Mercosur and U.S. Trade Policy

Mercosur and U.S. Trade Policy

Order Code RS22408
March 22, 2006
CRS Report for Congress
Received through the CRS Web
Mercosur and U.S. Trade Policy
J. F. Hornbeck
Specialist in International Trade and Finance
Foreign Affairs, Defense, and Trade Division
Summary
Mercosur is the Common Market of the South established by Brazil, Argentina,
Uruguay, and Paraguay in 1991. By reducing barriers to trade and encouraging
economic investment and sectoral collaboration, Mercosur was created to foster
balanced economic growth, social development, and political stability in the region.
Mercosur has succeeded on the political side and developed as a credible collective
voice in the World Trade Organization and in talks on the Free Trade Area of the
Americas (FTAA). It has survived difficult economic times and expanded on a limited
basis to other Latin American countries, yet its success at economic integration is an
open question. Mercosur also has elements of being both a complement and alternative
to the FTAA in the quest for Western Hemisphere integration, so bears careful watching
for how it may affect the direction of U.S. trade policy in Latin America.
Brazil, Argentina, Uruguay, and Paraguay signed the Treaty of Asunción on March
26, 1991, establishing the Common Market of the South (Mercado Común del Sur —
Mercosur or Mercosul in Portuguese). Mercosur evolved from a series of bilateral
agreements signed by Argentina and Brazil in the mid-1980s. Designed to foster new
levels of political and economic cooperation in the region, they were expanded and
institutionalized under Mercosur. Regional integration was also a collective response to
concerns over economic stagnation, the 1980s debt crisis, and expanding economic
integration efforts in the European Union (EU) and North America. Mercosur is an
important economic bloc in South America; its collective voice affects regional and
multilateral trade negotiations, perhaps most notably in its opposition to the U.S. version
of the Free Trade Area of the Americas (FTAA). This report examines Mercosur’s
development and the implications the pact may have for U.S. trade policy in Latin
America. It will be updated.
Formation and Institutional Development
The Treaty of Asunción called for the creation of a common market between Brazil,
Argentina, Uruguay, and Paraguay for the stated purpose of accelerating economic
development and social justice. The treaty was made under guidelines set out by the Latin
American Integration Association (Asociación Latinoamericana de Integración —
ALADI), the region’s umbrella organization that oversees trade agreements of both
Congressional Research Service ˜ The Library of Congress

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“regional and partial scope.” As emphasized in ALADI guidelines, Mercosur is
administered with a sense of “gradualism, flexibility, and balance,” and provides for the
negotiated accession of other ALADI member countries. An important overarching goal
of Mercosur is to improve living conditions in all countries through increased trade.
Mercosur envisioned an incremental path to a common market, beginning with a
transition period (1991-95) in which it operated as an increasingly comprehensive free
trade agreement (FTA) using a schedule of automatic tariff reductions. The formal jump
to a common market was made on January 1, 1995, but in reality, Mercosur had
transitioned only to a partial customs union at that point.1 It adopted a common trade
policy and a set of common external tariffs (CETs) that applied to 85% of tariff line items,
but with some very important exceptions for sensitive sectors such as automobiles, capital
goods, and computer technology products. The exceptions were to be phased out by
2006, but some have been extended to 2011. As shall be seen, the achievement of a full
common market with the free flow of labor remains a distant goal.
The Treaty of Asunción also envisioned macroeconomic policy coordination and
harmonization of policy legislation at the sectoral level (e.g. energy, agriculture, industry,
technology). By proceeding on a sectoral basis, inter-country factor mobility could be
achieved gradually, easing the adjustment process. All parties were also required to
accept a common set of rights and obligations, with little allowance for special and
differentiated treatment for smaller economies. There were many follow-on protocols.
Among the most important was the December 17, 1994 Protocol of Ouro Preto, which
formally established the common market and extended the institutional framework
accordingly. Mercosur adopted a democratic commitment clause in 1996, and there were
two protocols that clarified and expanded the dispute settlement process, the last being
the Olivos Protocol signed on February 18, 2002, and implemented two years later.2
Intra-Mercosur Trade and Internal Policy Dynamics
As Mercosur lowered tariffs, it was expected that intra-Mercosur trade would grow
relative to trade with third-party countries. As seen in Figure 1, this was the initial
response from 1991 to 1998, with the percentage-point jump in intra-Mercosur exports
also due to its growth from an initially small base, the decade’s lengthy global economic
expansion, and other economic reforms. There is, however, an equally evident and
sudden collapse of this trend, with intra-Mercosur exports falling from 25% of total trade
in 1999 to 13% in 2005 (by comparison it is 60% for intra-EU trade). This setback
reflects a number of problems that the common market proved unable to resolve.
From the outset, Mercosur struggled to reconcile a basic inconsistency of partial
economic union: how to achieve trade integration, while also ensuring that the benefits
would be balanced among members, and that each country would retain some control over
1 A free trade agreement (FTA) eliminates tariffs on goods traded among participating countries.
In a customs union, the members also adopt a common external tariff (CET) and common trade
policy toward third-party countries. A common market takes the next step of allowing for the
free flow of all factors of production (capital and labor) among the countries.
2 For details on the legal documents, see Porrata-Doria, Jr., Rafael A. MERCOSUR: The
Common Market of the Southern Cone. Durham: Carolina Academic Press. 2005.

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its trade, production, and consumption structure. At the heart of the problem are the
“natural asymmetries” that exist among four economies with inherently large
discrepancies in size, structure, resource endowment, and level of development, perhaps
most noticeable between Brazil and Paraguay. These differences can be compounded by
“policy asymmetries” that arise from incongruities in fiscal, monetary, industrial,
exchange rate, and other policies. Either type of asymmetry can distort trade flows,
causing large imbalances that threaten the stability of the agreement.3 When they operate
in tandem, and at times when the countries are facing external economic shocks, the
Mercosur policy adjustment framework has proven to be vulnerable.
Figure 1. Intra-Mercosur Exports as Percent of Total, 1990-2005
Asia Financial Crisis
25
Brazilian Devaluation
Chile and Bolvia
Associate Members
20
Argentina’s Financial Crisis
15
Mercosur Formed
10
CAN and CSN Agreements
5
1990
1992
1994
1996
1998
2000
2002
2004
Data Source: Inter-American Development Bank, MERCOSUR Report, February 2006, p. 21.
This situation occurred in the late 1990s and is reflected in the decline in intra-
Mercosur trade after 1998 shown in Figure 1. The first shock was the mid-1997Asian
financial crisis, followed by the Russian default in 1998. Fear over sovereign financial
vulnerability then spread to Brazil, causing prolonged capital flight, a steep devaluation
of Brazil’s currency in January 1999, and the loss of its fixed exchange rate program.
With Argentina’s strict dollar convertibility regime still in place at the time, the two
countries faced a significant “policy asymmetry.” It was compounded by Argentina’s
lengthy recession that also began in 1998, leading to its own, far more serious, financial
crisis. Brazil’s devaluation exacerbated Argentina’s crisis, which ended with the loss of
its fixed exchange rate in December 2001. Each crisis diminished economic growth,
which in turn caused a precipitous fall in trade from 1998 to 2002 between the two
countries that account for 90% of intra-Mercosur trade.4 Relations became increasingly
3 For details, see Inter-American Development Bank. Integration and Regional Programs
Department. MERCOSUR Report: 2004-2005. No. 10, February 2006. pp. 39-41.
4 Bouzas, Roberto. Mercosur After Ten Years. In: Tulchin, Joseph S. And Ralph H. Espach, eds.
(continued...)

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strained, with Argentina applying temporary restrictions on imports from Brazil on
multiple occasions, further reducing trade.
Since 2002, intra-Mercosur trade has rebounded slightly. This parallels a trend
toward export growth in all four countries as they recovered from the Brazilian and
Argentine economic setbacks and benefitted from the forced convergence of their
exchange rate systems. Argentina’s prolonged recession reduced demand for imports, and
so it maintained a small trade surplus with Brazil even after the Brazilian devaluation.
With Argentina’s economic recovery in 2003, however, it began to run large trade deficits
with Brazil, mostly in industrial goods. Argentine exports fell from 13% of Brazilian
imports in 1998 to 8% in 2004. Brazilian exports, in contrast, rose from 22% to 34% of
Argentine imports. The growing imbalance resulted from numerous factors: 1) new
exchange rate equilibriums that favored Brazilian goods in the Argentine market over
U.S. and European products; 2) a post-recession jump in Argentine aggregate demand;
and, 3) Brazil’s export promotion policy emphasizing more use of domestic inputs.5
Mercosur was meant to achieve balanced gains for its members, but there was no
enforceable mechanism to guard against suddenly large trade imbalances. In 2003,
Argentina once again called for a managed solution to the growing and, what some feared
may be, a structural bilateral trade imbalance with Brazil. By June 2004, Argentina had
raised trade barriers on Brazilian appliances to protect its domestic production against
what it considered to be Brazil’s unfair mechanisms to develop its industrial capacity.
This was done in the context of Argentina’s decision to “re-industrialize” its own
economy, a policy that the sudden increase in Brazilian exports threatened.6
By February 2006, over the objections of Brazilian industry groups, Brazil finally
agreed to a Competitive Adaptation Mechanism (CAM) with Argentina. It allows for the
application of tariffs and quotas in cases where sudden increases in imports of one country
are deemed to hurt the industry of the other (safeguards). The CAM represents a major
shift in Mercosur internal policy and raises multiple issues. First, it is a bilateral
arrangement between Brazil and Argentina established under the ALADI system. It is not
governed by Mercosur nor does it involve Uruguay and Paraguay, which are the two
economies most dependent on the Mercosur trade relationship. Second, import restrictions
represent a retreat from the free trade philosophy of Mercosur, increasing doubts about
its ability to proceed toward a common market. Third, the CAM has no enforcement
mechanism under ALADI. In short, it presents serious administrative and judicial
problems and may end up undermining the Mercosur agreement even as it attempts to
restore balance to the largest bilateral relationship within it.7
4 (...continued)
Paths to Regional Integration: The Case of Mercosur. Woodrow Wilson International Center
for Scholars. Washington, D.C. 2002. p. 120.
5 Inter-American Development Bank, MERCOSUR Report: 2004-2005, pp. 30-32.
6 Ibid., p. 47.
7 Haskel, David. Bilateral Agreements: Argentina, Brazil Start Safeguard System To Shield
Industries from Mutual Imports. International Trade Reporter. February 7, 2006. p. 247, and
Inter-American Development Bank. Southern Common Market: New Integration and Co-
(continued...)

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Relaunch and Expansion
Mercosur’s weaknesses were exposed by the 1998-99 macroeconomic setbacks in
Argentina and Brazil. In May 2000, the four member countries responded with the
“Mercosur Relaunch” program by formally reaffirming those policies that had so far
proved elusive, but were still necessary to reach the common market goal. They agreed
to take the first steps toward macroeconomic coordination by harmonizing their statistics
and establishing “convergence criteria” on fiscal policies, prices, and public debt. They
disallowed adoption of measures that would restrict reciprocal trade and reinforced those
that would limit recourse to antidumping investigation and improve dispute settlement.
This renewed enthusiasm, however, did not last. The trade imbalances that ensued
challenged the relaunch effort and macroeconomic coordination was still in the early
stages. The relaunch effort dissipated and Mercosur shifted emphasis from deepening to
expanding the arrangement.
To date, Mercosur has been most successful in expanding in South America, where
it worked with other countries under the ALADI system. In 1996, Chile and Bolivia
became early additions as “associate members;” Peru followed in 2003 (not
implemented), and Venezuela and Mexico in 2004. Associate members have no voting
rights and need not observe the common external tariff. In October 2004, after years of
talks, Mercosur and the Andean Community of Nations (Comunidad Andina de Naciones
— CAN) signed a trade pact, giving all Andean countries the equivalent of associate
membership. This breakthrough led directly to creation of the South American
Community of Nations (Comunidad Sudamericana de Naciones — CSN) two months
later in a pact that included 12 countries (those in Mercosur, CAN, along with Chile,
Guyana, and Suriname). In December 2005, Mercosur agreed to the accession of
Venezuela as a full member of the pact, but the process may take some time to finalize.
The CAN and CSN are limited trade pacts and in some ways not true regional
agreements. Although there are common rules adopted by Mercosur and the CAN, details
on market access and other specific provisions are bilateral arrangements between each
Mercosur country and the CAN. Brazil also granted numerous unilateral concessions to
ensure the agreement would be completed.8 These agreements do, however, offer the
potential for important political integration for the entire continent, arguably Brazil’s main
reason for establishing Mercosur. They are also a potentially competing integration
process to U.S. bilateral initiatives and the Free Trade Area of the Americas (FTAA).
Sectoral initiatives, such as the proposed South American gas pipeline, already reflect a
growing attitude of cooperation and collective self-determination that is taking hold in the
region, and which now has an institutional presence in the CSN.
Mercosur’s other negotiations have had mixed success. Trade talks with the
European Union and for an FTAA have both come to an impasse over the inability to
reach an agricultural agreement acceptable to Brazil. Brazil has also declined U.S. and
EU overtures on market access for industrial goods, services trade, enforceable
intellectual property rights, and investment provisions. Speculation has also turned to
7 (...continued)
operation Agreements Between Argentina and Brazil. [http://www.iadb.org/intal]
8 Inter-American Development Bank, MERCOSUR Report No. 10, 2004-2005, p. 93.

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dwindling interest by the EU given the stalemated FTAA, the growing EU perception of
Mercosur as less than a credible collective negotiating authority, and the desire by all
parties to wait for the conclusion of the Doha Round. So-called South-South trade pacts
have progressed only in limited form. Mercosur has begun preliminary discussions with
a host of countries that include China, India, SACU, Canada, the Russian Federation,
Korea, Egypt, Morocco, and Pakistan. None have progressed beyond a simple framework
agreement, but Mercosur continues to pursue limited agreements with much of the world.9
Outlook and Implications for U.S. Trade Policy
In pursuit of balance, Mercosur seems to have retreated from deeper economic
integration, placing greater emphasis on enhancing political cohesion. First, its internal
integration process has stalled, and may even have taken a step backward with the
bilateral safeguards agreement between Brazil and Argentina. Second, despite entering
so-called “economic complementarity” agreements with the rest of South America, its
outreach to the region and to other developing countries is limited largely to market
access agreements that will take a long time to implement, with the possible exception of
Venezuela. Third, trade talks with developed countries are on hold. These same trends,
however, may be interpreted as being politically advantageous if seen as accommodating
Argentine interests, deepening formal ties with Venezuela, leading efforts to coalesce
South American interests, and reaching out to extra-regional developing countries.
The United States has a strong interest in pursuing an FTAA that includes Mercosur
and there is also little doubt that Mercosur, under Brazil’s leadership, will influence the
FTAA’s final outcome. The United States and Mercosur, however, are at odds over how
to proceed with Western Hemisphere integration, with the stakes raised by concerns over
each others’ broader influence in the region. With the FTAA negotiations stalled, Brazil
has opted to offer, in its stead, bilateral market access talks between the United States and
Mercosur, an overture the USTR has repeatedly rejected. Brazil and Mercosur are
pressing for gradual, “partial scope” ALADI-type framework agreements that address
their market access priorities, whereas the United States is negotiating for more
comprehensive agreements that accommodate its broader interests — competing visions
that have yet to be reconciled.10
Mercosur’s future seems less clear given recent developments, yet its progress, or
lack thereof, will likely affect the direction of U.S. regional trade policy. It is quite
possible that Mercosur’s heightened politicization, particularly the possible accession of
Venezuela as a full member, will increase the sense of competition between the two
models of Western Hemisphere integration, thereby constraining progress on the FTAA.
Alternatively, the new bilateral safeguards policy may weaken Mercosur’s unification,
increasing the possibility that its smaller members may reconsider various alternatives,
including negotiating with the United States for either deeper bilateral FTAs, or joining
the FTAA separately.
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9 Ibid., pp. 90 and 96-100.
10 For more, see CRS Report RS20864, A Free Trade Area of the Americas: Major Policy Issues
and Status of Negotiations, CRS Report RL33258, Brazilian Trade Policy and the United States,
by J. F. Hornbeck, and CRS Report RL33162, Trade Integration in the Americas, by M. Angeles
Villarreal.