How Latin America Pays the Price of Protectionism

As Donald Trump talks of tariffs, Argentina and Brazil show the costs that consumers and taxpayers pay for barriers on trade

As U.S. President-elect Donald Trump contemplates tariffs and other limits on trade, he might consider the results of such protectionist measures in two economies on the other end of the hemisphere, in Argentina and Brazil.

For decades, South America’s two largest economies have tried to shield their workers from global trade, largely through high tariffs and regulations that promote domestic production over imports. The World Bank ranks Argentina and Brazil among the world’s most closed big economies.

In Brazil, locally made products are enshrined in the constitution. Gadget-loving Argentines often use the black market or go to Miami to buy iPhones, which were barred for years because Apple wouldn’t produce them in Argentina.

These protectionist policies have created tens of thousands of well-paid factory jobs and may have helped avoid factory layoffs like those that rattled Midwestern U.S. states like Michigan. But they have come at a huge cost to consumers, who now pay higher prices, and to taxpayers, who underwrite the subsidies. Taken together, these measures essentially transfer wealth from society at large to a smaller group of workers.

In Tierra del Fuego at Argentina’s southern tip, where cruise ships sell sightseeing tours of icebergs and penguins, one can see the results of an experiment to create a “Made in Argentina” electronics manufacturing hub. To help it thrive, the Argentine government slapped a tariff of up to 35% on imported electronics.

Now, 14,000 workers in 55 factories in this grimy industrial town and the nearby tourist paradise of Ushuaia churn out products including phones, TVs and air conditioners. Most of the components are Asian-made, imported duty free and assembled by Argentine workers, with a few local components like Argentine-made screws thrown in. Chinese, Japanese and Korean executives have moved to Tierra del Fuego to oversee the production of everything from Samsung phones to Sony TVs, officials at several factories said.

But the combination of government regulations and market forces has meant some striking eccentricities. Argentina opted to build an industrial hub 1,800 miles from the country’s biggest consumer market, Buenos Aires.

At Newsan, Argentina’s leading electronics firm, workers disassemble partially built air-conditioning units, imported from Asia, before rebuilding them with mostly imported but locally manufactured contents. The air conditioners and other products are then shipped to Buenos Aires—nearly three times as far from here as Antarctica—to be sold for two to three times the market price of other countries.

The cost to Argentina’s taxpayers of these jobs is steep: up to $72,000 per factory worker a year, including tax breaks and other incentives, officials say. The largess was needed, said former President Cristina Kirchner, because “without manufacturing, we’d have no country and no future.”

But for ordinary Argentines, the products’ price tag can be hefty. An unlocked Samsung J7 smartphone sells for $240 in the U.S. but costs nearly $500 in Buenos Aires.
“The irony is that people who live here don’t buy the products made here,” said Cintia Davalos, 27, who works in a Tierra del Fuego five-and-dime. She explained that residents will drive seven hours to free-market Chile to buy everything from auto parts to clothing to TVs.

Mr. Trump, who blames trade deals for sending American jobs overseas, has promised to pull out of the 12-country Trans-Pacific Partnership. He has suggested special tariffs or other barriers to reduce the U.S. trade deficit with Mexico. And he has vowed to slap a 45% tariff on Chinese imports if Beijing doesn’t alter practices that Mr. Trump calls unfair.

But most economists say that protectionism—whether the kind Mr. Trump has promised or the version Argentina has tried—is deeply damaging. Indeed, Argentine President Mauricio Macri is trying to open up the economy by cutting subsidies and tariffs.
“Taking a protectionist turn would be extraordinarily disruptive, not just for our trading partners but for the United States,” said Eric Farnsworth, a former U.S. diplomat who is now vice president of the Council of the Americas.

He and other advocates of free trade often highlight the self-inflicted wounds that protectionism has caused economies in Latin America. Here, import substitution gave Mexicans the notoriously unreliable Zonda TV back in the 1970s and left Brazil producing the 1950s-era Volkswagen Type 2, or hippie bus, until 2013.

Most countries have long abandoned that model. Mexico, for instance, has become a global leader in free trade, signing deals with 44 countries. Since 2010, Latin America’s open economies—tied together in the Pacific Alliance, which groups Mexico, Colombia, Peru and Chile—have grown by an accumulated 29.7%.

Meanwhile, members of Mercosur, the protectionist trade bloc led by Argentina and Brazil, grew 19.4% and had less investment and much higher inflation, according to a study by Santander Rio. In Brazil, Latin America’s largest economy, exports accounted for just 13% of GDP last year—a fraction of the ratio in trade-focused economies such as Mexico (33%) or Germany (50%). In Argentina, exports are 11% of GDP.

Critics warn that Brazil’s long history of protectionism bred complacency in its manufacturers, leaving them unprepared and vulnerable.
Consider Brazil’s auto industry, until recently one of the world’s 10 largest. Shielded for decades by high tariffs, it has devolved into a peddler of rinky-dink hatchbacks with one-liter engines that barely sell outside of the Mercosur bloc. After nearly three years of deep recession, with few export markets to support the industry, output has fallen some 45%. And for Brazilian consumers, cars are far pricier: A new Volkswagen Gol Comfortline lists in Brazil at $15,231—nearly twice as much as in Mexico, which has low tariffs and an efficient car industry.

The effects of protectionism go beyond cars. After big offshore oil finds a decade ago, Brazil’s government set “Made in Brazil” mandates for drilling vessels, refineries and shipyards. That drove up costs and fostered corruption.
Major construction firms like Odebrecht and Andrade Gutierrez formed a cartel to drive up prices for the state-run oil company Petróleo Brasileiro SA, or Petrobras, according to convictions of executives and politicians in Brazil’s courts. Since 2014, Petrobras has taken some $37 billion in charges due to corruption, overpriced assets and falling oil prices.

Still, workers say the system in Argentina has created thousands of dignified, middle-class jobs. “I was able to buy a new car and build my own house thanks to this job,” said Darío López, 36, a quality-control supervisor at Mirgor, which makes air conditioners, stereos and GPS units for car makers including Toyota.

Rubén Cherñajovsky, president of Newsan, which operates six plants in Tierra del Fuego, says Argentine companies can’t compete with labor costs at Asian firms like Foxconn Technology Group, which makes the iPhone. “If you opened imports in the extreme, we’d have a country with 35% or 40% unemployment,” he said.

But Nicolas Dujovne, a former Argentine central bank director, noted that Argentina—a big, resource-rich country with a relatively well-educated workforce—still hasn’t become an industrial country. “The losers from populism can be found everywhere,” he said. “They are the millions of jobs and hundreds of thousands of companies that were not created because of very disorderly macroeconomic policies.”