Mercosur and the Lack of Economic Integration

Executive Summary

Mercosur is one of the biggest regional free-trading blocs in the world and the largest one in Latin America. Mercosur is an economic bloc comprised of Brazil, Argentina, Uruguay, and Paraguay that is characterized by a common market and customs union. One of Mercosur’s goals was to stimulate economic development through increasing intra-regional trade among the Mercosur nations. This report will answer why intra-regional trade has not increased since 1991 to the levels that political leaders were expecting. This report will also elaborate on how reliance on international markets, lack of common macroeconomic policies, and the prevalence of separate agreements and exceptions to Mercosur rules have prevented regional trade from expanding. In conclusion, the impacts of a continued stagnation in intra-regional trade will be explained.

Background:

Mercosur was created in 1991 when Argentina, Brazil, Paraguay, and Uruguay signed the Treaty of Asuncion (Felter and Chatzky 2019: 4). According to the treaty, these countries agreed to implement a common external tariff on 85% of goods and to eliminate internal tariffs on 95% of goods (Felter and Chatzky 2019: 4). The intended goal of these policies was to expedite and facilitate regional trade with the hopes of increasing economic development and creating common macroeconomic policies among the Mercosur countries. In addition to an economic aspiration, Mercosur was also intended to pursue a political goal of strengthening democracy and increasing political integration among the Mercosur nations (Albertoni 2019). Mercosur would strengthen democracy by ensuring that members hold each other accountable to uphold democratic values (Albertoni 2019). The intention to increase political and economic integration was especially desired by Brazil and Argentina who saw Mercosur as a solution to their historical economic tensions and competition for regional dominance (Albertoni 2019).

Even though increased regional trade was central to Mercosur’s goal, since 1991 intra-regional trade between Mercosur countries has not increased as much as some hoped. According to a report from the UN Conference on Trade and Development (UNCTAD), from 1995 to 2015, intra-Mercosur trade increased from $50 billion to $100 billion (UNCTAD 2015). However, trade between Mercosur and the rest of the world increased from around $200 billion to $500 billion (UNCTAD 2015). In Brazil, exports to Mercosur countries made up 20% of total exports in 1995, but by 2011 exports to Mercosur only made up 10–15% of their total export (Economist 2012). In Argentina exports to Mercosur made up 35% of total exports in 1995, by 2011 it only made up 25% of total Argentine exports (Economist 2012).

Reliance on international Markets:

The first reason why Mercosur has not been successful in increasing intra-regional trade is because of reliance on foreign countries, especially China (Felter and Chatzky 2019: 3). Since the early 2000s, trade between Latin America and China has increased exponentially. According to a report done by the US Congressional Research Service (USCRS), total trade between China and Latin America increased from $17 billion in 2001 to over $308 billion in 2018 (USCRS 2019). Trade between Latin America and China has expanded because of China’s growing middle class and a subsequent increase in demand for raw materials and primary commodity exports from Latin America (Basnet 2017: 11). Since China has a very large and growing middle class population, there is a much higher demand for raw commodities such as soybeans or beef which are common Latin American exports (USCRS 2019).

According to the World Trade Institute, China is the largest destination for Brazilian exports (WTO 2018). In 2018, Brazilian exports to China was worth $47,488,448.66 billion compared to only roughly $18 Billion with Argentina which is Brazil’s largest trading partner in Mercosur. As for Argentina, Mercosur’s second largest economy, it has become increasingly dependent on China. Brazil primarily exports raw commodities such as beef or minerals to China. Although Brazil is still a larger trading partner than China for Argentina, Chinese markets have become an important destination for Argentine exports such as soybeans. The soybean industry is one Argentina’s biggest source of revenue. Currently, soybeans are Argentina’s top export and 22% of the world’s production of soybeans come from Argentina (De Angelis 2015). Argentina’s soybean exports to China have risen by 80% in the last ten years (De Angelis 2015). Other Mercosur countries like Uruguay and Paraguay (which are much smaller economies and more economically dependent on Argentina and Brazil), have also began trading extensively with China. Currently 28.2% of Uruguayan exports go to China while 17% of Paraguayan exports go to China (Basnet 2017: 109).

The demand of Latin American goods to the Chinese markets prevents the emergence of increased intra-regional trade since exports to China are more significant than exports to other Mercosur countries. One explanation for why there is not a demand for internal Mercosur goods is because Mercosur countries export similar goods. Nearly all Mercosur countries export raw materials and low value added commodities such as ore, beef, soybeans, or sugar (De Angelis 2015). In some cases, Mercosur countries produce the same products. For example, even though the Argentinian economy is dependent on soybeans, they do not export soybeans to Brazil (Mercosur’s largest economy) because Brazil also produces soybeans. In fact, Brazil export value of soybeans is worth $25 billion compared to around $5 billion for Argentina (OEC 2019).

Exceptions to Mercosur Rules:

Aside from dependence on international and Chinese markets, Another obstacle that has prevented a substantial increase in intra-regional trade has been separate agreements or exceptions to Mercosur rules. According to the Treaty of Asuncion, all Mercosur states have to have a Common External Tariff (CET) for certain products. This means that Mercosur countries must have the same tariffs on certain foreign exports. A coordinated CET is important for Mercosur’s ability to increase trade within the bloc because it increases interdependence. If Mercosur countries have the same external tariff on certain goods, then they can coordinate policy easier which would allow for increased regional trade. Having a CET also means that there are more incentives for Mercosur countries to trade with each other since the cost of importing certain foreign goods may be too expensive. But instead of coordinating external tariff rules, “politically negotiated exceptions to the block’s rules has become the norm” (Economist 2012). Currently, there are more than 800 exceptions to CET regulations (Carranza 2006: 79).

Some of the exceptions to the CET regulations are due to the existence of bilateral agreements that were signed before the creation of Mercosur, mainly with members of the Latin American Integration Association (LAIA)(Laens and Terra 2007: 4). Although many of these agreements were renegotiated during the early stages of Mercosur in the 1990s, some remained. For example, prior to the creation of Mercosur, Argentina and Brazil had bilateral agreements with other non-Mercosur Latin American countries concerning telecommunication goods. Since then, Argentina and Brazil have not followed Mercosur’s CET for telecommunication goods (Laens and Terra 2007: 4). Despite Mercosur charters prohibiting the separate bilateral agreements with non member states, many countries have ignored these charters. For example, in 2007 Uruguay signed a free trade agreement with the United States which liberalized Uruguay’s beef market to the US (Laens and Terra 2007: 8). This agreement not only violated Mercosur’s charter, but it also undermined Mercosur’s CET which includes tariffs on beef (Klonsky 2007) (Laens and Terra 2007: 8).

Aside from separate bilateral agreements, many Mercosur states have been able to circumvent CET rules through political negotiations. Even though all states have to abide by CET regulations, under Mercosur charters countries can ask for certain products to be exempt from the CET to protect certain industries (Laens and Terra 2007: 4). Argentina and Brazil have taken advantage of this rule by increasing tariffs on automobile products to protect their local manufacturing industry (Keller 2012). Currently, Brazil has a 35 percent fee on vehicle imports and Argentina has a 30 percent fee compared to the CET’s 10 to 15 percent fee (Campos 2018: 866).

Macroeconomic Policy:

The last, and possibly biggest, challenge to increasing intra-regional trade has been the lack of macroeconomic coordination among Mercosur states. Even though one of Mercosur’s goals was to coordinate common macroeconomic policy, many Mercosur states have taken divergent policies from the rest of the bloc. This includes differences in trade regime and exchange rate policies. Different exchange rates among Mercosur countries and divergent policies on industry and trade have hampered efforts to promote regional trade.

The challenge of separate and volatile exchange rates toward intra-regional trade was illustrated during the late 1990s to the early 2000s when Brazil and Argentina had different exchange rate policies. From the 1991, Argentina embarked on the convertibility plan where the Peso (Argentinian currency) was pegged to the US dollar (Campos 2018: 876). This allowed for the Argentinian Peso to appreciate in value. In 1999, Brazil’s central bank decided to depreciate the value of their currency (Real) by 40% to the dollar (Carranza 2006: 81). The depreciation in the Real and the fixed rate of the Peso to the dollar allowed Brazilian exports such as footwear and chicken to penetrate into Argentina’s markets and threatened local industries because it was cheaper to import Brazilian goods (Campos 2018: 876)(Carranza 2006: 83). The devaluation of the Real also made Argenitinian exports into Brazil less attractive since the fixed exchange rate meant that the prices of Argentinian exports would be more expensive ( Carranza 2006: 83)(Campos 2018: 878).

Argentina responded to Brazil’s devaluation aggressively by taking protectionist measures and by looking toward other Latin American countries for trade. Argentina’s former economic Minister, Domingo Cavallo, attacked Brazilian policy when he said, “those who devalue their currency are stealing their neighbors’ house” (Baer, Cavalcanti, and Silva 2001: 12). At one point Argentina considered leaving Mercosur and establishing a free trade agreement with the US instead (Carranza 2006: 86). Instead, Argentina imposed licenses for Brazilian footwear exports and quota restrictions for certain Brazilian goods (Carranza 2006: 85). Brazil responded by also enacting quota restrictions for Argentinian goods (Almeida 2018: 10). By 2001, Argenitian exports to Brazil decreased by 28.4% and Brazilian exports to Argentina decreased by 27% (Carranza 2006: 81). As a result, Brazilian and Argentinian trade with Paraguay and Uruguay also decreased causing a decline in intra-regional trade (Felter and Chatzky 2019: 2).

In addition to a lack of coordination in exchange rate policy, a lack of coordination in trade policy has also been a strain on Mercosur ability to create regional trade. Developing policies for Mercosur’s CET and Common Internal Tariff (CIT) has been tenuous because of differences in national policy toward trade. Historically, the lack of policy coordination has been between Argentina and Brazil. Given that these are the two biggest countries in Mercosur, their bilateral policies have significantly impacted the bloc (Keller 2016). Argentina and Brazil have tended to apply trade policy on external countries that are not in line with each other. They have applied “… temporary​ trade barriers against imported products from different non-MERCOSUR countries in different sectors at different moments in time”(Brown and Tovar 2016: 3). A recent example was in 2016, when Brazil enacted anti-dumping restrictions on Chinese steel imports due to concerns of China manipulating the price of their steel exports into the Mercosur market. Although it would seem that other Mercosur countries would follow Brazil’s lead, Argentina enacted anti-dumping restrictions on Brazilian fabric imports during the same period (Brown and Tovar 2016: 4).

Another historical challenge toward macroeconomic coordination in trade policy has been the division between the larger members, Argentina and Brazil, and the smaller ones Uruguay and Paraguay. Brazil and Argentina have tended to be less inclined to liberalize their markets both to Mercosur and non-Mercosur countries through lowering tariffs. Unlike Paraguay and Uruguay, Argentina and Brazil have large domestic industries that they want to protect from foreign competition (Campos 2018: 888). Mercosur’s common market almost broke apart in 1995, after Brazil and Argentina’s refused to lower tariffs for automobile imports from Mercosur and non-Mercosur countries (Carranza 2003: 81). Brazil and Argentina’s concern for their domestic automobile industry was also an issue during the negotiations with the European Union about a trade agreement where both countries were hesitant to lower external tariffs on European car imports (Felter and Chatzky 2019: 4).

Uruguay and Paraguay, have tended to be more in favor of liberal policies than Argentina and Brazil. They have pushed Brazil and Argentina to further open their markets and for Mercosur to lower external tariffs on foreign goods. Both Uruguay and Paraguay are very dependent on foreign imports, especially from Brazil and Argentina (Keller 2016). According to the Observatory of Economic Complexity, in 2017 roughly 32% of imports to Paraguay came from Argentina and Brazil, and roughly 37% of imports to Uruguay also come from Brazil and Argentina(OEC 2017). Paraguay and Uruguay are dependent on foreign imports and do not have industries or enough resources capable of sustaining themselves (Keller 2016). The divergence between trade policies of the smaller and the larger countries has caused Paraguay and Uruguay to be more inclined to form FTAs seperate free trade agreements. In 2006, Uruguay began looking toward an FTA with the USA now called TIFA (Klonsky 2007). Recently, Uruguay was also the only Mercosur country to sign China’s One Belt One Road Memorandum of Understanding signaling a willingness to look for trade elsewhere (Elis 2019).

Conclusion:

Intra-regional Mercosur trade is vital for promoting economic development in Latin America. Countries like Brazil, Argentina, Uruguay, and Paraguay will not be able to achieve economic development and sufficiency unless regional trade increases. One of the reasons why Latin American countries have been economically unstable is due to the boom and bust cycle where their economies are dependent on global demands for certain products. In a boom and bust cycle when the demand for certain goods are high, the economies do well but when that demand drops, so do the economies. This was seen in Mercosur countries like Brazil or Argentina where their economies began to improve in the mid 2000s when the demand for their commodities
such as soy, beef, or ore was high, but sank after the demand for those commodities were down during the great recession (Talvi 2006: 6).

Regional liberalization and the establishment of a common market allows Latin American countries to participate in the international market while not being too vulnerable to global economic uncertainty. Increased regional trade could help Latin American countries increase economic growth that is not entirely dependent on trade with foreign economies. It could also allow Latin American countries to diversify their economies through having easier access to raw materials which can be used to produce finished goods. Having a common market like in Mercosur also helps reduce exposure to global economic volatility since Latin American countries have more power in determining the terms of trade. This includes having more agency in determining tariff levels for foreign imports.

Overall, Mercosur has not been successful in increasing regional trade because of unwillingness to move away from dependency on the international market, political negotiated exceptions, and a lack of macroeconomic coordination. In order for Mercosur to become a legitimate trading bloc and common market that is capable of achieving its goals, it must overcome all of these challenges. If not, regional trade will not increase to substantial levels and the hopes of economic development in Mercosur countries will continue to struggle.

Bibliography:

Almeida, Paulo Roberto de. 2018. “ Regional Integration in Latin America: Historical Developments, Current Challenges, Especially in Mercosur” ​https://ssrn.com/abstract=3182150 or ​http://dx.doi.org/10.2139/ssrn.3182150​(December 6, 2019).

Albertoni, Nicolás. 2019. “Can Mercosur Be Updated and Reformed or Is It a Relic of the Past?” Global Americans​. https://theglobalamericans.org/2019/01/can-mercosur-be-updated-and-reformed-or-is-it-a-relic-o f-the-past/ (December 6, 2019).

Baer et al. 2001. “Economic Integration Without Policy Coordination: The Case of Mercosur.” SSRN​. https://papers.ssrn.com/sol3/papers.cfm?abstract_id=283461 (December 6, 2019).

Basnet, Hem C., and Gyan Pradhan. 2017. “Regional Economic Integration in Mercosur: The Role of Real and Financial Sectors.” ​Review of Development Finance.​https://www.sciencedirect.com/science/article/pii/S1879933716301075 (December 6, 2019).

Brown , Chad, and Patricia Tovar . “MERCOSUR Is Not Really a Free Trade Agreement, Let Alone a Customs.” ​MERCOSUR is not really a free trade agreement, let alone a customs union | VOX, CEPR Policy Portal.​ https://voxeu.org/article/mercosur-not-really-free-trade-agreement-let-alone-customs-union (December 6, 2019).

Carranza, Mario E. “Can Mercosur Survive? Domestic and International Constraints on Mercosur.” ​Latin American Politics and Society​ 45, no. 2 (2003): 67–103. www.jstor.org/stable/3176980​.

Campos, Gabriela Lomeu. “From Success to Failure : Under What Conditions Did Mercosur Integrate?” (2016).

China’s Engagement with Latin America and the Caribbean.​ 2019. China’s Engagement with Latin America and the Caribbean https://fas.org/sgp/crs/row/IF10982.pdf.

Felter, Claire, and Andrew Chatzky , eds. 2019. “Mercosur: South America’s Fractious Trade Bloc.” ​Council on Foreign Relations.​ https://www.cfr.org/backgrounder/mercosur-south-americas-fractious-trade-bloc (December 6, 2019).

Keller, Mark. 2016. “Explainer: What Is Mercosur?” ​AS/COA​. https://www.as-coa.org/articles/explainer-what-mercosur-0 (December 6, 2019). Klonsky, Joanna. 2007. “Backgrounder: Mercosur: South America’s Fractious Trade Bloc.” ​The New York Times​. https://archive.nytimes.com/www.nytimes.com/cfr/world/slot2_20070301.html?_r=1&pagewant ed=print (December 6, 2019).

Laens, Silvia, and Maria Ines Terra. 2007. “Deepening Integration of MERCOSUR: Dealing with Disparities .” ​Mercosur: asymmetries and strengthening of the Customs Union Options for the Common External Tariff​.

“Mercosur RIP?” 2012. ​The Economist​. https://www.economist.com/the-americas/2012/07/14/mercosur-rip (December 6, 2019).

“Non-Tariff Measures in Mercosur: Deepening Regional Integration and Looking Beyond.” UNCTAD​. https://unctad.org/en/pages/PublicationWebflyer.aspx?publicationid=1826 (December 6, 2019).

“World Integrated Trade Solution (WITS).” ​World Integrated Trade Solution (WITS) | Data on Export, Import, Tariff, NTM​. https://wits.worldbank.org/ (December 6, 2019).