China’s rising power is not the cause of declining US influence in South America and the implications of China’s increasing presence on the continent will affect each country differently.

Thirty years ago, developing countries in Asia, Africa and South America contributed far less to the global economy when compared with the US and Western Europe.

Over the last 20 years, the economic rise of China has catalyzed a monumental shift in global trade flows.  Because China lacks sufficient natural resources within its own borders, it has turned to the resource rich regions of the developing world to satisfy growing demand among its 1.3bn citizens. South America has benefited particularly from this growing hunger for commodities.

Data from the United Nations Statistics Division published in 2008 exhibits that the participation of developing nations in international trade is increasing dramatically, in proportion with the rest of the world.

In 1995, China imported 68.6% of its commodities from developed countries.  By 2006, this figure had dropped to 38.8%.  On the flip side, in 1995, developing countries supplied 31.4% of commodities imported by China.  By 2006, this share of commodities had risen to 61.2%.

Not only are developing countries trading more with developed countries, even more significant is that for the first time in modern economic history, developing nations are trading increasingly amongst themselves.

Without Chinese demand for South American commodities, the resurgence of economic growth in the region over the past ten years, particularly for the major commodity producing countries in South America would not have been possible.

On closer inspections, in 2006, over 40% of all commodities imported by China came exclusively from countries in Latin America and the Caribbean.

With the exception of Mexico which sells the majority of its petroleum and mining products to the United States, the rest of Central America and the Caribbean are not major commodity producers – making South America the region’s largest single supplier of raw materials to China.

South America in Focus: Real Concerns and Benefits

Most of academia and many financial institutions, including the International Monetary Fund (IMF), the Word Bank and the Inter-American Development Bank (IDB) agree that the rise of China has provided a new and important engine of economic growth for most South American countries. Since China opened its economy to the world in 1978 and joined of the World Trade Organization (WTO) in 2001, the result for Latin America has been positive on many levels.  These benefits are especially strong for the five commodity giants of Argentina, Brazil, Chile, Colombia, and Peru.

It is indeed difficult to argue that China’s ascension in the world economy has been purely negative for world.  Despite the optimism of ten years ago, presently, the focus on China has grown increasingly critical, at times sensationalizing, the potential for a geopolitical struggle involving China and the US over South America.

In this respect, the US has grown especially weary.

However, in South America, China’s diplomatic overtures are not the main concerns. Rather, the central question rests on whether economic gains from China’s rise, will fade into another boom-bust cycle.  Or more aptly put in economic terms, will South America suffer yet another round of the “Dutch Disease.”

Dutch Disease is an economic term used to describe countries which become overly reliant on the revenues generated from the export of natural resources, and do not efficiently re-allocate their new found wealth towards transforming their economies to become sustainable over the long-term.  It is a reference to the discovery of oil off the Dutch coast leading to the de-industrialization of the Netherlands’ economy.

South America, along with many parts of the developing world have a history of short economic booms, followed by long periods of decline.  An over-reliance on commodity export revenue as the prime engine of economic growth has proven a recurrent resource curse.

Applied to today, the concern is that if China’s economy slows, and the rest of the global economy continues to stagnate, commodity prices will plummet, causing a collapse in the economies of South America.

Balancing Misconceptions and Responsibilities

First and foremost, it is important to clarify a widely held misconception about China’s rising influence in South America. Though “China bashing,” became a common tool used by Democrats and Republicans during the 2012 election season, the accusations made by the respective media outlets of both political parties, could not be further from reality. These misconceptions are especially relevant with regards to a perceived displacement of US power in Latin America by “Chinese aggressors.”

If one compares the direct geopolitical clout of the US in Latin America and the Caribbean from the end of World War II into the 1990s, “US influence,” or perhaps better articulated as “US attention” directed towards the region has been on a steady decline.

This reduction in US influence in Latin America is not in any way due to the rise of China. During the Cold War, and before the era of globalization, countries were forced to choose between the free market model of US and Western Europe and the centrally planned economic approach the Soviet Union.  But, in today’s global economy, Latin American countries have more freedom to chart their own destinies than ever before. We often fall into the trap of envisioning Latin America through the lens of the traditional spheres of influence that pervaded the Cold War.

The Differing Symptoms of the Dutch Disease

Misconceptions aside, I return to the most crucial question of long-term economic stability and the potential for another bout of the Dutch Disease. The answer will vary significantly for each country.

Brazil, the largest economy in South America, represents a market of 200 million potential consumers, given its size and geopolitical power it is the best fit country in Latin America to confront a rising China.

Though Brazil has been largely dependent on mining and agriculture, two concurrent factors may encourage foreign companies to invest in the industrialization of its Economy.  Brazil’s very high value added tax (VAT) on imported products, makes goods manufactured abroad extremely expensive.

For example a new Honda Civic, which might sell for $20,000 in the US, could cost over $50,000 after the VAT.  Traditionally, high levels of poverty meant that only a small number of wealthy consumers could afford these types of goods, but over the last decade, 40mn Brazilians became members of the middle class. Now, foreign companies have incentive to set up factories inside Brazil or risk missing out on this growing market, which is unable to afford goods with such high import duties.   The benefits of industrialization in Brazil will likely spill over into the transfer of technology, skills and information.

For many years, Argentina has had some success with the same protectionist trade policy as Brazil.  With a relatively large market of 42mn consumers – many of them middle-income – multinationals were able to justify investing in Argentina’s manufacturing sector.  However, the recent nationalization of Spain’s REPSOL has now made foreign companies more cautious about investing in the country.

On the other side of the Andes, Chile has done a fairly good job at managing its surpluses from copper revenues to create a “safety fund,” in the form of a Sovereign Wealth Fund. Similarly, strong surpluses have allowed the nation to accumulate a large amount of foreign reserves, a rarity for many countries in South America.

However, Chile is still limited in its power to influence foreign investors considering, considering that it has a relatively small population of 17mn.  Additionally, unlike Argentina, Brazil, Peru and Colombia, Chile’s resource pool is not as diverse.  Chile is to Copper, as Saudi Arabia is to Petroleum.  With very little reserves in other metals, Chile has to manage its revenues carefully when the price of copper is high, in order to shield itself from a potential future drop in global demand.

Chile has been in the process of nurturing other sectors, ranging from agriculture and wine while attempting to establish its capital, Santiago as a technology hub.  Unfortunately, thus far these measures have not allowed it to escape the “middle income trap.”  With rising wages, Chile is now finding it difficult to compete in export markets with lower-cost producers from less developed countries.

In Peru, apart from the timber industry, the country has shown little progress in encouraging domestic companies, foreign countries and multinationals to do more than just mine its plentiful natural resources.  Peru’s population of 30mn offers a potentially lucrative market, but its people still lack the same disposable income of Chileans, Brazilians and Argentines. With one third of the population still living below the poverty line, its consumers do not have the geopolitical sway of Brazil or Argentina to encourage more investment in building refineries to process and add value to Peru’s metal exports.

One issue, however, is clearly applicable to every country in South America. If South America is unable to seize upon the economic growth which has been driven by China’s appetite for commodities, they cannot simply blame China for the explosion of some future bubble.  It is up to the leaders and people in each South American country to determine how best to allocate the proceeds from a decade of China fueled economic growth.  Avoiding the Dutch Plague is possible, but capital end energy must be allocated towards the educational institutions, social programs, infrastructure and various other sectors that form the pillars of establishing a sustainable and functional economy over the long term.

The views expressed in this article are the author’s own and do not necessarily reflect Fair Observer’s editorial policy.