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Jul 21, 2017 | 09:00 GMT

8 mins read

Mercosur Looks Beyond Itself

Flags of the countries that are full and associate members of Mercosur, the South American trade bloc. Political changes and recession in Argentina and Brazil have pushed the group to try to liberalize its trade policies.
(NORBERTO DUARTE/AFP/Getty Images)
Forecast Highlights
  • Mercosur will move toward gradual trade liberalization with other economic blocs and individual countries.
  • Political changes in Argentina and Brazil as well as reduced trade within Mercosur forced the bloc to seek other markets outside South America.
  • Among Mercosur's major trade negotiations, a deal with the European Union is the one most likely to be concluded this year.

A trade bloc long seen as averse to trading outside its own backyard is entering a new phase. The Common Market of the South, or Mercosur, is seeking to speed up trade negotiations with individual countries and economic blocs outside South America, and is especially eager to reach a free trade agreement with the European Union. Political changes and recession in Mercosur's two largest economies, Argentina and Brazil, have shifted the bloc toward a more liberal trade policy, a direction its other full members, Paraguay and Uruguay, have always advocated. With Mercosur's decision-making built around consensus, and with every member country holding veto power, the bloc's course has always been at the mercy of Argentina and Brazil. Their shift on trade is moving Mercosur past its protectionist reputation.

Mercosur holds a presidential summit in Mendoza, Argentina, on July 21, and the bloc's ongoing trade negotiations with the European Union will top the agenda. Mercosur also has begun or resumed trade negotiations with Chile, Colombia, Mexico and Peru, which together form the Pacific Alliance; Japan; and the European Free Trade Association (EFTA), which comprises Norway, Switzerland, Iceland and Liechtenstein. Mercosur's negotiations with the European Union, though, are more advanced. After largely being stuck in neutral for a decade, the talks began moving forward last year and since have gained momentum. Both sides hope to reach an agreement by the end of the year.

Political Changes in Argentina and Brazil

The fall of the left in both Argentina and Brazil provided a political opportunity for Mercosur's trade negotiations with other economic blocs and countries to move faster. The political shift began in December 2015 when President Mauricio Macri replaced Cristina Fernandez de Kirchner as Argentina's president. Fernandez's administration had been reluctant to open Argentina's economy, fearing that an inflow of imports could drain the country's foreign reserves. At the time, the Argentine government resisted reaching a deal with the hedge funds that held the country's defaulted debt, limiting Buenos Aires' ability to issue debt in foreign currency and cover its account deficit. As a result, Argentina's government imposed strict foreign currency controls in 2011, making it difficult to import products. The government also imposed further restrictions on foreign trade by delaying the issuance of import licenses. While the government avoided a currency crisis, it did so at the expense of foreign trade. One of Macri's first decisions after his election in 2015 was to strike a deal with bondholders and lift some restrictions on foreign currency. Argentina was once again able to access international markets, allowing imports to flow more easily as more foreign currency was available to Argentine importers.

Shortly after Argentina lifted its foreign currency restrictions, Macri visited Chile, where he expressed a desire for Argentina to join the Pacific Alliance as an observer member and open up trade with other countries and blocs. Macri and Chilean President Michelle Bachelet have been the main proponents of a trade convergence between Mercosur and the Pacific Alliance. Macri also changed Argentina's position regarding trade negotiations with the European Union and proposed that Mercosur should seek a deal with the Europeans.

In the meantime, the impeachment of President Dilma Rousseff in May 2016 opened the door for political change in Brazil. Rousseff belonged to the left-wing Workers' Party, but unlike Fernandez in Argentina, Rousseff had been taking small steps to liberalize Brazil's trade policy by negotiating, for example, the elimination of trade barriers with Colombia and Peru. Her successor, Michel Temer, accelerated this process, setting free trade negotiations with the European Union and the liberalization of Mercosur's trade policies as top priorities.

Mercosur's decision in 2016 to suspend Venezuela for violating the bloc's democratic rules illustrates how the fall of the left in Argentina and Brazil has changed Mercosur's outlook. In 2012, led by Fernandez and Rousseff, Argentina and Brazil moved quickly to bring in Venezuela, then ruled by Hugo Chavez, as a full member of Mercosur after the bloc had temporarily suspended Paraguay following the impeachment of President Fernando Lugo. Lugo had supported Venezuela's membership but the Paraguayan Congress opposed it. By suspending Paraguay, the other Mercosur members removed its ability to block Venezuela's admission. Paraguay was readmitted in 2013.

Since Mercosur's decision-making process is consensus-based, adding another member with veto power only complicated its negotiations with other countries and economic blocs. This changed after Macri and Temer came to power. They distanced themselves from the Venezuelan government, and Argentina and Brazil voted to suspend Venezuela from Mercosur in 2016.

Economic Recession in Argentina and Brazil

Brazil is Argentina's main trade partner, and an economic shock in Brazil affects Argentina. Brazil's recent corruption scandals, coupled with the decline in commodities prices and economic mismanagement, have led to recession. Brazil's economy contracted the past two years and is expected to report only a small economic recovery, with less than 1 percent growth this year. Argentina's economy also has contracted — 2.6 percent last year, the government reported — as Macri's administration has tried to implement measures aimed at taming public spending.

Because of the recessions in Argentina and Brazil, trade between Mercosur's two largest economies dropped from $36 billion in 2013 to $22 billion in 2016. This reduction in bilateral trade has forced Buenos Aires and Brasilia to change their positions on foreign trade, and both have started looking for alternative export markets. Brazil, for example, dropped a number of trade barriers in 2016. In 2015, the World Trade Organization (WTO) ranked Brazil third on its list of most protectionist countries. Last year, it ranked 11th. And on June 30, the WTO said Brazil had adopted more measures to reduce trade barriers between October 2016 and May 2017 than any other member country.

When they were enjoying high economic growth, Argentina and Brazil resisted opening up their markets to foreign competitors. Reduced trade within Mercosur has eased this resistance and provided the bloc with an opportunity to resume trade negotiations with countries outside South America that had been delayed for years.

 

Because of recessions in Argentina and Brazil, trade between Mercosur's two largest economies dropped from $36 billion in 2013 to $22.4 billion in 2016. This reduction in bilateral trade has forced Buenos Aires and Brasilia to change their positions on foreign trade.

Getting Closer to a Deal With the EU

In the past couple of years, Mercosur has reached out to other markets, starting or re-energizing negotiations with the European Union, EFTA, Japan, the Pacific Alliance and Canada. Negotiations with all but the European Union and Pacific Alliance have a long way to go, however. And when it comes to the Pacific Alliance, Mercosur's main interest is expanding trade with Mexico.

A deal between Mercosur and the European Union, which began their on again, off again negotiations in 1998, has never been as close as it is now. The Brazilian government so desperately wants new markets it would be willing to negotiate a superficial trade deal with the European Union as long as the agreement left room for future improvement. Argentina holds a similar position, which is why Buenos Aires repeatedly has said it hopes a deal can be reached by December, even if it is not as comprehensive an agreement as Mercosur would like. On the European side, the German and Spanish governments also have expressed a desire to conclude negotiations by December.

There are some disagreements that could hamper the negotiations. Agriculture is Mercosur's most competitive sector, but some European countries — Poland and Ireland in particular — oppose liberalizing their agricultural sectors. According to a July 8 report in the Brazilian newspaper Valor, EU officials told their Mercosur counterparts during an early July meeting in Brussels that they were not ready to offer a deal that would include agricultural products. Meanwhile, though their resistance to a free trade agreement has diminished in the past few years, some manufacturing industries in Argentina and Brazil still oppose opening up trade with the European Union.

Another source of tension comes from European ethanol and sugar producers, who want the talks to exclude sugar and ethanol because the Brazilian government provides $1.8 billion annually in subsidies to its ethanol and sugar producers. The Brazilian minister of agriculture, Blairo Maggi, admitted last year that some Brazilian ethanol producers were not competitive enough without government subsidies.

Even though economic recession in Mercosur's two largest economies coupled with the fall of leftist governments have pushed the bloc toward gradual trade liberalization, it is not an inevitable trend, however. Brazil holds a presidential election next year, and its position could change again depending on who wins. That possibility is why Mercosur wants to take advantage of the current climate favoring trade liberalization to reach some sort of pact with the European Union in the next six months, even if it falls short of the deal both sides have been seeking for nearly 20 years.

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