Trade Profile: Mercosur Lets Its Guard Down Gradually

10 MINS READJul 31, 2017 | 09:15 GMT
The flags representing the four current Mercosur countries stand on display at a summit for the bloc in Mendoza, Argentina.
Editor's Note

Global trade is changing. The kinds of multilateral agreements that characterized the postwar years have stalled out over the past two decades, prompting countries and economic blocs to try to negotiate smaller deals with fewer partners. Nations and blocs have more leeway under this new model to negotiate the trade agreements that best suit their interests and to avoid those that don't. Now, more than ever, the future of international trade depends on a country or bloc's defensive interests, offensive interests and underlying factors of production. Our fortnightly Trade Profiles aim to break down these factors to facilitate an understanding of where global trade stands today and where it's headed.
In the sixth installment, we focus on the Common Market of the South, or Mercosur.

A Snapshot of Mercosur
Offensive Interests, Defensive Interests and Factors of Production

Economic Background

The Common Market of the South walks a fine line on global trade. The bloc, commonly known as Mercosur, has made great strides over the past three decades opening its economies to foreign competition and increasing international trade — both among its members and with more distant partners. When compared with other major trading blocs in the hemisphere, however, Mercosur is far more protective of its domestic industries. Brazil and Argentina, the two South American states at the heart of Mercosur, rely on an array of tariff and non-tariff barriers to shelter their politically sensitive sectors and keep their trade balances on an even keel. As the bloc matures, it will liberalize in fits and starts, but lingering protectionist and populist policies will limit its ability to do business with others.

Mercosur is protectionist by today's global trade standards. The bloc maintains a common external tariff of up to 35 percent that members may elect to apply against imports they feel are undercutting domestic industry. But relative to South America's previous trade policies, Mercosur's current stance is far more liberal. For decades before Brazil, Argentina, Paraguay and Uruguay formed the bloc in the early 1990s, the countries' governments relied on an economic development strategy known as import substitution industrialization. The tactic aimed to avoid trade imbalances and curb currency outflows through high tariffs on imports that competed with domestic products — Brazil's tariffs averaged 57 percent in the late 1980s — and subsidies to stimulate those industries.

Between the 1950s and 1980s, import substitution industrialization helped many countries in South America develop their economies. It enabled, for example, Brazil and Argentina to create domestic automotive sectors that are important to their economies to this day. After three decades of pursuing the strategy, though, the South American states gradually began rethinking their trade stance. Several countries, including Argentina and Brazil, experienced recurring bouts of inflation as their governments printed off currency to cover growing deficits. Trade liberalization offered the states a way to invite a steadier flow of taxable income into their borders and a partial solution to the problem. At the same time, Brazil and Argentina were taking steps toward integrating their economies. Throughout much of the 20th century, South American states traded primarily with partners outside the region, in part because demand for raw materials such as agricultural goods and minerals was lower in nearby countries than it was in Europe or the United States. But as their internal markets grew, Brazil and Argentina saw greater opportunity for trade, not only in each other, but also in other neighboring states such as Paraguay and Uruguay.

Creating a common market was a logical step to facilitate regional trade while still protecting sensitive sectors from external competition. Discussions over a possible trade bloc began in the mid-1980s, at first between just the Brazilian and Argentine governments. The talks eventually grew to include Uruguay, Paraguay and Venezuela, and by 1994, the constituent countries had signed a treaty agreeing to progressively reduce tariffs on trade and travel. Brazil and Argentina carry the most influence in Mercosur because of their central role in its creation, as well as their economic heft, though a unanimous vote is required to change the bloc's policies.

Trade among Mercosur's members increased after tariffs fell, just as its founders intended. And the bloc's core members grew closer than ever: Brazil became Argentina's top export market, accounting for 15 percent of Argentine exports in 2016 (down from about 20 percent in the preceding several years). The trade ties within the bloc are on track to deepen in the years ahead, as Brazil boosts its investment into Paraguay, and Mercosur's constituent economies become more complex. Furthermore, Bolivia is in the process of achieving full membership.

But more than two decades after the common market's inception, its four current members still rely primarily on exports of raw materials. (Venezuela's membership in the bloc was suspended in late 2016.) Exports of agricultural products have risen dramatically. Soy products, for example, now account for around 31 percent of Paraguay's total exports by value, as well as 13 percent of Brazil's and 23 percent of Argentina's, thanks in large part to growing demand in China.

Even Uruguay has benefited from China's rise; today, the Asian powerhouse buys up about 13 percent of the tiny South American country's exports by value. Notwithstanding its bustling export activity, however, Mercosur's current trading patterns are a liability for the bloc. Member states' economies are vulnerable to slowing demand for agricultural exports abroad, for instance in China. Furthermore, because of their close trade ties with one another, Mercosur countries are susceptible to economic fluctuations elsewhere in the bloc. In an effort to overcome these obstacles to trade growth, the current administrations in Brazil and Argentina are working to expand their ties with nations and economic organizations outside the common market.


Trade Implications

Trade Strategy

Mercosur's member states will move to liberalize their trade policies in the coming decades. The process won't be a quick one, though. For one thing, the bloc's members, as part of a common market, can't sign free trade agreements on their own. If a single Mercosur country objects to aspects of a prospective trade agreement, it can significantly delay the deal's signing. For another, populist and protectionist policies will continue to draw support in member countries across the bloc. Argentina's Peronist parties, for example, will probably turn to protectionism — or at least turn against attempts at further liberalization — to maintain their popularity at home, no matter the cost to other Mercosur members. That's not to say that liberalization is impossible for the South American bloc, but it means that enacting free trade agreements with foreign partners will be a complicated undertaking. And should populist parties regain power in Mercosur member states down the line, they may well derail the bloc's attempts to diversify its trade relationships.  

Offensive Interests

Mercosur's main advantage lies in its vast agricultural production. Between its four current member countries, the bloc has a wealth of arable land at its disposal. Opening foreign markets to its agricultural products will remain a central focus of Mercosur's trade negotiations for decades to come. Brazil already is taking steps to enhance transportation infrastructure and address bottlenecks in the supply chain, thereby increasing the bloc's chances of expanding its agricultural trade. But supply chain inefficiencies are only part of the problem. Given the higher degree of protectionism it practices relative to other trading blocs, Mercosur has limited options available for boosting its market access.

News of negotiations to change the North American Free Trade Agreement presented the South American bloc with a rare opportunity. Brazil and Argentina are the world's second- and third-largest producers of soybeans, respectively, and they also are key exporters of corn, beef, chicken and pork — all products Mexico imports from the United States. Depending on how the talks to retool NAFTA go, Mercosur may be able to chip away at the United States' dominant share of Mexico's agricultural imports market. Mexico City will keep threatening to diversify its agricultural trade relationships to discourage the United States from pulling out of NAFTA. And in the meantime, Mercosur's agricultural producers will likely make further inroads into Mexico as the bloc works to expand its existing trade agreement with the country. Brazil, in fact, has managed to increase its agricultural exports to Mexico even without the broadened trade pact; from 2016 to 2017, Mexico doubled its imports of Brazilian soybeans, which reached $69 million by value in the first half of this year.

Defensive Interests

When negotiating trade deals, Mercosur closely guards its manufacturing sectors. Brazil and Argentina are the primary forces behind the bloc's protectionism, eager as they are to shelter their domestic automotive sectors from foreign competition. Their defensive stance on automotive manufacturing dates back to the days of import substitution industrialization, when Buenos Aires and Brasilia shielded the industry in hopes of advancing their economic development. Today, protectionism lives on in the economically and politically important sector. Brazil and Argentina both maintain high tariffs on imported vehicles; Argentina, in fact, applies a 35 percent tariff — the maximum common external tariff allowed in Mercosur — to passenger cars. Neither country will readily agree to lower the trade barriers, considering the industry's political sensitivity and vulnerability to foreign competition. (Brasilia and Buenos Aires alike have, however, been exploring new international markets for their vehicles and auto parts, which traditionally supplied only the domestic market.)

Manufactured goods, such as cellphones and their components, footwear and textiles, are another area of Mercosur's industry where protectionism lingers. Brazil and Argentina keep high tariffs on these products, primarily to slow the influx of imports and to prevent small local industries from being overwhelmed by their East Asian competitors. Nevertheless, Chinese imports have gained significant ground in Mercosur during the past decade. China's total exports to the bloc grew nearly fivefold from 2005 to 2016, when they hit nearly $35 billion — 15 percent of its total imports. Even without a free trade agreement in place, Chinese goods are cheap enough in the Southern Cone that they will continue to undercut their domestic competition.

Select services sectors, including transportation and services related to the energy sector, also are subject to protectionist measures in Mercosur. Under pressure from unions and the private sector, member states have heavily regulated portions of their economies, such as water and air transport, to fend off foreign competitors. Argentina, for example, only recently moved to allow low-cost air carriers to fly from its airports. Brazil is still mulling whether to let foreign companies own domestic airlines in their entirety, while also trying to relax local content rules for exploration and production in the energy industry to enable firms abroad to provide more services. Argentina's local content regulations on energy, by contrast, vary from province to province. Given the variety of services sectors and interest groups in Mercosur, loosening these restrictions will be a piecemeal effort. Any attempt to loosen local content requirements in the bloc as a whole, moreover, is likely to meet with resistance from the member states' domestic unions. 

Mercosur's Trade Pacts

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