What the EU could learn from the Pacific Alliance

July 6, 2016

In theory the EU should be a great idea. In practice not so much.

As a trade bloc it has a lot going for it. It’s the world’s richest single market, with standards that protect the consumer. It gives the European countries weight against China, which often uses predatory trade practices, such as dumping, against smaller trade ‘partners’.

But of course the trouble with the EU is that it’s not just a trade block. The core EU states also have monetary union – and the perils of two economies as distinct as Germany and Greece sharing the same monetary policy have become clear.

Elsewhere in the world other trade blocks look they are learning from the EU’s mistakes….

The other problem is the lack of democracy. At Europe’s core there is a cadre of policymakers that want an ever closer European Union – something akin to a United States of Europe. Every crisis is an excuse to bind the countries ever closer. Be it complex financial bailouts or immigration deals, they are all decided by this elite cadre without consulting the voters of member states, and serve to draw the EU ever closer.

It all sounds pretty depressing. Especially considering that the EU was often considered the shining example for other attempts at regional integration around the world. But fortunately elsewhere in the world other trade blocks look they are learning from the EU’s mistakes.

Latin America’s most exciting trade block

The Pacific Alliance combines Chile, Peru and Colombia – the dynamic, medium-sized Andean economies of the South American Pacific coast – with Mexico, a geographical colossus that straddles the North American continent, stretching from the Pacific to the Atlantic. All four have excellent macroeconomic track-records, healthy public finances, young populations and lots of natural resources.

Looked at as a single economy, the Pacific Alliance is Latin America’s biggest, accounting for 40% of Latin American GDP and around half of all trade. With 210 million people it’s bigger than Brazil and richer too, both in absolute and per capita terms. Its capital markets are on par with Brazil’s and it is already attracting more foreign direct investment. It’s also an export powerhouse, accounting for about half the regional total. Moreover, those exports are balanced – a healthy mix of manufactured goods and commodities – and growing at 8% per year.

But most important of all, they also all have open economies and are committed to free trade. It’s a stark contrast to Mercosur, a more established Latin American trade group that has failed to boost trade between Brazil, Argentina, Venezuela and Uruguay.

Looked at as a single economy, the Pacific Alliance is Latin America’s biggest…

The contrast between the Pacific Alliance and Mercosur is “obvious”, says a Foreign & Commonwealth Office (FCO) briefing. The Pacific Alliance “is designed as a purely economic proposition to the genuine mutual benefit of its members”, rather than a political group set up to “issue political communiqués”. Moreover, “this group of pro-free trade, open economies” stands out in a region where “growing protectionism” is an increasing problem. Its creation makes Mercosur look “stalled and unambitious by comparison”.

Damning words there from the FCO on Mercosur. One wonders if it is so brutally honest about the EU… Because the fact is, the Pacific Alliance has also avoided some of the EU’s worst mistakes. There are no supranational organisations, no elite cadre of Pacific Alliance policymakers and no massive grant and subsidy system to misallocate resources. Instead it focuses purely on expanding trade between the members and forming cross-border supply chains that better allow them to export to the world.

A new stockmarket

But not everything the Pacific Alliance has touched has turned to gold. The Mercado Integrado Latinoamericano, was launched in 2011 as a part of an ambitious plan to integrate the financial markets of the four member countries. Mila is a platform that allows investors in one country to freely trade equities listed on the exchanges of fellow members. The idea is to create scale by pooling the financial assets of the four countries. A virtuous cycle is expected as this increased scale and liquidity attracts more international capital. Yet, so far at least, Mila has been a slow starter, with low trading volumes and few products.

It didn’t help that the Pacific Alliance picked the worst possible time to launch its integrated markets project. Back in 2011, Latin America was still riding high on the commodity super-cycle and local bourses were booming. But since then a crash in mineral and oil prices – the major exports of the member countries bar Mexico – has sent their stockmarkets tumbling. These losses have understandably hit investor appetite, causing trading volumes to fall as investors look for better returns on their capital.

It didn’t help that the Pacific Alliance picked the worst possible time to launch its integrated markets project…

Unsurprisingly Mila investors have suffered. For example, the S&P Mila 40, an index that tracks the fortunes of the 40 largest equities on the Mila platform, has lost almost half of its value since launching in August 2011.

But there are signs that could be about to change. A few months ago LatAm INVESTOR interviewed Juan Pablo Córdoba, CEO of the Colombian stock exchange. Admittedly he has a dog in this fight but he thinks now is a good time for investors to get back in. “Of course the last 18 months have been difficult but a lot of equities are looking very good value right now. If you believe in the medium-term growth potential of these countries then this could be a perfect entry point.”

FX is another factor as when the local currencies stabilise against the dollar it would help to stem equity losses. “Right now the dollar is not helping [equities]”, says Diego Icaza CIO of BBVA Asset Management Peru, “while the possible rise in rates during next 12 months would hurt the region as a whole. So it could be a dead year for the next six to 12 months in terms of capital investment in emerging markets, but after that we should see a pick up.”

Another huge potential driver could come from the member country pension funds. Together these funds manage $450billion of assets of which just 1% of the total sum is invested in other Pacific Alliance stockmarkets. Both those figures will rise in coming years.