By Andres Carrizosa *
Recently, the U.S. ambassador to Paraguay, Marc Ostfield, shocked the Paraguayan political establishment by publicly designating three Paraguayan citizens as “significantly corrupt.” Among those accused were Horacio Cartes—Paraguay’s former president who also owns many businesses, including Tabacalera del Este, a tobacco producer and exporter— and Hugo Velázquez—the current vice-president of Paraguay. Weeks ago, Emanuele Ottolenghi argued that through these actions, Paraguay has become a test case for the United States’ efforts to combat corruption globally. However, are these potential arrests likely to move Paraguay into a path of being less corrupt?
I think not. Paraguay’s illegal economy is more deep-seated than a couple of individuals. Specifically, two global and regional factors provide strong incentives for illegal behavior in Paraguay: 1) the war on drugs, and 2) Brazil and Argentina’s protectionist economies.
In terms of the war on drugs, although Paraguay is a large producer of marijuana, Paraguay’s role in the international drug trade is mostly as a trafficking route of cocaine, which is produced in Bolivia and Peru, and which moves through Paraguay into Brazilian, Argentinian and European markets. Like the rest of Latin America, the war on drugs affects Paraguay because of the economic incentives it creates. By making cocaine illegal, the international community seeks to limit the supply of cocaine. However, without reducing the demand for cocaine in international markets, a strong incentive to produce cocaine exists because high profits can be made (albeit illegally). In fact, simple economic theory says that if one reduces supply without reducing demand, suppliers are able to charge higher prices for their products, generating more profit, which raises incentives for supply. Like in the rest of Latin America, the economic incentives created by the war on drugs affect Paraguay by generating a vicious cycle. That is, prohibition artificially limits supply, which artificially raises drug prices, which artificially creates higher incentives for illegal supply. If the production of drugs were legal, an idea which is gaining ground internationally, then supply would be able to naturally meet demand, prices would stabilize, and what today are called smuggling or trafficking-networks would tomorrow be simply called commerce and supply chains.
However, in contrast to the rest of Latin America, Paraguay’s problems with illegality are larger than just smuggling narcotics. Paraguay smuggles a large variety of products, including tomatoes, cigarettes, tires, eggs, wine, vegetable oil, and more. In a sense this wider smuggling trend is caused by something similar to what causes drug smuggling in Latin America. That is, international market interventions that attempt to limit the supply of certain products inadvertently create higher incentives for the illegal supply of those same products. However, for these other products perverse incentives are not created by the war on drugs, but by Paraguay’s neighboring interventionist markets in Brazil and Argentina.
The U.S.’ efforts would be more effective if they promoted free trade both at the regional level and between the region and richer, Western industrialized countries. For example, it could look into the EU-MERCOSUR trade agreement being held up by certain European countries. Pushing through this free trade agreement may have an epic effect in reducing illegal trade in the region because it would eliminate most price distortions mentioned in this articly. By facilitating trade between MERCOSUR and the E.U., and by enforcing trade agreements among MERCOSUR countries themselves, the MERCOSUR-EU trade agreement has tremendous potential in reducing crime in the region.
There are different reasons why Brazil and Argentina are more interventionist than Paraguay. Some are benign reasons. Take for example tobacco. For health reasons, several countries often highly tax or limit the sale of certain tobacco products. Brazil and Argentina follow this example. According to a WHO report on global tobacco use, in 2019 in Brazil, a 20-piece cigarette box costed 42 cents to produce, but Brazil levied a 2.03 dollar tax on each box, leading to a cost of 2.45 dollars for a box of cigarettes. In Argentina, that same box would cost 0.96 cents to produce, and 4.04 dollars after taxes. In contrast, in Paraguay a box costs 66 cents to produce (higher than Brazil), but after negligible taxes of 14 cents, the total cost of a box of cigarettes is 80 cents. It is therefore no mystery why Paraguay is such a large smuggler of cigarettes regionally and globally. By buying smuggled Paraguayan cigarettes, Argentinians can save 3.24 dollars per pack and Brazilians 1.65 dollars per pack. Furthermore, Paraguayan producers can easily add to their profit margins by raising prices, and they will still find eager consumers because even steep raises are likely to lead to lower overall prices than the regular market-price cigarettes in Brazil and Argentina.
Other reasons for market interventions in Brazil and Argentina, however, are less benign. Historically, interventionism in Latin America is rooted in an economic theory called “Import Substitution Industrialization” or ISI for short. ISI argues that because developing country industries are not as strong as those of Western Industrialized nations, it is therefore necessary to protect local industries—substituting imports with homegrown production—so that local industries may eventually compete on par with those of Western Industrialized nations. This economic theory, while generally believed to be a failing economic strategy, still serves as the justification for protectionism in the region.
This kind of protectionism also feeds into Paraguay’s illegal behaviors. Take for example a seemingly harmless product: tires. Tires in Paraguay can be imported with nothing more than a 5% tariff. In contrast, industry standards consider Brazil “a huge, unfriendly, market for the tire industry” despite being the fifth largest global market. It is possible that the difficulty of importing tires to Brazil is a remnant of ISI, where local tire producers are protected to foment local industry at the expense of more efficient imports. What is clear, however, is that Brazil’s protectionism in the tire industry foments smuggling from Paraguay. Like cigarettes, Paraguayan smuggled tires are cheaper than Brazilian ones, and this creates a strong incentive to meet unmet Brazilian demand with illegal supply.
What happens with cigarettes and tires, also takes place with a large variety of different products. Overall, this occurs because of the different levels of economic openness between Brazil, Argentina, and Paraguay. In terms of trade freedom, Paraguay ranks 3rd in the region, and Argentina and Brazil 7th and 11th respectively. In contrast to Uruguay, which is similarly contiguous to Brazil and Argentina, Paraguay has the disadvantage that it is landlocked. Therefore, while Paraguay is restricted to selling mostly to its neighbors—pushing Paraguay to engage in smuggling that exploits distorted prices—Uruguay has the luxury of turning its back on the region and selling to the world.
So, what can be done to reduce illegality in international markets in Paraguay? As mentioned above, one positive thing would be to end the war on drugs, but this is unlikely to happen in the short term, and many people and governments have legitimate reasons to argue against a full-blown legalization of all drugs. Similarly, to reduce the smuggling of cigarettes, Brazil and Argentina would either have to lower their taxes on cigarette consumption, or Paraguay would have to raise them. Brazil and Argentina may have legitimate health-related reasons for not wanting to lower taxes on tobacco, and Paraguay has failed to raise taxes on tobacco several times—no less because its former president owned a tobacco company. Paraguay may continue to try to raise taxes to make its tobacco prices closer to that of its neighbors.
However, where Brazil and Argentina hold most of the responsibility is in everything else that is smuggled into and out of Paraguay. Tires, tomatoes, eggs, electronic devices, clothing, shoes, meat, soy, and other day-to-day, harmless, and mundane products are smuggled into and out of Paraguay because of the protectionism of its neighbors. If Paraguay is expected to commit a large amount of its limited resources in cracking down on the smuggling of cocaine and tobacco, the least the rest of the world can do is free Paraguay’s hands from having to deal with tomato and sunflower oil smugglers. From a regional point of view, strengthening and deepening free trade relationships in the southern cone—perhaps through strengthening MERCOSUR trade agreements—would naturally reduce Paraguayan smuggling and convert much of it into regular commerce.
In a similar vein, if the United States seeks to reduce illegality in Paraguay, it is right to strengthen the country’s judiciary, and it is right to push the country to extradite certain bad actors. Yet the U.S. can do much more to seek to address the root causes of crime (distorted regional trade) rather than the symptoms (individual criminals). It is notable, for example, that both Cartes and Velázquez are thought to have engaged in trade-related crimes—cigarette-trafficking and undue influence in Paraguay’s customs agencies, respectively.
The U.S.’ efforts would be more effective if they promoted free trade both at the regional level and between the region and richer, Western industrialized countries. For example, it could look into the EU-MERCOSUR trade agreement being held up by certain European countries. Pushing through this free trade agreement may have an epic effect in reducing illegal trade in the region because it would eliminate most price distortions mentioned in this articly. By facilitating trade between MERCOSUR and the E.U., and by enforcing trade agreements among MERCOSUR countries themselves, the MERCOSUR-EU trade agreement has tremendous potential in reducing crime in the region. The US would be smart to encourage progress on this agreement. Finally, if the US is really dedicated to reducing corruption and illegality in the region, it could also push for freer trade among MERCOSUR countries, perhaps even by proposing a free trade agreement of its own.
*Andrés Carrizosa is a PhD in political science. Andrés received a Bachelor of Arts in Political Science and a Bachelor of Science in Journalism from the University of Kansas. Andrés then went on to complete a Master of Global Politics from the University of Salamanca, Spain, and he subsequently received a Master in Arts and a PhD from Rice University, where he carried out most of the work contained in this book.
Cover image: Paraguay Gigante