101540 v1 URUGUAY Trade competitiveness diagnostic October 2015 URUGUAY Trade competitiveness diagnostic Trade Group, Trade and Competitiveness Global Practice, The World Bank Alberto Portugal Jose-Daniel Reyes Gonzalo Varela Acronyms ANII National Agency for Research LAC Latin America and Caribbean and Innovation LAIA Latin American Integration Association BPO Business Process Outsourcing MEF Ministry of Economy and Finance CAGR Compound Annual Growth Rate MERCOSUR Southern Common Market CCM Mercosur’s Trade Commission MFN Most Favored Nation CET Common External Tariff NAFTA North American Free Trade Agreement CMC Council of the Common Market OLS Ordinary Least Squares CU Customs Union PPP Purchasing Power Parity CUTI Uruguayan Chamber PPPs Public-Private Partnerships of Information Technologies PTA Preferential Trade Agreement EBM Export Business Model R&D Research and Development EU European Union RCA Revealed Comparative Advantage FDA Food and Drug Administration REER Real Effective Exchange Rate FDI Foreign direct investment RER Real Exchange Rate FOB Free on Board ROW Rest of the World FTA Free Trade Agreement SACU Southern African Customs Union FTZ Free Trade Zone SMEs Small and Medium Enterprises GDP Gross Domestic Product UN United Nations GMC Common Market Group UNCTAD United Nations Commission GTAP Global Trade Analysis Project for Trade and Development HHI Herfindahl Hirschmann Index US United States of America HS Harmonized System UTEC Technological University ICT Information and Communication WBG World Bank Group Technology WDI World Development Indicators IMF International Monetary Fund WITS World Bank Integrated INAC National Institute of Meats Trade Solution ITC International Trade Center WTO World Trade Organization Contents Background and Acknowledgements 5 Executive Summary 7 1. Macroeconomic Environment and Public Policies 13 1.1 A Favorable External Environment Has Supported Export Growth 14 1.2 The External Sector 14 1.3 The Role of the Real Exchange Rate 16 1.4 Monetary Policy and Exchange Rate Flexibility 18 1.5 Fiscal Policy and the Real Exchange Rate 19 1.6 Public Policies to Promote Investment and Exports 19 2. Export Growth and Orientation 21 2.1 Exports, Imports, and Trade Balance 22 2.2 Export Market Shares 24 2.3 Trade Openness 24 2.4 Patterns of Exports of Value Added 31 2.5 Composition of Exports 34 2.6 Exporter Size Dynamics 38 2.7 Foreign Direct Investment 40 2.8 Trading Partners 41 2.9 How ‘Natural’ Are Export Destinations? 42 2.10 How Can Uruguay Consolidate Export Growth? 43 3. Diversification 47 3.1 Number of Products and Markets 48 3.2 Concentration 48 3.3 Export Diversification by Sector 50 3.4 Intensive and Extensive Margins of Exports 50 3.5 How Can Uruguay Penetrate New Markets? 52 4 Quality and Sophistication 57 4.1 Quality 58 4.2 How Can Uruguay Further Improve Export Quality? 61 5. Survival 63 References 68 Appendix 71 List of Figures Figure 1. Contributions to GDP Growth, Demand Side 15 Figure 2. Contributions to GDP Growth, Supply Side 15 Figure 3. Commodity Price Cycle Index, 2010 = 100 15 Figure 4. International Prices of Uruguay’s Exports 15 Figure 5. Annualized Real GDP and Import Growth, 2002–2013 15 Figure 6. Current Account Balances 15 Figure 7. Real Exchange Rates 16 Figure 8. Large Co-movements with the Argentina GDP 16 Figure 9. Real Effective Exchange Rate, Index 2010 = 100 17 Figure 10. Real Exchange Rates, Index 2010 = 100 17 Figure 11. Real Exchange Rate Cycle and Growth/ Index 2010 = 100 18 Figure 12. Real Exchange Rates 18 Figure 13. Central Government Balances 19 Figure 14. Uruguay’s Merchandise Trade Performance 22 Figure 15. Share of Exports of Goods and Services, 2005 and 2013 23 Figure 16. Services Trade Balance as a Share of GDP 23 Figure 17. Uruguay’s Services Trade Performance 24 Figure 18. Export Market Shares, Uruguay and Comparators - 2000–2013 25 Figure 19. Export Market Shares, Uruguay and Comparators - 1997–2013 25 Figure 20. Merchandise Trade as a Share of GDP vs. Income Level 26 Figure 21. Trade Orientation Index - 2000–2013 27 Figure 22. Services Trade as a Share of GDP vs. Income level 28 Figure 23. Distribution of Import Refusals at the U.S. Border (2012–2013) 31 Figure 24. Distribution of Unit Rejection Rates at the U.S. Border (2012–2013) 31 Figure 25. Evolution of Exports of Goods and Services in Gross and Value Added (US$, billions) 32 Figure 26. Growth of Exports, Gross and Value Added - Comparators (CAGR 2004–2011) 32 Figure 27. Share in Total Exports by Main Sector, 2011 34 Figure 28. CAGR of Value Added in Exports by Sector (Current US$), 2004–11 34 Figure 29. Growth Orientation of Products 36 Figure 30. Services Exports Composition (%) 37 Figure 31. Number of Exporters by Sector 39 Figure 32. Growth in the Average Size of Exporters by Sector 39 Figure 33. FDI Net Inward Flows to Uruguay 40 Figure 34. FDI as a Share of GDP vs. Income Levels 41 Figure 35. Growth Orientation of Trading Partners, 2003–2013 42 Figure 36. Benchmarking Bilateral Trade Relationships in Uruguay Using a Gravity Model (Average 2010–2012) 43 Figure 37. Number of Export Destinations and Exported Products 49 Figure 38. Concentration of Products and Markets 49 Figure 39. Share of Top Five Products and Markets 49 Figure 40. Number of Markets Reached by Sector 51 Figure 41. Export Composition in Destinations (Average %) 51 Figure 42. Technological Classification of Exports (Lall Classification - %) 59 Figure 43. Change in Export Sophistication 59 Figure 44. Relative Quality Upgrading from 2007 to 2009 60 Figure 45. Quality Ladder for Fresh Boneless Beef - 2006 61 Figure 46. Quality Ladder for Fresh Boneless Beef - 2012 61 Figure 47. Fresh Boneless Beef’s Importers’ Relative Income per capita (PRODY) - 2006 61 Figure 48. Fresh Boneless Beef’s Importers’ Relative Income per capita (PRODY) - 2012 61 Figure 49. Export Relationships Survival Rates (1996–2013) 65 Figure 50. Export Relationships Survival Rates - Product Type (1996–2012) 65 Figure 51. Exporter Entry and Exit Rates by Sector 66 Figure 52. One-Year Survival Rates of New Exporters by Sector 67 Figure 53. 1-Year Survival Rate of New Exporters by Sector in Each Destination Market 67 List of Tables Table 1. Export Market Shares, by Product - Uruguay, Merchandise (%) 25 Table 2. Summary of Tariffs and Imports for Agricultural and Nonagricultural Products, 2013 29 Table 3. Applied MFN Tariff Structure for Agricultural and Nonagricultural Products, 2013 (in percentages) 29 Table 4. Merchandise Exports: Sectoral Composition, Revealed Comparative Advantage, and Growth 36 Table 5. Services Exports: Sectoral Composition, Revealed Comparative Advantage, and Growth 38 Table 6. Most Important Destinations 42 Table 7. Uruguay: Over-Trading and Under-Trading Export Relationships 45 Table 8. Decomposition of Export Growth 50 Table 9. Selected Evidence on Export Promotion Interventions and its Estimated Impact 54 Table 10. Uruguay Rejections at the U.S. Border (2012–2013) 72 Table 11. CAGR of Value Added in Exports by Sector and Across Comparators, 2004–11 (current US$, %) 73 List of Boxes Box 1. Measuring Openness to Trade 27 Box 2. Challenges to Market Access: Benchmarking Uruguay Trade Compliance in the U.S. Market 30 Box 3. Measuring the Value Added in Exports 33 Box 4: Benchmarking Bilateral Export Relationships using a Gravity Model of Trade 44 Box 5. Measuring Export Sophistication 59 Box 6. Measuring Relative Quality of Exports Using Disaggregate Trade Data 60 Background and Acknowledgements This report has been prepared as part of the Uruguay Pro-Growth Public Policies and Competitiveness Programmatic Approach. The report provide a basic diagnostic of Uruguay’s export competitiveness challenges based on the analysis of publicly available data and evidence, by examining export dynamics and outcomes and using field interviews with the public and private sector. The report then formulates a number of hypotheses for an in- depth competitiveness diagnostic of the external sector, as well as policy recommendations to further trade integration and on how to increase benefits from integration. The report was prepared by a World Bank team led by Gonzalo Varela (GTCDR) under the guidance of Jesko Hentschel (Country Director, LCC7C) and Marialisa Motta (Practice Manager, GTCDR). The following team 5 members were part of the core team of the report: Gonzalo Varela (GTCDR), Alberto Portugal (GTCDR), and Daniel Reyes (GTCDR). Ana Fernandes (DECTI) and Esteban Ferro produced the background paper ‘Exporters in Uruguay: Competitiveness and Dynamics in 2005-2013’. The macroeconomic context and public policies section was produced by Cristina Savescu (GMFDR). Administrative assistance was provided by Silvia Gulino. Writing and editing support was provided by Esther Florence Thiyagaraj and Susi Victor. The report has benefited greatly from comments, advice, guidance, and technical discussions with Jose Guilherme Reis, Laura Gomez-Mera, Marcelo Olarreaga, Zafer Mustafaoglu, Andrea Mario Dall’Olio, Javier Suarez, Massimiliano Cali, Leonardo Iacovone, Ekaterine Vashakmadze, and many others. The report owes a lot to the government agencies that supported the team with provision of data, comments, guidance, and advice; the list includes but is not limited to the Ministry of Economy and Finance; Ministry of Industry, Energy and Mining; the National Institute of Statistics (INE); the Planning and Budgeting Office (OPP); Uruguay XXI; the National Institute of Agricultural Research (INIA); and the National Meat Institute (INAC). Executive Summary A s a small economy, Uruguay’s growth and deep recession and a number of shocks that impacted poverty reduction prospects are closely their decisions and welfare. Two of the most prominent related to its performance in international ones were a currency and banking crisis in 2002 and an markets. Integration into the global marketplace is a episode of foot-and-mouth disease in the same year. The powerful vehicle for productivity and per capita income currency and banking crises severely affected economic convergence to developed country levels. For economies activity both in Uruguay and in its then main trading like Uruguay, this vehicle is particularly important as partner, Argentina. It also affected the solvency of many the scale of the domestic market limits the feasibility of firms and the supply of credit to the private and public inward oriented growth strategies. sectors. It also resulted in a dramatic realignment of relative prices in 2002, with a sharp real depreciation of This report analyzes export dynamics in Uruguay the domestic currency which, while eroding the purchasing over the period 2000–2013, benchmarking them power of most Uruguayan households, increased the 7 against relevant comparator countries. Following profitability of firms in the tradable sector by reducing the World Bank’s Trade Competitiveness Diagnostic the dollar cost of the inputs sourced domestically. Bovine Toolkit (Reis and Farole 2013), it looks at export products, the largest foreign exchange earner among outcomes through four different dimensions of export merchandise exporters at that time, were hit hard by the performance: (1) the evolution, composition, and growth episode of foot-and-mouth disease. orientation of the country’s export basket; (2) the degree of diversification across products and markets; The period that followed the crisis years was (3) the level of sophistication and quality; and (4) the characterized by relatively more positive shocks to survival rate of export relationships. The analysis is the external sector. In addition to the real depreciation complemented with field interviews with the public of the peso that followed the crisis, the international and private sector, constituting a first pass at the prices of Uruguay’s main export products soared. This diagnostic of export competitiveness challenges based stimulated investment in technological improvements on the analysis of publicly available data and evidence. in the production of these natural-resource-intensive The report then offers a number of hypotheses for an in- products. The process was reinforced by important depth competitiveness diagnostic of Uruguay’s external Foreign Direct Investment (FDI) inflows into the economy. sector, as well as policy recommendations to increase integration and to gain from it. However, the same period of rising commodity prices implied higher energy costs for firms and households The period under consideration, 2000–2013, in Uruguay, an oil-importing country. This particularly is an interesting one for the analysis of export affected firms operating in tradable sectors that were competitiveness in Uruguay. not ‘compensated’ by high international food prices and which also had to cope with the steady real Toward the beginning of the period, Uruguayan strengthening of the Uruguayan peso that followed the households and firms were affected by a long and economic recovery after 2004. As a consequence, Uruguay’s export sector experienced at the extensive margin (exports of new products or to important changes during this period, which are new destinations). The paradigmatic example is that reviewed in this report. The main messages that emerge of the foreign firms that set up business in Uruguay to from it are the following: produce chemical wood pulp and that operate within free zones. The list, however, is long and involves Uruguay has become more integrated in investment in primary, manufacturing, and service- global markets. related activities. Uruguay’s exports have experienced a substantial Public sector support to add knowledge and value expansion over the last 15 years, becoming key in the to exports has also resulted in increased market country’s successful growth model during this period. access and increased prices. Although a large portion Today, Uruguay is more integrated into the world of Uruguay’s exports can be classified as ‘primary’ or economy than it was in the late 1990s, with exports and ‘resource based’, there has been substantial technical imports having increased at double-digit yearly rates change and knowledge addition into some of these over the last decade, either when measured in gross export products that are typically considered ‘primary’. or in value added terms. The rapid expansion of trade One example is that of the bovine traceability from farm is concurrent, when looking at the firm level, with an to consumer, which electronically identifies each bovine explosion in exporter size, which doubled in the primary in the country, and which was achieved through a strong goods, medium-tech, and high-tech manufacturing partnership between the private and public sectors. sectors during 2007–2013. Policies toward increasing market access have also been fruitful, for example, to secure markets for beef in Tailwinds due to high commodity prices the United States and Mexico or for citrus in the United certainly helped export growth. States. While there has been some product churning, In services, investment attraction efforts, combined 8 Uruguay’s merchandise exports remain dominated by with export promotion, have also contributed to primary and resource-based products. The observed export dynamism. The dynamism in this sector has churning at the product level shows the effects of been driven not only by exports of traditional services increased commodity prices on the supply decisions of (transport, travel, distribution) but also of modern firms. For example, there was a sharp increase in the services, such as business services and Information exports of soybeans and wheat. Soybeans are now the and Communication Technology (ICT), to a wide variety top export product (with about 2 billion dollars exported of markets. Some of these sectors have been targeted in 2013), and wheat features among the top ten. Animal by specific export promotion activities such as support products also—on the back of unprecedentedly high for participation in trade fairs and for development of international prices—performed very well. business plans, as well as by investment incentives. However, the observed dynamism was also Yet, there is still room for greater and better supported by a dynamic private sector and integration. sound trade and investment policies. To continue growing An attractive framework for investment, along with increased global liquidity, consolidated Uruguay as a Uruguay remains weakly integrated in the global destination for export-oriented FDI. FDI inflows grew marketplace. It exhibits trade to gross domestic product tenfold between 2000 and 2012. While from 2000 to (GDP) ratios that are lower than those displayed by other 2003 Uruguay’s record on FDI was below the world countries at similar levels of development, even after average given its level of development, from 2010 to controlling for remoteness from the main international 2013, the country’s FDI was well above average. FDI markets. Its share in export markets is still lower than it inflows were not only associated with export growth at was in the late 1990s. Moreover, Uruguayan firms exhibit the intensive margin (that is, more exports of the same poor export survival rates compared to peers. As entering products to the same destinations) but also with growth export markets is a costly activity in which fixed costs play an important role, it is crucial that export flows price increases during this period. The EXPY indicator, that start in a given year remain active for long so that that provides one measure of export sophistication exporters secure a flow of profits that compensate for however, may hide important changes in sophistication the fixed costs incurred. Thus, expanding and sustaining of the export bundle associated with, for example, export growth requires a better understanding of the additional knowledge content in seeds used for key factors constraining the export survival of firms. crops or the case of the bovine traceability. In this latter case, for example, data on unit values suggest that To continue diversifying Uruguayan exporters managed to improve their export quality during the period, climbing from the bottom Diversification along the market dimension has been to the top of the ranking and securing access to high- impressive, explaining a third of export growth during income markets. 2003–2008 and more than half during 2010–2013. This reduces Uruguay’s vulnerability to country-specific In services, a transition toward more knowledge- shocks. Still, there is substantial heterogeneity across intensive activities is observed. Booming services sectors. While in traditional export sectors such as sector exporters are in computing and business services, animal and crops, Uruguayan exporters reach about with a high knowledge content. The services sector has 100 or more destinations, in other sectors firms remain also contributed to increase the knowledge content reliant on few destinations, often neighboring countries, to Uruguay’s export basket through the provision of making them vulnerable to country-specific shocks. inputs embedded in exports of merchandise. Exports of modern services constitute a unique and yet not fully Diversification along the product dimension, however, untapped opportunity for Uruguay since remoteness has remained elusive and vulnerability to product- and small scale are not as strong constraints as they specific shocks has increased. Although the number are in manufacturing. of export products increased slightly, this increase did not matter substantially for export growth. The Challenges ahead and policy 9 new export products only accounted for 2 percent of recommendations export growth during the period 2003–2008 and for 6 percent during the period 2010–2013. In fact, the Exporters in Uruguay face three additional and concentration of the export basket along the product important challenges in the short to medium term. First, dimension increased. The top five products exported the deceleration in economic activity of its main trading accounted for 28 percent of total merchandise exports partners, particularly that of Brazil and China. Second, during 1998–2000 while they accounted for 39 percent and related to the first, the slowdown in the international of exports during 2011–2013. Although this is to be prices of key commodities exported by Uruguay. Third, expected during a period of fast growing food prices, the relative strengthening of the dollar against the it increases Uruguay’s vulnerability to product-specific currencies of Uruguay’s main trading partners. These shocks. This is exacerbated by the fact that these top factors, which shape today’s international context export products show substantial price volatility in suggest a less positive outlook for export performance international markets. and deserve attention. Indeed, recent data on export trends reveal a deceleration of export flows to many To continue improving in quality of the main trading partners. Firms will need to remain alert to preserve their market shares and to continue In terms of sophistication and quality, although contributing to growth and development. some key products show important improvements, stronger efforts are required to climb up the quality The following policy recommendations, seeking to ladder and increase value addition. Merchandise alleviate the challenges faced by Uruguay, emerge export sophistication remained stable while the service from this report. sector has contributed to the sophistication of the overall export bundle. The pattern is similar to what 1. Increased market access for Uruguayan exporters. is observed for countries with a comparable export There are two levels at which policymakers could structure, which were also affected by the commodity support access to markets for Uruguayan exporters. a. Negotiations at the country level. The first is related b. Support to firms. In addition to negotiating market to negotiations that contribute to the elimination of access, it is important to support firms as they tariff and non-tariff barriers that export products attempt to penetrate foreign markets. There is a clear face. This is particularly important given the fact case for government intervention in this respect. As that Uruguay recently lost access to the Generalized argued above, export diversification along product System of Preferences, as it transitioned into a high- and market dimensions reduces the country’s income economy. vulnerability to shocks. In addition to the returns that accrue to the firm, decreased vulnerability i. Negotiate within the Southern Common Market offers social returns, thus justifying government (MERCOSUR) to speed up the agreement between support to diversification efforts. Uruguay XXI, the the European Union (EU)-MERCOSUR and encourage export and investment promotion agency, has gone a two-speed alternative in which Uruguay and Brazil a long way in this respect, providing information to could start offering concessions before Argentina firms, supporting their participation in trade fairs and Paraguay. and missions, and helping them develop business plans of internationalization, particularly for small ii. Given the constraints that MERCOSUR represents and medium enterprises (SMEs) and in some sectors for trade policy negotiations, particularly in (mainly knowledge-intensive services with export merchandise, the systematic expressions of the potential). It is then crucial, in the context of reduced government of Uruguay on the need to pursue a fiscal space, to evaluate the impact and effectiveness policy of ‘open regionalism’ are most welcome. There of these interventions. is a precedent of waivers that MERCOSUR has granted to Uruguay to negotiate bilateral free trade 2. Attracting investment. During the period of analysis, agreements (with Mexico). Efforts to continue in this worldwide flows of FDI increased dramatically. Uruguay direction should be most welcome as they would managed to secure an increasing share of global increase Uruguayan exporters’ competitiveness. investment flow relative to the country’s size, making 10 the ratio of FDI to GDP soar. Domestic investment has In addition, there is space for negotiating market access on a bilateral level even within the also increased to historical levels. Investment promotion institutional arrangements of MERCOSUR. The policies have arguably played an important role in recent negotiations with the United States that ensuring this outcome. Activity in free zones has also lifted barriers to the entry of Uruguayan citrus boomed, with these zones now hosting thriving firms are an example that needs to be pursued more that operate in a diverse range of sectors. Part of the systematically and for other export products. For incentives received by investors involves sacrificing example, more efforts toward lifting barriers to fiscal revenues. Rigorous impact evaluation of these bovine meat with bone in the United States and beef incentives is needed. Interviews with foreign firms in Korea are needed. operating in Uruguay suggest that, while the investment attraction services provided by Uruguay XXI are of iii. For services and particularly for modern services good quality by international standards, there is room where remoteness does not crucially impede trade, for improvement in the after-care services provided as mentioned above, negotiating market access to investors, particularly to navigate the complicated is essential to diversify the export bundle, increase public sector system. its quality, and as a result, create good quality jobs. Negotiating trade agreements for services in which 3. Gaining from increased FDI. International experience national treatment is secured for services firms shows that given certain conditions, FDI can lead to interested in setting shop in foreign markets is as technology and knowledge spillovers to the rest of the important as negotiating market access for goods. economy. FDI in services, for example, results in more However, participation in trade agreements is not varieties of services inputs, better prices, and often, the only vehicle to improve market access in services. higher quality, which has economy-wide gains. FDI that Efforts toward the elimination of double taxation in competes with domestic firms (horizontally) can induce Uruguay’s most important markets are crucial for competition-driven or imitation-driven productivity export competitiveness of service firms. gains in domestic firms. The interaction of foreign and domestic firms either through client or supplier are needed—this is the consensus opinion of all of the relationships can also lead to productivity spillovers. firms interviewed in the process of elaborating this The conditions under which these spillovers tend to report. Indeed, several logistics indicators show that materialize have to do with the absorptive capacity of Uruguay has substantial space for improvement in this domestic firms (for example, the level of skills of the respect. Here, public-private partnerships (PPPs) are a labor force, the stock of research and development crucial instrument. Specifically, Uruguay needs to (a) [R&D] spent, and the technological distance between deepen its ports for the efficient circulation of larger the foreign and domestic firms). Efforts to increase ships; (b) upgrade road infrastructure, particularly those these absorptive capacities, in the form of, for example, linking west with east (for example, upgrading Route 26, incentives to train the labor force or to invest in R&D to reduce transportation costs of merchandise across will likely increase the chances that these spillovers the country and allowing the most efficient use of the materialize. Uruguay XXI’s program to incentivize the lands); and (c) seriously consider the feasibility of a set-up of research and development centers of medical railway system for cargo. and pharmaceutical services firms in the country is most welcome, although it is not clear why its objective is 6. Energy costs. While the reduction of international sector specific. When it comes to suppliers, large foreign prices of Uruguay’s main export products hurt exporters, firms also tend to engage with reliable firms that comply the fall in international oil prices should alleviate some with certain standards. To ensure that domestic firms of their costs if these reductions are actually passed can comply with these standards, many governments, on to the consumers. In Uruguay, diesel price at the including Uruguay, have implemented supplier pump is the highest in the continent and its dynamics development programs. Some of these programs have do not fully reflect international prices. Revising the been evaluated, and the impact has been shown to be price-setting mechanisms for fuels would reduce some positive. Uruguay would also benefit from evaluating of the cost pressures that the private sector faces. The these programs’ impact and strengthening their design public sector has engaged in important mega projects appropriately. on energy development and efficiency with important fixed costs. Yet, it is not clear whether demand will exist 11 4. Promoting firms’ productivity upgrading for the extra energy produced and how these costs will and linking labor costs with labor productivity. affect the prices. Productivity upgrading is key to competing in demanding international markets. Here, the quality Disclaimer and Structure of the Report of management and the propensity to innovate in processes and products are usually important driving A disclaimer is in order. We rely on publicly available forces. Well-functioning, deep financial markets are merchandise export data from UN Comtrade, services needed for firms to be able to conduct the needed export and FDI data from United Nations Conference investments. In addition, key for productivity gains on Trade and Development (UNCTAD) and World to translate into better jobs and wages is that labor Development Indicators (WDI), and trade in value markets operate flexibly enough so that wages actually added data from the World Bank’s Trade in Value reflect productivity of labor. Labor market rigidities Added Dataset. As we rely on UN Comtrade for the have indeed been identified by firms as a constraint for analysis of merchandise trade, the results treat Zonas competitiveness and value addition. Francas (Free Zones) as another export destination and exclude the exports that originate within the zones. 5. Logistics and infrastructure. Uruguay is one of the The analysis reported here is complemented by that of most remote countries in the world. It is distant from the Ferro and Fernandes (2015), which looks at patterns of main trading growth poles in the world. Within the region, growth and dynamics of exporters, relying on exporter- however, it has a privileged location. Ensuring excellent level data from customs administration, where it is connectivity is important for Uruguayan exporters of possible to incorporate into Uruguay’s export flows merchandise, and it is also important for exporters of those originating in the Zonas Francas.1 Using a more logistics services to other countries in the region. The comprehensive set of comparators, Figures A.1 and A.2 export boom of this decade has put substantial pressure in the Appendix show that Uruguay exhibits a lower on the logistics infrastructure and further investments 1  See Appendix A.1 of Ferro and Fernandes (2015) for details. number of exporters than countries of comparable size as well as countries at similar levels of development. The cutoff date of the analysis of overall export competitiveness is 2013. For the analysis of exports of value added, the cutoff is 2011. In both cases, this is based on data availability. The remainder of the document is structured as follows. Section 1 analyzes the macroeconomic environment in which exporters operate in Uruguay during the period of analysis. Section 2 looks at level, growth, composition, and market share performance of Uruguay’s exports, as well as the country’s main trading destinations. It also briefly considers the evolution of FDI inflows and their sectoral composition. Section 3 focuses on the diversification of products and markets, considering several measures of concentration, including the share of top five products and markets in exports, and the Hirschman-Herfindahl Index for Uruguay’s export portfolio. Sections 4 and 5 address quality and sophistication and survival, respectively. 12 M E P 1 P 13 Macroeconomic M cro conomic Environment Environm nt and Public Policies nd Public Polici s The prudent macroeconomic framework, strong Uruguay has benefitted from a period of robust institutions and a positive external demand shock, import demand from its main economic partners. and terms of trade shock fostered export growth in the Growth in Uruguay’s main trading partners has been post-crisis period. In the aftermath of the 2002 crisis, robust between 2002 and 2013, with Argentina and Uruguay has managed to rebalance its macro economy Venezuela expanding 6.1 percent and 4.4 percent, relatively quickly through prudent policies. This, together respectively, while GDP in the Brazil and Euro Area with a stable political system and institutions and a expanded at an annualized pace between 3.7 and 3.3 much more competitive exchange rate, has enabled it to percent. Meanwhile, China, an increasingly important pursue new export-oriented investment opportunities in destination, has expanded at a rate of 10 percent. tradable items such as soybeans, rice, meat, forestry, Uruguay has one of the largest elasticity to Chinese pulp and paper, ports, tourism, software, and export of growth in the Latin America region (World Bank 2015). business services. A stable and more predictable macro Import demand in the main economic partners grew environment has fostered investment and growth. The at an even faster pace, averaging more than 8 percent large positive external shock supported strong domestic annually during this period, with the import demand of demand growth, driven by both private consumption the MERCOSUR partners and the Euro Area growing and investment. at double-digit rates. Brazil remained the main trading partner during this period, alongside the Euro Area, while A Favorable External Environment Has the importance of Argentina and the United States Supported Export Growth declined to a certain extent. Meanwhile, exports to China, Venezuela, and Russia have increased at a rapid Commodity prices have experienced a super cycle rate, becoming important destinations for Uruguayan in the 2000s after a secular decline of almost four exports. Exports of goods and services have contributed, decades. Prices of food commodities have increased on average, 2.4 percentage points to growth during the sharply between 2003 and 2012. With soybean prices 2003–2012 period, or close to half the annual growth more than doubling, this commodity has become one of over this period. 14 the main export commodities of Uruguay, considering that by 2011, close to 50 percent of the agricultural land The External Sector was used for soybean production. By 2012, soybeans were the largest export item, representing 15.9 percent The current account deficit has been more than of merchandise exports. International beef prices financed by FDI inflows. The current account deficit have increased 105 percent between 2003 and 2012, has averaged 2 percent of GDP over the 2000–2013 and Uruguay beef prices have increased even more period. This is because the merchandise trade deficit and rapidly because from 2007 they have commanded a the income deficit, which averaged -2 and -2.5 percent traceability-linked quality premium over world prices. of GDP over this period, respectively, exceeded the Meanwhile, pulp prices have also increased, albeit more surpluses in the income and transfer accounts, which slowly over this period, and pulp has also become an averaged 2.5 and 0.5 percent of GDP, respectively. The important export and paper output, up by more than non-oil merchandise balance has been in surplus of close eightfold. to 3 percent of GDP, notwithstanding strong capital imports. Meanwhile a combination of high oil prices and The commodity price boom, in conjunction with recurrent droughts2 has caused a marked increase in stable macroeconomic environment and a favorable the oil merchandise balance to nearly 5 percent of GDP. investment climate, has led to increased investment, The larger deficit in the income account is explained by including FDI, in the agriculture sector. Over the 2003– higher interest payments as a share of GDP as well as 2008 period, about a third of investments went to the rapidly rising dividend payments on rising FDI. agriculture and forestry sector, with about 60 percent of that going to land acquisitions. Increased foreign participation in the agricultural sector brought more 2  Droughts affect the imports of oil, which is used for thermal power generation. Uruguay has been undergoing a structural sophisticated production technologies, contributing to a transformation of its energy matrix to reduce reliance on sharp increase in productivity in the agricultural sector hydropower while increasing the contribution of renewable and reallocation of farmland to the agricultural sector. sources such as wind power generation. Drought years are 2006, 2008/2009, and 2012. Fi ur 1. Contributions to GDP Growth, D m nd Sid Fi ur 2. Contributions to GDP Growth, Suppl Sid Percentage points Percentage points 20 9.0 16 7.0 5.0 12 3.0 8 1.0 4 -1.0 0 -3.0 -4 -5.0 -8 -7.0 2001 2003 2005 2007 2009 2011 2013 2001 2003 2005 2007 2009 2011 2013 Private Consumption Investment Imports Agriculture Industry Government Consumption Exports GDP Services GDP at factor costs Source: Banco Central del Uruguay (BCU) and World Bank staff Source: BCU and World Bank staff calculations. calculations. Fi ur 3. Commodit Pric C cl Ind x, 2010 = 100 Fi ur 4. Int rn tion l Pric s of Uru u ’s Exports 160 160 140 140 120 120 100 100 80 80 15 60 60 40 40 20 20 0 0 1980 1985 1990 1995 2000 2005 2010 2015 1980 1985 1990 1995 2000 2005 2010 2015 Foods Grains Oil Beef Soybeans Rice Wood pulp Source: World Bank. Source: BCU and World Bank. Fi ur 5. Annu li d R l GDP nd Import Growth, Fi ur 6. Curr nt Account B l nc s 2002–2013 Percentage points 16 6.0 14 4.0 12 2.0 10 0.0 8 -2.0 6 -4.0 4 -6.0 2 -8.0 0 -10.0 Ar ntin Br il Euro Chin USA V n u l Export 2000 2008 2006 2009 2003 2005 2002 2004 2007 2001 2010 2013 2012 2011 r m rk t rowth GDP Imports Merchandise balance Services balance Income balance Transfers CAB Source: World Bank. Source: BCU. Over this period, the current account balance has been reduction in the horizon and quality of investment. more than financed by FDI inflows. FDI has averaged Higher volatility in relative prices leads to reallocations close to 4.6 percent of GDP over this period, one of the between tradable and nontradable sectors, which largest in Latin America. On an average, a fifth of these come with an adjustment cost. Furthermore, frequent flows went to the agriculture and forestry sectors, a volatility in RER is linked to interest rate volatility and fifth to construction, followed by manufacturing and financial instability. The impact of the variability of financial services with about 10 percent of total FDI exchange rate on growth depends, however, on the level flows each. of political and macroeconomic stability (Eichengreen 2008), at the level of financial development and if The Role of the Real Exchange Rate economic agents can hedge against risk using financial instruments (Aghion et al. 2009). The real exchange rate (RER) depends on the relation between savings and investment and expenditure The effect of exchange rate volatility on exports is and income, with higher savings leading to RER found to be significantly negative in Latin America depreciation. Empirically, it has been shown that but it depends on the type of goods and country growth takeoffs materialize during sustained periods of (Sauer and Bohara 2001). Haddad and Pancaro (2010) depreciated RERs and are significantly associated with find similar results, confirming the negative relation sustained export growth (Hausmann, Pritchett, and between large RER variability and exports to GDP. The Rodrik 2005). Conversely, real overvaluation hinders effect on the output growth of MERCOSUR countries, in exports and contributes to a fall in economic growth particular, has been found negative overall but depends (Easterly 2005; Johnson, Ostry, and Subramanian on how productive firms are and how exposed to trade 2007). Haddad and Pancaro (2010) find that real they are (Varela 2011). undervaluation has a positive effect on economic growth and export expansion in countries with low per capita Uruguay’s RER has experienced large swings, and even income and that it is insignificant for countries with real the five-year moving average has been quite volatile 16 per capita incomes between US$2,500 and US$6,000. compared to other developing countries. This variability Meanwhile, in the long run, the undervaluation effect on has tended to dwarf the impact from microeconomic economic growth becomes negative and insignificant policies aimed at encouraging exports. Historically, on exports. in Uruguay, improvements in terms of trade have been associated with an appreciation of the terms of The variability of the RER is empirically shown to affect trade. It has been argued that RER appreciation is also economic growth. This variability results in volatility in associated with strengthening the demand in Argentina relative prices, increasing uncertainty and risks, and for goods and services that would otherwise be sold only Fi ur 7. R l Exch n R t s Fi ur 8. L r Co-mov m nts with th Ar ntin GDP 5 1.0 1,000 0.9 900 4 0.8 800 3 0.7 700 2 0.6 600 0.5 500 1 0.4 400 0 0.3 300 1980 1985 1990 1995 2000 2005 2010 1980 1985 1990 1995 2000 2005 2010 Uruguay Argentina Brazil Uruguay real exchange rate, inverted Argentina real GDP Source: World Bank staff calculations. Source: World Bank staff calculations. Fi ur 9. R l Eff ctiv Exch n R t , Fi ur 10. R l Exch n R t s, Ind x 2010 = 100 Ind x 2010 = 100 240 110 105 240 100 200 95 160 90 85 120 80 80 75 40 70 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Extrarregional Global Regional Extrarregional Global Regional Source: Central Bank of Uruguay. Source: Central Bank of Uruguay. locally in Uruguay. The latter has been mirrored by large import demand from China, has in turn translated in a correlation between the RERs of Uruguay and Argentina shift from regional goods toward globally trade goods. in the past (Lorenzo, Daude, and Noya 2001). The real effective exchange rate (REER),3 which is also Strong economic ties with Argentina and Brazil over used to assess a currency’s overall alignment, has this period mean that they had an impact on Uruguay’s appreciated over the past decade. The appreciation has macro economy, including through the impact on the been more pronounced with respect to the currencies of RER relative to the U.S. dollar. Volatility in Argentina, the regional economic partners, Brazil and Argentina. 17 and to a lesser extent in Brazil, had spillover effects in This appreciation is, however, largely attributed to Uruguay due to, among other things, fluctuations in changes in fundamentals. With technological progress— external demand and relative prices. particularly in the agribusiness sector—that has resulted in large productivity increases in the tradable RER developments in the 1990s, with a stable and sector, lowering prices for these goods relative to strong peso with respect to the currency of its main nontradables resulted in REER appreciation through the regional economic partners (Argentina and Brazil) and ‘Balassa-Samuelson effect’. Both theory and empirics appreciation with respect to the U.S. dollar contributed support that much of the REER appreciation is due to to the shift in Uruguay’s tradable production in favor fluctuations in relative prices (tradable/nontradables), of regional goods and to a deeper integration with especially in developing countries. Persistent changes in MERCOSUR (Hausmann, Rodriguez-Clare, and Rodrik terms of trade and differences in fiscal policies, tariffs, 2005). and financial development can also explain part of the differences in REER across countries. Large portfolio The sharp devaluation of the Brazilian real in January capital inflows and high FDI levels have resulted 1999 and the Argentine peso in December 2001, in in appreciation of the Uruguayan peso, which has conjunction with plummeting import demand from accelerated between 2012 and mid-2013 as the peso these countries, caused Uruguay to undergo a large strengthened against the U.S. dollar, while the Brazilian real depreciation against the U.S. dollar. This eventually real and the Argentine peso depreciated against the U.S. helped boost the profitability of the sectors exporting dollar, translating in particularly sharp real appreciations globally traded goods, such as agricultural products, of the Uruguayan peso with respect to the currencies of including beef, rice, soybeans, and forestry, whose regional partners. profitability depends on the U.S. dollar’s international prices and on Uruguay’s RER with respect to the U.S. dollar. These, in conjunction with the international 3  The REER is a weighted average of bilateral RERs between the commodity price boom, linked at least in part to rapid country and its trading partners, weighted by the respective trade shares of each partner. Fi ur 11. R l Exch n R t C cl nd Fi ur 12. R l Exch n R t s Growth/ Ind x 2010 = 100 Ind x 2010 = 100 240 110 200 100 160 90 120 80 80 70 40 60 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Argentina China Brazil USA Argentina China Brazil USA Source: Central Bank of Uruguay. Source: Central Bank of Uruguay. An RER assessment by the International Monetary Fund certain extent and allowing the central bank (IMF) in late 2013 (IMF 2014) found that the Uruguayan to have lower real interest rates than would RER was slightly above its equilibrium level.4 have been otherwise. Following the 2002–2003 crisis, exchange rate flexibility has been crucial in Monetary Policy and Exchange Rate preventing RER misalignment, with interventions Flexibility on the foreign exchange market aimed at reducing volatility while maintaining the exchange rate near 18 Uruguay is part of the full-fledged inflation equilibrium level. However, quasi-fiscal losses linked targeters in Latin America, alongside Brazil, Chile, to sterilization of capital inflows by the central bank Colombia, Mexico, and Peru. Conventional wisdom is have increased during the period of strong capital that it is impossible to achieve international financial inflows. In addition, the Central Bank of Uruguay has integration, monetary independence, and an effective used monetary instruments and macroprudential target on the exchange rate, and Uruguay has been regulations to avoid excessive volatility and stem targeting inflation during this period while having short-term capital inflows. a flexible exchange rate. Following the 2002–2003 financial crisis, inflation overshot to almost 30 percent The appreciation lowered the prices of tradables, but subsequently decelerated to a single digit by 2004, affecting employment and investment in the remaining in the single-digit range for the longest tradable sector, and contributed to an expansion period in history. However, inflation has exceeded the in the supply of nontradables. Nevertheless, higher upper limit of the targeted range throughout most of commodity prices have attracted investment in the period between 2006 and mid-2009, embarking the agribusiness tradable sector over this period. on a moderate yet persistent upward trend since The central bank tightened the monetary policy in 2010. Since 2011, inflation and inflation expectations the second half of 2012, but overall, the monetary have been consistently above the upper limit of the policy remained accommodative with the central targeted range. bank facing trade-offs between bringing inflation within the targeted range and containing nominal Important capital inflows over this period have appreciation pressures. put pressure on the currency to appreciate, thereby moderating inflation pressures to a For Uruguay, the effectiveness of monetary policy is affected by the lower level of financial intermediation 4  IMF 2014 finds that the Uruguayan peso was between 0 percent and 10 percent above its equilibrium level as of June given the income level and also due to liability 2013, having appreciated strongly over the previous decade, and dollarization on account of balance sheet effects. particularly since end-2011, against regional trading partners. Fiscal Policy and the Real Exchange Rate Fi ur 13. C ntr l Gov rnm nt B l nc s Percent of GDP Over the long run, the RER is determined by the 6 balance between aggregate demand and aggregate 4 supply, and an anticyclical fiscal policy, conditional on strong solvency of the government, could lead to 2 a less volatile RER. Conversely, larger fluctuations in 0 aggregate demand would result in a volatile RER in the long run. -2 -4 Uruguay has implemented a prudent fiscal policy in the wake of the 2002–2003 crisis, which together -6 00 08 06 09 with strong economic growth has helped bring down 03 05 04 02 07 01 10 12 11 20 20 20 20 20 20 20 20 20 20 20 20 20 debt levels. Uruguay has recorded a primary surplus Primary balance Structural primary balance on its consolidated public sector balance, averaging 2.7 Overall balance Structural overall balance percent of GDP between 2003 and 2011, before recording Source: Pizzolon and Rasteletti 2013; World Bank Staff calculations; a deficit of 0.2 percent of GDP in 2012. About half of Ministry of Economy and Finance (MEF). Note: Estimates of structural balances up to 2008 are based on Pizzolon and Rasteletti (2013). World the deterioration was on account of one-off transfers Bank staff estimates after 2009. and higher electricity generation costs and the other half on account of costs associated with the impact of the pension and health care systems. The structural promote investments that would help attract large- balances of the central government5 has averaged about scale FDI investments. The Investment Promotion 2.3 percent of GDP over 2003–2012, with stronger Regime (Law 16.906/998) was established in 1998 outturns during 2003–2007, when it averaged 3.5 and its role has received a significant boost since 2007 percent of GDP, and a deterioration during 2008–2012, (Decree 455/007), which was further enhanced in 2012 19 when it averaged 1 percent of GDP. The deterioration (Decree 002/2012) to ensure a higher contribution to has been more marked since 2011, resulting in a positive development goals in relation to fiscal incentives (MEF fiscal impulse and a pro-cyclical fiscal stance. Indeed, 2013). Uruguay has also signed numerous bilateral the World Bank (2015) has reported that the fiscal investment treaties. Few of the bilateral agreements policy has been pro-cyclical in Uruguay, exacerbating allow for the pre-establishment of investments, the fluctuations of consumption and output. including those with Chile and United States. All bilateral investment treaties that Uruguay signed Public Policies to Promote Investment and since the early 1990s include mechanisms to resolve Exports possible disputes between the investor and the State. Uruguay has actively pursued a gamut of public policies The government has also provided a variety of to promote exports and competitiveness, using trade incentives such as fiscal measures ranging from policy measures, fiscal incentives, and making efforts lowering profit tax rates, tax holidays, tax credits to improve infrastructure and access to competitive for investments, accelerated depreciation, and public services. It promotes investments in a bid to indirect tax refunding, as well as direct subsidies bolster productivity and enhance competitiveness to and special regimes (automotive). To promote exports engender a structural change in the economy and steer the government has used indirect tax refunding, investments in priority areas that would help achieve temporary admission, and export financing (pre- and its development goals. The government has sought to post-financing). The 2007 tax reform sought to align, streamline, and improve the design of these incentives 5 The central government structural fiscal balance was estimated using the standard method, correcting only for one-off while also dis-incentivizing exports of unprocessed factors and the effect of business cycles on the primary balance. raw materials. Following the 2008–2009 crisis, the This methodology is used by the IMF and by the MEF in Uruguay. Correction for the effect of business cycles on the primary government has increased the refund rate to 4 percent balance is based on estimates of potential output and the output to provide temporary relief for the sectors most affected gap, combined with estimates of the elasticity of revenues and by the crisis and by the regional situation, including expenditures to changes in GDP. poultry meat, processed fish, leather products, plywood, Many of these sectors have contributed to boosting ceramics, glass, textiles and clothing, shoes, and exports. To bolster tourism and regional development, metalwork and has better aligned the various export especially along the border with Brazil, the government promotion regimes. has also promoted the Free-Shops activity. The objectives of the Free Zones Regime, established Among the more sector-specific instruments used since in 1987 (Law 15.921) were “to promote investments, 2007 are the subsidies to the textile and clothing sector, expand exports, increase the use of national labor according to Articles 308 and 309 of Law 18.172 and force, and incentivize international economic Law 18.846 of November 2011, which complement the integration,” and the Regime also had a general incentives provided by the special regime for tax refunds coverage, with a specific mention of the services sector. and export financing. Meanwhile, the automotive sector, It has also helped attract an estimated US$4 billion which exports almost exclusively to MERCOSUR, has in investments between 2006 and 2013, particularly continued to benefit from a special regime, according to in the forestry industry (UPM, Punta Pereira); global Decree 316/92, which stipulates a subsidy of 10 percent export services (Aguada Park, World Trade Center); of the free on board (FOB) export value. specialized services (Parque de las Ciencias); and logistic services. The value added within the Free Trade Zones As part of the economic structural reforms initiated (FTZ) has risen to above 4 percent of GDP with close in the 1990s, Uruguay has also implemented trade to 90 percent of goods exports from the FTZ destined liberalization measures, unilaterally reducing tariffs to markets outside Latin America (MEF 2013). In 2013 following the General Agreement on Tariffs and Trade the government submitted to the Parliament a bill that and through trade liberalization within the region with seeks to modify and broaden the Free Trade Zones Law. the creation of the free trade area (MERCOSUR) in The bill, which was resubmitted to the Parliament by 1991 and its transformation into a customs union in the new administration seeks to promote investments, 1994. Certain sectors, particularly the agricultural, diversify the productive matrix, generate productive agro-industrial, and chemicals sectors, continue to 20 benefit from an important degree of trade protection, quality employment, increase national value added, stimulate high-technology activities and innovation, largely through non-tariff measures. Uruguay has promote decentralization and regional development, also made strides in increasing market access and increase the capacitation of national labor force, and facilitating trade. Uruguay has, for example, signed promote insertion in international trade and investment. seven preferential trade agreements (PTAs) for merchandise trade and three PTAs in services (Ferreira The Uruguayan government has also used sectoral and Vaillant 2014). regimes (Law 16.906/98)—more intensively since 2007—to provide the stimulus for specific sectors and encourage international insertion, development of supply chains, diversification, technology adoption, and quality employment. Among the sectors that have benefited from sectoral regimes are software, tourism, call-centers, the naval industry, renewable energy, agricultural equipment and machinery, electronics, hotels and condominiums, seeds and trees, industrial residues, biotechnology, and hydrocarbon exploration. M E P 2 P 21 Export Growth M cro conomic and Orientation Environm nt nd Public Polici s Exports, Imports, and Trade Balance countries (Figure 14b). The performance of Uruguay’s exports, which increased 3.95 times their value between Uruguay’s merchandise trade balance has been 2000 and 2013, lags behind regional competitors such relatively steady over the last decade, with a slight as Chile (4.3 times) or Paraguay (10.8 times).6 While tendency toward a deterioration. Although export Uruguay outperformed Costa Rica, Argentina, and New and import nominal values have steadily increased in Zealand, the country is an average performer. the past ten years, their performance as share of GDP has been fairly stable except for a marked jump in the Services exports have also performed well in recent trade deficit in the early 2000s (Figure 14). Among years and account for almost one-third of total other factors, the latter was the result of a combination exports. As shown in Figure 15, the share of services of a general shift toward trade openness in the Latin in total exports did not change significantly between American region, a positive shock to export prices, 2005 and 2013. Yet, Uruguay is more reliant on services and fast GDP growth post 2002, which fueled import exports than comparator countries in the Latin American demand, and the realignment of relative prices, followed region. In fact, the share of services in total Argentine by gradual strengthening of the Uruguayan peso in real and Chilean exports is almost half that of Uruguay’s. terms after 2004. Uruguay still lags slightly behind New Zealand, which experienced a greater expansion in its share of export Overall, exports increased from 10.1 percent of GDP services over the last decade. in 2000 to 16.3 percent in 2013 while imports moved from 15.2 percent to 20.9 percent of GDP during the In the services sector, Uruguay has maintained a same period. Remarkably, trade flows were relatively positive trade balance over the last decade. The resilient to the global crisis, which caused only a short- services trade balance as a percentage of GDP tripled term deterioration in the trade balance. Despite not between 2002 and 2007 but deteriorated considerably yet surpassing pre-crisis levels, trade balance as a during 2010–2013 (Figure 16a). This is explained by percentage of GDP increased in 2013. both an export contraction from 7.6 percent of GDP in 22 2011 to 5.7 percent in 2013 and an import expansion Uruguay has still much to gain from further integration from 4.3 percent to 5.8 percent in the same period. The in the global marketplace. Uruguay’s exports have key driver behind the import growth was the segment increased rapidly over the last decade when compared of travel services, which more than doubled its import to historic averages. However, it is important to compare 6  In this two cases, the substantial increases in international its performance with that of peer and aspirational prices of key commodities (copper for Chile, soybeans, beef and oil for Paraguay) have substantially contributed to the export expansion. Fi ur 14. Uru u ’s M rch ndis Tr d P rform nc . M rch ndis Tr d B l nc , 2000–2013 b. Merchandise Export Growth, 2000–2013 (Sh r of GDP) (2000 = 100) 20 16.3 1000 800 Index (2000=100) 10 0 600 -10 400 -20 200 20.9 -30 0 * 00 00 20 8 08 06 09 06 20 9 03 05 03 20 5 02 20 4 20 2 20 4 20 7 20 7 20 1 10 20 1 10 13 20 2 12 11 11 13 0 0 0 0 0 0 0 0 0 0 1 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 Exports Imports Tr d B l nc ARG CHI CRI NZL PRY URY Source: Authors’ calculations using data from UN Comtrade. Source: Author’s calculations using data from the World Develop- Note: The figure shows the evolution of exports, imports, and trade ment Indicators (WDI). Note: The figure compares merchandise balance for merchandise trade, measured as a percentage of GDP. export growth in Uruguay with selected peer countries. value, going from US$644 million in 2011 to US$1,312 Uruguay’s commercial service exports grew quite million in 2013, driven partially by the strengthening of steadily between 2002 and 2010 but experienced a the domestic currency and by the sustained growth of significant decline in the last three years. Measured in income per capita. current U.S. dollars, exports of commercial services grew, on average, by 7.4 percent per year during the Uruguay’s services trade balance as a share of GDP period 2000–2013. Over this period, however, there has been higher than that of several of its peers. was some volatility. Services exports declined in Indeed, the consistent surplus over the period 2000– 2001 and 2002 (mostly due to the contraction in 2012 stands in stark contrast to the performance of travel services associated with the Argentine crisis) neighboring countries such as Argentina, Chile, and and also in 2012 and 2013. During the period of Paraguay. Uruguay was substantially outperformed uninterrupted growth from 2003 to 2011, services by Costa Rica, which recorded a substantially higher exports increased at an impressive rate of 19 percent services trade balance surplus during this period. per year (Figure 17a). Fi ur 15. Sh r of Exports of Goods nd S rvic s, 2005 nd 2013 a. 2005 b. 2013 100 100 Share of Exports 2005 Share of Exports 2013 80 80 60 60 40 40 23 20 20 0 0 NZL NZL CHL URY CHL URY CRI CRI PRY PRY ARG ARG Goods Services Goods Services Source: Authors’ calculations based on data from UNCTAD. Note: Services exports include government exports of services. Figures for 2013 are estimated. Fi ur 16. S rvic s Tr d B l nc s Sh r of GDP a. Exports, Imports, and Trade Balance b. Trade Balance (Share of GDP), 2002–2012 Service Exports Trade Balance (2000−2012) (Share of GDP), 2000–2013 10% 15 8% 5.7 6% 4% 10 2% 0% -2% 5 -4% -6% -5.8 -8% 0 -10% 00 08 06 09 03 05 20 2 20 4 20 7 20 1 10 13 12 11 0 0 0 0 ARG CHL CRI NZL PRY URY 20 20 20 20 20 20 20 20 20 20 Export Import Tr d B l nc 2000 2007 2012 Source: Authors’ calculations using data from UNCTAD. Source: Authors’ calculations based on data from the WDI. Note: The figure shows exports, imports, and trade balance for services trade in Uruguay, measured as a percentage of GDP. Fi ur 17. Uru u ’s S rvic s Tr d P rform nc a. Services Export Growth Index, 2000–2013 (2000 = 1) b. Services Export Growth Rate, 2002–-2013 20 Services Exports Index (2000=1) CAGR of Service Exports 3 10 2 0 1 −10 −20 0 2000 2003 2006 2009 2012 2000−2003 2010−2013 Uruguay Argentina Chile Uruguay Argentina Chile Costa Rica Paraguay New Zealand Costa Rica Paraguay New Zealand Source: Authors’ calculations based on data from UNCTAD. Note: Figures for 2013 are estimated. Export Market Shares Export market shares have increased dramatically in vegetable products and wood products. The soy price The analysis of export market shares is boom and the investments around forestry-related complementary to the analysis of export growth activities resulted in market shares doubling and tripling both in goods and services. While the previous section since 1998, respectively. Other sectors have seen compared how Uruguay’s export performance fared their world market shares collapse. The paradigmatic 24 when benchmarked against select comparators, it is example is that of leather products (hides and skins). also useful to compare its performance against others’ While in 1998 Uruguay accounted for 7 out of every performances. The period of analysis, 2000–2013, 1,000 dollars exported globally, in 2013 it accounted for is one in which world trade expanded dramatically. less than 3. Similar losses were observed in the textiles, How much of that expanded market did Uruguayan clothing, and footwear sectors. producers secure? Trade Openness In 2013, out of every million dollars exported globally, 70 originated in Uruguay. Figure 18 shows How open is Uruguay to trade? There are two approaches the evolution of market shares for Uruguay and to this question. The first focuses on outcomes. A typical comparators.Figure 19 shows the same for the period indicator is the trade-to-GDP ratio. It weighs the combined 1997–2013) and reveals that Uruguayan exporters importance of export and import of goods and services in secured 0.07 percent of the market in 2013. In 2000, an economy and gives an indication of trade integration they secured 0.06 percent of the market, implying that in the global marketplace. The problem with this indicator market shares grew by 19 percent during the period. is that some countries may trade more than others for reasons related to their geography (for example, remote Three distinct processes can be identified during countries like Uruguay or island states typically present the period. First, a sharp fall of market shares, from a handicap to trade) or their economic size (for example, 1997 to 2003. In 1997, exporters in Uruguay accounted firms in large economies tend to trade less internationally for 88 dollars out of every million exported globally, than small economies because they have more scope to while in 2003, that contribution more than halved, trade among themselves). For these reasons, outcome- to 42 dollars. Second, rapid export share expansions based indicators of openness are typically complemented were observed during 2004–2005 (boosted by the real with policy-based indicators. The second approach depreciation of the Uruguayan peso) and 2008–2009 then focuses on policies, for example, the tariff barriers (due to the relatively more rapid contraction of world that the country imposes on the import of goods and trade). services and the tariffs that its exports face abroad. Fi ur 18. Export M rk t Sh r s, Uru u nd Fi ur 19. Export M rk t Sh r s, Uru u nd Comp r tors - 2000–2013 Comp r tors - 1997–2013 Comparators - 2000–2013 Comparators - 1997–2013 Market Shares − Goods & Services (%) Market Shares − Goods & Services (%) Market Shares − Goods & Services (%) Market Shares − Goods & Services (%) .6 .7 .15 .1 .12 .6 .5 .1 .02 .04 .06 .08 .5 .4 .05 .3 .4 .00 .3 .2 2000 2002 2004 2006 2008 2010 2012 2014 1995 2000 2005 2010 2015 Uruguay (LHS) Paraguay (LHS) Chile (RHS) Uruguay (LHS) Paraguay (LHS) Chile (RHS) Costa Rica (LHS) Argentina (RHS) New Zealand (RHS) Costa Rica (LHS) Argentina (RHS) New Zealand (RHS) Source: Authors’ calculations using data from World Integrated Source: Authors’ calculations using data from World Integrated Trade Solution (WITS) and UNCTAD. Trade Solution (WITS) and UNCTAD. Table 1. Export Market Shares, by Product - Uruguay, Merchandise (%) Product Group 1998 2003 2008 2013 01–05 Animal 0.768 0.487 0.806 0.774 06–15 Vegetable 0.290 0.210 0.299 0.572 25 16–24 Foodstuffs 0.093 0.040 0.035 0.037 25–26 Minerals 0.059 0.009 0.010 0.003 27–27 Fuels 0.010 0.005 0.008 0.002 28–38 Chemicals 0.030 0.015 0.025 0.031 39–40 Plastics/Rubber 0.048 0.036 0.049 0.057 41–43 Hides, Skin 0.738 0.551 0.391 0.277 44–49 Wood 0.057 0.050 0.131 0.158 50–63 Textiles, Clothing 0.126 0.059 0.049 0.044 64–67 Footwear 0.044 0.004 0.004 0.001 68–71 Stone/Glass 0.031 0.017 0.022 0.018 72–83 Metals 0.011 0.006 0.007 0.008 84–85 Mach/Elec 0.004 0.001 0.002 0.003 86–89 Transportation 0.027 0.004 0.010 0.017 90–99 Miscellaneous 0.007 0.005 0.004 0.010 Source: Authors’ calculations using data from WITS. Fi ur 20. M rch ndis Tr d s Sh r of GDP vs. Incom L v l a. 1997 − 2000 b. 2010 − 2013 250 250 MYS 200 200 MYS Trade to GDP (%) Trade to GDP (%) 150 150 PRY 100 PRY CRI 100 KOR CHL CHL NZL NZL PER URY 50 50 COL URY COL PER BRA BRA 0 0 6 8 10 12 6 8 10 12 Log of GDP per capita (PPP, av. ) Log of GDP per capita (PPP, av. ) Source: Authors’ calculations using data from the WDI. Note: The panels plot the relationship between trade openness and GDP per capita for all countries in the world. Relevant comparators are labeled. The curve shows the expected trade openness for a given per capita income. The white band represents the 95 percent confidence interval. Countries above (below) the confidence interval are said to be more (less) open to international trade than what their economic development implies. Outcomes comparison of panels (a) and (b) shows an increase in this regard, although Uruguay remains below the Figure 20 plots the trade-to-GDP ratio against GDP per average for its level of development. Other comparators capita for all countries in the world for the periods 1997– such as Costa Rica or Paraguay appear substantially 2000 and 2010–2013.7 The curve shows the average of more integrated, as suggested by this indicator. trade openness conditional on a given per capita income. 26 Focusing on the service sector alone, Uruguay’s trade The grey band represents the 95 percent confidence interval of that conditional average. The comparison of (exports plus imports) as a share of GDP is also lower both panels reveals that the average of trade-to-GDP than expected given its level of income. Figure 22 plots ratio slightly increased between the periods 1998– commercial services trade as a share of GDP against 2000 and 2010–2013, indicating that there has been a the income level for all countries in the world for two worldwide increase in the openness of countries to trade periods, 1998–2000 and 2010–2013. Panel b shows in the last 15 years. that, as observed for total trade, Uruguay falls below the curve, which suggests that the country’s openness in Uruguay has become more open to international trade commercial services is less than expected given its level (in goods and services) although it is still less open of development. Yet, when comparing the two periods, than expected given its level of economic development. Uruguay has narrowed the distance to the predicted Uruguay’s location in the chart is below the predicted line curve. In fact, in contrast to the trade in merchandise, in both periods, indicating that considering its income Uruguay’s openness to services trade is higher than level, the country trades substantially less with the that of some of the regional comparators, namely Chile, world than expected. In fact, Uruguay is less integrated Argentina, and Paraguay. Only Costa Rica and New in the global marketplace than Chile and Costa Rica and Zealand outperformed Uruguay in 2013. shows similar trade-to-GDP ratios as other larger South American economies that are typically less reliant on Trade Policy trade such as Peru or Colombia (see Box 1 for the role of geographical and economic characteristics on openness Since it joined MERCOSUR, Uruguay’s trade policy to trade). It is also interesting to examine changes has been to a large extent determined by the common in Uruguay’s degree of trade openness over time. A policies adopted at the regional level. MERCOSUR is a customs union composed of Argentina, Brazil, Paraguay, 7  Note that empirically there is a concave relationship between Uruguay, and Venezuela. Bolivia is in the process of the two variables, by virtue of the fact that trade increases with joining it. income per capita at a decreasing rate. Box 1. Measuring Openness to Trade The most common indicator to assess the extent capita at PPP. A dummy variable for island states to which a country is integrated into the global is also included. Our trade orientation indicator marketplace is the ratio of its trade (that is, shows a more accurate indicator of the revealed exports or imports) to GDP. These indicators have openness to trade. been reported here in Figure 21. As argued above, these indicators show that although Uruguay’s Our measure of remoteness ranks Uruguay openness to trade has been increasing over time, 183 out of 195 countries (where New Zealand it is still below average when compared to other and Australia are the most remote and the countries at a similar level of development. Netherlands, Great Britain, and Belgium are the least remote). However, assessing integration by just looking at trade-to-GDP ratios can be misleading. Many Latin American economies are generally factors condition a country’s possibility to poorly integrated into the global economy. participate in international trade markets, apart Given their geographic characteristics and the from its level of development. For example, larger size of their markets, the trade orientation of countries tend to display a lower international most Latin American countries is at the bottom trade intensity because there are more players of the distribution, with some exceptions such inside the domestic economy with which as Panama or Costa Rica (just above the to trade. Geographical characteristics also mean). Within South America, Chile is the most determine patterns of trade irrespective of how integrated and Brazil the least. open trade policies are, as shown by countless implementations of gravity models. For example, Uruguay appears at the bottom of the countries that are remotely located from the distribution even after controlling for its most important international markets face remoteness from the main world markets. 27 greater transport costs and so tend to trade Indeed, it is distant from Chile or Costa Rica and less. Similarly, island nations tend to face higher only above Brazil, Argentina, and Colombia. trading costs as land transportation—usually a cost-effective means of moving goods across borders—is not an option for them. Fi ur 21. Tr d Ori nt tion Ind x - 2000–2013 Here we present an alternative indicator of trade MYS 1 openness that controls for remoteness, the size THA IRL of the domestic market, whether the country is Trade Orientation Index an island state, and the level of development. .5 KOR CHN The indicator is the residual of a regression of DEU CRI the trade-to-GDP ratio on these factors. We use 0 cross-country averages for the period 2000–2013 CHL NZL for 168 economies. Remoteness is calculated −.5 PER as a country’s weighted average distance to all URY COL markets, where the weights are the share of each ARG BRA market’s GDP on the world’s GDP. The size of the −1 domestic market is proxied by domestic GDP (and a squared term to capture non-linear effects), and the level of development is proxied by the GDP per Source: Authors’ calculations. Fi ur 22. S rvic s Tr d s Sh r of GDP vs. Incom l v l a. 1998–2000 b. 2010–2013 Services Trade as % of GDP 1998−2000 Services Trade as % of GDP 2010−2013 100 100 80 80 60 60 40 40 20 CRI 20 NZL CRI NZL CHL URY CHL PRY URY PRY ARG ARG 0 0 4 6 8 10 12 6 8 10 12 log GDP per capita (current USD) 1998−2000 log GDP per capita (current USD) 2010−2013 Source: Authors’ calculations based on data from the WDI. Note: The panels plot the relationship between trade openness (in services) and GDP per capita for all countries in the world. Relevant comparators are labeled. The curve shows the expected trade openness for a given per capita income. The gray band represents the 95 percent confidence interval. Countries above (below) the confidence interval are said to be more (less) open to international trade than what their economic development implies. MERCOSUR’s institutional structure, as determined examine the current CET structure and submit a proposal by the Ouro Preto Protocol, which has been in force for the GMC’s consideration in 2015. In the context of since December 1995, provides for two types of bodies the global economic crisis, MERCOSUR member states categorized by the binding force of their acts: were also authorized to increase their tariffs for up to 200 tariff lines until the end of 2014, within the World (a) Decision-making bodies produce binding decisions Trade Organization (WTO) bound rates. MERCOSUR’s 28 on the state parties and are (i) the Council of the rules provide that none of the state parties may apply Common Market (CMC), which acts essentially any trade policy measure independently to goods except through decisions, is responsible for deepening the in those sectors that are in the process of converging integration process, and achieving the objectives toward the customs union and those that have been of the Treaty of Asunción; (ii) the Common Market granted a waiver from the general regime for extra- and/ Group (GMC), which acts through resolutions and or intra-regional trade. Thus, since no common policy is the executive body responsible for monitoring has been agreed on sugar, automotive vehicles, or spare implementation of the Treaty of Asunción; and (iii) parts; these sectors continue to be governed by national the Trade Commission (CCM), which issues directives law (sugar) and bilateral agreements (automotive and is entrusted with monitoring the application of sector), according to the WTO (2012). common trade policy instruments and examining common trade policies related both to regional trade Through its participation in MERCOSUR, Uruguay has and trade with third parties. signed preferential trade agreements, including with countries of the Andean Community (Bolivia, Ecuador, (b) The non-decision-making bodies are the MERCOSUR Colombia and Peru) as well as with Chile and Cuba. Parliament, the Economic and Social Advisory Uruguay also has bilateral preference agreements Forum, and the Secretariat. with other member countries of the Latin American Integration Association (LAIA). Of these, the broadest MERCOSUR member states share a common external in scope is the Free Trade Agreement (FTA) with Mexico, tariff (CET), which entered into force in 1995. Various signed on November 15, 2003, which entered into force exceptions have been allowed through decisions by on July 15, 2004, following the adoption of Law No. the CMC. All MERCOSUR member states are currently 17.766 and covers almost all tariff headings except oil authorized to have an exception list, although there and motor vehicles. A partial scope agreement between are different provisions for each country. Decision CMC MERCOSUR and India and an FTA with Israel has entered 56/10 established the creation of an ad hoc group to into force since 2006. Agreements have also been signed between MERCOSUR and the Arab Republic of Egypt and Some Evidence on Uruguay’s gains in between MERCOSUR and the Southern African Customs MERCOSUR Union (SACU) but have not yet entered into force. Existing literature is mixed about the gains that Tariff Structure Uruguay accrued from being a member of MERCOSUR. In general, positive effects have been reported that are The simple average of bound tariffs are 31.5 percent as not related to the customs union membership as such agreed with the WTO, whereas the simple average most but rather to the process of economic integration in the favored nation (MFN) tariff is 10.5 percent, which is low region. for world standards, as shown in Table2. The trade- weighted applied MFN average falls to 8.3 percent as Moncarz and Vaillant (2010) observe how tariff products with lower tariffs tend to have a higher volume. preferences affected the origin of imports of Weighted average MFN applied for agricultural products MERCOSUR members, to shed light on whether is 11.7 percent whereas the average for nonagricultural MERCOSUR produced diversion of trade. Diversion of products is 7.9 percent. trade happens when, in the context of a customs union, importers switch suppliers away from the lowest cost Uruguay’s applied tariff has 11,345 lines (at the ten-digit option due to the introduction of a preferential tariff rate level), with rates ranging from 0 percent to 35 percent. applied to the previously less competitive supplier who is Table 3 summarizes the structure of tariff values for now part of the customs union. From a welfare point of different ranges. For instance, only 8.7 percent of tariff view, trade diversion reduces welfare because it leaves lines for agricultural products have a zero-MFN tariff the economy with less tariff revenue, and that loss is not or are duty free, whereas 16.1 percent of tariff lines in fully matched by a reduction in production costs faced by nonagricultural products are duty free. Most of the the user of the imported good. Using a detailed database tariff lines (56.4 percent) in agricultural products are on intra-MERCOSUR tariffs, the authors show that tariff between 5 percent and 10 percent. Around 38 percent preferences did affect import patterns for Argentina and 29 of nonagricultural products are between 15 percent and Uruguay, supporting the hypothesis that MERCOSUR 25 percent. produced trade diversion for these countries. Table 2. Summary of Tariffs and Imports for Agricultural and Nonagricultural Products, 2013 Summary Agricultural Nonagricultural TOTAL Simple average final bound (%) 34.0 31.2 31.5 Simple average MFN applied (%) 9.9 10.6 10.5 Trade-weighted average. MFN applied (%) 11.7 7.9 8.3 Imports (billion US$) 1.2 10.1 11.3 Source: WTO International Trade Center (ITC) UNCTAD - World Tariff Profiles 2014. Table 3. Applied MFN Tariff Structure for Agricultural and Nonagricultural Products, 2013 (in percentages) Frequency Distribution Duty Free 0