmerica in the divestiture of public-owned enterprises.

Chile's record of reform, growth, and development corresponds with increased measures ofincome and social well being. In 2001, Chile's per capita income level was second only toArgentina's in Latin America and will likely be first once data reflect Argentina's financial crisis. In addition, Chile's human development index (HDI) for 2002 ranked second in Latin Americabehind Argentina and ahead of the much larger economies of Brazil and Mexico. (5) Welfare gains for the poorersegments of Chilean society are also being seen, with a relatively low child mortality rate andabsolute measures of poverty declining over the past decade and registering lower than most otherLatin American countries. (6) High unemployment and a skewed income distribution in line withthe rest of the region, however, point to the need to increase the quality and quantity of workforceparticipation, which is related to improving education, health care, and other public policies.

Chile's Trade Policies and Relations

Over the past decade, Chile's increasingly expansive and independent trade policy portraysa strategy that is commonly referred to as "open regionalism." This approach combines unilateralismwith the formation of sub-regional integration groups open to future expansion, such as the AndeanCommunity and the Southern Common Market (Mercado Comun del Sur -- Mercosur), amongothers, while also leaving open the possibility for bilateral and extra-regional trade agreements. Aspointed out in one study, it differs from earlier, fundamentally unsuccessful, attempts at economicintegration in Latin America by emphasizing trade opening rather than collective sub-regionalprotectionism. (7)

The "open regionalism" policy took shape in the early 1990s when Chile signed economiccomplementarity agreements (simplified free trade agreements) with Bolivia, Mexico, Venezuela,Colombia, and Ecuador under guidelines set out by the Latin American Integration Association(Association Latinoamericana de Integracion -- ALADI). Similar arrangements followed with Peruand Argentina. Chile has signed FTAs with Canada, Mexico, and Central America. In April andOctober 2002 respectively, Chile completed negotiations for an FTA with the European Union andSouth Korea. It is currently courting other countries including Japan, New Zealand, and Singapore,and closing in on an agreement with the European Free Trade Association (EFTA), see AppendixD . All are considered part of a strategy to open industrial economies further to Chilean exports. Chile joined Mercosur as an associate member in 1996, limiting its commitment largely because ofMercosur's higher common external tariff. Chile is also an active participant in the World TradeOrganization (WTO), seeing it as the venue to settle controversial issues less suited to regional orbilateral discussions.

Figure 1. Growth in Chilean Trade with MajorPartners, 1993-2001

Trade data reflect Chile's open and independent trade policy. Its exports to the worldexpanded by 89% over the eight years 1993-2001 (see Figure 1 ) and imports grew by 56%. Although Chile is not part of the Andean Community or a full partner of Mercosur, its fastest exportgrowth has been intra-regional, a testament to Chile's trade strategy that combines unilateralreductions in tariff and nontariff barriers with an aggressive effort to enter into bilateralarrangements. From 1993 to 2001, Chilean exports expanded by 126% to Latin America, comparedto 100% to the United States, 43% to Japan, 70% to the rest of Asia, and 71% to the EuropeanUnion. Chile's trade with Canada points to another interesting trend. Although the dollar value ofexports is very small, it grew by some 380%, an issue that was not lost on many U.S. businessadvocates of a U.S.-Chile FTA, who argued that the Chile-Canada FTA put U.S. firms at acompetitive disadvantage until a similar or better agreement could be reached with the United States.

Figure 2. Chile Direction of Trade, 2002

As seen in Figure 2 , Chile has diversified export markets, which not only increasesopportunities for trade, but also reduces dependence on a few markets and thereby softens exposureto foreign shocks (e.g. Argentina). Its largest export market is the European Union, which accountedfor 23% of exports in 2002, followed by the United States with 20%, and Latin America with 19%. Japan accounted for 11% of Chilean exports and the rest of Asia 17%. These figures reflect somerelative change over the past decade, as seen in the growth patterns in Figure 1 . There was adecrease in the European Union's and Japan's share of Chilean exports, as well as to Latin America. Although Chile's exports to Latin America had been rising during the 1990s, slow regional growthat the turn of the century reduced its export market share. The export shares to Asia and the UnitedStates, two areas that have experienced relatively faster growth, have risen recently. There was alsoa large increase in Chilean export share to Canada, although from a very small base.

Latin America is Chile's largest importing area, accounting for 35% of imports, followed bythe EU with 18%, the United States with 15%, and Asia with 13%. Japan and Canada follow at adistance with 3% and 2%, respectively. The EU trade presence in Chile has declined over the pastdecade, as it did with other Latin American countries. The relative importance of the United Statessuggests that Chile has had a strong incentive to pursue a bilateral FTA, other than a generalpreference for expanding its export base.

Chile's open regionalism and export driven trade policy have been challenged, however, fornot focusing enough on diversifying the country away from minimally refined agriculture and miningproducts (copper, fish, grapes, and wood). Manufactured products account for less than 15% of totalexports, suggesting two potential problems. First, relying on traditional commodities can providestrong export earnings, but earnings are unpredictable given the volatile nature of commodity prices(see Chile's swings in its terms of trade in Table 1 ). (8)

Second, little movement toward a manufacture-based, value-added approach to exportpromotion can limit long-term economic growth, a point developed by an Inter-AmericanDevelopment Bank (IDB) study arguing that the relatively poor income growth performance ofcommodity exporting countries can be traced to this lack of export diversification. Although manyLatin American countries have expanded their intra-regional trade, deepening integration withdeveloped economies seems necessary to achieve greater export diversification.

The large gains in export manufactures of Mexico and the Central American countries in the1990s, for example, were related, in some measure, to preferential trade arrangements with theUnited States. Other Latin American countries had much slower growth of manufacturedexports. (9) Whether Chilewill adopt export diversification as part of its long-term development strategy is unclear, but Chile'sefforts to develop trade relationships with developed economies, including the U.S.-Chile FTA,would seem to be an important component of such a goal.

On Chile's import side, most from developed countries are capital goods, highlighting thelink between an open trade policy (lower tariffs on capital goods) and development (capital goodsform the investment base for other production). Importantly, there is strong competition in theChilean capital goods market from firms around the world. Given Chile's many trade negotiationsunderway, there was pressure exerted by U.S. firms to expedite the Chile-FTA. A closer look at thestructure of U.S.-Chile trade suggests there is potential for mutual benefit from strengthening tradeties between the two countries.

The U.S.-Chile Bilateral Trade Relationship

The United States is Chile's largest single-country trading partner, accounting for 20% ofChilean exports and 15% of imports in 2002. By contrast, Chile is the United States' 34th largestexport destination and 36th largest import contributor, accounting for 0.3% of U.S. trade (2002 data). Chile's relatively small share of U.S. trade has actually slipped slightly in recent years, but itsincreasing openness to U.S. trade is evident in the numbers. In 2002, Chile's per capita imports fromthe United States were $163, higher than other major South American countries considered lessliberalized in their trade policies such as Argentina ($44) and Brazil ($71). (10)

Figure 3. U.S.-Chile Merchandise Trade, 1992-2002

Trends in U.S.-Chile merchandise trade are shown in Figure 3 (data appear in Appendix B )and mirror the trend in Chile's economic growth. U.S. exports grew significantly in the first half ofthe last decade, rising by 77% from 1992 to 1997. After that, they fell precipitously for two years,coinciding with the precipitous fall in Chile's economic growth from 7.4% in both 1996 and 1997to 3.4 % in 1998 and -1.1% in 1999 (see Table 1 ). As economic growth picked up again in 2000,rising to 5.4%, so too did the demand for U.S. goods, but economic and U.S. export trends falteredagain in 2001 and 2002, with the United States running a merchandise trade deficit with Chile forthe first time since 1988. In 2002, U.S. exports were not much above levels ten years earlier. Thispattern parallels declining exports levels to Latin America, as a whole, reflecting weaker economicconditions and therefore demand for imports in general.

U.S. imports from Chile have grown steadily since 1992, reflecting continuing U.S. interestin Chilean products and the extended expansion of the U.S. economy. U.S. imports grew by 172%from 1992 to 2002, a higher rate of import growth than from either Latin America, excluding Mexico(107%), or the world (118%). The United States maintained a trade surplus with Chile from 1989until 2000; in 2001 the trade balance turned to a deficit equal to 6% of total trade between the twocountries and 18% in 2002.

Major U.S. products exported to Chile are mostly capital goods (see Appendix C ). Theseinclude: machinery (31%), particularly computers, office machinery, and industrial equipment suchas gas turbines and bulldozers; electrical machinery (16%) including television and radiotransmission apparatus, telephone equipment, spare parts, integrated circuits, sound recordingequipment and media; vehicles (8%) mostly trucks and passenger cars; aircraft and parts (5%), andoptical/medical instruments (5%). In recent years, the U.S. export trends have exhibited a slowingin transportation equipment such as airplanes and automobiles, and an increase in computer andelectronic equipment relative to other goods.

The top five U.S. imports from Chile are natural resource based goods that reflect somerefining of the basic resource, but little value-added manufacturing activity. They account for nearly70% of total imports from Chile and include: copper articles (19%), mostly refined alloys; ediblefruits and nuts (18%), most of which are grapes; fish (15%), mostly salmon; wood (13%), varioustypes of lumber; and beverages (4%), virtually all wine. Recent trends have seen an increase in grapeand fish imports, with a steady level or slight decline in demand for copper, wood, and wine productsrelative to other goods.

Review of Negotiations and Policy Issues

The congressional debate over trade agreements invariably turns to their potential economiceffects on the United States, including both aggregate macroeconomic, as well as, sectoral effects. Assessing these effects is the responsibility of the United States International Trade Commission(ITC), which in June 2003 released a comprehensive study as part of the congressional consultationprocess. The report provides both quantitative and qualitative estimates of the FTA's possibleimpact.

The overall estimate of the ITC study was that by 2016, when the full effect of the tariffeliminations would be felt, U.S. exports to Chile would increase in a range between 18% and 52%;U.S. imports would rise between 6% and 14%. The study noted that this would be very smallrelative to total U.S. trade and that the economy-wide effects on trade, production, and overalleconomic welfare would be small to negligible (in a range of negative 0.001% to a positive 0.003%of GDP). This is in keeping with general expectations from the outset of the negotiations thatrecognized the limited benefits that could be achieved by the FTA given Chile is already a relativelysmall open economy with a relatively small trade position with the United States. The ITC finding,however, serves as an estimate of confirmation, focusing largely on the implications of tariffreduction, which may be quantified, unlike changes in many nontariff barriers. (11)

The rest of this section briefly summarizes the major policy issues that had to be reconciledin the negotiating process and references the ITC's conclusions with respect to each major issue area,where applicable.

Tariffs and Market Access

For the United States, market access and particularly reducing tariff rates, was a central goalof the negotiations. For countries that have trade agreements with Chile, such as Canada, theuniform 6% tariff is being phased out on most goods, an advantage the United States wanted toeliminate. On the other side, the primary U.S. imports from Chile face varying levels of tariffs,although some goods enter the United States duty free under normal trade relations (see AppendixC for U.S. tariff treatment of major Chilean exports). The major U.S. imports from Chile do notqualify for duty-free treatment under the Generalized System of Preferences (GSP), a preferentialtrade arrangement made by developed countries for developing country imports. The United Statesand Chile negotiated tariff reduction phase-out schedule on a product-by-product basis thatdifferentiated treatment for sensitive products, as was done in the North American Free TradeAgreement (NAFTA).

The ITC identified the major sectors that would likely benefit the most from the FTA basedon quantitative estimates of the likely increase in U.S. exports and imports for the year 2016, whenthe full effect of the tariff reductions would be felt. The estimated ranges of increase in U.S. exportsfor the most affected sectors are: 1) motor vehicles and transportation equipment (35%-215%); 2)textiles, apparel, and leather goods (29%-101%); and 3) coal, oil, gas, and other minerals(26%-72%). For U.S. imports, the range estimates for most affected sectors are: 1) dairy products(169%-575%); 2) textiles, apparel, and leather goods (77%-372%); and other crops (55%-114%),particularly avocados when the tariff rate quota is eliminated in 12 years. In all cases, the increasesare estimated to be large on a percentage basis because of relatively high tariff or tariff equivalentbarriers on these goods. Because the changes are computed from relatively small bases on a dollarvalue basis, however, the effects on industry production are expected to be small. (12)

Services Trade

Services are an important part of U.S. exports and are a key negotiating area in tradeagreements. The United States is a leading provider of financial (insurance, banking, securities),telecommunications, and management consulting services. The U.S.-Chile FTA would lowerbarriers and would enhance disciplines with respect to the provision of these services, but would notalter significantly U.S. imports of these services, nor would there likely be a large change in the U.S.export position. First, Chile has only a small presence in the United States with respect to theseservices and second, Chile is a relatively small market for U.S. services and has been relatively openfor some time. (13)

Trade Remedies

In addition to tariff reductions, trade remedies presented negotiators with significantchallenges. In the United States, low tariffs on most products have caused domestic industries to relyon trade remedy laws to fight import competition. Perhaps the most controversial issue was theapplication of U.S. antidumping statutes (investigations to determine if goods are being sold at lessthan fair value), which Chile expressed a desire to address in the bilateral FTA. This was not a newissue and was tackled in the Canada-Chile FTA, which provides for the "reciprocal exemption fromthe application of anti-dumping laws," except under "exceptional circumstances." (14) The thrust of thatagreement appears not to force the elimination of antidumping remedies, but to make their use a lastrather than first recourse, under WTO guidelines.

Chile's sensitivity to U.S. antidumping investigations was based on their "frequent and attimes unjustified use," and Chile argued that just the filing of dumping charges initiated a processwith significant unrecoverable costs regardless of the investigation's outcome. In recent years,antidumping investigations were concluded on Chilean salmon, mushrooms, grapes, and raspberries. The ITC ruled that there was reasonable indication that material injury was caused to U.S. producersin the cases of salmon, mushrooms, and raspberries, but not for grapes. (15) The United Statesindicated that trade remedy laws would not be negotiated unless otherwise directed by Congress andthe Bush Administration, and extended an offer to Chile to make the process more transparent. Chileresponded with concrete proposals to make this suggestion operational. (16) The United States also hadNTB concerns over Chile's price band system used to maintain domestic agricultural prices and itssanitary and phytosanitary regulations that restrict imports of U.S. agricultural and meatproducts. (17)

IPR and Investment

Among the other issues of special interest to the United States were intellectual propertyrights (IPR) and investment provisions. Chile has signed the Trade Related Intellectual PropertyRights (TRIPS), but its congress has yet to pass legislation implementing the provisions. In additionChile has also signed two World Intellectual Property Organization (WIPO) treaties, but has failedto conform fully to these obligations, as well. The U.S.-Chile FTA reaffirms obligations underTRIPS and adds another layer of important protection for U.S. industries, which if enforced wouldpotentially increase revenues to a number of industries including: motion picture, sound recording,business software, book publishing, pharmaceuticals, and agricultural chemicals, among others. (18)

Chile is known for its transparent and high level treatment of foreign investment and haseliminated restrictions on capital inflows that existed in the 1990s (see next section). As a WTOmember, it is a signatory to both the WTO Agreement on Trade Related Investment Measures(TRIMS) and the WTO General Agreement on Trade in Services (GATS), both of which affectinvestment rules. The U.S.-Chile FTA goes beyond these rules and provides U.S. investors withstrong protection. As important as these provisions are for the United States, the ITC estimates thatbecause of Chile's historically open economy and small investment market, the FTA might fosterincreased U.S. investment in Chile, but it is unlikely to be significantly higher than would otherwisebe the case. (19)

Labor and Environment

Labor and environment provisions have become accepted as legitimate, but difficult issuesto resolve in trade agreements. At the heart of the matter is whether a difference in environmentaland labor standards between developed and developing countries creates economic and social issuesthat should be addressed in trade agreements. This has led to a strong divergence of opinion, bothamong groups within the United States, and between developed and developing countries.

Advocates of including labor and environment provisions in trade agreements argue thatdeveloping countries enjoy an "unfair" competitive advantage because their lower standards translateinto lower costs, which in turn are reflected in lower prices for goods that compete with thoseproduced in developed countries. (20) Over time, this argument suggests that the difference instandards leads to investment and jobs moving abroad to take advantage of the lower productioncosts. On the other hand, many studies show that these costs are usually not high enough todetermine business location, where productivity remains the primary factor. (21) There are also socialconcerns to the labor and environmental issue that relate directly to the human impact of diminishedhealth and living conditions caused by pollution, poverty, and unsafe working conditions. Givencountries' different levels of development and therefore capacities to address these issues, there isconsiderable disagreement over how far a trade agreement should go in engaging these domesticpolicy issues.

Developing countries, including Chile, have expressed two basic concerns regarding theinclusion of environmental and labor provisions in trade agreements: 1) that their sovereignty maybe undermined if such agreements endorse higher standards; and 2) that such provisions may be usedto justify disguised protectionism. Free trade advocates in the United States and other developedcountries have expressed similar sentiments in opposition to placing environmental and laborprovisions in trade agreements.

Labor and environment provisions in trade agreements have evolved over time. NAFTA'sside agreements set a precedent in both labor and environment provisions that all parties: 1) not relaxstandards to attract investment or reduce costs of exports; 2) strive to improve standards over time,and; 3) enforce effectively their laws and regulations. The U.S.-Jordan bilateral FTA (theimplementing legislation was signed into law by President Bush on September 28, 2001 -- P.L.107-43 ) took labor and environmental provisions a step farther. It includes most key features of theNAFTA side agreements, but moved the provisions to the main body of the text, thereby placingthese provisions under the dispute resolution process of the entire agreement. Significantly, thisincludes language stating that an affected party may take "any appropriate and commensuratemeasure," including trade sanctions if the dispute remains unresolved. (22)

Chile recognized the importance of labor and environment provisions when it included themin the 1996 FTA with Canada, but kept them equally general in NAFTA-like side agreements. Thelabor and environment provisions differ from the Jordan model by their placement in a sideagreement and their reliance on less stringent dispute resolution options, emphasizing monetaryassessments rather than trade sanctions. (23) During the negotiations, it was unclear whether theChile-Canada, U.S.-Jordan, or some new or hybrid model would work for the U.S.-Chile FTA. U.S.negotiators looked to guidance in the TPA legislation and the core debate focused on disputeresolution and enforcement mechanisms, particularly the use of trade sanctions in cases ofnoncompliance. Chile was on record, however, as flatly rejecting inclusion of any language thatallows for the use of trade sanctions.

Congress and the U.S.-Chile FTA

In recent years, the United States has signed bilateral FTAs with Jordan, Singapore, andChile. All three have common elements, but each reflects country specific issues. A recurringquestion for the U.S. Congress with respect to the trade negotiation process has been, to what extentdoes one agreement become a model for another? For example, when the U.S.-Chile FTA wassigned in December 2002, United States Trade Representative Robert Zoellick announced that itcould serve as a "template" for U.S.-Central American Free Trade Agreement (CAFTA). (24)

As the 108th Congress considered the U.S.-Chile FTA implementing legislation, a few issuesbecame highly controversial and some Members suggested that some language in this agreementshould not be considered as a model for future FTAs. One or more of these issues were raised inhearings before the House Ways and Means and Senate Finance Committees, as well as bothJudiciary Committees. This section provides a brief summary of the relevant provisions in theU.S.-Chile FTA and amplifies the debate over three controversial aspects of the agreement.

The U.S.-Chile FTA in Brief

With implementation of the U.S.-Chile free trade agreement, Chile joined a select group ofonly five other countries that have an FTA with the United States (Canada, Mexico, Jordan, Israel,and Singapore). Market access was a critical provision, with duty-free access negotiated for allgoods traded between the two countries. When the agreement enters into force on January 1, 2004,fully 87% of bilateral trade in consumer and industrial products will become duty-free immediately,with the rest receiving reduced tariff treatment over time. Some 75% of U.S. farm exports will enterChile duty-free within four years and duties on all goods will be fully phased out within 12 years. With a few exceptions, the agreement will also increase market access for a broad range of services,with new opportunities for the financial services sector, among others. (25)

Export subsidies on agricultural products will be eliminated, but either country will be ableto respond in-kind if damaged by third party export subsidies. There is also a safeguards provisionto address possible surges in agricultural imports from Chile. (26) Importantly, the chapteron trade remedies deals only with the safeguards provision, so there is no change to the antidumpingand countervailing duty options currently available to both countries under WTO rules.

For Chile, 95% of its export products will gain immediate duty-free status and only 1.2% willfall into the longest 12-year phase-out period. Other important market access gains will includephasing out the luxury tax on automobiles over four years, less restrictive treatment of textile andapparel products that meet rules of origin criteria, and reduction over time of Chilean price bands,a provision not included in either of the FTAs Chile negotiated with Canada and the EuropeanUnion.

Other achievements of importance to the United States include consolidating and stabilizingrules governing openness of services trade, telecommunications, intellectual property rights (IPR),e-commerce trade, and investment. These areas were of much greater interest to the United Statesthan Chile and reflect gains for highly competitive U.S. industries. There are few exceptions to thenew services rules, benefitting firms working in financial, telecommunications, computer, andprofessional services. Chile's approach to IPR is also adjusted to accommodate U.S. concerns oversoftware, music, text, and videos. A new e-commerce chapter addresses the growing trade in digitalproducts.

Despite these many achievements, the 108th Congress raised questions on three provisionsin particular that may prove even more difficult to pass in future FTAs if language is similar to thatof the U.S.-Chile FTA. These involve the treatment of labor and financial transfers in disputesettlement, and the temporary entry for business persons.

Labor Dispute Settlement Provisions

A key controversy surrounded the treatment of three labor provisions in the agreement. Labor advocates argued that they are a step backward from the provisions agreed to in theU.S.-Jordan bilateral, as well as the Generalized System of Preferences and Caribbean Basin TradePartnership Act, which currently govern much of the U.S. trade with Latin America. Specifically,provisions: 1) requiring effective enforcement of domestic labor laws, 2) reaffirming commitmentsto ILO basic principles, and 3) requiring parties to strive to ensure the "non-derogation" fromdomestic standards (not weakening or reducing protections to encourage trade and investment) aretreated differently. (27)

In the first case, failure to enforce domestic labor laws can be formally challenged in thedispute resolution process as defined in the FTA (Article 22.16(1)). In the case of the other twoprovisions, which are supported in principle, such recourse is not available. The USTR points tocooperative mechanisms for improving workers' rights in the FTA, (28) but labor advocates arguethat unless all three are enforceable, the FTA provides "a meaningful trade discipline where -- andonly where -- the country's labor laws are adequate. Otherwise we would simply lock in low andunacceptable labor standards through our trade agreements." (29) Although Chile has asound record in support of basic labor rights, such differentiated treatment is challenged asinadequate for use in other countries, particularly those in Central America, (30) and so raises a questionfor some as to whether the Chile agreement does or should constitute a precedent.

In addition, in the one case where the formal dispute resolution process may be invoked, itis differentiated from disputes related to commercial issues. Ultimately, if a commercial disputeremains unsettled, the country faces the possibility of suspension of benefits under the FTA "ofequivalent effect" (Article 22.15(2)), resulting in the raising of tariffs, or payment of a monetaryassessment equal to 50% of what a dispute panel determines is "of equivalent effect." This articledoes not apply to the disputable labor provision. The difference is that the option for failing toresolve a labor dispute is a monetary assessment, which would be capped at $15 million per year,with recourse to an equivalent dollar value of suspended benefits (higher tariffs) if the monetaryassessment is not paid. The monetary assessment would also be paid into a fund and expended for"appropriate labor initiatives." Labor advocates argue that by capping the assessment at $15 millionand having the assessment paid into a fund in the offending country render the labor provisionsineffective. The USTR argues that for a small country like Chile, such a fine would be significantrelative to the dollar value of the trade benefits it will receive. (31)

From a congressional perspective, there is an additional question of whether differences inthe treatment of the three labor provisions in some way fail to meet in full the principal negotiatingobjectives of Congress as outlined in TPA legislation. Although the three provisions are notaccorded the exact same treatment in the FTA, neither are they in the TPA language. Section2102(b)(11) of the Trade Act of 2002 (TPA) states that among the principal labor negotiationobjectives is the provision " to ensure that a party to a trade agreement with the United States doesnot fail to effectively enforce the environmental or labor laws ." This may be contrasted with theapparently weaker objective " to strengthen the capacity of United States trading partners to promoterespect for core labor standards, " and, in Sec. 2102(a)(1)(7) to " strive to ensure that they do notweaken or reduce the protections afforded in domestic environmental and labor laws as anencouragement for trade."

There is a final point. Although the TPA provisions seem to differ with respect to treatmentof these three labor provisions, under the dispute resolution provision (sec. 2102(b)(12)(G)), aprincipal negotiating objective also listed is "to seek provisions that treat United States principalnegotiating objectives equally" with respect to the ability to resort to dispute settlement, theavailability of equivalent procedures, and the availability of equivalent remedies. Whereas the laborgroups have argued that this is not the case with labor and commercial disputes, the USTR hasresponded that this standard has been met since both commercial and labor disputes are subject tomonetary assessments and suspension of benefits. The dispute settlement procedures do operateslightly differently, however, and it may be a matter of interpretation as to whether there is a problemin their meeting congressional negotiating objectives. (32)

Capital Controls

A second controversial provision in the agreement relates to capital controls. The relevantlanguage is set out in the dispute settlement portion of Chapter 10 -- Investment of the FTA. Duringthe 1990s, Chile became famous for controlling capital inflows, a policy intended to limit the realappreciation of the Chilean peso that large capital inflows can cause. This policy, some argue,helped Chile avoid the currency overvaluation problem that contributed to multiple developingcountry financial crises in that decade. Chile's main control policy on portfolio capital, known asthe Ley de Encaje , was discontinued in 2001. While in force, however, it raised issues with respectto the U.S. position favoring the free flow of transfers and payments related to investment, whichhas become a standard position in both U.S. bilateral investment treaties (BITs) and otherFTAs. (33) In hearingson the U.S.-Chile FTA, some Members of Congress expressed concern that U.S. negotiated positionsinsisting on the free flow of payments and transfers might be imprudent if they inhibit countries fromusing controls on capital to help maintain financial stability during times of international financialturmoil. (34)

The provisions at issue appear in two annexes of the investment chapter of the U.S.-ChileFTA that cover treatment of both long-term and short-term capital investment. The provision inAnnex 10-F focuses on the treatment of long-term investments under Chile's Decree Law 600 (D.L.600). This law provides an investment option in the form of a contract with the Government ofChile that stipulates certain rights of the investor, but also requires that foreign direct investment(FDI) remain in country for a minimal period of one year (three years at one point). Should a disputearise, the language in the U.S.-Chile FTA would allow the investor the option to make a claim ininternational arbitration as opposed to having to work through the domestic Chilean court systemas set out in D.L. 600. It is the less controversial provision of the two.

The more controversial provision relates to Chile's Ley de Encaje , which governs short-termportfolio capital flows, and the recourse that U.S. investors may have if faced with restrictions onthe outward flow of certain payments and transfers as defined in Annex 10-C. This annex must beunderstood as part of the larger dispute settlement provisions related to foreign investment, asdefined in Section B of Chapter 10. The U.S.-Chile FTA adopted what has become more or less ofa standard provision, which states that, U.S. investors who seek to file a claim for breach of theChapter 10 provisions can do so only after six months have lapsed from the event giving rise to theclaim. This general rule applies to a broad range of potential investment disputes such as failure toobserve national treatment or expropriation.

Annex 10-C, the mutually-agreed compromise developed by Chilean and U.S. negotiators,is actually an important exception to the six-month rule. Paragraph 1(a) states that claims allegingthat Chile has breached an obligation under Chapter 10 from its imposition of restrictions ontransfers can only be made one year after the restriction was put in place, with certain exceptions. In general, the United States wanted to make sure that Chile did not have a general "balance ofpayments" exception to impose capital controls. (35) Chile wanted to ensure that it would not be penalized if it wereever to reimpose its Ley de Encaje . Under Chile's Ley de Encaje, any short-term capital investmentin Chile required that an additional nonremunerated deposit equal to 10%-30% of the investmentvalue be placed in the Central Bank of Chile for one year. (36) The deposit would be forfeited if the portfolio investment wererepatriated in less than one year, imposing an additional cost on capital volatility. In essence, Annex10-C attempts to reconcile these goals by allowing for an extension from six months to one year (thelife of the encaje ) of the "cooling off period" before a claim can be made for dispute resolutionrelated to restrictions on transfers and payments, and by stipulating that the encaje is not anopen-ended invitation to restrict (may not substantially impede) capital movements. (37)

The important qualification relating to portfolio capital states that Chile will not incur anyliability for damages:

arising from its imposition of restrictive measures withrespect to payments and transfers that were incurred within one year from the date on which therestrictions were imposed, provided that such restrictions do not substantially impede transfers. (38)

There are two important thresholds that the Ley de Encaje must not exceed to avoidtriggering a claim for dispute resolution. First, it cannot affect an investment for more than one year. Historically, this has been the case. Second, the encaje cannot be considered as having "substantiallyimpeded" capital outflows. Although in any actual arbitration a panel would be empowered todetermine what constitutes "substantially impede," this language was crafted with the intent that theforfeiture of the encaje not be construed as substantially impeding capital outflows and so may beviewed as unlikely to open the door to U.S. investor dispute settlement. (39)

The U.S.-Chile FTA provisions do not eliminate Chile's right to reimpose its capital controllaws per se, especially the Ley de Encaje , but do extend certain additional rights to U.S. investors. In addition, they indicate that U.S. investors could pursue dispute settlement if Chile were to imposecontrols that substantially impeded portfolio capital from leaving the country, setting up the debateover whether such restrictions belong in FTAs. Attention to the issue has grown in the aftermath ofcongressional approval for the U.S.-Chile FTA, particularly in light of the number of subsequentFTAs that are heading for congressional action. Although in the U.S.-Chile case the languagegoverning capital controls may be viewed as a compromise, it is far from clear that language adoptedto fit the specific Chilean case will be able to accommodate other countries negotiating FTAs withthe United States, or U.S. congressional concerns.

Temporary Business Personnel and Workers(40)

Key Provisions. Chapter 14 of the U.S.-ChileFTA creates separate categories of entry for citizens of each country to engage in a wide range ofbusiness and investment activities on a temporary basis, i.e ., nonimmigrants. The FTA addresses fourspecific categories of temporary nonimmigrant admissions currently governed by U.S. immigrationlaw: business visitors; treaty traders; intracompany transfers; and professional workers. Thesecategories parallel the visa categories commonly referred to by the letter and numeral that denotestheir subsection in Â§101(a)(15) of the Immigration and Nationality Act : B-2 visitors, E-1 treatytraders, L-1 intracompany transfers, and H-1B professional workers. (41) Neither Party would beallowed to require labor certification or other similar procedures as a condition of entry and wouldnot be able to impose any numerical limits on these categories, with some exceptions noted for theprofessional workers (including an annual cap of 1,400). (42)

The FTA clearly states the desire to facilitate the temporary entry of persons fitting thesecategories, provided the person complies with applicable immigration measures for temporary entry( e.g ., public health and safety as well as national security). Chilean citizens who are businessvisitors, for example, would be able to enter the United States for business purposes on the basis ofan oral declaration or letter from the employer specifying the principal place of business, detailingin the FTA an admissions policy not currently specified in statute.

Title IV of the enabling legislation amends several sections of the Immigration andNationality Act (INA, 8 U.S.C.). Foremost, it amends Â§101(a)(15)(H) of INA to carve out a portionof the H-1B visas -- to be designated the H-1B-1 visa -- for professional workers entering throughthe FTAs. In many ways the FTA professional worker visa requirements parallel the H-1B visarequirements, notably having similar educational requirements. The H-1B visa, however, specifiesthat the occupation require highly specialized knowledge, while the proposed FTA professionalworker visa specifies that the occupation require only specialized knowledge.

The legislation also amends Â§212 of INA to add a labor attestation requirement for employersbringing in potential FTA professional worker nonimmigrants that is similar to the H-1B laborattestation statutory requirements. The additional attestation requirements for "H-1B dependentemployers" currently specified in Â§212 are not included in the labor attestation requirements foremployers of the proposed FTA professional worker nonimmigrants.

There are numerical limits of 1,400 new entries under the proposed FTA professional workervisa from Chile. The legislation does not limit the number of times that an alien may renew the FTAprofessional worker visa on an annual basis, unlike H-1B workers who are limited to a total of 6years. It counts an FTA professional worker against the H-1B cap the first year he/she enters andagain after the fifth year he/she seeks renewal. Although the foreign national holding the FTAprofessional worker visa would remain a temporary resident who would only be permitted to workfor any employer who had met the labor attestation requirements, the foreign national with a FTAprofessional worker visa could legally remain in the United States indefinitely.

On July 10, 2003, the House Judiciary Committee held a "mock" mark-up of the USTR'sdraft language. Chairman Sensenbrenner took the lead in stating that "immigration policy does notbelong in free trade agreements," citing Congress's plenary authority over immigration policy inArticle 1, Â§8 of the U.S. Constitution. Members on both sides of the aisle expressed agreement withChairman Sensenbrenner's position, with several Members going further to state that the draftlanguage was an "insult to Congress." The House Judiciary Committee recommended including theFTA professional workers in the H-1B nonimmigrant visa and counting an FTA professional workeragainst the H-1B cap the first year he/she enters and again after the fifth year he/she seeks renewal.These recommendations are reflected in the legislation as introduced and passed.

Title IV of S. 1416 / H.R. 2738 also amends the INA to includeChile citizens as E-1 treaty traders and E-2 treaty investors.

Major Points of Debate. The USTR maintainsthat ensuring cross-border mobility of professionals and other business persons is critical for U.S.companies in developing new markets and business opportunities abroad. The USTR further arguesthat the temporary business personnel provisions in the FTAs are not immigration policy becausethey only affect temporary entry. The USTR points out that it issued a notice of intent to negotiateprovisions to facilitate the temporary entry of business persons in October 2001 and that it briefedcongressional staff on the FTA provisions on numerous occasions.

Others express concern that the USTR has overreached its negotiating authority by includingimmigration provisions in the FTAs. Critics maintain that the USTR's assertion that temporary entryof foreign business personnel and professional workers is not immigration policy is disingenuous. More generally, some point out that these provisions would constrain current and future Congresseswhen they consider revising immigration law on business personnel, treaty investors and traders, intracompany transfers, and professional workers because the United States would run the risk ofviolating the FTA.

The specific issue of FTA professional worker is sparking the most debate. The LaborAdvisory Committee, one of six private sector advisory committees for the USTR, is critical of theprovisions on the temporary entry of business personnel and professional workers because it appearsto enable workers from Chile who have no direct employment except a service contract to enter theUnited States. (43) Othershave expressed concern that professional workers from Chile would be held to a less stringentstandard than existing H-1B law ( specialized knowledge versus highly specialized knowledge ) andthat the stricter attestation requirements for H-1B dependent employers would also be omitted.

The USTR argues that it is incorrect to assert that the labor attestations required under theFTA would be less rigorous than the LCA called for under current U.S. law. According to theUSTR, the labor attestation required under the FTA also is to be modeled after the LCA that theDepartment of Labor requires under the existing H-1B visa program, and (as is the case under theH-1B program) fees may be collected along with the labor attestations. (44) The USTR states that thelabor attestations, education and training fees, and numerical limits provisions have been added tothe FTAs in response to congressional concerns.

Issues surrounding legal authority to enforce immigration law are also arising. Some arequestioning whether Â§106 and Â§107 of the legislation would enable an international panel to overruledecisions by officials in the Department of Homeland Security or by the Attorney General to rejectvisa applicants from Chile and Singapore. USTR responds that the panel that would be establishedby the FTA would be bi-national and would only deal with cases brought by a Party to the agreementin which there is alleged to be a pattern of violations.

Appendix A. Chronology of U.S.-Chile FTA

Appendix B. U.S.-Chile Merchandise Trade

Table 2. U.S.-Chile Merchandise Trade,1985-2002

Appendix C. Major U.S.-Chile Product Trade and Tariff Rates

Table 3. Major U.S.-Chile Product Trade and Tariff Rates,2002/2003

(% of total dollar value)

Data Source: U.S. Department of Commerce.

* By HTS number = Harmonized Tariff Schedule of the United States. Note, HTS numbers are notprovided on U.S. exports, which are subject to Chile's 6% nominal uniform import tariff rate.

** NTR is the general or normal tariff rates (also known as most favored nation rates) applied toproducts not given preferential tariff treatment.

# GSP = Generalized System of Preferences or preferential tariff treatment given to selectdeveloping country imports by developed countries. Some imports receive GSP treatmentonly if the exporting country is considered a "least developed country." Because Chile doesnot qualify under this designation, most of its exports to the United States are not eligible forGSP treatment.

Appendix D. Chile's Multilateral, Regional, and Bilateral Trade Agreements

# limited trade agreement negotiated under guidelines see forth by the Latin American IntegrationAssociation (LAIA), known in Spanish as the AsociaciÃ³n Latinoamericana de IntegraciÃ³n (ALADI).

* Guatemala, Honduras, Nicaragua, El Salvador, and Costa Rica (ratified January 2002).

Data source: Organization of American States. Foreign Trade Information System. This may befound at: http://www.sice.oas.org and Embassy of Chile.