Council on Hemispheric Affairs - Mercosur Future

After decades of chronic political unrest within a number Latin American countries, that featured complex transnational relations within the region, multilateral trade agreements that linked a few major economies began to emerge. These informal agreements were targeted at increasing stability within the region, and eventually developed into an official trade agreement. In order to promote economic cooperation, Brazil, Argentina, Uruguay, and Paraguay established the Common Market of the South (El Mercado Común del Sur). Formed in 1991, the union of these four countries (referred to as the Mercosur pact) almost immediately came to be dominated by Brazil. Over the past two decades, the Mercosur countries have sought to alter a legacy of distrust and a determination to work towards “an incremental growth to achieve common market.” In order to do so, the member nations have managed to reduce or eliminate nearly all trade tariffs for fellow Mercosur partners. By 1994, Mercosur countries imposed standardized tariffs on imports from non-member countries in order to further ratioanlize trade among member nations. By decreasing or eliminating the relative import taxes on Mercosur countries, members were able to benefit from both increased exports as well as achieve cheaper imports from within their economic union.

Since Mercosur members’ economies rely so heavily upon one another, fluctuations in one nation’s economy and further political transformation undeniably affect the other Mercosur countries. Specifically, when Brazil and Argentina both were experiencing economic recessions, the remaining member nations as a result experienced economic setbacks; such deep dependency on one another for economic prosperity ultimately disrupted trade and caused apprehension and friction among members.

This analysis was prepared by COHA Research Associate Rebecca Gorn.

Brazil’s Real(ly) Big Problem

September 9, 2011

• The Mercosur agreement, given birth in 1991, allows Argentina, Brazil, Paraguay, and Uruguay to trade freely amongst themselves.
• Interdependent economies lead to tensions among member countries, especially between Brazil and Argentina over Brasilia’s plan to combat hyperinflation and the ebbing demand for Brazilian goods.
• Export-dependent economies trading more expensive goods, like Brazil and Argentina, face enhanced competition from abroad; therefore, these countries must now focus on opening up trade and cooperation with other countries possessing major export sectors while protecting their own economies.

After decades of chronic political unrest within a number Latin American countries, that featured complex transnational relations within the region, multilateral trade agreements that linked a few major economies began to emerge. These informal agreements were targeted at increasing stability within the region, and eventually developed into an official trade agreement. In order to promote economic cooperation, Brazil, Argentina, Uruguay, and Paraguay established the Common Market of the South (El Mercado Común del Sur). Formed in 1991, the union of these four countries (referred to as the Mercosur pact) almost immediately came to be dominated by Brazil. Over the past two decades, the Mercosur countries have sought to alter a legacy of distrust and a determination to work towards “an incremental growth to achieve common market.”[1]In order to do so, the member nations have managed to reduce or eliminate nearly all trade tariffs for fellow Mercosur partners. By 1994, Mercosur countries imposed standardized tariffs on imports from non-member countries in order to further ratioanlize trade among member nations.[2]By decreasing or eliminating the relative import taxes on Mercosur countries, members were able to benefit from both increased exports as well as achieve cheaper imports from within their economic union.

Figure 1. Average Tariff Rates in Mercosur Countries

Figure 1 illustrates the intensity of reductions in tariffs among the Mercosur countries in the late 1980s and early 1990s.

Since Mercosur members’ economies rely so heavily upon one another, fluctuations in one nation’s economy and further political transformation undeniably affect the other Mercosur countries. Specifically, when Brazil and Argentina both were experiencing economic recessions, the remaining member nations as a result experienced economic setbacks; such deep dependency on one another for economic prosperity ultimately disrupted trade and caused apprehension and friction among members.[3]As illustrated in Figure 2, trade among all Mercosur members is almost instantly affected when the domestic economy of even one member weakens or strengthens.

Figure 2. Intra-Mercosur Exports as a Percentage of Total, 1990-2005

The instability and integration of Mercosur is illustrated in Figure 2. The dramatic downturns in exports have occurred immediately following financial crises, with the impact across nations being quite significant.

While Mercosur countries have made extensive efforts to promote free trade initiatives among member countries in order to stabilize all members’ economies, the agreement’s success continuously has been in question. According to the U.S. Congressional Research Service, since its inception, Mercosur has “struggled to reconcile a basic inconsistency in its goals for partial economic union” due to its members’ repeated individualistic attitudes.[4]When even one Mercosur country has experienced economic or political hardship, the union’s level of integration has exacerbated existing transnational tensions. Thus, the realization of Mercosur’s initial goals have become much more difficult during these periods.

Brazil’s Economic Growth, Unexpected Results

For years, developed nations examined Brazil as it made its slow transition from a developing nation to an international economic superpower. Brazil’s abundance of natural resources and large labor pool has allowed it to dominate the international exporting market, generating enormous profit.[5]Now, according to the International Monetary Fund (IMF) and the WB, Brazil boasts the seventh largest economy in the world; by 2016, the World Bank expects Brazil to become the fifth largest.[6]However, what is most impressive about Brazil’s economy is the fact that it shows little sign of slowing down in the near future. In fact, it is just the opposite: studies show the worth of Brazil’s currency against the dollar has increased by 50 percent over the past three years. No longer with merely a foot in the door, Brazil has “moved into the group of countries with a strong currency, and with balanced fiscal accounts,” according to Brazilian Trade and Industry Minister Fernando Pimentel.[7]The government continues with efforts aimed at bolstering the country’s economy, while further affirming Brazil’s new, increasingly secure position in the international economy.

Prosperity, security, and a lowered level of poverty generally accompany economic growth; however, Brazil’s economy, though growing rapidly, is experiencing record inflation and an appreciating currency. As a result of the nation’s rapid growth, its domestic market and currency are attracting increased international investment, only further strengthening the intrinsic value of the real. The currency’s rapid appreciation has resulted in what some economists are beginning to refer to as the “Super Real.” According to Brazil’s Finance Minister Guido Mantega, the appreciation of Brazil’s currency “results from investors’ enthusiasm about Brazil because the country offers more stable, secure conditions.”[8]

However, the practical consequences of a sudden currency appreciation can prove to be ominous, often contributing to greater economic insecurity. Recently, the consequences of a highly valued currency hit Brazil’s export sector shockingly hard. Exports accounted for USD 201.9 billion of Brazil’s total gross domestic product (GDP) in 2010, indicating Brazil’s heavy reliance on its export sector.[9]With an appreciating currency, Brazilian goods tend to become more expensive and therefore, less desirable to other industrialized nations.

Appreciation Escalates, Brazil’s Drastic Response

Today, international markets are struggling amidst what many consider the worst economic downturn since the Great Depression.[10]While the rest of the world has been hit by the economic recession over the past couple of years, Mercosur countries’ growth rates have “exceeded 7.5% in 2010.”[11]Such growth would usually be a positive indicator for a nation’s economy; however, combined with a weak overseas market, the appreciation of the currency results in drastic consequences for export-dependent countries like Brazil. According to the National Confederation of Industry (CNI), half of Brazil’s export industries “reduced or eliminated their export activities in 2010,” due to the decreased demand for goods in overseas markets.[12]Slow world growth rates have exacerbated the Super Real phenomenon in Brazil, thus increasing the appreciation of the real to an unmanageable rate. Traditionally, the Brazilian government exercises highly interventionist policies in order to adjust these rates and protect the nation’s economy. Consequently, as “domestic producers are growing increasingly frustrated, and the government is concerned that appreciation is reducing competitiveness and undermining balanced growth,” President Dilma Rousseff’s administration has instituted a plan to slow the appreciation of the real.[13]

Embracing the rapid growth of the economy, the plan is appropriately titled “Bigger Brazil.” In short, the government administered plan aims to protect the export sector of the nation’s economy through broad-based tax reform. On the day of its implementation, on August 2, President Rousseff referred to Bigger Brazil as “the first step to boost Brazil’s competitiveness relying on innovation.”[14]The government hopes that this two-year, 25 billion real (USD 16B) initiative will help manufacturers cope with current market conditions until the real begins to equalize and the world market recovers. Most of the subsidies are intended for the encouragement of textile, footwear, software, and vehicle production, since labor-intensive industries are being impacted most by fluctuations in international market demand. Incentivizing the purchase of local products is another major component of Bigger Brazil, which will be executed in order to both boost production and strengthen businesses.

Accusations and Actuality

Given the level of interdependence that exists among the Mercosur countries, the economic success of one bloc member would presumably lead to similar growth in the other three nations. However, current domestic reforms at the height of Brazil’s economic development could call this norm into serious question. Through Bigger Brazil’s government purchasing-program component, the purchase of domestic products over inexpensive imports will be encouraged. By focusing on and stimulating its export industry, Brazil has sparked considerable fear among the other Mercosur countries, whose domestic economies have grown to depend heavily on the lower tax rates agreed upon among the trade body’s members. With the implementation of Brazil’s self-satisfying plan, Mercosur countries are now accusing the Brazilian government of the specter of protectionism—a move that aims to strengthen the Brazilian economy through discouraging imports that may come at a cheaper price than domestic goods. Not surprisingly, of greatest importance to Brazil’s new plan is the support of their aspiring major South American neighbor, Argentina. President Cristina Fernández de Kirchner administration has taken issue with multiple parts of the proposed initiative, especially the government purchasing program that favors Brazilian products. Jose Ignacio De Mendiguren, president of the Argentine Industrial Union (UIA), called the plan “impulsive, [and] emotional.”[15]

In contrast with past patterns of economic parallelism, Argentina’s growth is not comparable to that of Brazil. With a history of turmoil between the rival industrializing nations, including accusations between the two surrounding breaches in the Mercosur pact, Buenos Aires has been quite vocal concerning how Brasilia’s economic plan will ultimately affect the Argentine economy. One indicator of the disparity in Argentina’s economic growth and impetus for expansion is its current concern that while the real has appreciated rapidly against the dollar over the past few years, Argentina’s peso “has weakened versus the greenback over the same period.”[16]Furthermore, with the implementation of “Bigger Brazil,” Argentina is concerned not only about Brazil’s commitment to Mercosur, but also the estimated competition that will result if Brazilian exports become cheaper. In May, Argentine products were no longer granted non-automatic import licenses in Brazil, leading to delays in trade and tensions between the two nations. Since exports represent such a large sector of Argentina’s economy, any decline in trade is bound to register a very negative impact. The implementation of the Bigger Brazil initiative further exacerbates these already existing tensions between these two South American economic forces.

In response to Buenos Aires’ accusations, the Rousseff administration has been assiduously assuring Mercosur nations, specifically Argentina, that rather than discouraging imports, the provision of subsidies to Brazilian industries via Bigger Brazil has simply encouraged local production. In fact, the government has promised to “pay up to 25% more for local goods which contain at least 40% local content from Brazil or any Mercosur country.”[17]Not only has the Brazilian government considered Mercosur countries in the formation of its plan, but it also sought to offer incentives in order to ensure a positive impact on the economies of their fellow South American neighbors. In fact, according to Alberto Ramos, a senior economist for Goldman Sachs, “on the whole, Argentina maintains a competitive advantage due to the currency [and] is running a…surplus in the automotive industry.”[18]

Similarly, while a devaluation of Argentina’s currency is not conducive to growth, it does offer Argentina a major advantage because exported goods became less expensive as the nation’s currency devalued. In addition, Brazil is less of a threat in a competitive market, since its goods became more expensive as the relative price of Argentine commodities dropped. Therefore, it is unlikely that Brazil’s new initiatives will affect Argentina’s prevailing level of export or trade activity between the two nations. For that matter, Mercosur countries, protected by the same measures, will remain relatively unaffected, if not actually advantaged, by Brazil’s economic reforms.

Bigger Brazil is not Biggest Threat

Despite the controversy surrounding how Brazil’s plan will prove inevitably damaging to the economies of other Latin American nations—especially Mercosur members who are usually under the protection of the trade agreement that exists among them—these countries could face a much larger threat than the Rousseff administration’s domestic reforms. Competition from other areas of the world, specifically countries that are able to offer lower priced goods, is an increasingly ubiquitous threat to Latin American nations whose economies depend heavily on exporting to industrialized nations. According to Pimentel, “the situation in all of Mercosur has been dramatic because of the entrance of cheap goods from abroad.”[19]Given this rising threat, Brazil’s reforms to protect domestic producers may be an entirely appropriate reaction.

Additionally, the plan may also signal to other export-dependent nations that government action through protective policies is a perfectly orthodox solution; if the plan succeeds, it could very well have the potential to serve as a model to these nations as well. Bigger Brazil includes investments not only in the export sector and in industries. Since developed countries are based upon industrial economies, countries competing to export to developed economies may benefit from industrializing themselves through similar investments.[20]In addition to adjusting to new market conditions, opening up trade may also appease any international tensions resulting from increased competition. According to Adrian van den Hover, the head of international relations for Business Europe, “an agreement with the South American block would help [Europe] to retain our bilateral trade relation” and could potentially ease concerns with Chinese competition within Mercosur.[21]Thus, both learning from and working with countries with similar concerns will aid countries like Argentina in their efforts to avoid being affected by countries offering cheaper goods to the international market.

Conclusion

Due to Brazil’s status as a Western Hemisphere coastal commercial powerhouse, its fiscal expansion is a necessary compass for the rest of the region’s progress. Brazil’s domestic economic plans explicitly stand to help Mercosur countries, despite opposing cries from Argentina. While Brazil’s economic plan to correct the rapid appreciation of the real and revive the export industry may be beneficial for Mercosur countries like Argentina, it is impossible to predict the effect these domestic reforms will have on non-member Latin American who, as major trading partners, are inherently integrated with Mercosur economies. More importantly,however, Bigger Brazil serves as an indication that the international market is transforming, meaning adaption and protection of domestic economies is essential. Therefore, export-dependent economies must be able to rely upon government policies to protect them from competition abroad.