U.S. auto tariffs will have little direct effect on the South American trade bloc Mercosur. The economic alliance, also known as the Common Market of the South, is insulated from the prospective fees because most of its vehicle production stays in the bloc. But the alliance, known for its own high tariffs on vehicles and auto parts, was already taking steps to open its automotive industry before the United States started threatening tariffs. Over the past two years it has been working on free trade agreements with Mexico, Japan, South Korea and the European Union, whose automakers may look to the bloc to make up for lost U.S. sales if the tariffs enter effect.
As the United States considers higher tariffs on auto imports from Mexico, Canada, Asia and Europe, Mercosur is on a path to gradually reduce the barriers around its auto sector. The move will open up opportunities for the European Union, Mexico, South Korea and Japan — which are all negotiating free trade agreements with Mercosur — to increase their market share in parts of the Southern Cone.
Keeping It in the Family
The auto markets of Mercosur, which comprises Brazil, Argentina, Paraguay and Uruguay, make a tempting target for carmakers. At their peak in 2010, consumers in the trade bloc bought more than 5 million new vehicles, and they purchased closer to 3 million in 2017. Production in the alliance satisfied most of that demand. Brazil, Mercosur's largest member, produces about 80 percent of the vehicles sold domestically, and almost all the major global auto companies have plants there and in Argentina.
But the appeal of a large market is just part of the reason for the factories' location. The other is Mercosur's high tariffs on vehicle imports. Brazil, for instance, charges a 35 percent fee, while Argentina keeps its automotive tariffs around 30 percent. The combination of a large consumer base and high import tariffs drove automakers such as Volkswagen AG, General Motors Co., Ford Motor Co. and Toyota Motor Corp. to put up factories in those countries. Without them, the tariffs would make it too expensive to export vehicles to Mercosur.
On the flip side, Mercosur is not set up to export the vehicles it produces beyond the bloc. Argentina and Brazil produced almost 3.2 million cars and commercial vehicles in 2017 but exported less than 30 percent of them. And 70 percent of Brazil's auto exports went to Argentina last year, showing that most of the bloc's auto production stays close to home.
Barriers to Business
One reason for Mercosur's lack of focus on exports is that its manufacturing industry is not competitive on the global market. Businesses in Argentina and Brazil — which boast the largest economies in Mercosur — must deal with corporate taxes of about 35 percent, a lot of red tape, and a history of high inflation and high public debt. Both states, in fact, ranked toward the bottom of the World Bank's ease-of-doing-business list this year; Argentina came in at 117th and Brazil at 125th out of 190 countries. For a while, Mercosur members tried to solve their problems by protecting domestic industries with high tariffs, rather than pursuing reforms.
Now, the wind is shifting. Argentina and Brazil have been steadily moving over the past two years to improve business conditions by liberalizing their trade and economic policies. The Argentine government has approved a tax reform and lifted foreign currency controls, while its counterpart in Brazil has reformed labor rules to give companies more flexibility in outsourcing their activities. Most important, Brazil decided to revise its tax incentive program in the automotive sector, which several countries said violated World Trade Organization rules. The government recently approved a program, called Rota 2030, that will offer companies tax incentives for investing in research and development and for reaching energy efficiency goals — instead of providing incentives for meeting guidelines, for example, on the use of local components in auto production. Some of these changes already have been beneficial for fellow bloc member Paraguay. To reduce production expenses, automakers in Argentina and Brazil are building auto parts factories in the neighboring country, where taxes and labor costs are much lower.
These economic and trade reforms, coupled with currency depreciations in Brazil and Argentina (the value of the Argentine peso has dropped by over 100 percent this year), have led Mercosur to look beyond its members. The bloc has become more open to negotiating free trade agreements with other countries and economic alliances to help with business and with the automobile sector. Its first targets were in its own neighborhood: Colombia and Peru. Mercosur signed agreements with those two states to lift import tariffs, and, under its deal with Colombia, it will be able to export nearly 100,000 cars to the country free of tariffs over the next four years.
But the trade agreements that will have the greatest effect on the automotive industry are those Mercosur is negotiating with the European Union, Mexico, South Korea and Japan. In the EU negotiations — the most advanced discussions of the bunch — the auto sector has become one of the main sticking points. While the European Union is demanding that Mercosur remove its import barriers, the South American bloc is hesitant to open the domestic auto industry too far for fear that it won't be competitive enough without the protections.
In June, Mercosur offered to cut its tariffs on EU vehicles by half to 17.5 percent, where it would leave them for seven years before gradually eliminating them. EU negotiators, wanting a steeper reduction and a shorter period before the complete removal of tariffs, rejected the offer. Auto tariffs are also a major issue in Mercosur's talks with Mexico, South Korea and Japan. All three countries are eager to find new export markets for their vehicles now that they are facing higher U.S. import tariffs, which would limit their access to the American market.
Mercosur's trend toward openness may not last, though. Upcoming political transitions in Argentina and Brazil could jeopardize the bloc's economic and trade liberalizations and, in turn, limit the chances that the bloc will successfully conclude trade negotiations, especially over the auto industry. Mercosur and the European Union, as well as Mexico, may end up being pressed for time as they try to take advantage of their window of opportunity before the next presidential elections in Argentina and Brazil close it.