The Resource Curse Haunts Chile-China Trade

Earlier this month, Chinese Vice President Xi Jinping met with Chilean President Sebastián Piñera as part of a trip that covered other Latin American countries. Chile was the first South-American country to establish diplomatic ties with China in 1970 and the first Latin American country with which they signed a Free Trade Agreement (FTA) in 2005. This longstanding relationship of friendship and cooperation was reaffirmed at the meeting by committing to deepen bilateral relations and by signing cooperation agreements in agriculture, mining, and finance: strategic areas for Chinese interests in Chile and Latin America.

While Latin American countries primarily export raw materials and mining products to feed China’s increasing demand, China is heavily investing in Latin America in terms of real estate, infrastructure, and transportation. The UN’s Economic Commission for Latin America and the Caribbean (ECLAC) reports that 90% of the region’s export basket to China is composed of raw materials and minerals. In turn, 85% of China’s exports to Latin America are manufactured products. Additionally, according to Delloite & Touche, in the period from May 2010- June 2011 China invested $15.6 billion in Latin America, up 286% from the previous 12 month period (most of it went to Brazil and Argentina). So we have commodities being used to manufacture electronics and automobiles in China, being exported back to where those raw materials came from in Latin America. Each party takes part of their own competitive advantages in a classic example of international trade. Could this be a win-win situation for all the parties involved? Not quite.

In the case of Chile, China surpassed the United States as its main trading partner in 2007, the first year of entry into force of the Chile-China FTA. The export basket is composed of 86.8% metallic mining products and 9.2% of raw materials (including cellulose and iron), 96% of Chilean exports to China. Compare that to 61% in the case of the U.S., a much more diversified basket. 

And it makes sense, since Chile has 38% of world’s copper reserves and is the largest copper producer, having produced over a third of the world’s copper in 2010. Revenues from the mining industry constitute an important share of fiscal income and key social programs in areas such as health, pensions, disability and innovation are funded in part by the revenues stemming from this industry. The Economic and Social Stability Fund aimed at saving copper revenues in years of bonanza to use in periods of distress was key in helping the country overcome fairly well the effects of the international financial crisis of 2008.

However, there are several reasons to be weary of this boom cycle. The increase in the price of copper in 2004, which is still reaching historic high levels, carries risks associated to exchange rate pressures, which may lead to what is called the “resource curse.” The latter is a reference to the “Dutch disease” a term coined by the Economist used to describe the negative impact that a gas windfall had in the economy of the Netherlands. It implies that real exchange appreciations driven by natural resource booms could prove to have negative long-term effects in exports and productivity. It may also lead to less competitive economies in the long-term by limiting the ability to diversify the export basket into more sophisticated products. In fact, several studies show that countries whose export basket is associated to higher value-added products (e.g. electronics, hi-tech manufactures) tend to have overall higher GDP per capita. With the Chilean peso highly appreciated, exporters in other sectors have been widely affected with little incentive to innovate moving to more sophisticated goods. At this pace, will Chile ever evolve to a fully developed country? 

The Dutch disease is not a curse, only a possibility. Whether China ends up being friend or foe relies on how Chile and other Latin American countries are willing to frame their relationships with China. Just as Chile has done with the U.S., it should take advantage of the good standing of bilateral relations to promote higher investment and cooperation in strategic technological industries, fostering entrepreneurship and technology transfer in areas where China has vast expertise. Higher cooperation and investment in terms of R&D is crucial and should therefore be at the core of any initiative developed by both countries. This may not reduce the Chinese demand for commodities and consequent exchange rate pressures, but an active strategic approach attending the tech knowledge-based needs of Chile’s productive base could be the start of truly beneficial bilateral relations.

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