Bolivar's Dream Come True?

Table of Contents

Chapter 1 - Introduction
1.1 Introduction
1.2 Previous Research
1.3 Methodology

Chapter 2 - Concepts, Explanations and Consequences of Regional Integration and a Theorisation of the Treaty of Cartagena
2.1 Theories of Regional Integration
2.1.1 Some Remarks about International Co-operation
2.1.2 Political Integration Theory
2.1.2.1 Intergovernmentalism
2.1.2.2 Neofunctionalism
2.1.3 Economic and Social Effects of Integration
2.1.3.1 Classical Trade Theory
2.1.3.2 Convergence or Divergence?
2.1.3.3 South-South Integration and Development
2.1.3.4 The Relation between Economic and Social Development
2.2 A Theorisation of the Cartagena Agreement
2.3 Subconclusion

Chapter 3 - The Andean Community
3.1 The Region
3.2 History and Achievements of Andean Integration
3.3 The Institutional Structure of the Andean Community
3.4 Subconclusion

Chapter 4 - Integration and Economic Development in the CAN
4.1. Conditions for Export-Oriented Economic Development in the CAN
4.2. The Remaining Problems
4.2.1 Economic barriers
4.2.2 Political Barriers
4.2.3 Physical Barriers
4.3 The Results: Development of Cross-Border Trade and Investment in the CAN
4.3.1 Integration and Trade
4.3.1.1 Static Effects
4.3.1.2 Dynamic Effects
4.3.2 Integration and Investment
4.4 Political Participation of the Private Sector in the CAN
4.5 Subconclusion

Chapter 5 - Integration and Social Development
5.1 The Socio-Economic Situation in the Andean States
5.2 The Social Effects of Integration – Convergence or Divergence?
5.3 National and Supranational Social and Regional Policy
5.3.1 Policies in the Member States
5.3.2 Supranational Policies
5.4 Civil Society and the CAN
5.5 Subconclusion

Chapter 6 - Conclusion

Table of Charts

Chart 1 Methodological Framework

Chart 2 Thepories of European Integration

Chart 3 Theorisation of the Cartagena Agreement

Chart 4 Main Industries and Export Goods Of CAN Countries

Chart 5 Logo of the Andean Community

Chart 6 Main Decision-Making Organs of the CAN

Chart 7 CAN growth rates of intra-regional and extra-regional Exports 1969-2002.

Chart 8 CAN: Growth rates of intra-regional and extra-regional imports 1969-2002

Chart 9 export partners of the CAN countries 2004

Chart 10 import partners of the CAN countries in 2004

Chart 11 Composition of intra-and extra-CAN trade by sectors, 1991-2001

Chart 12 GDP of CAN Member States, 1992-2000, In Billion USD

Chart 13 CAN: Annual Growth Rates 1996-2004, in %

Chart 14 Net FDI inflows into the Andean Community by destination, 1990-2004, in million USD

Chart 15 Net FDI Inflows into the CAN by sector, in 1995-2004, Million USD

Chart 16 Poverty in the CAN, in %

Chart 17 CAN: Income Distribution, in %

Chart 18 Economically Active Regions in CAN Trade

Chart 19 Theorisation of Cartagena Agreement: An Assessment of Integration

Table of Abbreviations

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Chapter 1 - Introduction

1.1 Introduction

The last decades have witnessed the rise of a series of regional integration processes, in Europe as well as in other regions of the world. The European Union (EU) can certainly be called the most advanced of these projects. It all began as a project of integration of major industries in order to overcome the division between the largest European states, France and Germany, prevent future wars and raise the living standards of the population through enhanced economic development. With the initial aid of the Marshall Plan, the European Union today is one of the three major players of the world economy besides the United States of America and East Asia. It has brought welfare and an exceptionally long-lasting period of peace to its peoples, who had once been divided by a number of devastating wars.

Shortly after the treaties founding the European Coal and Steel Community (ECSC), European Atomic Energy Community (EAC) and European Community (EC) were signed, there were efforts in other regions of the world as well to follow this example, notably in Latin America, where the Latin American Free Trade Association (Asociación Latinoamericana de Libre Comercio, LAFTA), the Central American Common Market (Mercado Común Centroamericano, CACM), the Caribbean Community and Common Market (Comunidad del Caribe; CARICOM) and the Andean Pact (now Andean Community or Comunidad Andina de Naciones, CAN) were established. The founding Treaty of the latter, the Cartagena Agreement (or Acuerdo de Cartagena, AC), was signed in 1969, when five nations, Bolivia, Colombia, Chile, Peru and Ecuador, decided to seek “a balanced and harmonious development” through integration and economic and political co-operation. Venezuela decided to join in 1976 and withdrew again in April 2006, whereas Chile withdrew membership as early as in 1976, after the accession to power of Augusto Pinochet. In order to achieve the aims laid down in the Treaty, a complex institutional framework was drawn up, modelled upon the European Community and featuring intergovernmental as well as supranational elements.

In contrast to that on European integration, however, most political and academic discourse on the Andean Community agrees upon the fact that this integration process has, up to now, not been very “successful”, and quite often it is called a complete failure. This thesis wants to contribute to the search of possible reasons for this. For this purpose, it is first of all necessary to define what is meant by the term “successful”. This concept is used here in a triple sense. First, it means success in achieving the aims established in the founding treaty of the Andean regional integration agreement – namely raising the living standards of its people through economic co-operation. Second, it refers to the speed of the integration process and the level and scope of supranational governance. The third dimension of the term “success” is the perception of the value of integration by the people concerned.

In order to explain the lack of “success” of Andean integration – especially in the period since the late 1980s - this thesis focuses on an element which, in most integration theories, is considered the most important prerequisite for regional integration: interdependence, and thus a demand for integration on the part of the region’s citizens. It is argued that in principle, integration can create or at least reinforce its own demand, but that this has only happened in the Andean case to a relatively small extent and limited to few sectors of the highly unequal societies in Bolivia, Colombia, Ecuador, Peru and Venezuela.

1.2 Previous Research

The Andean Community is probably one of the integration schemes in the world for which hardly any literature is available. Research about Latin American integration is mainly focused on the Mercosur and the North American Free Trade Agreement (Tratado de Libre Comercio de América del Norte, NAFTA), neglecting other schemes such as the CACM and CARICOM, and, of course, the Andean Community. Most articles about the Andean Community are confined to descriptive accounts of its history and institutional structure, giving possible reasons for its “failure” without referring to any kind of integration theory. The documents issued by the Interamerican Development Bank (IADB), the Institute for Integration in Latin America and the Carribean (Instituto para la Integración de América Latina y el Caribe, INTAL) and the Economic Comission for Latin America and the Carribean (ECLAC; or Comisión Económica para América Latina y el Caribe, CEPAL) as well as the working papers and seminar papers prepared for or by the CAN offer the most extensive accounts of what is happening in the CAN. There are, moreover, a number of journals issued by the Venezuelan Universidad de los Andes, notably Aldea Mundo and Nueva Sociedad, which contain articles about different aspects of Andean integration.

Among the few authors who deal with Latin American integration from a theoretical point of view, three deserve to be explicitly mentioned. First of all, Ernst Haas - one of the early and most important theorists of European integration. In co-operation with Philippe Schmitter, he develops a theoretical framework for analysing integration in Latin America, based on his neofunctionalist theory (Economics and Differential Patterns of political Integration; Projections about Unity in Latin America, 1964). Second, Andrés Malamud, who mostly focuses on the Mercosur, but who has also published a number of articles in which he at least makes reference to the CAN (e.g. together with Luís de Sousa: Regional Parliaments in Europe and Latin America: between Empowerment and Irrelevance, 2004, and Regional Integration in Latin America. Comparative Theories and Institutions). Third, Walter Mattli, who has written a book about The Logic of Regional Integration - Europe and Beyond. (1999).

1.3 Methodology

This thesis wants to contribute to explaining the slowness of the integration process, applying – though not uncritically – one of the most important currents of integration theory: neofunctionalism and its more recent variants. These theories suggest that, if certain preconditions are fulfilled, economic co-operation leads to the formation of a political community. Political actors begin to shift their loyalties, expectations and political activity towards a new centre, assuming that they can better achieve their aims at the supranational than at the national level. In the CAN, apparently, this shift of loyalties, expectations and political activities has not taken place, showing that the CAN has not yet gone very far on the road to an economic or a political community and that the states themselves seem to be free to back out of the process whenever they feel that the CAN no longer serves their interest. This was demonstrated by Venezuela’s withdrawal in April this year.

The thesis uses the normative ideas of the Cartagena Agreement as a framework for analysis, proposing a theorisation of the Treaty and then applying it to the concrete situation of the CAN. The rationale of the Cartagena Agreement is to use integration as an instrument for achieving social development through economic development:

The objectives of this Agreement are to promote the balanced and harmonious development of the Member Countries under equitable conditions, through integration and economic and social cooperation; to accelerate their growth and the rate of creation of employment; and to facilitate their participation in the regional integration process, looking ahead toward the gradual formation of a Latin American Common Market.

This Agreement also seeks to reduce external vulnerability and to improve the positioning of the Member Countries within the international economic context; to strengthen subregional solidarity, and to reduce existing differences in levels of development among the Member Countries.

These objectives are aimed at bringing about an enduring improvement in the standard of living of the subregion´s population. (Art 1, CA)

This thesis is especially concerned with the second part of Art 1 CA, thus the idea that integration leads to economic development which, in turn, stimulates human/social development. The thesis will analytically split up this normative assumption of the Cartagena Agreement into two steps: first, it will look at relation between economic integration and economic growth, searching for factors which hamper this process. The same will then be done with regard to the link between economic and social development.

The procedure adopted is visualised in chart 1. The rationale of the founding treaty is displayed vertically, in bold characters. The different steps of the Cartagena logic (integration – economic development, economic development - social development) are linked by double arrows, labelled with the type of integration theory (in italics) which will be used in the analysis. For example, economic integration theories like external trade and customs union theory explain how economic integration leads to economic development. Political science integration theory, displayed on the right hand side of the chart, explains why and how economic integration deepens and finally leads to the formation of a political community.

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Chart 1 Methodological Framework

The main questions to be answered here are thus: What results has integration achieved so far for the people, and, in turn, what are the effects of these results on the potential deepening of integration?

The subsequent part presents the most important integration theories, which are then organised according to the normative ideas of the Cartagena Agreement. Here, a set of criteria is established which will be used as the framework for the actual analysis. Chapter 3 will introduce the regional integration process in the Andes, its origins, logic and institutional structure. Chapter 4 will examine the first of the two steps of the welfare-enhancing effect of regional integration, namely the link between integration and economic growth. The conditions for the private sector to operate in the Andean zone are examined and remaining barriers to cross-national business activity are identified. Finally, the overall economic results of the integration process and its effects on supranational politics are analysed. Chapter 5 focuses on the causal link between economic growth and human development in the Andean countries, taking a closer look at the socio-economic situation in the area and the social effects of integration as well as the national and supranational efforts to improve the prevailing conditions. Chapter 6 concludes.

Chapter 2 - Concepts, Explanations and Consequences of Regional Integration and a Theorisation of the Treaty of Cartagena

2.1 Theories of Regional Integration

2.1.1 Some Remarks about International Co-operation

This chapter will deal with the questions of how and why countries pursue regional integration in general, and how integration is expected to function in the Andean case in particular. First of all, some problems of collective action are pointed out. Subsequently, the most important political science integration theories are presented which explain the how of integration. Afterwards, economic science integration theories are introduced in order to give some reasons why countries integrate. Finally, section 2.2 proposes a theorisation of the Cartagena Agreement.

As for collective action, there are situations in international relations in which states can solve their problems more effectively by co-operating instead of selfishly following their own national interest, given rational government behaviour. However, in an anarchic world, as it is seen by realists, this implies a number of problems. The two traditional approaches to explaining such problems in international relations theory, (neo-)liberalism and (neo-)realism, both draw on game theory – initially used by micro-economists to explain the behaviour of economic actors in different market conditions - to elaborate on the problems of collective action. In perfect competition, it is supposed that every actor chooses the behaviour that maximises his profits, and everybody benefits from that. This, however, does not work with public goods. Here, rational and profitable individual behaviour might lead to irrational collective behaviour. An example: if all the inhabitants of a village gain their living by fishing in the lake next to the village, everybody will try to maximise his own profit, but when there are no more fish in the lake, everybody will have a problem. People can either decide to keep on going like that or co-operate – in our example, they might agree on certain quotas - but they can never be sure if the others will comply with the co-operation agreement. If the others do not co-operate, the actor who mistakably thinks that they do and who himself adopts a co-operative behaviour – will suffer losses. Nobody can trust the other although everybody knows that co-operation would probably be a better strategy than competition^[1]. This makes co-operation difficult to achieve, but does not preclude it. An option to surmount the problem of cheating and mistrust is the creation of international organisations or international regimes^[2] providing information and, possibly, surveillance mechanisms (e.g. a hegemon is present who polices the regime)^[3].

2.1.2 Political Integration Theory

2.1.2.1 Intergovernmentalism

Regional integration can be seen as a type of international institution in the sense that countries opt for co-operation, jointly dealing with problems which concern them all. However, it is obviously more than just co-operation in a given issue area.

Integration theory has been developing in close relationship with the European integration process as the first and most evolved “specimen” of regional integration schemes, evolved to such an extent that is pictured as a phenomenon sui generis by most authors (n=1 problem). During the history of integration, diverse approaches of conceptualising the EU have appeared. The first ones, developed from the 1960s onwards, focus on explaining integration outcomes. A second broad stream of integration which came up in the 1980s in the context of a deepening of integration focused more on the analysis of governance.

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Chart 2 Theories of European Integration

Source: Peterson/Blomberg (1999), p. 319

The earlier and also a lot of the newer theories are explanatory, foundational theories. However, anti-foundational and constitutive theories - such as discourse theory or post-colonialism - have become more and more important in the last years^[4].

Since this thesis tries to explain the role of subnational actors in an integration scheme which it is not yet as advanced in terms of the degree of economic and political integration and supranational decision-making, “history-making”^[5] theories, which try to explain integration outcomes, seem to provide the most useful tools for the analysis. This is why the presentation of theories will be limited to these approaches.

In general, rationalist integration theories can be divided into two main currents – state-centred theories and multi-level-governance theories. The main difference between these types of approaches is the role they attribute to national states on the one hand and to society on the other hand in the integration process. State-centred approaches affirm that the states act as “gatekeepers” of the integration process. Supranational institutions may be created by these states in order to be better able to pursue their national interest, but they will never be more autonomous than the member states allow them to. Other approaches take the opposite view: states will, at some point, loose some of their initial control over the actions of supranational institutions as the latter and the civil society push for a deepening and widening of integration.

Among the state-centred approaches, the most prominent one has been Moravscik’s Intergovernmentalism. As to the relation between Intergovernmentalism and Neofunctionalism, which will be presented later on, according to Malamud, “neofunctionalism may be considered the opposite of intergovernmentalism, as it does not fully explain the starting up of an integration process but advances a hypothesis on the causes for further expansion instead”^[6]. Malamud claims that Andean integration has not gone much beyond an Intergovernmentalist project^[7].

Derived from International Relations Theory, Intergovernmentalism was developed in the 1960s, criticising earlier theories like Neofunctionalism for heavily under-emphasising the power of national governments. Intergovernmentalists like Hoffman state that European integration would only happen if it was in the best interest of national governments, an assumption which seemed to be confirmed by de Gaulle’s empty chair policy in the 1960s.

Moravscik, the founder of the most important stream of Intergovernmentalism (called liberal IG) puts the main emphasis on the role of the state and national interest, but also stresses the importance of relative strength of some national governments over that of others. His approach has three main components. First of all, he assumes rational and utility-maximising state behaviour. Second, he explains how national preferences are determined through inner-state bargaining and third, how states try to realise their interest in inter-state negotiations^[8].

Intergovernmentalism does not see any automaticity in the integration process – thus, if there is a deepening of integration, it is the result of “great bargains” among heads of states and governments. Sub- and supranational actors who - as will be seen in the next section - are the most important actors in Neofunctionalism, play a more indirect role in Intergovernmentalism. The question of whether integration is deepened or not is determined by either convergence or divergence of national interests.

Intergovernmentalism has been confronted with the criticism that it focuses too much on the final stages of decision-making and pays too little attention to informal integration and the constraints that such integration imposes on decision-makers. Moreover, it underestimates the role of supranational bodies.

2.1.2.2 Neofunctionalism

The first ideas about integration of states in the post-World War II area were uttered by David Mitrany. Aware of the failure of various political/institutional co-operation schemes in the past, he campaigned for a process of technical co-operation in different policy areas which would, in the end, connect all countries in the world and put an end to nationalism and the territorial division of power. Cram points out that Mitrany’s theory cannot actually be considered a theory of European integration since he held that “nationalism at the nation-state level must not […].simply be replaced by nationalism at the European level”.^[9] However, Mitrany’s thinking laid the basis for a number of later theories concerned explicitly with European integration.

Another early theorist dealing with integration in Europe, Karl Deutsch, defines integration as the

attainment, within a territory, of a ‘sense of community’, and of institutions and practices strong enough and widespread enough to assure, for a ‘long time’, dependable expectations of ‘peaceful change’ among its population. When a group of people or states have been integrated this way, they constitute a ‘security community’^[10]

Laursen states that

Deutsch coined the term of amalgamation to define this state, meaning the „merger“ of two or more previously independent units into a single larger unit, with some type of common government.^[11]

Deutsch finds nine conditions for such an amalgamated security-community to exist, for example the mutual compatibility of main values and a distinctive way of life, as well as mobility of persons at least among politically relevant states and unbroken links of social communication, both geographically between territories and sociologically between different social strata.

Ernst Haas takes up Mitrany’s idea of technical co-operation, but rejects the notion that technical and political co-operation can be neatly separated from each other. He focuses on integration within the European community, but does not neglect other parts of the world. Haas’s frequently quoted definition of international integration reads as follows:

The process of attaining this condition [the formation of a political community] we call integration, the process whereby political actors in several distinct national settings are persuaded to shift their loyalties, expectations, and political activities toward a new and larger center, whose institutions possess or demand jurisdiction over the pre-existing national states.^[12]

An important indicator for integration is the mode of conflict-solving. Haas names three different types of conflict-solving. First, there are lowest common denominator solutions, where equal bargaining partners gradually reduce antagonistic demands by exchanging concessions. But this type of accommodation never goes beyond what the least co-operative member wants. A second way of solving conflicts is “splitting the difference”, meaning that actors reduce their demands, exchange concessions and admit a mediatory service, for example, a general secretariat. A solution is then found somewhere in between the opposing views of negotiators. The third mode of accommodation is “upgrading the common interest”. Here, both parties gain since states have redefined their aims and work out solutions at a higher level, which often implies the expansion of the mandate of the mediator, and thus a rising degree of supranationality. Where the latter two are predominant, a political community is in the making.

For Haas integration is a process which will, at some point, gather momentum and continue automatically through the mechanism of so-called political and functional spillovers described above. Functional spillovers arise from the interconnectedness of modern economies which makes it difficult to confine integration to one sector. If two political areas are functionally linked, integration in one area will create problems in adjacent areas, which can, in the long run, only be solved by further integration. Political spillovers largely follow from economic integration. The term designates the process by which national interest groups, in a rational and opportunist fashion, increasingly turn to the supranational levels of activity to campaign for their interests, eventually aligning with their equivalents from other countries and forming a transnational civil society which leads to an expansion of scope and level of the new institutions. Neofunctionalism thus considers sub- and supranational actors as the main catalysts of integration. The member states’ only function is to fulfil the ambitions of non-state actors^[13]. This assumption, as mentioned above, is heavily criticised by intergovernmentalists and convincingly presented by Mattli who alleges that in order for integration to be successful, not only demand, but also supply conditions must be fulfilled, such as the perception of governments that they politically win from it^[14]. When Haas recognised this flaw at the moment of de Gaulle’s empty chair policy, he tried to remedy his own theory by adding two new dimensions to it, namely nationalism and the perception of the value of integration as well as the power of statesmen. This modification is criticised by Mattli, in whose opinion “the link between the two analytical extensions is only weakly drawn, and neither one adds much explanatory power”^[15].

The original version of neofunctionalism assumes that, in order for a shift of loyalties, expectations and political activities to occur, several conditions need to be fulfilled according to Haas (1961) and Haas/Schmitter (1964). These can be divided into institutional, functional and environmental factors. As for institutional preconditions for political integration, Haas states that it is necessary to create supranational bodies which are little susceptive to different phases induced by changes in national policies. Functional requisites include a clear definition of tasks of these supranational institutions. These tasks need to be specific and economically important. The first two sets of preconditions in the CAN will be touched upon in Chapter 3.

The main focus of this thesis, however, will be on the “environmental” conditions, since these are considered the decisive ones for the case of the CAN. They will be examined extensively in Chapters 4 and 5. The environmental factors listed by Haas (1961) and Haas/Schmitter (1964) include political pluralism and a modern, industrial society.

Urbanism is the great outreaching dynamic, breaking down isolation and encroaching upon tradition. Modern industrial urbanism is innately inimical to any isolation […] Because the modern “industrial-political” actor fears that his way of life cannot be safeguarded without structural adaptation, he turns to integration; but by the same token, political actors who are neither industrial, nor urban, nor modern in their outlook usually do not favor this kind of adaptation, for they seek refuge instead in national exclusiveness.^[16]

Why an urban-industrial society is considered so important can be summarised in one word: interdependence. This is what Mattli calls the main “demand condition” of integration.^[17] This “demand” is also the most important element of a more recent variant of Neofunctionalism: Sandholtz and Stone Sweet’s “transaction-based approach to integration” which focuses on the variation of nature and extent of supranational governance over time and across different policy areas in the European Union. In a first step, Sandholtz and Stone-Sweet ask whose interests are served by supranational governance. These are identified as those individuals, groups and firms who transact across borders. They are the ones that are advantaged by uniform European rules, and disadvantaged by the presence of a multitude of diverging national rules. Sandholtz and Stone-Sweet hypothesise that as transnational exchange expands, these groups exert an increased pressure on the EC’s institutions to expand supranational rules in order to achieve collective gains and accomplish Treaty aims. This makes the relative intensity of transnational activity the main determinant of variation of supranational governance, although member states’ governments possess the means to obstruct or facilitate decision-making in the supranational institutions. Nevertheless, when transnational exchange arises, so do the costs for governments not to participate. Integration is thus seen as a process in which horizontal relationships (between actors organised in one MS with actors organised in another) and vertical relationships (between actors organised at EC level and actors organised below MS level) emerge and evolve.^[18]

In the subsequent Chapters, it will be demonstrated that the insufficient demand seems to be the main reason why Andean integration has apparently not gone beyond intergovernmental co-operation, the Andean countries being only very partly interdependent and also only partly pluralist. Since integration in the Andes lacks a strong demand on the part of the society, the CAN has remained an almost exclusively state-led process, driven (or obstructed) by presidents of the Member States.

If there is no real demand for integration, why then did governments decide to integrate at all? The next section will look at economic theories about the potential positive effects of regional integration.

2.1.3 Economic and Social Effects of Integration

2.1.3.1 Classical Trade Theory

When talking about regionalism, what comes to most people’s mind immediately is economic co-operation. But in many cases, economic integration between countries is not considered an aim in itself, but the basis for deeper, political integration. This has obviously been the case in the European Union, and it is also the case in the Andean Community.

Theory knows five stages of economic integration. The first one is a free trade area, meaning that customs tariffs and quantitative restrictions for trade in goods are removed between two or more countries. The next stage is a customs union, i.e. a common external tariff vis-à-vis third countries is established. The third step towards economic integration is a common market, meaning a customs union plus free movement of production factors and including an institutional and legal framework which permits free movement of persons, capital, goods and services to effectively exist. This framework touches on, among others, taxation, public procurement and economic and social policies. Also, there are often macroeconomic policy frameworks to secure a stable economic environment. The fourth stage of economic integration is an economic union, which is a common market plus a certain degree of harmonisation of economic, monetary, fiscal, social and counter-cyclical policies. The fifth and final stage is an economic and monetary union, i.e. an economic union plus a common monetary policy, where governments cede their sovereignty in monetary policy to supranational institutions, e.g. a supranational central bank. Even though in the European Union economic integration has proceeded in this order, the Andean example proves that this is not always the case.

On the macroeconomic level, a common market and a customs union have a number of potential advantages for the participating economies. External trade theory argues that international trade is executed on the basis of comparative advantages. This means that every country specialises in what it is relatively better at producing given its respective factor endowments (Hecksher-Ohlin- Samuelson model).

According to customs union theory, the macroeconomic effects of economic integration on trade can be divided into static and dynamic effects. Static effects include trade creation and trade diversion. In the case of trade creation, high-cost domestic production will be replaced by lower-cost imports from partner countries, implying lower prices for consumers. Trade diversion means that previous exporters outside the union who still have to pay tariffs may no longer be able to compete with internal producers whose goods circulate freely. Consumption may be shifted away from low-cost producers to higher-cost producers in partner countries. As Viner puts it, in the case of trade creation, “one of the members at least must benefit, both may benefit, the two combined must have a net benefit, and the world at large benefits”, whereas in the opposite case of trade diversion, “one at least of the member countries is bound to be injured, both may be injured, the two combined will suffer a net injury, and there will be injury to the outside world at large”^[19] Thus, a customs union is considered welfare-enhancing where trade creation is greater than trade diversion.

As for the dynamic effects, regional integration is assumed to bring about specialisation and export diversification as well as the increase of exports of more technology intensive and thus higher added-value goods. Furthermore, economies of scale are made possible which are then reflected in lower prices for the consumer. The increase of intra-industry trade further promotes specialisation and product differentiation. Structural changes in production patterns increase the region’s competitiveness, enhancing the production of those goods in which regions have their comparative advantage.

Besides its macroeconomic implications for trade, regional integration also has effects on foreign direct investment (FDI). Whereas FDI was considered undesirable not long ago in Latin America because it was conceived to enhance outside dependency, it is now increasingly perceived as a chance for knowledge and technology transfer. According to Blomström and Kokko, regional preferential trade areas affect FDI inflows in two ways: first, through the effects of trade liberalisation, and second, through special investment provisions^[20],. Concerning the effects of trade liberalisation, they state that, in the early literature, trade and capital movement were considered substitutable modes of serving foreign markets.

According to this theory, if tariff protection increases as a result of regional integration, outsiders’ exports decline, whereas capital imports grow. If FDI was initially restricted, either by national policies or by the limited size of markets, inflows of foreign capital might also increase as a consequence of integration. In the opposite case of a general reduction of the external tariff, capital inflows would decrease since it is more profitable to export goods and services instead of investing.

Contrarily to what one would expect, integration does not necessarily mean that inter- and intra-Community investment decline because transaction costs for export become less important. As Blomström and Kokko suggest,

regional integration would not create incentives to reduce investment or repatriate capital for projects that were primarily undertaken to internalise the exploitation of intangible assets. In fact, the reduction of regional trade barriers could instead stimulate overall FDI flows among the relevant trading partners by enabling MNCs [multinational companies] to operate more efficiently across international borders.[…] [C]ountries with low initial trade are more likely to benefit from increased intra-regional FDI flows as trade barriers are reduced, since they are not very likely to host import-substituting FDI project that might be withdrawn.^[21]

In addition to these static effects, Blomström and Kokko also describe potential dynamic effects of regional integration. They refer to analyses of the European common market, which argue that the integration process has led to significant efficiency gains that raised the participating countries’ growth rates over the medium or long term. These dynamic benefits may raise the attractiveness of the integrated market as a location for domestic as well as foreign investment. Likewise, the authors stress that these increases in efficiency and output potentially raise factor rewards and generate new savings and investments that can contribute to further output growth.

2.1.3.2 Convergence or Divergence?

Regional integration can have different effects on the allocation of resources across the territory. Convergence theory suggests that disparities between regions will vanish, since resources become more efficiently located. The mobility of production factors is the key element that can restore an economic system to a stable equilibrium. A sub-optimal capital intensity can be altered by movements of goods and services and/or factors of production between regions, or by changes in the savings and investment rates relative to the growth rate of the population. For example, if wages are higher in more developed regions, migration of labour will take place with the consequence that labour becomes scarce in the less developed regions and abundant in the more developed one, causing wages to fall in the latter and to rise in the former, which in turn is an incentive for migration. Thus, according to this theory, in the long run, integration will lead to identical production technologies in all regions and thus identical payment to labour and capital.

But there are also economic models which suggest that integration, implying a free play of market forces will, at least in the short term, cause further divergence instead of convergence, especially when there are large initial disparities and market imperfections. New Economic Geography - which tries to explain the emergence of large agglomerations - deals with these kinds of growing inequality, relying on increasing returns to scale and the importance of transportation costs and emphasising linkages between firms and suppliers as well as between firms and consumers. When distances and transportation costs play a role, attractive locations for production are those which are close to markets and suppliers, other things being equal. This concentration of production in some location tends to attract the mobile factors of production, since workers have better job and consumption opportunities where production is concentrated. The resulting concentration of labour force leads to more demand for consumption goods in that location, which makes the region more attractive for producers. This pattern is likely to reinforce itself once a region has a high share of production: a so-called second-nature advantage for the dominant region develops. The region becomes attractive for firms because so many other firms already produce there. This factor may be more important than superior resource endowment. But such a concentration of production can also produce negative effects: land rents and housing prices may go up, and environmental problems may arise. Also, if immobile factors of production remain in peripheral areas, firms from the centre may want to move there to serve these areas. In sum, the presence and nature of agglomerations are determined by centripetal and countervailing centrifugal forces^[22].

This theory stresses the importance of lasting technological differences, transport costs, differences in regional economic structures and the importance of agglomeration effects and economic clusters. It predicts a development of heterogeneous economic landscape within the region with a significant differences in the factor returns in central and peripheral areas. This, in turn, leads to out-migration from the peripheral areas towards the more developed ones, reinforcing disparities across regions.

2.1.3.3 South-South Integration and Development

The theories presented above have mainly been developed in relation to industrialised countries. What are the particularities of integration in developing countries? Theory suggests a number of benefits, but also costs, of South-South integration, which can be divided into economic and non-economic issues.

According to neoclassical external trade theory as elaborated by Viner and Balassa, international economic regimes promoting free trade are assumed to be beneficial for all countries because they maximise global output due to specialisation. However, this assumption does not correspond to the experiences of many developing countries, as Møen correctly points out^[23].

Underdeveloped countries’ economies are usually based on the export of raw materials to developed countries, often of just one or two products. This makes them highly vulnerable to price fluctuations on the world market. Moreover, as the Prebisch-Singer-Thesis expresses, the relative importance of these goods is declining in international trade, since with increasing incomes in the centre, more money is spent on advanced than on basic goods. Hence, terms of trade for less developed countries are declining. They have to export an increasing amount of commodities to the industrialised nations in order to be able to import constant amounts from these countries. This forces them to overproduce, which in turn lowers the prices. Developing countries typically lack the technology and markets to elaborate goods and produce an added value. The profit via added value is made in the industrial nations and raises the income there whereas the developing countries themselves have little perspectives for development. Political barriers such as tariffs of developed countries pose a further barrier to development. They are typically imposed in manufacturing industries where developing countries are most likely to be competitive, e.g. in textiles and footwear^[24]. Additional factors which hinder development in these countries are deficiencies in administrative capability (a lack of strong institutions to implement policies effectively, corruption) and a lack of bargaining power in multilateral rounds which leads to the ignorance of Third World countries’ interests^[25].

According to Møen, integration might pose a solution for at least some of these problems. Quoting Todaro (1992), he states:

While it may not be possible for many LDCs to be self-reliant on an individual country by country basis, some form of trade and economic co-operation among equals is probably preferable to each country trying to “go it alone” in a world of unequal trade, technological dominance, increasing protectionism among developed nations and various forms of non-market price determination^[26]

Devlin/Ffrench Davis indicate that South-South trade and integration may offer a number of potential remedies to these specific problems.^[27] The most powerful arguments are those presented above in this section: the static and dynamic effects of a customs union and the vital importance of these for developing countries. By trading more among themselves, they become less dependent on the industrialised nations. What is more, the larger markets increase product differentiation and enhance competitiveness of the economies. South-South trade is often more technology intensive than South-North trade, thereby helping to industrialise and differentiate Southern economies and reducing their dependence and vulnerability.

ECLAC recommends that the Latin American economies should be strategically integrated into the international economy instead of practising economic nationalism. The timing, speed and sequencing of opening up the economies for different types of goods and factor movement should be gradual, in order to enable national enterprises to face international competition.

Regional integration is therefore one of the central elements of the development strategy (neo-structuralism) promoted by the ECLAC in the 1990s:

[N]ational economic growth involves a process of catching up, in which national enterprises build up production capabilities and international competitiveness in a range of activities undertaken in more advanced countries. The structure of the economy changes as the relative importance of agriculture and natural resources exploitation declines while that of manufacturing activities increases, and as production progresses from less to more skill-, technology. and capital-intensive activities.^[28]

ECLAC stresses the opportunity of learning from internationally available technologies in order to reduce costs, improve quality, and introduce goods and services not existing in the country. It also stresses the importance of diffusion of best practices from more advanced to less advanced enterprises within the country, including from foreign owned to locally owned firms.

Integration in developing countries can thus have a “training” effect: Within a regional setting, both production and marketing techniques can improve and promote diversification, which, in the long run, enables local businessmen to compete with exports of companies from other parts of the globe. Economies of scale in technology, infrastructure and information technology may be a further asset of South-South integration.

As to non-economic effects, integration is often seen as an instrument for consolidating peace and democracy. Many of the regional agreements, including the CAN, have a democracy clause established in their founding treaties, giving them the opportunity to penalise non-democratic measures in member states, for example by depriving them of their voting rights. The democratic vocation of the Andean integration scheme has been reaffirmed, for example, by its action for contributing to the fall of the Nicaraguan dictator Somoza in 1979 and its non-recognition of the coup d’Etat attempted by Coronel Natush Bush in Bolivia in the same year, which contributed to his renunciation to power and the restoration of democracy in the country.^[29]

Apart from being beneficial to the population, the consolidation of democracy and the possible policy lock- in effects arising from the fact that governments can no longer take decisions unilaterally and independently from its partners have positive implications for the economy, reducing uncertainty for business because of a more stable legal and institutional environment^[30].

Last but not least, integration among developing countries which leads to larger markets may improve these countries’ bargaining power vis-à-vis multilateral rounds and, even more strongly, multinational companies.^[31]

However, integration does not only entail benefits, but also significant costs. First of all, a government may be hesitant in ceding sovereignty. Especially the harmonisation of economic policy may deprive it of instruments for stabilising the almost chronically unstable economy. Moreover, as already mentioned above, there is the possibility of trade diversion. Also, agreements improve the terms of trade for their signers to the detriment of non-signers, giving incentives for retaliation measures. Furthermore, the loss of tariff revenues can have redistributive effects as those countries with initially higher tariffs loose compared to those with initially lower tariffs.

An effect of integration which is particularly serious for third world countries and therefore a central theme of this thesis is the above mentioned effect of unequal distribution of benefits. Especially in the Andean countries, where large parts of the population are cut off from the formal economy, integration is bound to benefit only few sectors of the population – those working in labour-intensive, export-oriented sectors in the urban areas.

2.1.3.4 The Relation between Economic and Social Development

The relation between economic and social development has been subject to discussion throughout the different phases of development policy. Some development strategies, such as the Washington Consensus or Latin American neostructuralism, exclusively focus on the achievement of economic growth in order to modernise the society and the economy.^[32] The economic gains derived from the practical application of this approach are expected to trickle down to most sectors of the population. Other ideas, such as the United Nations Development Programme’s Sustainable Human Development (SHD) approach espouses a set of values different from that of the Washington Consensus. Criticising the latter’s top-down, donor-conditionality-driven and outside-export-led approach, it emphasises that the ultimate goal of development policy must be a change in living conditions of the people. According to this approach, moreover, development policy should be founded on participation and a more horizontal relationship between donors and developing countries. SHD has promoted the introduction of poverty alleviation as a key goal of development practice and paid increasing attention to a possible relaxation of Washington Consensus policies in order to better achieve poverty objectives. As Gore states

[t]hese changes have certainly made the Washington Consensus more humane. But at the same time, the SHD approach has had the effect of conserving key features of the world-view of the dominant paradigm.^[33]

Ranis/Stewart/Ramírez (2000) take up the idea that “ ‘human development’ has recently been advanced as the ultimate objective of human activity in place of economic growth”.^[34] They identify a number of factors which influence the relationship between economic growth and human development, stating that these two are mutually reinforcing, thus creating either vicious or virtuous circles for the countries concerned.

They state that a rise in GDP mainly contributes to human development (HD) through household and government activity.^[35] They assume that the same level of GDP can lead to a very different performance in human development according to the allocation of GDP among and within these institutions and variations in their behaviour.

Higher household incomes mean, first of all, that more money can be spent on basic needs, but they also improve the chances of child-schooling and, possibly, the access to health services.^[36] Thus, higher incomes through increased employment and/or higher wages are the main determinant of human development.

With regard to governments, public expenditure is dependent on public revenue, which - besides the overall performance of the economy - is determined, among other things, by the tax capacity of the system, the strength of the demand for non-HD expenditure, e.g. military expenditure, and the varying interplay between bureaucratic forces, vested interests and popular pressures. It is also affected by the degree of centralisation of the governments, since “decentralisation tends to increase the total revenue available, it often raises the HD-allocation ratio, and it almost always improves the HD priority ratios”.^[37]

Ranis/Stewart/Ramírez do not make explicit mention of the outside pressures governments are exposed to, such as the diverse effects of trade liberalisation and the obligations imposed upon them by international organisations and agreements. Regional integration mainly influences poverty and income distribution in two ways. On the one hand, through its economic effects, and on the other hand, through supranational policy-making.

From a convergence perspective, integration is expected to lead to a more efficient allocation of factors, implying a convergence of factor incomes such as wages. Moreover, it is expected to create growth and thus jobs in the sectors which are most affected by it, i.e. exporting sectors and those sectors which receive an increasing amount of FDI.^[38]

From a more “pessimistic” divergence perspective - according to which integration leads to high gains for some regions, while others with a much lower initial development loose – integration is bound to lead to unequal distribution. Here, state or subregional intervention may be considered necessary for efficiency or moral reasons. This intervention typically takes place by redistribution measures such as regional or social policies which compensate the regions which have lost through integration.

2.2 A Theorisation of the Cartagena Agreement

How are all these theories related to the concrete case of the Cartagena Agreement? First of all, it needs to be recalled that the founding Treaty of the CAN regards integration as desirable because it is assumed to lead to economic development which, in turn, enhances human development. Moreover, many of the political actors involved in integration desire that Andean integration be more than purely economic co-operation.

Chart 3 establishes a connection between these normative aims and assumptions and the relevant political science (neofunctionalism) and economic science (customs union theory etc.) theories

illustration not visible in this excerpt

Chart 3 Theorisation of the Cartagena Agreement

First, the Agreement relies on (convergence) economic integration theory, according to which the process of integration leads to economic development through the static and dynamic effects on trade and investment induced by it. These effects make the private sector feel that it profits from integration and it thus becomes supportive of the process (assuming rationally-orientated behaviour).

Second, the Agreement assumes that economic growth translates into human development. Reality has shown that this does not happen automatically, but theories have been developed to explain links between the two types of development. In general, integration is presumed to influence human development through job creation and positive effects on household and public income, but also, if the free play of market forces cannot guarantee this, the will and capability of national governments and supranational institutions to correct this type of market failure by regional and social policy, thereby “artificially” generating HD.

Human development through better education and health reinforces economic growth through higher productivity rates and through the creation of a domestic demand, making the private sector more supportive of integration. At the same time, the population becomes supportive of integration, since it becomes more integrated into the formal economy, which means that interdependence between the economies can be further increased. The population is increasingly aware of the benefits of integration, especially if the national state, up to then, has not been able to achieve any improvements. Via the support of the private sector and civil society in general, the economically integrated area may develop into a political community.

2.3 Subconclusion

The questions to be answered in this Chapter were how and why regional integration occurs, and how the Cartagena Treaty can be conceptualised in these terms from a neofunctionalist point of view. The different types of integration theories given in this Chapter indicate a number of explanations how and why integration occurs.

Political integration theories offer a variety of different explanations of the how: whereas one strand stresses the importance of periodical governmental decisions to either deepen or loosen integration in accordance with their national interest, another current conceives of integration as a process in which sub-national actors are the decisive ones for the process and governments merely respond to the demands of these actors. Neofunctionalism suggests that the signing of an agreement of economic integration will automatically lead to the formation of a political community if three types of preconditions are present. A modern industrial society is one of these preconditions because only this type of society sustains a demand for integration and actively tries to further it once it becomes aware of the benefits of supranationalism.

As for the reasons of economic integration, economic theories suggest a number of advantages for the members, especially in developing countries, the most important of which are the static and dynamic effects on both trade and FDI. Integration is believed to reduce dependency on the industrialised countries as well as to bring about a process of modernisation of production structures and increased competitiveness of these economies.

The normative goal of Andean integration, however, is not just economic, but also social development. Economic trade theory per se does not offer an explanation for the processes leading from the former to the latter, so further theories need to be introduced with a view to explaining how the Cartagena Agreement is supposed to bring welfare to its people. These theories suggest that the main mechanisms leading from economic to social development in integration schemes are job creation and rising wages induced by increased trade and FDI inflows. But there is also the possibility that supranational legislation influences or complements national legislation with regard to redistribution mechanisms. Using this theorisation of the Cartagena Agreement, the following sections will investigate whether the CAN’s aims can be judged realistic according to the relevant integration theories and to what extent they have been achieved so far.

Chapter 3 - The Andean Community

3.1 The Region

In order to gain a deeper insight into the Andean integration process, it is useful to have a look at the region in general and at the history, development and achievements so far of integration as well as at the institutional structure of the CAN in particular.^[39] As announced above, this chapter will also touch upon the first two preconditions for integration identified by Neofunctionalism.

The Andean Community consists of the four Andean states of Bolivia, Ecuador, Colombia, and Peru. Venezuela was a member from 1976 till April 2006 when the country’s president, Hugo Chávez, withdrew from the Agreement. On the other hand, Chile, which was one of the founding members but withdrew as early as in 1973, is currently negotiating its re-accession.

What all these countries obviously have in common geographically are the Andes. Apart from this mountain chain, however, the territory of the Andean Community also embraces Caribbean regions (in Colombia and Venezuela), the Pacific lowlands (Peru and Ecuador), and regions in the Amazonian jungle (Colombia, Venezuela, Peru). All this implies an impressive degree of bio-diversity and natural resources and a mix of different cultures, constituted of descendants of European immigrants, indigenous peoples and African slaves who were brought to South America in the 18th and 19th century. This diversity, however, coincides with a highly unequal distribution of political and economic activity across the countries’ regions. In Peru, for example, nearly all this activity occurs at the Pacific coast, whereas the Amazonian area is completely cut off from it. Socio-economic inequality is one of the main, if not the most important problem of this subregion, leading to political instability which also influences the economy, as is demonstrated by various examples. In Peru, in April 2004, an angry mob set on the mayor of Ilave, a small city in Peru’s impoverished highlands, and lynched him for corruption. In Bolivia, the same fate befell the mayor of a town in the Bolivian highlands shortly after. The so-called water-war in 2000, highway blockades in 2002 and the 2003 resurrections against President Sánchez de Lozada are further instances of instability. In Venezuela, demonstrations for and against president Hugo Chávez seriously affected the political peace and the economy of the country. The ongoing fight of the Colombian government against the narco-guerrilla also demonstrates that the Andean region is not a politically and economically stable area and that integration has not yet much changed this situation.

[...]

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^[1] This situation is also illustrated in game theory in the so-called prisoners’ dilemma: The governor of a prison has two prisoners whom he cannot hang without a voluntary confession of at least one of them. Thus, he separately tells them that if they confess before their fellow-sufferer, they will be rewarded and the other one will be hanged. In case both confess on the same day, both will get ten years in prison. If, however, neither of them confesses, they will both be released. This last option would be the pareto-optimal outcome. However, since neither of the prisoners knows what the other one will do, they may be more tempted to act individually and confess, thus causing the other one to be hanged.

^[2] According to the consensus definition of regimes as developed by Krasner, regimes are “implicit or explicit principles, norms, rules, and decision-making procedures around which actors’ expectations converge in a given area of international relations. Principles are beliefs of fact, causation, and rectitude. Norms are standards of behaviour defined in terms of rights and obligations. Rules are specific prescriptions or proscriptions for action. Decision-making procedures are prevailing practices for making and implementing collective choice.“ Krasner, as quoted by Hasenclever/Mayer/Rittberger (1996), p. 179

^[3] For detailed analyses of the collective action problem, see Little (2004), Gamble/ Payne (1996) and Hasenclever/Mayer/Rittberger (1996).

^[4] Diez/ Wiener (2004), p.7

^[5] Peterson/Blomberg (1999), p. 319

^[6] Malamud (2004), p. 144

^[7] Malamud (2001)

^[8] Moravscik (1993)

^[9] Mitrany, as quoted by Cram (2001), p.53

^[10] Deutsch, as quoted by Laursen (2003), p.4

^[11] ibid., pp. 5

^[12] Haas (1961), pp. 366

^[13] Corbey (1995), p. 256

^[14] cf. Mattli (1999a,b)

^[15] Mattli (2005), p. 332

^[16] Haas (1961), p. 375

^[17] Mattli (1999a), (1999b)

^[18] cf. Sandholtz/Stone Sweet (1998)

^[19] Viner (1950), p. 44

^[20] Blomström/Kokko (1997)

^[21] Blomström/Kokko (1997), p.4

^[22] Schmutzler (1999), p.356

^[23] Møen (1998), pp 246

^[24] ibid, p. 294

^[25] Devlin/ Ffrench Davis (1999), pp.273

^[26] Todaro, as quoted by Møen (1998), p 251

^[27] cf. Møen (1998), Devlin/ Ffrench Davis (1999)

^[28] Gore (2000), p. 796

^[29] Rincón Eizaga (2003), p. 94

^[30] Devlin/Ffrench Davis (1999), p. 247

^[31] Møen (1998), p. 259

^[32] The “dominant approach to development from the early 1980s to the present”, the Washington Consensus has advised developing countries to pursue macroeconomic stability by controlling inflation and reducing fiscal benefits, to open their economies to the rest of the world through trade and capital account liberalisation and to liberalise domestic product and factor markets through privatisation and deregulation. Gore (2000), pp.789

^[33] Gore (2000), p.796; a closer look at such policy measures in Latin America will be taken in section 5

^[34] Human development is defined as “enlarging people’s choices in a way which enables them to lead longer healthier and fuller lives“. Ranis/Stewart/Ramírez (2000), p. 197

^[35] They also attribute a certain role to civil society, i.e. community and non-governmental organisations.

^[36] However, higher incomes do not automatically „generate“ health. Roca Rey/Rojas, in a study on social exclusion in Peru, point at the fact that people keep away from health services not only because of a lack of money: cultural and linguistic reasons and geographic remoteness also play an important role. Roca Rey/Rojas (2003)

^[37] Ranis/Stewart/Ramírez (2000), p. 199

^[38] cf. te Velde/Page/Morrissey (2004)

^[39] The chapter mainly focuses on internal issues, only occasionally touching on outside influences on the region.